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

Lowe’s Companies, Inc. (NYSE:LOW)

Q4 2007 Earnings Call

February 25, 2008, 9:00am ET

Executives

Robert Niblock - Chairman and CEO

Larry Stone - President and COO

Bob Hull - Executive Vice President and CFO

Analysts

Bud Bugatch – Raymond James

Dan Binder – Jefferies

Colin McGranahan – Bernstein

Brian Nagel – UBS

Mike Baker – Deutsche Bank

Gregory Melich – Morgan Stanley

Chris Horvers – Bear Stearns

Eric Lessard – Cleveland Research

Steve Chick – JP Morgan

Operator

Good morning everyone. Welcome to Lowe’s Companies Fourth and Fiscal 2007 Earnings Conference Call. This call is being recorded. Statements made during this call will include forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management’s expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company’s earnings release and its filings with the Securities and Exchange Commission.

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’ll 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 provide additional details on our performance and describe his objectives for 2008 including what we are doing to manage the business in today’s challenging environment. Then Bob Hull will review our fourth quarter and year end financial results.

Two thousand seven presented a challenging sales environment. Many external pressures affected our industry and weighed on consumers throughout the year. Total sales decreased 0.3% for the quarter but increased 2.9% for the year. With comp sales declining 7.6% for the quarter and 5.1% for the year. While our top line results were disappointing we did have solid market share gains indicating that we are continuing to provide a compelling offering to customers despite the pressures on the overall industry.

Earnings per share of $0.28 for the quarter and $1.86 for the year were within our guidance but down 30% and 6.5% respectively from last year. In a year when the housing market softened in an unprecedented rate mortgage markets tightened considerably especially in the back half of the year. Deflationary price pressures from lumber and plywood impacted our sales and adverse weather, including the exceptional drought in certain areas of the country pressured our industry.

Our relative performance reflects the strength of our team and suggests we are providing customer value solutions in a challenging environment. Sales trends continue to get worse in the second half of 2007. We are obviously working to further understand the variables impacting our industry. Over the last several quarters we’ve used third party home price information to define three broad market groupings, based on home price dynamics within those markets.

We described our performance in overpriced markets with the correction expected or occurring. Overpriced markets with no price correction expected and not overpriced markets. One thing that has remained consistent since we began this analysis is the logical tiers within our sales performance. Basically, the worse markets from a home price perspective have generated the worse relative results. In markets with less impact on the housing front has generated better relative comp sales.

As we’ve monitored these markets we’ve seen an erosion in comp performance across all three market brackets. Both troubled and relatively stable housing markets have seen an erosion in comp sales. That was true from Q2 to Q3 and from Q3 to Q4. Obviously this erosion is concerning and while this analysis is not intended to be predictive, continued erosion in comp sales across three market types has led to increased caution in our outlook for 2008.

The good news is that based on this analysis and supported by customer sentiment surveys we are seeing an indication that once a market reaches a trough, essentially a point where home prices are no longer declining consumers begin thinking about and acting on home improvement purchases very similar to consumers in markets where home prices weren’t expected to decline. We’ve only seen a few markets progress completely through this cycle. We’ve only recently seen shifting consumer sentiment in those markets.

It’s too early to put too much confidence in these numbers but they are encouraging signs that demand patterns should improve as markets move through the cycle. In addition, as I mentioned earlier we continue to capture market share despite the pressures on the home improvement industry. In the fourth quarter we gained 80 basis point of total store unit market share. Later in the call Larry will provide more details about specific category performance.

Our original plan for 2007 proved to be too optimistic. In this challenging sales environment we’ll continue to pursue our disciplines of providing excellent customer service and gaining profitable market share. My goal is to ensure we maintain an inspired an energetic workforce. Given the external pressures we faced in 2007 I’m grateful and appreciative of the hard work and dedication displayed by the entire Lowe’s team.

As we progress through 2008 we’ll closely monitor the structural drivers of demand including housing turn over, employment and personal disposal income as well as consumer sentiment related to home improvement. As 2008 unfolds we anticipate at least some of the headwinds will lessen. The affects of the recent economic stimulus package and the Fed rate cuts should aid in stabilizing many of the factors that pressured sales in 2007.

Additionally, normalized weather following last year’s unusual pattern should lead to better relative results. Even with these lessening headwinds fiscal 2008 will be another challenging year as many pressures on the home improvement consumer remain. Considering these pressures we feel is an appropriately conservative plan. We are managing the business for the long term and will continue to focus on providing customer value solutions and capitalizing on opportunities to gain market share and strength in our business.

Our stores will remain best in class and the strength and experience of the Lowe’s team positions us to drive profitable growth over the long term. Now here’s Larry to describe in greater detail the results of the quarter and provide insights on how we are managing the business today.

Larry Stone

As Robert mentioned the sales environment remains challenging and external pressures facing our industry will continue into 2008. I’ll start this morning by reviewing some details for fourth quarter and fiscal ’07 results and I will share how our outlook for 2008 will impact our organizations. Finally I’ll update you on how we are thinking about the business longer term.

For both the fourth quarter and fiscal year only two of our product categories had positive comps. Rough plumbing and lawn and landscape products. In rough plumbing we had success with our clean air and water filtration programs. Our new operation efficient sets and rough fitting categories drove strong year over year increases. Finally we experienced some inflation in raw materials for the pipe category that contributed to the comp growth.

In lawn and landscape the positive comps for the quarter were driven by snow related products such as ice melt, snow shovels and winter gloves. For the year we experienced strong sales in pest control products, mulch and watering products which was one of the few product areas aided by the extreme drought conditions we faced in various parts of the country. We also had relative success in other categories that outperformed the company average.

For example, our hardware category performed above the company average comp for the fourth quarter driven by weather related products such as weather stripping. In addition the outdoor power equipment posted numbers above the company average driven by the sales of snow blowers. Our appliance sales also had relatively better results in the quarter driven by cooking and refrigeration products. While market share data on appliances has been mixed through 2007, in the calendar fourth quarter we gained unit and dollar share and improved both our draw rate and close rate.

Not resting on these gains we are in the process of rolling out the Electrolux brand to all stores by mid March. We are excited about adding this premium brand to our appliance department. Electrolux has been the leading brand in Europe for over 70 years and they have many new features including a new curve front design and LED controls. We are confident that these styles and features will appeal to customers and be another way to make Lowe’s the destination store for major appliance purchases.

Electrolux is just one example of how we continue to enhance our offering across all categories to provide a better selection of products customers want to purchase. From a regional perspective we are continuing to see dramatic differences in performance. We have six regions with double digit negative comps in the quarter and four with double digit negative comps for the year. For the quarter and the year our four worst performing regions were in California, Florida and the Gulf Coast.

Also on a slightly positive note we did see an improvement in the fourth quarter comp performance of our Florida and our Gulf Coast regions. While comps are still double digit negative in both the run rate in the fourth quarter was better than the year to date numbers. Comps are still double digit negative in both, the run rate in the fourth quarter was better than the year to date numbers. Those four worse performing regions reduced total company comps over 2% for the fourth quarter and 2.5% for the year.

Attracts in those markets we saw relatively better comp performance in our North Central and South Central divisions. For the quarter we have positive comps in two of our 22 regions which included areas to Texas and Oklahoma and those same two regions had positive comps for the year. In addition, one region in the North Central division has flat comps fiscal 2007. Finally in the fourth quarter we had 314 positive comps stores and 25 stores that posted double digit positive comps.

In the end, as Robert mentioned while some regions are performing much worse than others we did see erosion in comps across many areas of the country in the fourth quarter. The results of our install sales and special order sales initiatives continue to be pressured by the weakness in bigger ticket more complex projects as we have described in the past. That weakness is more pronounced in the most pressured housing markets.

In fiscal 2007 both programs had growth in total sales but comp sales fell slightly below the company average. For the year installed sales remained approximately 6% of our total sales and special orders fell to approximately 8% from 9% last year. Contrasting that weakness has been the relative strength in our commercial sales business. For the quarter and the year both comps and total sales growth outpaced company average.

Our efforts to build relationships and serve the needs of repair remodelers, property maintenance professionals and professional trades’ people continue to drive results. In the past year we’ve posted CBC comp increases in 11 out of 20 merchandising categories. Our comp transactions for CBC were positive for the year but average ticket was down driven by the decline in sales of lumber and building materials. We feel that our focus on the segments that have the greatest opportunity will produce growth in 2008.

Measuring relative performance is always important but in a difficult sales environment it comes even more so. Encouragingly we gained market share in the quarter and in fiscal 2007 evidenced by third party share market statistics. Continued strong market share gains shows we are providing great service and value to customers and we also feel this is evidenced by industry consolidation as the pressure of the cycle causes competitors to exit.

While our fourth quarter comps fell short of our expectations we did achieve some milestones in the quarter. We opened our first stores outside the US in December and we now have seven stores operating in the greater Toronto market. Customers in Canada have given us a warm welcome even in the cold months of winter. While it’s obviously early we are extremely pleased with the sales trends in our stores. I’d like to thank the team that’s worked for over two years to ensure a successful launch in Canada.

I’d also like to thank the employees in our Canadian office and stores who have shown incredible enthusiasm and excitement in providing a great store to this new customer base. In addition, we also opened our first store in the state of Vermont in January. We now have stores in all 50 states and we still see many opportunities to continue to grow market share in the markets we serve. Later this week we’ll be kicking of our annual sales meeting with all of our store managers and merchandising teams.

At that meeting we will highlight some of our successes of the past year and highlight the opportunities in the coming year. Yes, there are plenty of opportunities. As we look out to 2008 and consider how the best to address difficult sales environment we expect to face we are doing several things to maximize sales, capture share and grow profitable. First, we built what we believe to be a relatively conservative plan. Frankly the way 2007 unfolded perhaps the best way to describe it is if we chase sales down and probably remained a little heavy on expenses through the first half of the year.

We know it’s harder to cut from the expense plan than it is to add. We are planning a more conservative build into the spring season this year versus how we staffed in the past years. Some might think this staffing plan could affect service levels should sales outpace our plan but I’m confident we have the ability to add the hours we need to provide great service if sales ramp quicker than we expect. In addition, Lowe’s has always been a centerly managed company. We value the discipline and consistency that comes with that structure and we’ve built a regional and district support structure to ensure that happens.

As we further penetrate the US markets shortening the average distance between our stores we decided to increase the number of stores in a district from eight to an average of nine. We are also increasing the number of stores on average in a region from 69 to 75. I’m confident we will continue to have the oversight we need from district managers and regional vice presidents to ensure consistent application of our policies and procedures under this evolving model.

By expanding size of the average district region in 2008 we estimate that we’ll favor approximately $10 million through a combination of cost avoidance and true expense reductions. On the merchandising side we continue to enhance our offering to customers but with awareness and in many markets customers are more focused on maintenance versus enhancement. They are looking for great value regardless of the price point.

We are calling this innovation at a value and we are working closely with our vendors to deliver this strategy. We are also going to continue to diligently manager our seasonal inventory to ensure we maximize sales but minimize mark downs. Our goal is to be out when the season is over. A similar awareness of market differences will drive our advertising plan this year. We are focused on highlighting key maintenance projects and inexpensive enhancements in markets suffering through the biggest slow down in housing while continuing to highlight larger projects in less impacted markets.

Expense management is very important in times like this. Bob will provide a few specifics in a minute but we have and will cut expenses where we can without sacrificing customer service. Opportunities present themselves all over the stores for renegotiated purchases of register tape and plastic shopping bags to a reduction in non-needed or redundant signage. We continue to identify ways to cut costs that will not be noticed by customers.

Finally, we look critically at our capital plan for 2008. We reexamined every store in our pipeline and made the decision to reduce our 2008 new store openings by approximately 20 stores. Most of these 20 stores were planed for high markets like California and Florida where current conditions suggest sales may fall short of original forecast. We know these markets will recover and we’ll be ready to add stores when the time is right. We want to delay some of them until conditions improve.

Also, our commitment to reinvest in our existing store base remains strong but we have decided to pull back on what we call major remerchandising projects in 2008. Routine maintenance will continue at the same pace and we will continue to make sure that we deliver a bright, clean, easy to shop store with great merchandise. This is part of what differentiates Lowe’s and that will not change. We are working to ensure we are putting capital use in ways that drive the best return both short term and long term.

I want to make sure it’s clear that nothing we’ve seen in the current environment has materially changed our long term view of the industry and in fact over the next three to five years we are likely to build just as many stores as we planned a year or so ago. These openings will just be delayed in certain markets until conditions improve. I said it earlier but I think its worth repeating. Our plan for 2008 acknowledges the challenges we face this year and we are making decisions based on that reality and as a company I feel we have been proactive versus reactive.

I want to conclude by making sure its clear that we are also working to ensure we position the company for the opportunities to come, those that will be available to us when the cycle passes. The past 18 months has been extremely tough in home improvement industry. In fact, in my 38 years in this industry I can only recall one other time in the mid 70’s that we have experienced so many head winds. While I’m not suggesting my experience and the experience with the rest of Lowe’s management team which averages 17 years at the senior vice president level and above ensure we won’t make mistakes it certainly gives us some perspective.

Clearly Lowe’s has made more correct decision through the past cycle than bad ones evidenced by our success. I can remember a few instances where we reacted into a near term cycle and we are not in the best position when the cycle ended. Let me give you a couple of examples. In past slow downs we had many different products that did not fit in the home improvement channel. It sounds crazy today but we added everything from bicycles and sporting goods to toys.

While we generated some sales at the end of the day we never made any money and just created confusion for customers. We have avoided that pitfall in this cycle. In the past I’ve watched us make real estate decisions and store size decisions that were not best for long term growth and decisions that we later regretted. While we are reducing our expansion plans for 2008 we have matured as a company and we are making sure that we are positioned for longer term growth.

The same can be said for remerchandising efforts. While we are committed to having the best store in the industry we feel the prudent business decisions to decrease the number of major remerchandising projects from 116 in ’07 to approximately 80 projects in 2008. As I stated earlier our minor reset program will continue with basically the same number of projects we had in 2007. We are finding on two fronts, maximizing results in the environment we face over the next several quarters and positioning the company for longer term opportunity ahead.

Eventually the housing market will turn around and I’m confident that decisions we are making are the right decisions for our customers and our shareholders. While no one enjoys slow down I can say that it’s been educational process for many, a chance to critically analyze everything we do and it will make Lowe’s a stronger company in the future. Our centralized structure compared with knowledgeable and hard working people at all levels of the organization caped off with the best stores in the industry ensure we’ll maximize every opportunity.

Thanks for your attention and I’ll now turn the call over to Bob Hull to review the financials.

Bob Hull

Good morning everyone. Sales for the fourth quarter were $10.4 billion a slight decrease over last year’s fourth quarter. For the year sales increased 2.9% to $48.3 billion. Comp sales were negative 7.6% for the quarter which is below our guidance of negative 3% to 5%. Building materials deflation in the quarter was offset slightly by lumber inflation. That impacted comps on the fourth quarter was negative 25 basis points. Looking at the monthly trends comps were negative 4% in November, negative 9% in December and down 11% for January.

For the year comp store sales were negative 5.1%. In Q4 total customer count increased 3.8% but average ticket decreased 3.9% to $64.06. For the quarter comp transactions declined 3.3% and comp average ticket decreased 4.2%. For the year total customer count increased 5.9% but average ticket decreased 2.8% to $67.05. For 2007 comp transactions declined 1.8% while comp average ticket decreased 3.3%.

With regard to product categories the categories that performed above average in the fourth quarter include rough plumbing, hardware, paint, lighting, seasonal living, outdoor power equipment, lawn and landscape products and appliances. In addition, rough electrical and home environment performed at approximately the overall corporate average. For the year the categories that performed above average include rough plumbing, hardware, paint, lighting, nursery, lawn and landscape, fashion plumbing and appliances. In addition, outdoor power equipment performed at approximately the overall corporate average.

Gross margin for the fourth quarter was 34.9% which was a 56 basis point decrease compared with Q4 2006. The decrease in gross margin was attributable to a number of factors including seasonal clearance, mark downs related to recent activity and to a lesser degree commodity pricing pressures. The commodity pricing issues is a function of the timing of cost increasing per product relative to the timing of changes in retail prices.

These items were slightly offset by sales mix and lower inventory shrink. For the year gross margin of 34.6% represents an increase of 12 basis points over 2006. SG&A for Q4 was 24% of sales and de-leverage 153 basis points driven by store payroll and fixed costs. A sales per store decline additional stores are hitting the minimum hours threshold which increases the proportion of fixed to total payroll. For the quarter total payroll expense de-leveraged 71 basis points. Also, lower sales volumes in the quarter caused de-leverage in expense lines containing fixed costs.

Specifically utilities de-leveraged 21 basis points, rent 15 basis points, property taxes 11 basis points in the quarter. Lastly, bonus expense de-leveraged slightly in Q4. In an environment where rising delinquencies and losses are much discussed I’d like to give you an update on a proprietary credit program. Our partner GE Money manages the accounts and owns the receivables. Our agreement has us paying some of the expenses directly like promotional financing and interest gives us some limited exposure to losses and allows us to participate in the portfolio of profits.

In 2007 we planned for higher money costs and losses and these items came in close to plan for both Q4 and the year. Offsetting these increased costs cardholder income was higher than planned allowing us to realize higher portfolio profits. For the year SG&A is 21.8% of sales and de-leveraged 103 basis points to 2006 driven primarily by store payroll and fixed expenses.

Depreciation at 3.6% of sales totaled $370 million and de-leveraged 60 basis points for the quarter. This de-leverage was driven by 15% growth in fixed assets and negative comp sales. Operating margin defined as gross margin less SG&A and depreciation decreased 269 basis points in the fourth quarter to 7.3% of sales. For fiscal 2007 operating margin decreased 126 basis points from last year to 10%. For the quarter store opening costs of $61 million de-leveraged 12 basis points to last year as a percentage of sales.

In the fourth quarter we opened 72 new stores including the first six stores in Canada. This compares to 58 new stores in Q4 last year. Interest expense at $47 million de-leveraged three basis points as a percent of sales. Interest expense was lower than forecast due to capitalized interest. We reviewed our accounting policy related to capitalized interest and as a result we capitalized more interest than expected, reducing interest expense for the quarter by approximately $23 million or a penny a share.

For the quarter total expenses were 28.6% of sales and de-leveraged 228 basis points. Pre-tax earnings were 6.3% of sales for the quarter and 9.3% for 2007. The effective tax rate was 37.5% for the quarter and 37.7% for the year. Earnings per share for the quarter were $0.28 was within our guided range of $0.25 to $0.29 but decreased 30% versus last years $0.40. For 2007 earnings per share of $1.86 decreased 6.5% from 2006’s $1.99.

Weighted average diluted shares outstanding were 1.48 billion for the quarter. The computation diluted shares takes into account the affect of convertible ventures which increased fourth quarter weighted average shares by 21 million. In the fourth quarter we repurchased 14.1 million shares at an average price of $23.02 for a total repurchase amount of $325 million. For the year we repurchased 76.4 million shares at an average price of $29.79 for a total repurchase amount of almost $2.3 billion. We had $2.2 billion remaining share repurchase authorization.

Now to a few items on the balance sheet. Our cash and cash equivalent balance at the end of the quarter was $281 million. Inventory turn over calculated by taking a trailing fourth quarter cost of sales divided by average inventory for the last five quarters was 4.06% a decrease of 21 basis points from Q4 2006. Our fourth quarter in balance increased $467 million or 6.5% versus Q4 last year. The majority of this increase was from new stores.

Distribution inventory was also off slightly. Comp store inventory was down 3.2% from last year. At the end of the fourth quarter we owned 87% of our stores versus 86% at the end of the fourth quarter last year. Our debt to total capital was 29.3% compared with 22% for Q4 last year. This increase was due to the $1.3 billion of senior unsecured bonds issued in the third quarter and almost $1.1 billion of commercial paper outstanding at year end.

Return on invested capital measured using a trailing fourth quarter earnings plus tax adjusted interest divided by average debt and equity from the past five quarters decreased 319 basis points for the quarter to 13.9%. Return on assets determined using a trailing fourth quarter earnings divided by the average assets for the last five quarters decreased 226 basis points to 9.4%. Again the quarter lease adjusted debt to EBITDA was 1.46 times.

Looking at the statement of cash flows for the year cash flow from operations was $4.3 billion a 3% decrease from 2006 driven by the 10% decline in net earnings. Looking ahead I’d like to address several of the items detailed in Lowe’s business outlook. In constructing a 2008 plan we’ve attempted to take into account the external factors influencing the consumer and our business, the competitive landscape and the internal initiatives that Larry described. We have built what we feel is a prudent plan given this environment.

We expect a first quarter sales increase of approximately 2% which will incorporate the comp sales decline of 5% to 7%. The comp outlook of down 5% to 7% is an improvement from Q4’s trends but we feel this is achievable based on what we’ve seen from the start of the quarter and easy April 2007 comparisons where the first two weeks had negative 19% comps due to severe weather. We plan to open 21 new stores in the quarter, four stores in February, fourth stores in March and 13 stores in April.

Earnings before interest and taxes for EBIT for the first quarter are expected to decrease by approximately 170 basis points to last year as a percentage of sales. The biggest driver, the decline in EBIT is de-leveraged in store payroll as we maintain customer service levels in a negative comp sales environment. In addition, we expect de-leverage in depreciation, bonus, utilities, and property taxes and rent expenses in Q1. For the quarter interest expense is expected to be approximately $81 million.

The income tax rate is forecasted to be 38% for the year. We expect earnings per share of $0.38 to $0.42 which represents a decline of 12% to 21% over last years $0.48. For 2008 we expect to open approximately 120 stores resulting in an increase in square footage of approximately 8%. Our 2008 store expansion plan is more evenly balanced across the year relative to the 2007 opening schedule. As a result the average new store will open one month sooner in 2008 compared to 2007 new store openings.

We are estimating 2008 comp sales to be negative 5% to 6% and the total sales increase to be approximately 3%. For the fiscal year we are anticipating an EBIT decline of approximately 180 basis points. The decrease is higher for the year relative to the first quarter due to cycling last years self insurance adjustment in Q3 2007. For 2008 interest expense is expected to be approximately $273 million. Some of these inputs should yield earnings per share of $1.50 to $1.58 which represents a decrease of 15% to 19% for 2007.

For the year we are forecasting cash flow from operations to be approximately $4.5 billion or about 4% higher than 2007. Our capital plan for 2008 is approximately $4.2 billion with roughly $350 million funded by operating leases resulting in cash capital expenditures of approximately $3.8 billion. Our guidance for 2008 does not assume any share repurchases. We are now ready for questions.

Question & Answer Session

Operator

[Operator Instructions] Your first question comes from Bud Bugatch with Raymond James.

Bud Bugatch – Raymond James

My question goes to the guidance. I know you’ve talked about it being appropriately conservative. I’m trying to reconcile the guidance with the comments that you expect to see some head winds as the year unfolds. Obviously the easier comparison happen is you get against the 2007 even against the end of 2006. Could you give us some feeling on that as to the comps?

Robert Niblock

Certainly the fourth quarter the actual comp was weaker than we anticipated. If you look at the comp guidance for the first quarter and for the fiscal year ’08 we are expecting better comps than we had coming out of the fourth quarter. If you look at the unknowns that are out there, certainly there’s the stimulus package, how impactable is that going to be, we look at the credit markets and what’s taking place in the credit markets, how much more deterioration potentially do we have from there.

We do have easier comparisons in the back half of the year but certainly we’ve got some things we are cycling up against like Bob mentioned in his comments with the self insurance reserve adjustment that we had out there. We are trying to take all that into account and build the guidance but yet be somewhat conservative we believe because we’ve been a little bit surprised both in Q3 and Q4 in the weakness that we’ve had.

As Larry said in his comments by building a more conservative plan hopefully we continue to make sure that we have our payroll and our other costs right in the stores so that if the environment is better than we anticipate because either Fed rate cuts, stimulus package, cycling easier comparisons moving further through the housing cycle getting closer to the trough any of those things. We can try to feed into that demand versus trying to be in more of a reactive mode, reacting and trying to pull back and chase those volumes down.

Bob Hull

When you look at the comp guidance of negative 5% to 6% the mid point is negative 5.5% so we are implying that the comps for 2008 will actually be worse than 2007 reported negative 5.1%. We do feel like we’ve got an opportunity in the spring, based on the tough April of last year where we had negative 10% comps driven by the poor performance in the first two weeks. If some of that came to us in the second quarter last year and so we have tough comparisons in the second quarter last year was only negative 2.6% comps.

Our plan does consequent slightly improving performance in the back half of the year because of comparisons some of the markets improving as well as some potential benefit from the stimulus package and the lower interest rates.

Bud Bugatch – Raymond James

A follow up, can you parse your comps so far based on, I know you haven’t done this but maybe you can give us a feel, project business versus every day purchases. I know projects are where you are really feeling most of the impact; I think you would suggest you are feeling most of the impact. If you could quantify that differential for us that would be helpful?

Bob Hull

I won’t be able to quantify the differential at this point. I can tell you that we’ve seen relative strength in the smaller ticket purchases. Some of the traffic items that we’ve done in the fourth quarter the innovation at a value that Larry described we are seeing pretty good performance from a relative standpoint. As you might expect our worst performing categories are the biggest ticket categories, cabinets, mill work and flooring to a lesser degree.

Operator

Your next question comes from Dan Binder with Jefferies.

Dan Binder – Jefferies

A couple of questions for you. One, can you give us an idea of how many of the stores you are building this year are in California and Florida? Two, given the increased defaults on the credit portfolio what are you seeing in terms of availability of credit to your customers and where is that penetration today? What are you building in for your expectations in the coming year?

Bob Hull

I’ll start with the second part of the question. One of the things when we think about our credit portfolio we are not aggressively chasing the business for the past couple years. We had a very prudent growth strategy that allowed us to gradually increase the mix of proprietary credit total sales. As it relates to extending credit to consumers we’ve not had a change in our approach and our approval levels are relatively constant ’07 from prior years.

We do have good transparency into GE’s delinquency trends, watching effectiveness and losses. Hopefully this allows us to have a very good ability to be out front of any potential impacts. We have planned for some additional losses in 2008 that is contemplated in our 2008 plan. We don’t see any dramatic changes in our credit portfolio going forward.

Robert Niblock

For California and Florida you are looking at about 20 stores is in the plan currently for 2008.

Operator

Your next question comes from Colin McGranahan with Bernstein.

Colin McGranahan – Bernstein

I had a longer term question. It sounds like you are prudently taking a pretty hard look at capital and expenses, districts, regions, remerchandising plans and what not for ’08. How are you thinking about the duration of this cycle at this point? What is some of the work you’ve done looking at home prices in past cycles? What are you thinking about beyond 2008 and do you care to revisit your 2010 outlook that you went over last September, 8% to 11% top line growth in 12% to 15% EPS growth?

Bob Hull

I’ll start with the last question, at this point in time we are not going to revisit our 2009, 2010 assumptions. I think longer terms as Larry described there probably is an opportunity to build just as many stores in the next three to five years, as we thought about last year. We are trying to think about and get through 2008 at this point in time.

Robert Niblock

I think when you look at all of the data that’s out there as far as when the trough will occur and those type of things it looks like it’s moved out some. Obviously there’s a chance it could still move further. Right now when you look at some of the projections that are out there it puts your trough somewhere maybe around the third quarter of ’08 is when the biggest part of the markets have troughed out and you start to see some recovery. Then you still have part of the markets that are still troughing.

Overall we wouldn’t be looking to even begin a recovery until the first part of ’09 based on what we are seeing today. We would certainly expect ’09 to be better than what we are projecting in ’08. As Bob said until we get a little further out we really aren’t prepared to update that long term guidance we’ve given for ’09 or ’10.

Colin McGranahan – Bernstein

A quick follow up. You did mention that you’d seen some kind of bottoming in some places is that maybe Florida or California? What did you see in those individual markets when you did see the bottoming? Did you see comps go flat or did you actually see a slower decline?

Larry Stone

The comps were still double digit negative for the year. The comment in the fourth quarter we did see an improvement over the previous three quarters of the year. If you look at it and try to dissect the business there was really no one particular product category or categories that drove it. It’s a general improvement across all categories. Nothing really significant but there again you are always looking for a raised hope and certainly looking at that we did think that was significant to mention about the fourth quarter.

Florida stores and California stores and certainly the Gulf Coast stores are still those stores we’ve been having struggles with. Hopefully those will start to turn around as we get later in the year and hopefully by ’09, as markets will start to trend back to where they were in the past years.

Robert Niblock

Larry’s comment was specifically with regard to what we are seeing in the Florida and California markets that had some of the toughest housing price declines and some of the toughest comps we’ve seen over the past several quarters.

Operator

Your next question comes from Brian Nagel with UBS.

Brian Nagel – UBS

I have a relatively longer term question as well. The home improvement sector from a price perspective has been more rational in retail. As you see sales weaken relatively significantly since the earlier part of this year has price competition become any more of an issue within your space? Related to that you laid out some of the expense leverage opportunities you have. Are there levers you could pull on your own advertising, whether it is pricing or non-pricing advertising as you look into 2008?

Larry Stone

Certainly we monitor the competitive landscape on a daily, weekly basis. We haven’t noticed anything to give us any concern in the fourth quarter we looked at our advertising versus the competition we competed with in this sector. We didn’t see anything that gave us any real concerns about a pricing battle shaping up. We think there is still business out there, we think that everybody is taking a more rational approach to capturing that business and our advertising plans are solid for 2008.

We know what we are going to do and when we want to do it. Certainly we think there is a lot of opportunity to still gain market share by the way we go to market with our plans.

Operator

Your next question comes from Mike Baker with Deutsche Bank.

Mike Baker – Deutsche Bank

I have two questions. One on the commodity pricing, you said you’ve seen a little bit of a lag on when that gets half through. Is that normal what we see in the past or are you seeing that lag because consumers are being a little bit more hesitant to prices?

Larry Stone

On the commodity pricing a lot of times when you get into lumber and some other categories like pipe and copper cable and so forth. The way that we are so up to date on our costs and so forth sometimes the market will not allow you to go up. People have their current costs into their systems and some cases you have time to wait for a week or two or ten days or even a couple of days in some cases to take prices up to the current replacement costs.

That’s always been a norm in our business. Years ago we were selling a lot of lumber and building materials it was always the norm to compete with the smaller folks in that business. That’s been something that’s been ongoing forever in this business.

Mike Baker – Deutsche Bank

It’s not any different in this kind of environment?

Larry Stone

No.

Mike Baker – Deutsche Bank

One more question if I could. You said that the guidance assumes no share buy backs does that mean you are not planning on doing any more buy backs or you just haven’t put that in the plan?

Bob Hull

There are no share repurchases in the plan. We’ve talked in the past about maintaining a strong capital structure in a safe environment. Maintaining A1/P1 Commercial rating is extremely important that assures us access to capital. We are continuing to evaluate our capital structure. We talked to you about maintaining a guard rail of 1.4 times lease adjusted debt to EBITDA. We were slightly above that in the fourth quarter at 1.46 times.

We will continue to monitor the environment; we will continue to evaluate our strategy regarding capital structure. At this point in time we are focusing on investing in the business, 120 new stores and then whatever excess capital we have we will return to shareholders.

Operator

Your next question comes from Gregory Melich with Morgan Stanley.

Gregory Melich – Morgan Stanley

A follow up on that. The capex number that you gave is $3.8 billion looks relatively unchanged from the October or September meeting but there are 20 less stores. Could you describe why that is or the timing of it?

Bob Hull

First, we had some items slip from 2007 into 2008 about $80 million or so. Second, as you would expect building costs are going up related to cement, steel as well as increased fuel prices means increase costs of getting the goods to our site. In addition, we expect to have even a more balanced opening schedule in 2009. Ideally 50% in the first half, 50% in the second half. To be able to accomplish that we need to secure that land in 2008 to make that come together. Those three factors are driving relatively same capex outlook versus September on a lower store base.

Robert Niblock

Thinking about it we reduced the number of store that were opening this year, a number of those were slated for the fourth quarter they may have moved out to the first quarter of ’09. You’ll still expend part of that capital as Bob said this year we do save some of the grand opening and the other costs associated with opening that store by pushing that out to the first quarter. We shift those costs from ’08 to ’09 but a good part of the capital still gets spent in ’08.

Gregory Melich – Morgan Stanley

A second question, you announced the commercial paper you did in the fourth quarter, what’s the strategy of now having commercial paper as part of the capital structure.

Bob Hull

It’s about managing the capital structure. We were managing two the 1.4 times to EBITDA guard rail and that’s just part of the strategy.

Gregory Melich – Morgan Stanley

You are comfortable to keep that billion there now going forward?

Bob Hull

We are going to manage to the guard rail; we are forecasting a decline in EBITDA for the year so we are going to trim commercial paper throughout the year.

Gregory Melich – Morgan Stanley

A follow up on credit, I want to make sure I got this right. Credit hurts you year over year but it wasn’t any worse than planned? Was it actually better than planned because of some of the income that was made?

Bob Hull

For 2007 we performed slightly better than planned and slightly better than last year from a percent of sales.

Gregory Melich – Morgan Stanley

In terms of your outlook do you expect in your guidance for this year do you expect credit to be a bigger percent of sales or less?

Bob Hull

We expect project credit to increase roughly 100 basis point of a mix of tender type in 2008. It’s been fairly consistent to how it’s grown over the past couple of years. However, based on the forecast of higher losses that I mentioned earlier we would expect credit to be a slight drag of five or so basis points to operating margin in 2008.

Operator

Your next question comes from Chris Horvers with Bear Stearns.

Chris Horvers – Bear Stearns

As you took down your square footage by about 20 stores this year and you emphasized that something you want to come back to later when the market gets better. Could you take us through your thought process there? Is it that the new store productivity is getting hit right now and you expect that to return back to a higher level and perhaps what that expectation is?

Robert Niblock

A lot of these markets we were going into they were very high growth markets. We were trying to store and stay ahead of that growth. With what’s taking place in the housing environment you’ve seen that growth in that market slow dramatically. We were going in and having a significant hit on capitalizing existing stores trying to stay ahead of that growth. The market is now slowed so the comps in those existing stores have now slowed so you’d be going in and capitalizing those stores running at a much slower volume than you had originally anticipated when you were bringing in the additional store.

We’ve gone in and taken a hard look at those markets that have been hardest hit and we are saying let the market recover and let the volumes in the store recover before we are ready to come in and cannibalize. That’s going to be pushed out over a couple of years. That’s why we in many cases shifted these stores out either a few quarters or possibly even a couple of years depending on how hard the market was hit and how heavily those particular markets previously.

Chris Horvers – Bear Stearns

With these stores is it that you presented this way because you want to have the option later of coming back to those 20 stores in investor’s minds. Is it truly definite that will come back and bring those stores in?

Robert Niblock

There are a few stores where we’ve cancelled it at this point in time. We’ll come back to look at the market later. There are others where we’ve just delayed the closing on the site out a few quarters because we think it’s going to take a couple more quarters for that market to respond. It’s not one factor that we use, we did it on a market by market basis and also look at how tough is it to get sites in those markets, how well we store in those markets and a whole number of factors that went into each and every decision.

Chris Horvers – Bear Stearns

As a follow up, on the gross margin could you possibly talk about what the outlook is in gross margin for this upcoming year? Are there any particular factors that we should be thinking about in any particular quarter?

Bob Hull

If you look at 2007 gross margin was up for the year but it’s pretty lumpy quarter by quarter. We had a 56 basis point decline in Q4 against tough Q4 ’06 comparisons, so margin was up 41 basis points. We do expect gross margin to be up in 2008 but again it will be lumpy quarter by quarter and we expect gross margin to be down slightly in first quarter 2008.

Robert Niblock

Just to reiterate one of the points from Larry’s comments earlier that we are still had the same long term outlook for the market. We are still looking at a longer term for the North American market 2,400 to 2,500 stores. That has not changed.

Chris Horvers – Bear Stearns

That’s predicated on return to more normal productivity levels.

Robert Niblock

I’m also not stating over what period of time we will get there as well.

Operator

Your next question comes from Eric Lessard with Cleveland Research.

Eric Lessard – Cleveland Research

On the gross margin comment that was just made in regards to growth in 2008, can you give a little bit of insight into what might drive that gross margin expansion? I would especially be interested in what you are seeing in terms of sourcing costs within your direct import side of the business?

Larry Stone

Certainly we will continue to use Lowe’s global sourcing to help us on our gross margin expansion. We think that’s still got a lot of potential to grow and the source products from overseas and bring better value to customers at a lower price. That certainly figures in all the decision we make in terms of how we look at the markets. We think longer term there is still potential for margin to go up, albeit not as much as we had in the past.

There are a lot of different things we are doing from retail mark down optimization where we go in and optimize our mark downs as we cycle through products. We are doing a much better job with our productivity in the stores with the way that we take products to market. There are a lot of leverage that we are looking at in ways that we can continue to work on our gross margin and certain at our sales meeting this week we’ll be discussing that we our store management teams.

Bob Hull

Two items we think are going to help drive gross margin for the year. As Larry said we think there are still import opportunities one and two as I described in our fourth quarter performance we took a bit of a hit because of seasonal merchandise. We think we’ll do a better job in 2008 with seasonal merchandise which would aid our margin for the year.

Eric Lessard – Cleveland Research

Secondly related to that in terms of inventories, I know you commented that the growth has all new store related. Is there a material opportunity with inventories with structurally from the things you’ve done and also considering the environment in 2008 to make some changes there?

Bob Hull

We think long term there are opportunities to be more productive with inventory. It’s very hard to be productive when you are forecasting comps of negative 5% to 6%. Long term we feel, yes, we will be productive with inventory. Coming off six quarters of negative comps forecasting a year of negative comps its tough to be too aggressive from an inventory standpoint.

Operator

Your final question comes from Steve Chick with JP Morgan.

Steve Chick – JP Morgan

First, it relates to the store productivity question. It looks like for this year you’ve been below your 80% target. In your ’08 guidance if I have my math right to get the 3% sales growth it looks like, I know you are opening up less net new stores. It looks like you are assuming productivity will be back up to 80% for this year, is that correct?

Bob Hull

The thing that drives the improvement is still productivity is the acceleration in the store opening schedule. If you think about the average of 120 stores opening a month sooner that’s quite a bit of sales weeks and months gained which helps contribute to the improved new store productivity relative to the 72% or so we had for 2007.

Steve Chick – JP Morgan

Sorry if I missed this. With your comp guidance for the first quarter being down 11% for the month of January the last month of the past quarter, I had that that month was actually very easy year over year comparison. Have you seen an improvement so far at the beginning of quarter we are in? What are you seeing that gives you comfort that the sales will rebound from where they ended the quarter?

Bob Hull

In my comments I noted two factors, one was what we’ve seen so far to start the quarter we hadn’t seen improved performance to start February relative to January’s performance. In addition, we had negative 10% comps in April 2007 with the first two weeks negative 19% due to severe weather. Those two factors contribute to our outlook of negative 5% to 7% comps from Q1 relative to the negative 7.6% in the fourth quarter of 2007.

Steve Chick – JP Morgan

You have seen an improvement from the January trend so far in February?

Bob Hull

Yes.

Steve Chick – JP Morgan

The interest expense guidance for the year if I took these down right you are expecting $81 million for the first quarter and then is it $273 million for the whole year? That’s a pretty big increase in the first quarter. I guess the idea is your excess free cash will pay down debt as the year goes on? Can you walk through that a little bit?

Bob Hull

We do expect to pay down a level of commercial paper outstanding throughout the year. In addition, we’ve got some modest debt maturities $60 million or so a little bit higher interest rate. Those are a couple of factors that contribute to having a little bit heavier interest expense in Q1 relative to the rest of the year.

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 in May. Good bye and have a great day.

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

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

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

Source: Lowe’s Companies, Inc. Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts