Lowe's Companies, Inc. (LOW) Q4 2011 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter and Fiscal Year 2011 Earnings Conference Call. This call is being recorded. [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, President and CEO; Mr. Robert Gfeller, Executive Vice President of Merchandising; 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.

Good morning, and thanks for your interest in Lowe's. Following my remarks, Bob Gfeller will review our operational performance, and Bob Hull will review our financial results in detail. But first, let me share a summary of our fourth quarter performance and tell you how we're thinking about 2012. Sales for the fourth quarter increased 11%, including the 53rd week, while comparable store sales were positive 3.4%. Comps were positive in all regions of the U.S., as well as in 13 of 16 product categories. Comp transactions increased 3.8% in the fourth quarter and comp average ticket decreased 0.4%. While gross margin contracted largely in line with our expectation, we had good operating expense control and delivered earnings per share of $0.26, exceeding our guidance for the quarter. Delivering on our commitment to return excess cash to shareholders, in the fourth quarter, we repurchased $500 million or 20.7 million shares and paid $177 million in dividends. Overall, I'm encouraged by the progress we made in 2011 toward delivering better customer experiences and transforming our business to drive long-term sales growth and increased profitability and shareholder value. I would like to thank our hardworking employees for their ongoing dedication and customer focus. At our Analyst and Investor Conference in December, we outlined how we intend to build upon our core strengths and strategically invest in ways that will better position Lowe's for success. Among our top strategic priorities, we accelerated our investment in technology and store infrastructure in 2011 and increased our efforts to improve the customer experience. I'll share some specifics momentarily. We also refined our pricing and merchandising strategies and processes, actions that Bob Gfeller will review in a few minutes. With these enhancements in place, we are well positioned to drive stronger comparable store sales growth and expanded…

Thanks, Robert, and good morning, everyone. During my time today, I will provide some detail around our fourth quarter performance to help give you a sense of the opportunities we leveraged, and how we drove the business through our strategies and actions. I will also provide an update on the progress we're making on the initiatives we shared with you during our Analyst and Investor Conference in December: value improvement, product differentiation and creating the foundation for a more seamless and simple customer experience. So first, on the fourth quarter. Our approach was to start stronger than last year by driving excitement throughout November, leading to the key Black Friday and Cyber Monday events in select products like tools, holiday decorations and appliances. We wanted the customer to see Lowe's as a destination for compelling values and groundbreaking product innovations, and we successfully drove strong comp sales performance in these categories. One innovative and exclusive product we featured was the new Kobalt double-drive screwdriver, which delivered 35% higher sales than last year's featured item and at a higher margin rate. Another example of innovation that worked in the fourth quarter was LED decorative Christmas lights, where we enhanced our assortment to meet customer demand for more durable lighting. The customer is willing to spend more for the energy savings and longer life, and we are capitalizing on this same value proposition to drive strong comps within the interior light bulb category as consumers are quickly transitioning to longer-life LED bulbs. Within appliances, we more heavily invested in inventory this year to support our aggressive approach to the holiday season. We capitalized on our broad assortment of major appliances from key national brand partners and drove double-digit comps in the month of November, and comps for the quarter trended with the…

Thanks, Bob, and good morning, everyone. Sales for the fourth quarter were $11.6 billion, which represents an 11% increase over last year's fourth quarter. Lowe's' fiscal year ends on the Friday closest to the end of January. Therefore, 2011 included an extra week in the fourth quarter for a total of 14 weeks and 53 weeks for the year. Sales for the extra week were $766 million, which contributed 7.3% to sales growth versus Q4 2010. In Q4, total customer account increased by 11.4% while total average ticket decreased 0.4% to $61.11. Comp sales were 3.4% for the quarter, which is above our guidance of flat to 1%. Our higher-than-expected performance was driven by sales of seasonal items, continued strength of our proprietary credit value proposition and favorable weather. We estimate that the favorable weather aided Q4 comps by approximately 150 basis points. We estimate that our value -- our proprietary credit value proposition, which offers customers a choice of 5% off every day or promotional financing, positively impacted Q4 comps by 110 basis points. Also we estimate that sales related to sustained rebuilding in markets impacted by Hurricane Irene positively impacted Q4 comps by 40 basis points. For the quarter, comp transactions increased 3.8% while comp average ticket decreased 0.4%. Strong sales and lower ticket transactions, the impact of the proprietary credit value proposition and holiday promotions on larger-ticket transactions all contributed to mixing the average ticket down in the quarter. Looking at monthly trends, comps were positive in all 3 months with 0.2% in November, 3.2% in December and 7% in January. With regard to product categories, the categories that performed above average in the fourth quarter included building materials, lumber, nursery, tools, paint and fashion electrical. Hardware, rough plumbing, appliances and flooring performed at approximately the overall…

[Operator Instructions] Your first question will come from the line of David Schick with Stifel, Nicolaus.

You mentioned store resets are having a positive impact. Could you give some detail on how those stores performed versus control group or the non-touch stores?

David, this is Bob Gfeller. I can give you some color on that. The 500 stores that we have reset in 2011 are showing positive results across the store in terms of all the things that we have reset, the end caps, the drop zones, particularly the innovation end caps, and the most productive area in the store is actually the contractor pack area as we close the year.

Dave, this is Bob Hull, just to follow back up. Just remember those stores weren’t completely reset until December. So the earliest sets, we have a very positive read, but the most recent ones, towards the end of the quarter, still early. The other point is the inventory used for those end caps was largely in-line inventory, and we're just making dedicated buys, which should continue to improve our performance for those end caps for 2012.

Okay. Great. Could you update us on the number of MyLowe's accounts out there?

Yes, this is Robert. We're up to about 3,000 unique swipes out there on -- I mean, 3 million unique swipes. I'm sorry, 3 million unique swipes now on MyLowe's. And we have a goal, we really believe, with the additional functionality that we're adding during the year, our intent is to be to 10 million by the end of 2012.

The next question comes from the line of David Gober with Morgan Stanley.

Just one in terms of the scaling of guidance throughout the year, and I know, obviously, you're not giving quarterly guidance at this point. But I'm just wondering if you could speak broadly about how that phasing stacks up, particularly given the upwards slope of 2011 results. Would you expect the first half to show maybe stronger sales trends and weaker margins and the opposite to be true in the second half?

I think as it relates to sales, the week shift does have an impact and I suggest you may go take a look at 2006 to get a sense how that might play out relative to 2005. 2005 was the last time we had a 53-week fiscal year. As relates to sales I think, if you recall in Q1 last year we had a very tough spring, a very bad April. So we've got easier comparisons coming as it relates to spring. Conversely, we've got tougher comparisons now in fourth quarter as we cycle the mild weather that we had in Q4 '11. However, I don't see much disparity in comps across the 4 quarters of the year as relates to margin. Margin should be -- if you exclude the nonoperating charges, as well as the impact of the 53rd week, I think we'll see some slight gross margin pressure in the first half of the year and some margin improvement, which should guide what happens with EBIT margin for the year and by quarter.

Okay, and just a follow-up for Robert if I could. You mentioned some of the data points in terms of the overall economy and housing that we've seen over the last few months. And I wondered, as you guys think about the outlook for the next year or 2, what are the key metrics that you're watching? And is there any way to really tell, within the numbers that you've seen recently, whether consumers are thinking about their homes differently or thinking about investment in their homes differently than they have over the last couple of years?

David, I'll start and then I'll have Greg maybe follow on with any thoughts that he has. When you think about it, we did see an uptick in consumers' willingness, we think, to spend in the fourth quarter. So in addition to the favorable weather, we saw a bigger impact than we would normally see just with weather alone. So we do think that the consumer is more willing to spend. As we said, I think overall, there's still going to be downward pressure on home prices in 2012 because of the foreclosure overhang. But what I think you are seeing is that, with a lot of the other media news stories that are out there, the value of your home isn't the top news story every day. So it's kind of moved to the back burner. So I do think that it's helping as a little bit more favorable data on the economy, a little bit more favorable data from an employment situation is easing consumers' fear of the value of their home and what the future portrays for that and opening up their willingness to spend on some on those projects around the homes. Unless something comes to kind of knock their knees out from under them, we do feel like they're going to be more willing and more engaged on spending around the home. So Greg?

And to layer onto that, David, it’s a balance we’re watching between the effective economic pressures on homeowners and renters today, and especially on the part of homeowners, especially on the part of young homeowners. A continual mindset that wrapped around their home as a place that they still feel is special and they want to invest in. We keep checking for any kind of breakage in that mindset and we're not seeing it, we're seeing a continual devotion to the home. And as Robert said, as the economic pressures tend to mitigate as we look out over the next 3 to 4 years, we know that we have that underpinning of psychographics that is very much in our industry's favor.

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

First question for Bob Gfeller. Bob, it sounds like you've done about 8% of the product line reviews so far. You mentioned the reduction in cost but you also mentioned some vendor stress, which is certainly understandable and something we've kind of been picking up in some of our checks as well. Can you expand on that a little bit and tell us, as you've gotten started on this, one, what has played out as you expected, maybe what's played out a little differently? On average, what kind of a cost reduction are you seeing in first cost? And then what's some of the feedback been that prompted you to put this vendor council together?

Sure, Colin. I'll hit some of those. So we're 8% through the line review process at the end of the year. We're on schedule and on track. Some key learnings, number one, I think our merchants are utilizing the technology tools that we talked to you about in December very well. They're using them as great input into the line review process. As it relates to vendor learning, the vendor advisory council we actually formed last year in anticipation of wanting to, again, be our vendors' best business partner in home improvement. So it was not a reactive move, it was a proactive move. I think what the vendors are telling us is that we are approaching this in a firm and fair way. They're getting a lot of feedback on the line review process going in and also coming out whether they win or don't win the business, and we're going to continue to monitor that as we go through the rest of this year. And then the last thing I would say is on the cost reductions. We set targets, they were kind of initial targets. We're on target, particularly against the SKU reduction goals that we've set. And as we've said, we're going to continue to monitor them as we go through the first half, but so far, so good.

Okay, great. And then just a follow-up question for Robert. In terms of the voluntary corporate severance, maybe you could talk a little bit more about that. What prompted that in the big picture? And why that approach? I think we've seen that at some other retailers end up resulting in higher, longer tenure and higher-level people taking those buyouts. What would your expectation be? But maybe just a little bit more color, generally, on that approach and why you chose to go down that way.

Yes, a little bit on the why. Colin, if you think about it, in the past year everything we've talked about, really the past 18 months, with Wall Street and our new strategic mission, Lowe's experience of the future. If you think about it, the overwhelming majority of the people, if you ask them at Lowe's, they feel like they're working for a different company today than they were a year or 18 months ago. Some people are there, they're onboard absolutely supportive with the direction that we're headed in. For others, they've operated a different way in the past and we changed the rules in the middle of the game for them. So for those that may be struggling a little bit with the direction of which we're heading as an organization, this gives them another viable option. So that, hopefully, at the end of the day, we're left with a much higher percentage of people that are onboard and support the strategies of where we're going. So that's the reason we did it on a voluntary basis, and we think it'll be successful.

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

I'd like to start out by asking you about the composition of your gross margin increase for the year. You had a lot of moving pieces that you detailed here in the fourth quarter. If you could talk specifically to the impact that you think proprietary credit will have on gross margin, and any other line items that you think will stand out would be very helpful.

Matt, this is Bob. So specifically you're looking for color on 2012 outlook?

Correct.

Yes. So the way we're thinking about it, Matt, gross margin dropped 58 basis points in 2011. Roughly speaking, we're looking to make up about half of that in 2012. We've launched the consumer aspect of the value proposition in April and the Commercial in July. So we'll have some negative pressure, gross margin pressure, in the first half of the year as we cycle those. Bob Gfeller described to you the cadence of the line review process, that price reductions early will create some pressure before we get the full impact of the cost reductions. Therefore, we'll see margin improvement close to flat in the second quarter, begin increase as the year progresses and have probably healthy gross margin expansion in the back half of the year, especially as we cycle some of the declines we saw Q3 this year roughly 100 basis points, Q4 this year 133 basis points.

And as part of that, it sounds like some of the one-off promotional pressure that we saw, for example, here in the fourth quarter you quantified that at 28 basis points, you would expect that would more or less abate?

That should abate, yes. That should be either be flat to a positive. And then the other piece I would mention is roughly the 100-basis-point increase in private label products should help as well.

My second question is also a financial question, kind of a detailed one. I believe you guided to depreciation of $1.5 billion, which would be up a bit year-on-year, and depreciation was really declining in dollar terms for the past 2 years. So any color you could give us on that would be terrific.

Sure, Matt. So we spent a lot of time talking to you about the level and breadth of investments in technology, both corporate systems for services, for the Integrated Planning and Execution tool that Bob's and the merchant team are using to go through the line review process, MyLowe's, investments in lowes.com, et cetera, with additional investments required in 2012. So what we have there is a pretty high concentration of investments in a short-lived asset, 3- to 5-year depreciable asset. So that's really what's happening. It's causing depreciation to be up slightly in 2012 relative to 2011.

If you take a look at the multi-year outlook, is that essentially the peak for depreciation dollars as you see it?

It should be, which is why when we gave the long-term outlook in 2015, it declines because we cycled through the kind of jump in '12.

Your next question comes from the line of John Zolidis with Buckingham Research.

Just to make sure that we have clear on the guidance for operating margins. For 2011, we should be using a base of 7.5 from which you expect to get 100 basis points of improvement?

No, we guided based on GAAP figures. So it's the GAAP guidance versus the GAAP reported figure. So the reported figure of 6.53, it’d be the 100 basis points off of that.

Okay. And then secondly, I wonder if you could comment on the online business. You reported a 70% increase in revenues online. I assume that includes the benefit of the acquisition that you closed on in December. But even excluding that, my guess is that the online business is growing significantly faster than the store business. Where do you think that can be looking out 5 years as a percentage of your total business? And do you see any impact on the gross margin or the profitability from the shift from store business to online?

So specific to 2011's 70% increase it had 0 impact from acquisition of ATG Stores. That was all based on more items online, more multi-channel sales. So think about a still high percentage of our online sales are buy-online-pickup-in-store, so it's really leveraging all the channels to serve the customers. As we think about growing that business going forward, we have a target of roughly double the number of SKUs online in 2012 relative to 2011. ATG is certainly is going to help us. We bought a very interesting technology company that has a lot of good things going, that has roughly 3.5 million items online, a number of which we'll make available on lowes.com in 2012. Longer term, if you think about our outlook at the Analyst Conference, we gave you a roughly 3.5% comp for a 4-year average with about 1/3 of that coming outside of store. So online still is going to be huge growth opportunities beyond the 70% growth in 2011.

Your final question will come from the line of Alan Rifkin with Barclays Capital.

Bob, you mentioned that, with respect to the line reviews, 8% were done and you're looking for all of them to essentially be completed by the end of the year. Is there any quantification of what those line reviews aided your EBIT margin in the fourth quarter?

Alan, it's Bob. The completion of those line reviews had no impact in the EBIT margin in the fourth quarter. Alan, so if you think about it, there's a process to actually go through the work up front to evaluate the vendor offerings and compare that to where we are today, it's more of a planning process. The subsequent quarters, when those get rolled out to the store where the customer has an opportunity to vote on whether they like what they see or not, so we'll start seeing the impact of the 8% completed in Q4 in the first quarter of '12.

Okay. So question for Bob Hull as a follow-up. So as you go through the rest of the line reviews in the rest of the year, what is the benefit to your 2012 earnings that you anticipate from the line reviews for the full year?

That's the roughly 30 basis points of gross margin improvement for the year that we spoke of. Negative pressure in the first half of the year, and then recovery in the second half of the year obviously, paying big dividends in 2013 and beyond as we've got the process largely behind us.

Alan, I would just add -- I'm sorry, let me add one other thing on getting the right inventory in the right stores and managing that more effectively, that's that $400 million inventory reduction by the end of the year.

Okay. And one last question if I can, for Robert Niblock. With respect to the VSP, Robert, we certainly applaud you guys taking these steps at this point. Was curious on why the timing now? Does it come hand-in-hand with your reduction in new stores that you anticipate over the next 4 years?

Well, certainly, Alan, as I talked about in my comments, our structure was built to support a high-growth model, and we're going to be growing differently in the future. But really as I was responding to Colin, and over the past year, the past 18 months, we have dramatically changed what our expectations are of leaders throughout the organization. And while a majority of the people are very much on board, there are some that are very uncomfortable. They're, not going to raise their heads and say I'm uncomfortable with this. This gives them a viable option in order to, if they're not comfortable with the direction we're headed, to be able to give them a viable option for a path forward for them if they're not comfortable with the change we've made from the leadership. So we felt that was the best way to be able to approach the issue. So that at the end of the day, we have a much higher percentage of people that are on board because we've got to have the organization onboard in order to realize where we're trying to go with the organization. So...

Okay, and as a follow-up, Robert, if memory serves me right, I believe that election actually expires today. Any commentary relative to your plan, whether you're seeing fewer or more people take up the package?

I would say that, obviously, a lot of them will come in the last day, which is normally the case with these. But we've been very pleased with the response we've seen versus what we had anticipated from the group at this point. And once again, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2012 results on May 21. Have a great day.

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