Lowe's Companies, Inc. (LOW) Q1 2012 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to Lowe's Companies First Quarter 2012 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 Investor Documents. Hosting today's conference will be Mr. Robert Niblock, Chairman, President and CEO; Mr. Bob Gfeller, Customer Experience Design Executive; and Mr. Bob Hull, Chief Financial Officer. 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 provide a summary of our first quarter performance and share some strategic updates. Sales for the first quarter increased 7.9%, including the impact of the week shift, while comparable store sales were positive 2.6%. As expected, comp transactions increased 2.6% in the first quarter, and comp average ticket was flat to last year. For our fourth quarter call, we provided our annual comp guidance of 1% to 3%, and expected all quarters in 2012 to fall within that range. That guidance was predicated on transaction growth and for the first quarter, assumed better weather conditions year-over-year. We are pleased with the solid comp transaction growth in the quarter and continue to see stabilization in comp average ticket. Geographically, all divisions of the U.S. delivered positive comps in the quarter with our strongest performance in the North division. While we capitalized on better-than-anticipated weather during most of the quarter, demand for seasonal products slowed toward the end. Gross margin contracted, but the year-over-year impact was significantly less than the third and fourth quarters of 2011, and we believe we are now beyond the peak of gross margin declines. We continue to effectively control operating expenses in the quarter and delivered earnings per share of $0.43, which included approximately $0.01 of severance and other costs associated with the voluntary separation program. Delivering on our commitment to return excess cash to shareholders, in the first quarter, we repurchased $1.75 billion or 58 million shares and paid $174 million in dividends. We are building on our core strengths with focus areas like value improvement and product differentiation, and Bob Gfeller is…

Thanks, Robert, and good morning, everyone. During my time today, I will describe the internal and external drivers of our first quarter performance, highlighting the 3 internal sources of 2012 growth: first, leveraging the foundation for a more simple and seamless customer experience; second, product differentiation; and third, our progress on value improvement. Our first quarter comp sales performance was consistent with our expectation at the beginning of the year. For the quarter, 11 of 15 product categories comped positively, showing continued strength from the fourth quarter of 2011. Tools and outdoor power equipment, seasonal living, paint and lumber, led our performance with comps at least twice the company average for the quarter. In particular, a number of products produced double-digit comps, demonstrating that we were well prepared for the spring season. These products were riding and walk behind mowers, lawn chemicals, mulch and stone, trimmers, edgers and augers, handheld power tools, patio accessories, cleaners and exterior paints, stains and sealers. Within indoor products, solid single-digit comp performance in interior paints and applicators, ceiling fans, lightbulbs, window treatments, stock laminate flooring and fasteners was offset by anticipated softer sales in appliances, cabinets and countertops and Millwork. The comp sales drag in these categories was a result of our decision to run fewer percent off promotions, and those we did run were at lower discounts than last year. Additionally, while stable, we believe recovery in these and other large-ticket categories continues to be constrained. Looking at how the quarter unfolded in the first 9 weeks, we drove a U.S. comp sales increase of roughly 5% through strong sales of products associated with maintaining and beautifying the outdoor living space. We were well prepared for the warmer spring weather, with sharp values and a coordinated presentation of outdoor products across channels. Consistent…

Thanks, Bob, and good morning, everyone. Sales for the first quarter were $13.2 billion, which represents a 7.9% increase over last year's first quarter. There's a week shift in fiscal 2012 as a result of 2011's 53rd week. Essentially, this year's first quarter included one less week of winter and one more week of spring than last year. We estimate that the week shift aided Q1 sales by $514 million, which contributed 4.2% of the sales increase. Comp sales were positive 2.6% for the quarter, driven by comp transactions. Comp average ticket was flat to last year. Looking at monthly trends. Comps were positive 2.4% in February, positive 8% in March and negative 3.1% in April. As you heard from Robert, we were able to capitalize on better weather from most of the quarter, but demand for seasonal products slowed toward the end. In addition, April comps were negatively impacted by our decision to reduce the promotional intensity for big-ticket categories. We estimate that our proprietary credit value proposition, which offers customers the choice of 5% off every day or promotional financing aided Q1 comps by approximately 130 basis points. With regard to product categories, the categories that performed above average in the first quarter include tools and outdoor power equipment, seasonal living, paint, lumber, building materials, hardware, fashion electrical and Lawn & Garden. Rough plumbing, flooring and home fashion storage and cleaning performed at approximately the overall corporate average. Appliances, cabinets and countertops and Millwork underperformed the company average and negatively impacted comp sales by approximately 120 basis points. The remaining 1.1% sales increase was primarily attributable to new stores. Gross margin for the quarter was 34.7% of sales and decreased 74 basis points from last year's first quarter. The gross margin decline was a result of several factors.…

[Operator Instructions] Your first question comes from the line of Chris Horvers of JPMorgan.

Can you quantify how much the reduced promotions impacted same-store sales overall? And was this isolated to April or did you see anything in February and March? And related to that, as you think about the journey to EDLP, how are promotional levels -- what was the cadence of them last year? Do you think 1Q last year was more promotional than the second quarter? And then any commentary in relation to the fourth quarter as well?

Chris, this is Bob Hull. I'll start and let Bob Gfeller chime in as necessary. As it relates to the promotional impact on cost in Q1, as I said in my comments, we estimate that the impact for appliances, cabinets and countertops and Millwork was approximately 120 basis points for the quarter. It was more pronounced in April, which was closer to like 200 basis points in April for those categories. As relates to the promotional intensity, in Q1 last year, we were going up against Cash for Appliances in Q1 2010. Therefore, there were some incremental promotions that we ran in Q1 last year that we elected not to repeat in Q1 this year, driving the impact in appliances specifically.

And Chris, this is Bob Gfeller. Just to add a little bit more color on Bob's comments. As we look at promotions going forward, inside of the value improvement program, a couple of points. The 5% value proposition on our private label credit cards is critical in all of our thinking because it's value every day to our customer. So that's helping us to deep promote and rationalize promotions. Also, as we look at major holidays and key categories, we've always said that we are retailers, we've got to make sure that we're sharp certain categories at certain times and certain holidays. And specifically for the first quarter of the year, we did have 30% fewer promotions in the first quarter versus 2011. A significant number of those were advertised last year, and as Bob says, that many of them were in the big-ticket categories specifically in appliances where we were deeper discounting in 2011 than we were in this first quarter.

Chris, I'd to add, and this is Greg Bridgeford. As we look ahead to the second quarter, we're taking a very analytical look at the balance and the mix of our promotional activity and specifically where we're putting the focus on elements of the marketing mix like search, like print, like radios and make sure that we're balancing out the opportunity for driving tickets and transactions, specifically, as it relates to flooring, appliances, cabinets and countertops and Millwork.

So to follow up on that. Did you -- on 4Q, 4Q seems like a promotional quarter as well. So does that add, given the comparison, the weather lift in 4Q last year, does it add any risk to the thought that you can have consistent comps of 1% to 3% across the year?

Chris, we feel like that, as we said last quarter, that all 4 quarters this year will fall in the 1% to 3% range. We do have some pressure in the fourth quarter relative to the roughly 150 basis point weather favorable impact we experienced in Q4 '11. However, we still expect that to be in the 1% to 3% range, although it may be the lowest comping quarter of the year.

Your next question comes from the line of Budd Bugatch of Raymond James.

Just a couple of them. One on a 13-week comparable, I know that because of the calendar shifts you gave us, ended March 4. But if we looked at the 13 weeks ended April 27 versus last year's April 29, do you have what that number would have been in a comp basis to get an idea versus competition?

So 2 thoughts. One as we think about the 53rd week last year, to be true, we had 14 weeks of comparable sales performance in Q4 last year, the 14th week in Q4 comped against week 1 of 2011, which means weeks 1 through 13 this year comped against weeks 2 through 14 last year. So there is truly a comp versus comp. As we think about the calendar impact if we modeled our comp performance, assuming the 13th versus 13th the other way, comps would have been about 60 basis points higher than we reported. So it would have been roughly 3.2 versus the 2.6.

That's helpful. And on Bob Gfeller's comments, he gave a language, I'm not sure I heard before. It said and I think it was within a reasonable range of the nearest competitor for pricing. Can you maybe you flesh that out and tell us what that means exactly or is there a way to think about that?

Sure, Budd. This is Bob. The reason why I'm using that phraseology is because our lens is wider as we think about our competitive set, as we think about being an omni-channel company. So traditionally, we would look at price competitiveness just against our principal retail competitor. But as we look at the value improvement program holistically, we have a wider lens. So really depending on the category, depending on the product, we will be priced competitively based on what is a solid offer for the customer for that category against the relative competitors. So I think I had gotten a question before, we are certainly looking at Amazon and certainly looking at other retailers that play in categories that we also compete in and although they may not be core to those competitors. So it's just a broader lens as we look at being price competitive. One last note for you though is we have, as it relates to our principal competitor, looking at our price competitiveness as we said before, we've expanded the number of items we're looking at across our store, and we are very confident that we are priced competitively against that specific competitor.

Okay. And just one last quick one. Can you give us the big-ticket versus small-ticket comps that I think you've done in the past, I didn't hear that, Bob. The over 500, under 50 I think it was.

Yes. Budd, I don't have that available. We can certainly call you back. Just responding to your question regarding what comps would have been, the spread across the months would have been much flatter than the reported comps. On a restated 13 weeks, they would have been roughly 5% for February, 3% for March and flat for April. So less lumpy than the plus 2%, plus 8%, minus 3% that we reported.

Your next question comes from the line of Alan Rifkin of Barclays.

First question for Bob Hull. Can you maybe, if possible, shed some color on the performance of the southern markets, where one would probably expect that the weather did not have as profound an effect from month to month relative to the corporate average?

As Bob Gfeller spoke, the Northern markets had the best performance early in the quarter and it trailed off most at the end of the quarter. The Southern markets were the most consistent performing in the quarter, typically, right at the company average for most of the quarter.

Okay. Second question for Robert Niblock. On the VSP program, it sounds like the charges being a little bit greater than your anticipation implies that more people took the program than what you originally had thought. First, if you can confirm or deny that. And then maybe just a little bit more color as to where specifically you saw most of the people take this program, what divisions and categories were they in?

Yes, Alan. As far as -- we haven't built anything into our guidance for the year for VSP. So we'd wait and see what the impact of that was and treat it accordingly. As far as the magnitude of it, I think we had there's 526 people that took VSPs. As you know, it was really a program for the corporate office structure. And I think as we look through the number of people who took it, the years for which they took it, I'd say I'm pleased with the impact and what we accomplished with the VSP. It was pretty broad based across the organization, where we saw people taking the VSP for a number of different reasons, people may have been in different life stages and provided them opportunity to do something different. The other thing was, in the last 18 months, we've changed dramatically our expectations of leaders in the organization. So it really is a different company that they're working for today than it was 18 months ago, let's say, so that did provide people an opportunity if they wanted to move on because they weren't fully committed, let's say, to the direction we were heading. So as we looked across the organization, the people that took it really pleased with the outcome, really pleased with the way that it shaped up. And as far as getting into pretty broad based across the organization, I don't really want to get into particular areas as to where people took the VSP or not, but overall pleased with the results.

Okay. And one last question, if I may. With the respect to ATG, I remember you folks said that you were going to kind of lay off of them for the first 90 days. Now that we've kind of passed that mark, what changes, if any, are you making to the integration of ATG with your brick-and-mortar presence?

Alan, this is Greg Bridgeford. ATG is -- our primary focus with ATG is really to enable the processes that they have fine-tuned through the years to quickly add items and make it into meaningful assortments for consumers to be able to leverage those processes over to Lowe's core models for the purpose of expanding the reach and the impact of lowes.com. So if you look at that, that's working well, and we are adding items at a faster rate. We're learning their processes. We're keeping it very focused. Our interaction with ATG, as you said, there's some firewalls around it. And we're also, in the interim, we've been able to add ATG product to our SOS offering, Special Order Sales offering, within the Lowe's stores today. So 2 focus areas, keeping a pretty tight rein on any distractions for ATG, which operates its business model very effectively and getting the leverage we expected.

Your next question comes from the line of Michael Lasser of UBS.

Can you provide a little more clarity on what is driving the delay of the implementation of the line reviews by 30 days? And are you seeing any greater disruption from the process that's impacting your sales than you previously anticipated?

Michael, this is Bob Gfeller. I'll give you a little more color around that. So we've got the accelerated line review process, which is the upfront piece that the merchants are working them through and then, of course, we've got to execute the resets. We always knew this was going to be test and learn as we kind of move through because we're taking on such a challenge. And the 2 key learnings are really from a capacity of just workload from the number of line reviews we're going through, we've talked about almost 400 line reviews completed by, really, the end of this year. From a quality standpoint, number one is, we wanted to slow it down to make sure we're utilizing the analytics as best as we possibly can from the merchandising standpoint, number one. So that's the integrated planning execution tool, the efficient item assorting tool, number one. Number 2 is, there's a lot of work to be done when you move to reset. And because we are making significant changes in SKU assortment, in price progression and in some cases, presentation, our learnings to date have been, let's make sure that those handoffs are smooth as possible so that we make sure that the presentation to the customer is as good as we expected to be when we model the results on paper. So the reason why we're hedging a little bit more into the lead time is because as we move through these first few resets, as we're just kind of learning as we're going and we want to make sure that we give it enough time so that the results are what we anticipate.

Okay. And as you think about the quarter, how long do you think the impact from demand being pulled forward is going to influence your comp trend? And was the impact from being less promotional about what you expected for the quarter?

So Michael, this is Bob Hull. The comp impact from the big tickets was about as we expected. Deep promoting, we expected that's less of an impact in Q2. As I mentioned earlier, there's a lot of promotional activity in appliances specifically to Q1. So less impact of deep promoting in Q2. As it relates to the pull forward, we estimate that the impact on Q2 is roughly 40 basis points, so not terribly significant.

So the 40 basis points is all as a result of the favorable weather?

Correct. And then earlier Budd had a question on ticket bucket performance. I was able to run to my office and grab that information. So as you think about tickets below $50, they were plus 2%. Tickets below $100 and $500 were plus 3%. Tickets above $500 were negative 1%, again, driven principally by the 3 categories I noted: appliances, cabinets and countertops and Millwork.

Your next question comes from the line of Peter Benedict of Robert W. Baird.

A couple things. First, just on the week shift, Bob, maybe help us what you think the sales impact's going to be on the second quarter as you start to get back some of the benefit you got in the first. How is May to date? It sounds like, obviously, you guys are expecting 1% to 3% for the quarter, but just trying to get a flavor as to how things maybe come off of that depressed level in April. And then with the 30% fewer promotions in the first quarter year-over-year, can you give us a sense maybe what that was in April? And then what's been the competitive response to that? And how should we be thinking about the promotions year-over-year as we move throughout 2Q and beyond?

So Pete, I'll start with the first few and let others chime in. As it relates to the week shift impact, there really is no impact for the year. So the entire pickup in Q1 is given back largely in Q2 and Q4, but we still expect comps of 1% to 3% in each of those remaining quarters for the year. May has started off as expected. So we're in good shape out of the gate to hit the 1% to 3% target. As relates to Q1 promos, as I mentioned, the biggest impact on big-ticket promos was in April, roughly 200 basis points relative to the 120 basis points for Q1. And then your last question dealt with competitive response.

Yes. And Peter, this is Bob Gfeller. Just one other point on the big-ticket promotions in April. As I think we mentioned in the scripts, these were conscious decisions because we are moving back to EDLP. Some categories will be EDLP plus. But some categories don't need to be promoted at the depth that we did last year. So it's really a depth issue on appliances, Millwork, where we frankly bypassed some big offers that we had last year. From a competitive -- one other point on that as well is, the merchants upfront as they're looking at their lines, they are critically looking at the profitability promotions they've run in the past. And as Greg said, they are making hard decisions not to repeat where it wasn't a profitable decision that was right for the customer. That's happening all throughout the quarter inclusive in April. And as it relates to the competitive response, the competition quite frankly is doing -- they're executing their plan and we're executing our plan. We're certainly keeping an eye on it, but we did make some decision to make sure that we stayed on plan because we think what we put in the marketplace was still competitive to address customer needs. And as Greg said, in the second quarter looking at the promotional and medium mix, we think is going to help us move into the second quarter on plan.

Your next question comes from the line of Dan Binder of Jefferies.

My first question was with regard to the strategy behind fewer promotions on big ticket. I'm just curious as you consider the EDLP approach, if that's necessarily the right strategy across the store and whether or not you're seeing others in the industry pull back on promotion and big ticket? You mentioned that the customer is constrained, and I'm just curious if it's accretive if you do promote that particular area of the store, would you reconsider?

Dan, I'll start, then I'll get Bob Gfeller to jump in. As Bob explained, yes, there are still certain categories, certain times of the year when we will be promotional. It's all about rationalizing that promotional cadence. So for example, as he described in the first quarter, it was about going less deep on certain promotions such as appliance. I think last year, in many cases, we were doing 15% off E Star. We didn't do any of those 15% off this year. So it's really rationalizing that as we're moving back to EDLP, rationalizing the promotional cadence across the store, looking at the profitability of promotions previously, looking at which categories we think need to be promoted, which ones the customer's most likely to expect to be promoted or will respond most likely to those promotions. And part of that, when you pull it all together, is also being driven by what we did a year ago, which was rolling out our 5% off everyday value prop on the Lowe's credit card. We anniversaried that in April of this year for the consumer. And for the commercial customer, we'll anniversary that in the second quarter. So now that you've got that 5% off out there, we're taking that as an underpinning and reviewing our other promotional cadences to say when, where, how deep should we be promoting other categories. And that's what Bob and the merchants have been working through in this process.

And Dan, just to build one other comment around Robert's point. Robert's script talked about the stages of home improvement. And when we think about these big-ticket categories, both merchandising and operations, we need to sell the project. And so one of the other things that we are trying to look at critically is how do we use more than just price promotion where we bring in the value proposition, where we bring in the exterior selling solutions, where we bring in the technology to make the experience simpler for the customer. This is all about how we kind of encircle the project and sell the project in totality. So that type of a mindset is what we're trying to look at as we go forward so that, again, we move from just a product promotion to more of a project selling mode. And so that's something we're looking at based on selling across the stages and addressing customer needs.

Okay. My follow-up question was on the credit. Credit's been doing well for a while. Portfolios, in general, have been experiencing lower losses, lower write off. I'm just curious, as you look forward, what kind of leverage you would expect out of credit based on your current comp plan as we go through Qs 2 through 4.

So Dan, as Robert said, we cycled for the value proposition. We cycled the consumer piece in April. We cycle the commercial piece in July. So for the year, we do expect the credit program to generate leverage 30 basis points for the year, which is lower than the 63 we leveraged in the first quarter, principally, due to losses. So we'll still see benefit for the year, but to a lower degree than we saw in the first quarter.

Your final question comes from the line of Eric Bosshard of Cleveland Research.

Interested on the line review process. Bob Gfeller, I know you're in a new position now, so I'm just curious how that process is being managed related to the management change? And then also, you talked about the timing of implementing the line review changes. If there's anything else that is being done differently as you've worked your way into this process with the net price effort and the other pieces of it? If you could just expand on those thoughts.

Eric, sure. This is Bob, happy to do that. First of all, I'm in a transitionary role moving to this, the new customer experience team led by Greg, and currently continuing to lead the merchandising organization until that position is filled. I will tell you we've got very strong merchandising leadership and our 2 SVPs GMM and our MVP ranks, lots of tenure, lots of great capability as it relates to their leadership of the line review process. So I don't think we have any hiccup there. Two other elements as it relates to kind of moving past the 90 day and trying to look at this to make sure quality is the winner, is we -- as we've said in the past, our clearance program as it relates to clearancing out inventory is being scrutinized so that we are as profitable as possible on clearance. So that, again, we get the margin inflection in the back half. And then the second reason I would cite as it relates to taking a little bit more time is that as private brands grow their penetration in some of these lines, where they're relevant and where they don't displace the powerful national brand, there are some lead times related with import products that are also giving us a little bit of inflection on the 90 days.

Great. And then secondly, just in terms of market share, wonder if you all have any perspective on the market share performance relative to the channels or the competitors that you're now thinking about? How that looked in 1Q and how you think about that through the balance of the year?

Eric, this is Greg Bridgeford. I think that we -- when we look at share, we've looked at the NAICS figures and home improvement channel is the lowest performing of all the channels. But it seems to be quite a volatile figure as you've seen the revisions that Census Bureau has just applied to 2010 and some 2011 figures. But the home improvement subdivision of 4, 4, 4 is increasing at about 9%. It's driven heavily by the major players in that industry, but some of the hardware channel, the garden supply channel are increasing at significant double-digit rates. So what we're watching is, and I'll go back to what Bob said earlier, we're looking at, from the customer lens, where are they looking for an inclusion in the project process and where are they finding information related to pricing of projects help in this industry. So we're trying to make sure that as we look at what our channel has represented in the past, which was primarily getting supplies and that we're going to represent a different vehicle for them in the future. We've got to be fundamentally sound in getting supplies, but we also realize that specialists appear to be making gains in some specific categories. We want to make sure that as we alter our business model that, that business model reflects the changing points of entry for consumers today as they look at the projects both large and small.

Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again, when we report our second quarter 2012 results on August 20. Have a great day.

This concludes today's conference call, and you may now disconnect.