Good morning, everyone, and welcome to Lowe's Companies First Quarter 2014 Earnings Conference Call. This call is being recorded. [Operator Instructions] Also, supplemental reference slides are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call. During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. 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. Hosting today's conference will be Mr. Robert Niblock, Chairman, President and Chief Executive Officer; Mr. Mike Jones, Chief Customer Officer; 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. We delivered comparable sales growth of 0.9% for the quarter, driven primarily by an increase in comp average ticket. While prolonged winter weather exerted pressure on our business, our enhanced sales and operations planning process, along with our distribution infrastructure, allowed us to align resources, such as inventory, staffing and marketing, more effectively by climatic zone. In the South and the West, where weather was more favorable, comps were in the mid-single digits. The Northeastern part of the country, which was the most impacted by poor weather conditions during the quarter, experienced negative comps and some of these regions faced additional headwinds from last year's Superstorm Sandy recovery activity. For the quarter, 7 of our 12 product categories had positive comps. Overall, indoor products, which accounted for roughly 65% of sales, had solid performance with positive comps of approximately 2%. In fact, in areas of the country where weather was more cooperative, indoor comps were mid-single digits. However, outdoor products declined approximately 1.5% overall. We continue to see strength in our ProServices business, which outperformed the company average during the quarter. And I'm pleased to share that our team in Canada delivered double-digit comps in local currency for the fourth consecutive quarter. We remain focused on improving our profitability, even while investing in key capabilities to drive sales growth. For the quarter, gross margin expanded 70 basis points, driven by a number of factors that Bob will discuss. Additionally, we effectively controlled expenses in the quarter and delivered earnings per share of $0.61, which included unfavorable charges related to long-lived asset impairments and favorable impact of a lower tax rate for the quarter, for a net benefit of $0.03 per share. Delivering our commitment to return excess cash to shareholders, in…

Thanks, Robert, and good morning, everyone. We executed well during the quarter despite an unexpected prolonged winter in many areas of the country. While we saw reduced demand for many outdoor products, we bolstered performance in our seasonal categories by helping customers dig out from snow and ice, as we positioned truckloads of weather-relevant products at our regional distribution centers, which enabled quick deliveries to our stores in areas hardest hit by winter weather. We also offered customers a new outdoor living experience that inspired them to buy patio furniture and accessories even when the weather didn't cooperate in parts of the country. I'll share more of this experience in a few minutes. In rough plumbing and electrical, we generated strong sales by providing ample supplies of products customers needed to repair pipes damaged by the severe cold, as well as prepare their HVAC systems for spring. Moving to interior projects. We drove strong sales in fashion fixtures, where we saw particular strength in light bulbs, driven by LED and other energy-efficient products; and in fashion plumbing products, such as bath faucets, vanities and toilets. We are providing compelling new styles and coordinated sets for customers refreshing or remodeling their bathrooms, and our in-home Project Specialists are simplifying the process by guiding customers through inspiration, design and installation. We continue to drive solid performance in kitchen and appliances, where our extensive offering of major brands, along with service advantages of next-day delivery and haul away, and in-house facilitation of repairs and maintenance, provides a best-in-class customer experience. We also drove solid performance within tools and hardware. Particularly in power tools, where our lineup of Bosch handheld power tools and accessories performed very well. We are focused this year on 3 priorities to drive further top line growth using our enhanced…

Thanks, Mike, and good morning, everyone. Sales for the first quarter were $13.4 billion, an increase of 2.4% over last year's first quarter. Total transaction count increased 2.9%, while average ticket decreased 0.5% to $64.68. As previously discussed, the Orchard Supply stores had more transactions per square foot, but fewer per store and a lower average ticket than a traditional Lowe's store. So while Orchard aided total sales by approximately 110 basis points and it added roughly 240 basis points to our total transaction growth, it negatively impacted total average ticket growth by approximately 130 basis points. The Orchard stores are considered noncomp, but will be included in our comp sales calculation after the anniversary of the acquisition in the third quarter of 2014. Comp sales were up 0.9%, comp average ticket was up 0.8% and comp transactions were up 0.1%. Looking at monthly trends. Comps were essentially flat in February, 2.5% in March and flat in April. While the late Easter holiday did not affect comp sales for the quarter, it did impact the monthly spread. We estimate that normalizing for the timing of Easter holiday, March and April comps would have been 0.8% and 1.9%, respectively. We are encouraged that both ticket and transactions adjusted for the Easter shift improved sequentially each month of the quarter. This trend has continued into May. Gross margin for the first quarter was 35.5% of sales, a 70-basis-point increase over last year's first quarter. The increase was driven primarily by Value Improvement and the mix of products sold. SG&A for Q1 was 24.76% of sales, which deleveraged 14 basis points. Employee insurance deleveraged 18 points, primarily due to the Affordable Care Act, which drove a 10% increase in enrollment. We incurred long-lived asset impairment expense of $23 million, which resulted in 17…

[Operator Instructions] Your first question will come from the line of Matthew Fassler with Goldman Sachs.

My first question relates to sales and my second question or follow-up, if you will, relates to SG&A. Would it be possible for you, either to quantify the sales that you think you lost to the weather in Q1 or talk about the first half versus second half sales relationship that you would expect for 2014?

So Matt, we think the weather impacted our Q1 sales by approximately 150 basis points, that about 35% of our sales are outdoor or mix related. So it had a pretty good impact on Q1. As we said in our prepared comments, we do expect to recover the majority of that in the second quarter.

Okay. And as we think about the base that you would add that to, should we think about the run rate that you have in the nonweather-impacted markets and then add 1.5 points to that, or is that too simplistic of a calculation?

Probably too simplistic, since we've got tougher Q2 compares. As we indicated, our May is off to a good start. We're running at about mid-single-digit comp, driven by good balance of ticket and traffic. So we feel good about the start to Q2 and our ability to recover lost sales from Q1.

Great. And then on expenses, I just want to refer back to some of the color that I think you gave us after Q4, about a couple of expense items that you didn't reference. I think you had originally expected a bonus from retirement to deleverage for you a bit. You had also called out a property tax -- I'm sorry, store payroll item, in terms of significant leverage. Can you talk about what impact bonus accruals had on SG&A? And if it's possible to quantify the labor levers that you had, it would be very helpful.

So Matt, I think a couple of items we talked about were risk insurance would be unfavorable because of a unfavorable -- excuse me, to a favorable adjustment we had in Q1 '13. We actually experienced a favorable adjustment this quarter as well. But that was somewhat offset by the impairment, higher utilities and snow removal costs associated with the weather. We did think that bonus was going to leverage -- excuse me, deleverage in the quarter. It actually provided some leverage. If you think about our experience in the first quarter, we missed our sales and earnings plan. Our bonus plans are predicated on operating profitability, so the tax pickup had no impact on the bonus accruals, so we did leverage bonuses by about 9 basis points in the quarter.

And your next question is from the line of David Strasser with Janney Capital Markets.

Two questions. First of all, on the balance sheet, you had an impairment charge that you tend to take them usually in Q4. You took it in Q1 of this year. Can you just give a little background on what -- where the impairment came from and sort of why, the timing of it?

Sure. So we've got a process to evaluate the profitability and viability of store locations. That process occurs throughout the course of the year. There's a footnote in our 10-K that explains the process in some detail as we take a look at cash flows for the rolling 12 months to evaluate. There's no magic about what quarter that a trigger occurs and when impairment occurs. It does relate to 2 operating locations that gave rise to the $23 million charge in Q1.

Fair. Back in February, you had -- Bob, you had made a comment that Q1 would be the best comp of the year. Obviously, the weather kind of impacted that. You're -- as you kind of -- I'm asking Matt's question a little bit differently, but as you kind of look at for the first half of the year, how substantial of a recovery do you need to sustain in Q2 to hit your first half estimate -- to hit your first half sales estimates? I mean, do you -- can you see a deceleration as that tough comp continues -- the tough comparison from last year continues through Q2 and still get to the -- your first half plan? Or is it -- or is that kind of mid-single that you talked about a kind of number that you sort of need to hit?

Yes. So on the Q4 call, we talked about Q1 being our -- coming into the year, we thought that Q1 would be our best performing comp, Q2 would be our lowest performing comp, really based on compares relative to 2013. Obviously, weather is going to push some sales from Q1 to Q2. Q2 looks like it's going to be our highest comping quarter at this point in time, even with tough compares. But having said that, the band between comp for Q2, 3 and 4 is fairly narrow.

Your next question is from the line of Chris Horvers with JPMorgan.

I was curious. Your quarter ends on Sunday, and Home Depot's quarter ends on Friday. So we were out in the stores that weekend, and it was a pretty nice weekend on the West, on the East Coast. So do you think that was some of the delta in the comp performance, because you probably had a really not a great first week in the February weather-wise, and then you had -- you missed the -- what looked like, on the East Coast and Northeast, a pretty nice weekend weather-wise in the beginning of May?

Yes, Chris. This is Robert. Actually, what you said was that we end on Friday and they end on Sunday. So maybe that's what you meant, but I think you stated it backwards. But yes, certainly, as you think about the extent of the conversation that we've had so far today, weather was very difficult in the quarter, certainly pretty widespread. We've actually looked at the numbers and said, if we had adjusted and really looked at just the days that would have picked up that last weekend and dropped out the first weekend of the quarter, it would have made a difference on our first quarter comps of about 50 basis points favorable.

Okay, about 50 basis points. And then 2 expense questions. One, I might have missed it, but did you say anything about any negative impact in gross margin from proprietary credit? And then also, on D&A, when you say flat year-over-year, is that a -- that's a -- I assume that's a dollar number?

So the -- there was no negative impact, no significant impact to gross margin from the proprietary credit program and the 5% off val prop. As it relates to depreciation, we do expect dollars to be essentially flat to last year, therefore, driving some leverage that contributes to the EBIT increase of 65 basis points for the year.

And your next question is from the line of Budd Bugatch with Raymond James.

Just a couple of quick ones. Pros -- Pro sales penetration in the quarter, where was it as a percentage of sales and where do think it will wind up for the year, with your new Pro programs?

Budd, this is Rick. We look at Pro as now approximately 30% of our total mix of business, and we continue to work on that daily. The thing that we've really looked at Pro, when you look at Q1, it was roughly 3x our comp number for the company. And I think we're getting some credit for the continued progress of the initiative. When you look at the Pros, they're reacting very strongly to our structure that we implemented last year of in-store specialists who really manage and handle the customers when they come inside the stores; our market account specialists, which manage the larger accounts within the marketplace; and then our national accounts program, which manages those accounts that do business across many stores across the country. That process and that program is working extremely well. Keep in mind, the investments that we made in inventory as well as the val prop proprietary credit discounts that we offer them to give them additional incentives, as well as our normal Contractor Pack pricing, which Mike spoke about earlier, as well as our other programs there to help continue to provide great value for them. We see the relaunch of LowesForPros being a significant opportunity to continue to drive share and increase penetration with that customer. As Mike said, we'll begin to test that with some customers in Q2, with the expected full launch to be in Q3 from that program as well. So we feel very good about where we are from a Pro standpoint currently. We believe they have reacted very well to our initiatives and our programs that were put in place over the last 18 months, and we continue to see that to progress into this quarter. And Mike, I'll turn it over to you, let you talk about some of the initiatives from a merchandising standpoint we're working on, from a brand and assortment standpoint.

Absolutely. The team made good progress on being more relative with Pros inventory depth, certainly critical localization, we continue to make progress on, as well as on brand. We continue to work to our brand portfolio to ensure that we have the right brands that Pros need. So we feel very good that our holistic approach of separating out those divisions that lean very heavy towards categories that have a heavy penetration of Pro. I spoke about it earlier, lumber and building material, tools, hardware, rough electric, rough plumbing, millwork, that putting them together under a single leader has helped us put more focus there. And the team continues to make progress on those areas that are critical for Pros.

Your next question is from the line of Dan Binder with Jefferies.

So I had a couple of questions. First was on labor training and kind of where you are with labor add-back and training. I think last fall, you had thought you needed to maybe add some more training hours, so maybe an update on that. And then on gross margin, as you know, your main competitor has essentially put a cap on where they want to see gross margin go for competitive reasons. And I'm curious what your point of view is on that as it pertains to Lowe's and where you think your gross margin should be.

Dan, this is Rick. I'll take the first part of that question, and then turn it over to Mike to answer the question around margin. From a labor perspective, we feel very good about where we were and what the operations teams with Dennis Knowles was able to accomplish in the quarter as we continue to look at payroll to provide positive leverage during the quarter during a very difficult environment from a weather perspective. It was an outstanding job on their part. And we feel comfortable that the labor that we added back in the stores last year as part of our weekday teams helped us fill that void that we had during the peak selling times of the weekdays, and we think there is no need to continue to add any incremental labor back into that environment. So currently, what we're looking at, of course, is as sales improve, we continue to add labor to match sales rate. That's the way our staffing programs and plans work. And our part-time mix gives us the flexibility to flex up and flex down to meet sales trends throughout the quarter, and that's what really helped us continue to provide solid leverage during Q1. As it relates to training, we spoke about training in Q3 from a perspective of making sure that our investment of those weekday team members was as solid as we can get, and we realized there were some training gaps there. We made some adjustments to the program to help solve that issue by placing them into specific departments versus allowing them to work in multiple departments, therefore able to provide them much better training to assist the customers in those departments. We feel good about that. The other aspect that we talk about as we continue to migrate to becoming an omnichannel retailer is to continue to develop skill sets of our employees in the stores. And we've invested a substantial amount of training time last year, making sure that they were able to address our customers when they came into the stores looking at the type of trips they were into shop, whether that be the customer is in on a specific mission trip, whether it was a project trip, or whether they were in the store seeking inspiration. We did substantial training with every associate on being able to recognize those and being able to adapt to the customer and what they wanted to focus on. So we continue to work on training. It continues to be a significant focus as we move into 2014, but we feel very good about our programs from last year, the investments we made and the results they provided. So Mike, I'll turn it over to you to answer the question on margin.

Sure, absolutely. Our 2014 outlook talks to approaching 35%, but we don't think there's a hard cap on gross margin. Let me talk about Value Improvement, because that's the process that we use to really manage how we do our line reviews, which is a huge contributor to gross margin. We have a very balanced approach with our vendor partners. We always look at growth for both us and our partners. Innovation is central in those discussions. We look at value for customers. We see these engagement opportunities as an opportunity to build partnership. And of course, cost is always a part of that discussion. But when you think about gross margin, you also got to think about line design as it impacts mix, and you got to think about the ability to find efficiencies with both us and our vendor partners so that we can drive out cost. So we think all this comes together to allow us to go after improved margin. And it's working, and it's working very well along all those fronts. So I don't know that it is a hard cap. We are continuing to drive mix, look for efficiencies and -- while improving our partnerships and going after innovation, and we're doing it in an environment and in a way that's allowing us to expand margin.

Yes, Dan, this is Rick. Just to expand on one other key point, and that's related to our Sales & Operation Planning process. One of the things that we identified as we continue to look, over the last couple of years, was our ability to attach and how do we really continue to drive that through our employees and how we merchandise our stores and get our stores prepared for events. And our Sales & Operations Planning process helps us really understand the attachment to go along with the core item, which ultimately helps us improve the basket, therefore helping us to improve the overall margin mix within the basket as well.

Dan, this is Robert. Just to sum it up, we -- as we go to market, we will continue to be priced competitively. As Rick spoke of, it's helping, mix and margin, with attachment and the right items there. As Mike said, we've done a lot of work the past couple of years going through our Value Improvement line review process. If you recall, during that period of time, there was some disruption where we had excess product that we had to clear and mark down, and we refer [ph] to cycle through the majority of that now, so a little bit cleaner numbers are coming forward. But just so -- the underpinning for all of that is we will continue to be competitive on price in the marketplace across all channels that we compete in, so...

Your next question is from the line of Dennis McGill with Zelman & Associates.

You touched on a couple of regions, I think you mentioned the Southwest and Northeast. I was just wondering, how many regions do you have? And can you just maybe talk across all of them, sort of what you saw relative to the company, like comp in the quarter?

Yes, Dennis, this is Rick. We have 3 operating divisions, and that's what you heard us speak about when we talked about the Southern markets, the West and the Northeast. Within those, we have 14 regions encompassing a mix of each of those. What we saw was, as Bob highlighted in his comments, where we had solid weather or good weather, more normalized, we saw solid mid-single digit comps around each of those geo-zones, as we refer to them, Deep South and South being particularly strong. The central parts of the country performed well, particularly as we got into the latter half of the quarter. The North and the upper North was where we saw a greater amount of weather impact, and where we saw the negative comps from an overall sales environment as a result. So we feel very good in those markets from -- for the quarter from the Deep South, Southern and Central areas. The North and the upper North is what put pressure on the overall performance.

Okay. So at the highest level, the South and West was at mid-single and the Northeast was down at the 3 divisions?

That's correct.

Yes, and Dennis, basically, we look -- this is Robert -- we look inside the South and the West, every region in those had positive comps. When you get up to the North, the division, every region within that had negative comps. So it really does kind of [indiscernible] that we saw during the quarter, so...

Okay, great. And then second question, just on margins. I think you highlighted the Value Improvement, as well as mix, on gross margin in the quarter. Can you separate those 2 and just maybe talk to, on the outlook, how those 2 things would trend, particularly here in the second quarter?

So of the 70 basis points improvement, Value Improvement was 45 basis points and mix was 20. As we cycle last year's Value Improvement activity, we would expect that benefit to diminish as the year progresses. The mix impact was primarily a result of selling less seasonal goods in the first quarter. We would expect that to flip in the second quarter, as we recover lost sales. It should be a slight drag in Q2 and then revert back to being flattish or neutral in the second half of the year.

Your next question is from the line of Kate McShane with Citi Research.

I just wanted to know if we could have a little bit more detail on any changes we can expect from the changes in the merchandising team. Could we see further refinement to your merchandising strategy, and how disruptive could this be? And then just with regards to some of the refinement strategy you continue to make at the store, was there anything during the quarter that you could highlight that was particularly beneficial?

Sure, absolutely. This is Mike Jones. We don't anticipate any radical changes in our merchandising strategy. Our initiatives are very well vetted. We believe they will continue to create value for us. We love the enhanced partnerships that we have with our vendor partners. We're extremely close with our vendor partners. Our team has a very strong bench, and all of our leadership was united in our development of our functional plans. So there's no anticipated change at all. And we're confident that the changes that we've made with some of these promotions of some of our talent that's on our bench will be well received by our vendor partnerships. So we're very comfortable there. I spoke of the outdoor living set as one of the combined efforts between our merchandising team and our customer experience design team, which in particular, in areas that had pretty good weather, did extremely well, extremely well. So excited about that. As you look at the divisions that performed above the company average, you'll notice that our fashion fixtures is one of them. And if you walk our stores, you'll see a much more enhanced display of the way we do our bath sets, which is another example of how our merchandising team is working with our vendor partners to have the right products, as well as the influence of our customer experience design team as well. So we're very excited about our merchandising initiatives, we've very excited about our partnerships and we don't anticipate any dramatic changes.

And in -- Kate, you also had a question about, was it any store refinements? I'm sorry, I didn't really catch what you -- what the intent of your question was?

Just as you continue to refine some of your merchandising strategies, were there any wins during the quarter that maybe were surprising to the upside or that were better-than-expected?

Yes, the 2 I would note would be the success that we had with our fashion fixtures, as well as our seasonal set that I spoke of.

Your next question is from the line of Greg Melich with ISI Group.

I have a couple of questions. First on the traffic and ticket mix. I think at the beginning of the year, you guys said about 2/3 of the comp will be ticket and 1/3 traffic. Given how the first quarter played out, do you expect that to change for the full year? And as May has recovered, is it the -- how did the traffic and ticket breakdown look like?

So as we think about our seasonal business, lawn and garden in particular is a huge driver of transactions in traffic for us. That was weak in the first quarter. That is beginning to recover in the second quarter, so that gave rise to the -- an out-of-balance performance, with almost all the comp being driven by ticket in Q1. As we get that traffic in lawn and garden business back in Q2, that is more balanced, almost 50-50 thus far in the second quarter. We think for the year, the 2/3, 1/3 ticket and traffic still holds up.

That's great, helpful. And then on dot-com, you mentioned in several of the answers, how it's an initiative with the Pro, with the consumer and with some of the labor initiatives you have in specialist departments. Could you give us an update on where you are in that and in terms of percentage of sales, or ship-to-store or other things you got going on?

Yes. Overall -- I'll start and have others jump in. Greg, overall, our dot-com business was up a little more than 25% in the quarter, so we're pleased with what we see there. Obviously, we're excited about adding LowesForPros in the second quarter, will really give the Pro a dedicated website to be able to transact on, with the additional functionality that Mike spoke of in his comments. We're still continuing to see about 50% of what is bought online is actually picked up in store. So the customer is using it in a -- it's really our whole strategy of being there to meet their needs whenever and wherever they choose to engage. And then on top of that, there's about another 20% that is delivered from the store to the consumers' homes. If you think about it, about 70% of what we sell online is fulfilled through that store channel. So it's -- as I said, being there whenever and wherever the customer chooses to engage. And we're happy to ship it to them, have it available in store, whatever. And we're continuing to add functionality, continuing to add the necessary products and refine the offering that we have now. Mike, I don't know if you have anything else on...?

No, I think you summarized it well. The one thing I would add is that we do have very strong dot-com businesses in some of the seasonal areas, some of the OPE, where we tend to index very highly. And as we look at the first quarter, we can see that some of the divisions that were below the company average have a pretty big footprint on our dot-com sales. And so that was a little bit of a headwind that we expect to see pick back up as we go into the second quarter. But all told, we feel very comfortable with our continued build-out of our omnichannel environment.

And your final question will come from the line of Mike Baker with Deutsche Bank.

Just a quick one to start. You said the weather impacted you by 150 basis points. If we add that back, then you would have comped at 2.4% in the first quarter, which still would be below your plan. Your plan was for the first quarter to be the highest comp of the year, which may be, well certainly above 4%. So what else missed the comp line in the first quarter?

So we've had -- we were expecting some level of deflation in the quarter. It was a little bit higher than we anticipated. The -- as we think about the estimates of comp impact, they're not precise. As Rick and Robert took you through the geography, strong performance in West and South, really challenged performance in the Northeast. So we do feel like we can recover the lost sales. We do feel like there's other activity, some of the initiatives that Mike spoke of regarding the experience design. Rick and Mike both talked to you about some of the Pro initiatives that's going to gain traction throughout the course of the year. So we feel that we'll recover the lost sales and do have other initiatives that will drive the 4% comp for the year. And the good news is, we're seeing evidence of that thus far in May.

Okay. So to follow up on that, how much did deflation hurt, and does that get better? And I guess, maybe my words instead of yours, but you said 150 basis points. I guess, what we should interpret that is that's not that precise. It could -- the weather could have been more or less than that.

Right. So we estimate it's 150 basis points. However, the West and South comped roughly positive 4%. The Northeast comped roughly negative 5%. So that tells you that's a 900-basis-point spread, so...

And what percentage of your stores are in the Northern region?

I'm sorry?

What percent of the stores are in the Northern region? Is it roughly 1/3, 1/3, 1/3?

Probably 30% of our sales. So we've got a consistent methodology to calculate weather impact. That hasn't changed. But if you take a look at just the division performance, you can see that weather could potentially be bigger than that. The deflation impact was 35 basis points. We see improvement in comparisons relative to lumber, so we see that headwind going away as the year progresses.

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 2014 results on Wednesday, August 20. Have a great day.

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