勞氏公司 (LOW) 2002 Q2 法說會逐字稿

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  • Operator

  • Good morning, everyone, and welcome to this Lowe's Companies' Second Quarter Earnings Release Conference Call.

  • This call is being recorded.

  • Statements made during the call may include forward-looking statements.

  • Within the meanings of Section 27A a of the Securities Act and section 21E of the Exchange Act.

  • Although the company believes such statements are reasonable, it can give no assurance that they will prove to be correct.

  • Possible risks and uncertainties are detailed in the company's August 19, 2002, earnings release and the company's filings with the Securities and Exchange Commission.

  • Hosting today's conference will be Mr. Robert Tillman, Chief -- Chairman of the Board and Chief Executive Officer, Mr. Tom Whidden, Executive Vice President, Logistics and Technology, and Mr. Robert Niblock, Executive Vice President and Chief Financial Officer.

  • Please note that the conference will conclude promptly at 9:45 Eastern time.

  • I will now turn the program over to Mr. Robert Tillman for opening remarks.

  • Please go ahead, sir.

  • - Chairman of the Board and Chief Executive Officer

  • Good morning, and thank you for joining us.

  • Today in addition to hearing about our second quarter results from Robert Niblock, Lowe's' Chief Financial Officer, Tom Whidden, our Executive Vice President of Logistics and Technology will outline the competitive advantages of our centralized integrated logistics system.

  • I'll begin this morning by highlighting our second quarter results.

  • Sales quarter totaled $7.5 billion, a 22.2 percent increase over last year.

  • Comparable store sales increased 6.8 percent for the quarter.

  • We achieved a Lowe's record 10.6 percent EBIT margin in the quarter, surpassing the 10 percent mark for the first time in the company's history.

  • Earnings per share were 59 cents for the quarter, increasing 40.5 percent over last year.

  • For the past few quarters, we have discussed the balance we have seen in our business across all geographic regions across all product categories.

  • That balance continued in the second quarter.

  • In addition, we are pleased with our sales performance in the metro markets including those in the Northeast which provide clear evidence of the opportunity those markets provide for higher volumes, enhanced profitability, and population dynamics that will drive strong growth for years to come.

  • We also saw a balance across product categories during the quarter with no one category driving our total comp growth.

  • We were pleased with the strong comp performance we experienced across all home decor and outdoor living product categories.

  • In addition, we continue to capture market share in appliances with a 12.9 percent share of the total market at the end of the second quarter.

  • A topic that appears to be top of mind for everyone is the state of the economy.

  • In particular, much has been made of how consumers will react to following equity markets and the ongoing publicity of accounting scandals and irregularities.

  • And while it's somewhat inevitable that these events will likely have a short-term effect on consumer confidence, we're not experiencing the collapse of consumer spending that some have predicted but, rather, a continued and ongoing focus of customers investing in their homes despite the uncertainties of the current economic environment, customers continue to demand higher-value products.

  • This migration to quality is an indication that consumers view home improvement as synonymous with home investing and when you are investing in your single largest asset, great quality and tremendous value are a must.

  • Federal reserve Chairman Alan Greenspan recently noted that people are more likely to base spending calculations on the value of their homes rather than on the value of stocks and many economists forecast continuing strength in housing in years to come.

  • For the past 34 years, since 1968, when the National Association of Realtors began keeping track of medium and average home prices have grown each and every year.

  • Certainly during that time, housing has become overheated in particular markets but as a whole, the housing stock across the nation has continued to increase in value.

  • Demographics will play a big role in the continuing strength of the US housing market.

  • Factors such as an aging baby boomer population with many buying larger second homes with more amenities than their first, a growing immigration population focused on the American dream of home ownership, and maturing Generation X with a more traditional approach to home and family than their parents all bolstered by historical low mortgage rates, stabilizing unemployment, and increasing real disposal personal income, will provide support for the housing and home improvement markets in the years to come.

  • Last week, mortgage rates fell to an all-time low, which is continuing to drive mortgage refinancing activity.

  • Historically, approximately 1/3 of the equity that consumers take out of their home is spent in the home improvement channel.

  • In addition, for those who refinance but don't take out extra cash, they typically reduce their mortgage payment which generates extra disposable income.

  • These factors should continue to support consumer spending and offset other potential negative factors such as volatile stock market and declining consumer confidence.

  • As a result, we continue to remain optimistic about trends in home improvement spending.

  • The Home Improvement Research Institute seems to agree.

  • This industry research group recently increased their current year forecast for the industry to 4.2 percent growth from a previous forecast essentially no growth this year.

  • HIRI reasssments now call for 4 percent growth in 2003 and approximately 6.5 percent per year in '04 and '05.

  • We're confident the future remains bright for Lowe's.

  • We operate in a growing industry with with a store concept that focusing on serving our customers' needs with many years of highly profitable expansion opportunities remaining in both large metro markets as well as smaller more rural markets across the country.

  • Despite our rapid expansion over the past several years, we have continued to invest in updating our existing store base.

  • Our oldest stores have undergone continuous product resets and have been updated to ensure that all our customers in both new and existing markets enjoy our latest product offerings and merchandising resets.

  • One of our largest investments and ultimately our greatest asset is our people.

  • Employees trained to serve our customers to make Lowe's the first choice in home improvement in every market we serve.

  • The key to our success is that we ultimately retain the best people to represent Lowe's in the aisles of our stores every day.

  • Our success in that regard is evident in the numbers.

  • Our turnover rate for all employee categories both full and part-time, hourly and salary, is at the lowest level since Lowe's became a big box retailer.

  • I'm confident we have the most talented best trained team in our modern history which will allow to us continue to grow while providing exceptional customer service in our stores each and every day.

  • With that, I'll turn it over to Tom, who will discuss another one of our competitive strategic assets, our logistics and distribution infrastructure.

  • Tom?

  • - Executive Vice President, Logistics and Technology

  • Thanks, Bob.

  • Good morning.

  • In the past, when I have spoken about the logistics advantage at Lowe's, I have taken a holistic view of our system, highlighting the facts that logistics at Lowe's is much more than just a network of distribution facilities.

  • But, rather, an integrated network of people, systems, and infrastructure.

  • Much of what is logistics is what you may not be able to see.

  • It's what is behind the distribution centers.

  • It's the cross-functional integration of operations, merchandising, and logistics through point-of-sale systems, automated reordering, and years and years of systems development that is not available off the shelf at any price.

  • But what I want to do this morning is to focus in on only one piece of this capability.

  • I want to take a deep dive into the distribution component of our logistics advantage.

  • And discuss the approach we've taken to continue to drive costs out of our supply chain while improving in-stock positions in our stores.

  • Most of you listening this morning know at least a little bit about Lowe's' history.

  • We are a 56-year-old company and our roots began in the small to medium sized markets in the Southeast.

  • While logistics in streamline distribution were a vital component for [Carl Barkin's] vision back in the '50s, distribution became even more critical in the early '90s.

  • When we began converting our small commodity-oriented stores in these smaller markets into large, big box warehouses, we knew that if we weren't extremely efficient in managing an inventory and flowing product to these relatively lower-volume markets, we would struggle to make a profit.

  • This morning, I'd like to describe how our distribution infrastructure allows us to not only flow product to these smaller markets but also supply our higher volume metro markets efficiently and cost effectively, minimizing our inventory investment, shortening lead times, and maximizing sales.

  • If I were to describe the distribution advantage at Lowe's in one word, it would be flexibility.

  • One of the first steps in our distribution process is to look at every product from every vendor to determine the most efficient way to get it onto the shelves of our stores, balanced with acceptable lead times, and ultimately into the hands of our customers.

  • The benefits of effective distribution are at least threefold.

  • First, we minimize the fully loaded cost of products in our stores.

  • We minimize the operational resources needed to receive freight at the store level.

  • And lastly, we reduce our vendors' costs of doing business with Lowe's, a savings vendors share with us through lower product costs.

  • I'll discuss each of these benefits in a little more detail.

  • The first and probably the most obvious benefit of an efficient distribution network is the ability to minimize the fully loaded cost of products.

  • As I mentioned, we look at every product and every vendor to determine the most efficient way to get that product into the hands of our customers.

  • Some of the distribution options include, one, flowing product through our regional distribution network.

  • Two, shipping product through consolidation facilities, also called transit facilities.

  • Three, using commodity-focused flatbed reload distribution centers.

  • And, four, shipping vendor direct to our store.

  • The great thing about our infrastructure is that, based on both vendor and product specifications, we have the opportunity to use any of these options in order to get product to the stores timely and most efficiently.

  • The first piece and the backbone of our distribution system is our regional distribution centers.

  • We currently have seven RDCs in operation with two more under construction, one in Cheyenne, Wyoming, and the second in northeastern North Carolina.

  • These distribution centers average over one million square feet, each on average is designed to service 100 to 120 stores and flow over $1 billion of inventory each year.

  • Our RDCs are extremely flexible.

  • Not only are they one of the most efficient cross dock facilities in the world, but they offer the ability to break vendor master cartons or cases into single units, reducing the minimum ship quantity of any product to as low as one.

  • The break-pack feature of our distribution system is vital to its success and is a key reason we have been successful at managing our inventory investment even in lower volume markets.

  • Let me address cross dock.

  • Our RDCs are highly efficient cross dock facilities.

  • If individual store demand warrants receipt of full cases or cartons, we use the over six miles of automated conveyance in every RDC to move product directly from a receiving door across the facility and on to an outbound truck, all with only minimal human intervention.

  • In instances where product received at the RDC is palletized, we can also load full pallets on the individual stores' outbound truck

  • But cross docking is only a part of the story.

  • A key to effectively managing our inventory asset is to effectively manage the C and D items, items critical to providing our customers a full and complete assortment yet items that turn at a relatively low velocity.

  • Demand for these items can best be described as lumpy.

  • A store may go for several weeks without selling any of a particular SKU and then several within a week.

  • The key here is replenishment.

  • We can't afford to keep large amounts of safety stock on the shelf at every store but what we can do is keep safety stock in the racks of the RDC with replenishment capability to every store in the network within 48 hours.

  • On average, a store will receive three to four truckloads from its RDC every week, so on average, a product in any store can be replenished within 48 hours.

  • Our system allows us to first break a vendor shipping carton into individual units, keep replenishment stock at the DC and then on demand as the product is sold, send as little as one unit to the store that needs it.

  • Not via UPS or LTL shipment, but, rather, in a full truckload with all the other inventory going to that store.

  • The distribution costs of sending this single item to the store is kept to an absolute minimum because it travels as part of a mixed item full truckload.

  • Essentially, as we sell one, we can replenish one.

  • Most importantly, at a minimum freight cost.

  • As many of you have know our expansion focus over the next several years is in the major metro markets across the US and the question I have been asked is whether the higher volume of these markets, while an obvious benefit to Lowe's, would discount the value of our investment in our RDCs.

  • The argument assumes that as volume increases, shipping vendor direct to our stores becomes a better economic option.

  • The truth is that even a high volume 50 or $60 million store has a huge number of slower-moving SKUs that can be flowed using this process.

  • In a high volume store, the A and B items still drive the sales.

  • In fact, as volume increases, these A and B items capture an even higher percentage of the total store sales.

  • So even in high volume stores, there is competition for shelf space.

  • With A and B items driving even harder for that space.

  • But while it is perhaps tempting to give more space to As and pull out Ds, we know that in order to maximize sales those slower moving SKUs are critical to the assortment.

  • The answer is efficient replenishment of all items in the right quantities.

  • In addition, the higher volumes help us leverage the fixed cost of our distribution infrastructure, which highlights another point: Our RDCs are scalable.

  • As volume per store increases, we don't need more space or more doors in the DC.

  • We simply leverage the investment we've already made.

  • Reducing the company's distribution costs as a percentage of cost of goods sold.

  • But perhaps one of the greatest benefits to a high volume store from our distribution system is the concept of good faith receiving.

  • This is one of the greatest operational benefits of our distribution infrastructure.

  • Product is counted and vendor shipping invoices confirmed only once, when the product is received from the vendor at the distribution center.

  • Trucks are packed at the RDC and shipped to the stores.

  • When the store receives a shipment, they aren't required to count and confirm what is on the truck.

  • They simply receive the entire contents of the truck into inventory unload the products, and work to put them on the shelves.

  • Years of audits confirm over 99.95 percent accuracy of all truckloads so recounting not required.

  • This saves countless hours of labor that would be required to count and confirm the shipments a store receives.

  • Thus, the higher volume of a store the more shipments they receive and the greater this benefit is to the productivity of the store.

  • Also, consolidated full truckload shipments reduce the number of trucks bumping the dock at our stores every day.

  • Again, even more important in a high volume store.

  • More products flowing to the high volume stores in truckload quantities reduces the number of carrier and truck deliveries allowing better scheduling of receiving crews and the fast, efficient stocking of products on the shelves.

  • This ability to manage receipts is perhaps most important during the freight-intensive spring selling season.

  • The key is flexibility.

  • We're not limited to only a few distribution options.

  • Instead, we let the characteristics of the product and the capabilities of the vendor determine the distribution approach we use.

  • The goal is the highest level of in-stock position at the lowest possible landed cost of every product onto the shelves in our stores and into the hands of our customers, whether we're working with the high velocity A item or a slower turning D item.

  • An additional and significant benefit of the our distribution is our ability to allocate inventory to specific stores when product is shipped from the RDC, not when the order is placed with the vendor.

  • Vendor-prepared cross docks have their place and it's a system that we use for products with highly predictable demand.

  • But on items that are less predictable, we want to delay the store allocation decision until the product is received in the RDC and less than 48 hours from the store's shelves.

  • To describe this further, product is ordered based on a formula of expected demand and vendor lead time.

  • As you might imagine, we can be much more accurate in forecasting total company demand or demand at an RDC level than we can individual store demand.

  • We place our order based on that total demand, receive a full truckload of product in the RDC, and only then allocate to individual stores based on actual sell-through in that store, based on knowledge up to the previous day's sales.

  • This avoids sending too much inventory to any one store based on a forecasted sales rate that may or may not have occurred.

  • It also allows us to allocate more inventory to the stores that exceeded their forecast.

  • Again, we don't overburden stores with excess inventory.

  • We replenish based on the most recent actual sales results.

  • Freight consolidation or the use of transit facilities is another tool in our distribution system.

  • In some cases, one RDC may only require a partial truckload from a particular vendor to satisfy the needs of the stores it serves.

  • But the demand from the entire chain or several stores may equal a full truckload.

  • In such cases, we use third party operated consolidation facilities to minimize freight costs.

  • The role of the freight consolidator is to receive a full or partial truckload from one vendor, combine those shipments with product from other such vendors, and create mixed product, full truckloads, heading to a store or RDC , reducing total freight cost.

  • We have a sophisticated software application that looks across our entire distribution network, at all of the product vendor relationships, identifying opportunities to utilize this process.

  • Despite the efficiency of our RDC network, some product characteristics warrant this alternative distribution approach.

  • High cube or non-conveyable products are marked for this product.

  • Again, the key is flexibility.

  • Consolidation facilities are only one component of our entire distribution network.

  • A final distribution option is to ship vendor direct to our stores.

  • Again, some product characteristics warrant this approach either due to seasonality, economics, or product sourcing location.

  • High cube, low value products are typically sourced in local markets and are more efficiently shipped direct vendor to store, take quick crete for an example.

  • The economics of shipping bag concrete which is a high weight, low value item, means that direct shipping often makes sense.

  • Live nursery, concrete block and patio pavers are other examples of products that must be sourced locally.

  • And therefore, it makes economic sense to have the vendor deliver directly to the stores.

  • Once the distribution channel decision is made, the transportation planning process begins.

  • Lowe's uses the intelligence of our advanced transportation management system to choose the route, mode and carrier to achieve the highest level of on-time service at the lowest cost.

  • We use our transportation management system to periodically perform an on-line bidding process among carriers competing for our shipping lanes.

  • Each day's shipments are dynamically planned, routed and electronically dispatched to carriers.

  • Shipments and transit are tracked by satellite tracking, EDI status messages and by Lowe's' proprietary reporting to provide one of the see from's finest on-time delivery performances.

  • As an example, truckload on time delivery performance for 2001 was 99.3 percent on time.

  • The most meaningful LTL shipment statistic is transit time.

  • From 1999 through Q1 of 2002, we have significantly expanded our store base geographically.

  • In the average distance traveled for each LTL shipment more than doubled.

  • During that same time period, LTL transit times were reduced by six hours, allowing product to flow to our shelves more quickly.

  • The last concept I'd like to discuss this morning is how our distribution infrastructure saves our vendors money.

  • When we use our network to flow freight, we are able to place fewer total orders made up of more full truckloads from vendors.

  • Thus, we have one PO per RDC, not one PO per store.

  • It also reduces time spent on receiving discrepancies for both the vendor and Lowe's.

  • One discrepancy report per RDC, not one per store.

  • In addition, we require fewer vendor-prepared cross docks.

  • Minimizing the time required by a vendor to pull and shrink-wrap an order for an individual store.

  • All ensuring that Lowe's is our vendor's lowest cost customer, an advantage we use in our line review process.

  • As you probably realize from my comments today, distribution at Lowe's is a complicated and intricate but well oiled machine.

  • We have invested hundreds of millions of dollars and years of research and development to create what we are confident is one of the best logistics infrastructures in the world.

  • With flexibility comes complexity, supported by years of systems development and process training.

  • But it's that flexibility that allows us to minimize our costs, maximize our in-stock position, and ultimately drive margin dollars to the bottom line.

  • With that let me turn it over to Robert Niblock to describe our financial results in more detail.

  • Robert?

  • - Executive Vice President and Chief Financial Officer

  • Thanks, Tom.

  • And good morning, everyone.

  • As Bob indicated, sales for the second quarter were $7.5 billion, representing a 22.2 percent increase over last year's second quarter and slightly ahead of our guidance of 21 to 22 percent.

  • For the first half of 2002, sales were up 22.4 percent at $14 billion.

  • Comp sales were 6.8 percent for the second quarter, which exceeded our guidance of 4 to 6 percent.

  • In last year's second quarter, comps were 1.7 percent.

  • Thus, when you look at a two-year comp trend, our performance this quarter represents our best performance since the second quarter of 2000.

  • For the first half of the year, comps were 7.1 percent.

  • Deflation in lumber and building materials had a negative impact of approximately 24 basis points on second quarter comps.

  • With regard to product category, the categories that performed above average in the second quarter include: Paint, windows and walls, cabinets, flooring, nursery, appliances, outdoor fashion, outdoor power equipment, and rough plumbing and electrical products.

  • In addition, hardware and home organization performed at approximately the overall corporate average.

  • For the quarter we achieved a record second quarter gross margin of 29.41 percent, an improvement of 137 basis points over last year's second quarter and significantly ahead of our guidance of 50 to 60 basis points.

  • The primary driver of margin expansion was better margin rates driven by reduction of inventory costs.

  • Other factors that contributed to the improved margin rate include, product mix improvements which accounted for 21 basis points, and a reduction in inventory shrink as a percent of sales which improved margin by 11 basis points compared to last year.

  • The improvement in inventory shrink continues a trend we have experienced over the past several quarters, but one which will likely moderate in the future as we cycle against tougher comparisons.

  • On a year-to-date basis, gross margin of 29.55 percent is up 139 basis points over fiscal 2001.

  • SG&A deleveraged 15 basis points in the quarter, yielding slightly worse performance than our guidance of flat to slight leverage.

  • The deleverage in SG&A was attributable to above-planned bonus expense driven by above-planned earnings, and increased advertising costs driven by promotional credit offers.

  • Year to date, SG&A is flat as a percent of sales at 17.01 percent.

  • Store opening costs leveraged 15 basis points and reflects the opening of 21 new and 1 relocated store in the quarter.

  • This compares to 21 new and 2 relocated stores last year.

  • Depreciation at 2.04 percent of sales totaled 153 million and deleveraged 1 basis point.

  • On a year-to-date basis, depreciation is flat as a percent of sales at 2.14 percent.

  • At the end of the second quarter, we owned 74 percent of our stores versus 69 percent at the end of last year's second quarter.

  • For the quarter, we achieved a record operating margin of 10.9 percent, which represented an improvement of 121 basis points over last year's second quarter.

  • Interest expense increased to $46.3 million for the quarter, but leveraged 8 basis points as a percent of sales.

  • For the quarter, total expenses were 19.44 percent of sales, and leveraged 7 basis points which was in line with our guidance.

  • As Bob mentioned, earnings before interest and taxes were 10.59 percent, up 136 basis points over the prior year.

  • Net earnings of 467 million increased 41.9 percent for the quarter.

  • Diluted earnings per share of 59 cents increased 40.5 percent versus last year's 42 cents, and exceeded our guidance of 53 to 54 cents.

  • For the first six months of fiscal 2002, net earnings were up 46.6 percent at $813 million.

  • Diluted shares outstanding total 800 million for the second quarter.

  • The computation of diluted shares takes into the account the effect of convertible [debentures] which increased weighted average shares by 16.5 million.

  • In computing second quarter diluted earnings per share the after tax add-back to net income related to interest on convertible debentures was $2.6 million.

  • For each of the remaining quarters in 2002, the after-tax interest add-back is also $2.6 million.

  • For the third quarter, we are projecting diluted earnings -- shares outstanding of 801 million.

  • For the fourth quarter we are projecting 803 million, and for the full fiscal year 2002, we're projecting diluted shares outstanding of 801 million.

  • For the quarter, we saw a 2 percent increase in average ticket from $56.85 to $58.13.

  • Customer count increased 20 percent during the quarter.

  • Now, highlighting a few items on the balance sheet.

  • First of all, our cash position remains strong with $1.5 billion of cash on hand at the end of the quarter.

  • In addition, inventory increased only 9.2 percent for the quarter, significantly less than our 22.2 percent sales growth.

  • Inventory turns increased 27 basis points from 4.18 to 4.45.

  • Return on invested capital, measured using beginning debt and equity, and a trailing four quarters earnings increased 131 basis points for the quarter from 13.41 to 14.72.

  • Representing Lowe's strongest performance ever on this metric.

  • Our strong second quarter performance drove return on beginning shareholders equity determined using beginning equity and a trailing four quarters earnings to 20.83 percent, representing an increase of 341 basis points.

  • In addition, for the first half of 2002, cash provided by operating activities is $1.6 billion, representing an increase of over 100 percent versus the first half of last year.

  • Looking ahead, I'd like to discuss several of the items detailed in Lowe's' business outlook, which is included in today's release.

  • A third quarter sales increase of approximately -- of between 18 and 19 percent incorporates a comp assumption of 3 to 5 percent, which is expected to generate diluted earnings per share of 39 to 40 cents.

  • As a result of our strong year performance for fiscal 2002, we're now anticipating diluted earnings per share of $1.74 to $1.75, which represents an increase of 34 to 35 percent versus last year.

  • Comparing the middle of the range from today's earnings guidance to our prior guidance, we are increasing our 2002 earnings per share guidance by 7 cents.

  • Gross margin for the third quarter is expected to increase approximately 40 to 50 basis points.

  • For the entire fiscal year, we anticipate a gross margin improvement of approximately 58 basis points, which is an increase from our prior guidance of 50 to 60 basis points.

  • We expect to open approximately 20 stores in the third quarter and are on track to open 123 stores in fiscal 2002.

  • Regarding current sales trends, I mentioned earlier that our business outlook for the third quarter anticipates 3 to 5 percent comps.

  • For the first 16 days of the quarter, our comps are within this range.

  • Also during the quarter, we renewed our $400 million, 364-day credit facility with our existing bank group.

  • In addition to the 364-day [trunch], our credit facility also includes a $400 million five-year [trunch] both of which provide a backstop to our 800 million commercial paper program.

  • In addition, as mentioned in today's release, effective with fiscal year 2003, we will begin to recognize stock options as an expense.

  • Based on the current provisions of statement of Financial Accounting Standards number 123, the impact of this decision is expected to reduce earnings per share by approximately 3 cents in fiscal 2003, with the impact increasing to approximately 9 cents in fiscal 2005.

  • Before I turn the call over to the Operator for questions, I'd like to mention in addition to Bob, Tom and myself, several other members of management are also present for the question-and-answer session.

  • Operator, we're now ready for questions.

  • Operator

  • Thank you.

  • The question-and-answer session will be conducted electronically today.

  • If you would like to ask a question, you can signal us by pressing Star 1 on your touch-tone telephone.

  • We will proceed in the order that you signal us and take as many questions as time permits.

  • Once again, that is Star 1 to ask a question.

  • And we'll pause for just a moment to give everyone the opportunity to signal for questions.

  • Our first question will come from Dan Weaver from CIBC World Markets.

  • Good morning.

  • Terrific quarter.

  • I guess the -- the only blemish is the expense rate that you alluded to, Robert.

  • I wonder if you can provide a bit more clarity on the bonus accruals and if we're in a situation where perhaps the fourth quarter accrual could be, you know, less significant than a year ago?

  • Because you have been able to prepay so much in the first half of the year.

  • - Executive Vice President and Chief Financial Officer

  • Yes.

  • Couple of things.

  • Dan, uhm, first of all, on advertising and those type of things, that hit us for about 13 basis points of deleverage primarily caused by the promotional financing in the quarter.

  • When you look at bonuses, combination of the store bonus plan and the general office bonus plan and the amount by which we're exceeding our original plan for the year, it hit us for 53 basis points of deleverage in the second quarter so certainly to the extent that the second half of the year, uhm -- isn't as strong as the first half of the year, there may be some opportunity there.

  • Obviously, uhm, you know, we're having to accrue at this point to the level of profitability that we have seen year to date and match that up.

  • So we have tried to build all that into our guidance, but certainly that bonus for the year, uhm, to the extent that you are maxed out on it, particularly let's say for the general office bonus, we' already at the maximum.

  • Even if the profitability pulls down from the run rate some of the back half of the year we are still anticipating a maximum bonus level so it's not like we have a whole lot to pull back and we are having to spread that expense evenly across all four quarters.

  • Just one other question, on penciling through your quarterly guidance it looks like you're less optimistic on your fourth quarter.

  • Is that due to economic issues or concerns about how the promotional activity within your industry may evolve?

  • - Executive Vice President and Chief Financial Officer

  • Less optimistic on which line, Dan?

  • On the earnings per share.

  • It looks like you're penciling in about 32 cents.

  • It's only about 15 percent year-over-year.

  • - Executive Vice President and Chief Financial Officer

  • That's correct.

  • And it depends how you do the quarters and guidance we gave for the third quarter.

  • You're somewhere in the 32, 33-cent range for the fourth quarter and what that's really taking into account is we were up 50 percent last year and the fact that as you will recall, we had phenomenal weather in the fourth quarter of last year.

  • And a very strong comp as you know, the fourth quarter is always a very weather-sensitive month.

  • So not being able to accurately being able to predict the weather between now and then, certainly we want to be a little bit more cautious until we get to that point in time.

  • So....

  • Great.

  • Thanks a lot and good luck.

  • - Executive Vice President and Chief Financial Officer

  • Yup.

  • Operator

  • Our next question will come from Alan Rifkin with Lehman brothers.

  • I'll add my congratulations, as well.

  • Couple of questions.

  • You continue to drive the gross margin due to reduced shrink .

  • Can you comment on the sustainability of that going forward?

  • And then Tom, with respect to the three methods that you described with respect to the distribution infrastructure, can you maybe delineate like how much of your inventory is flowing through each of those metrics today and where you see that going forward and what potential synergies of that transition may be?

  • - Executive Vice President and Chief Financial Officer

  • I'll start off with the inventory shrink and then I'll ask Larry to jump in or anybody else in the room.

  • As far as inventory shrink, Alan, as you know, one thing that is certainly a factor that's going against us more and more of our stores are going into metro markets and we generally have a higher percentage of inventory shrink in metro markets.

  • As we get more and more of our stores there,ers that certainly a factor we are fighting against every day when you look at a year-over-year trend line.

  • We have put in several initiatives within the past year that really helped improve that shrink over I think it's four quarters in a row running that we have had an improvement in inventory shrink.

  • But it's not something that we would expect to be, you know, significantly sustainable to continue to drive year-over-year those type of reductions.

  • As a matter of fact, as we put more and more stores in metro markets, being able just to maintain it at or near this level would be a huge win or huge accomplishment for us.

  • So I think I indicated as much particularly in my comments that I went through.

  • Okay.

  • - Executive Vice President and Chief Financial Officer

  • Tom, if you could address the other question.

  • - Executive Vice President, Logistics and Technology

  • Yes.

  • Through our DC network, Alan, we're right in the neighborhood of 50 percent of our inventory flowing through that means.

  • The -- in terms of using the consolidation facilities, I don't have a real good number for you there.

  • It's probably -- it's only probably in the 5 to 10 percent range.

  • That's going to -- that's an opportunistic thing that we use, and, uhm, of course, as volume per stores go up and the more full truckloads, then less than truckloads will kind of diminish the utilization of those facilities.

  • And then obviously the balance is direct.

  • I would tell you, Alan, there's probably some product today -- one of the things that, you know, I talked about at the analysts' meeting last year was our supply chain initiative that's going on.

  • We believe there is a opportunity to move some product that's direct today into our distribution network.

  • Basically, our ultimate goal is to be really sending more trucks center our -- from our distribution -- more trucks from our distribution centers more often with any one less SKU from from a store productivity standpoint.

  • It will certainly help us with our stores that as we move into some of the bigger metropolitan markets and we are challenged with high volume stores with very little storage capacity, it's something that we have to do.

  • Over the next year or so, probably don't see a lot of margin contribution as we are making that transition.

  • But what it will be is the opportunity to drive more sales by being better in stock and again better store efficiencies.

  • Beyond that, yeah, there ought to be some margin opportunity but that's far enough out to not predict.

  • All right.

  • That's very helpful.

  • Congratulations again.

  • - Executive Vice President and Chief Financial Officer

  • Thanks, Alan.

  • Operator

  • Up next we'll hear from Peter Caruso with Merrill Lynch.

  • Good morning.

  • In your presentation you talked about the distribution advantages and those analysts we see that showing up in inventory tern and improving profit margins but your customers see it basically in terms of merchandising.

  • Can you provide just some more detail on the selection advantage that you have against competitors in the industry today?

  • I think your inventory per store is about 15 percent more in obvious areas where you have selection advantage, appliances and I think nursery and maybe outdoor patio.

  • Are there other categories we should be thinking of that you do have selection advantage of that you see your ability to draw market share from?

  • - Chairman of the Board and Chief Executive Officer

  • Peter, this is Bob Tillman.

  • As you know, we have not made a significant reduction in number of SKUs that we stock in our stores today, even in smaller markets because we believe that's part of the strength of our offering.

  • And, of course, across most categories, not just major appliances but across most of the categories we're broader than most of our competitors, particularly in the fashion categories lighting, plumbing, hardware and areas like that.

  • You know we don't see that changing actually we're adding SKUs in some of the areas that like outdoor fashion, outdoor living categories, from where we have been in the past.

  • So we are looking for even broader offering as we move up the continuum in those categories that requires that we carry a much broader offering than what we have even in the past.

  • So I hope I'm answering the question that you are trying to pose here.

  • The advantage we have by carrying 45 - 50,000 SKUs in the store, the distribution component allows us to keep those in stock without carrying excessive inventory.

  • And even in smaller markets, we're still carrying a very wide range of product in those markets, as well.

  • Bob, Lowe's has done a great job over the last decade really differentiating itself to the DIY customer.

  • - Chairman of the Board and Chief Executive Officer

  • Right.

  • Can you talk to us about what you can possibly do to really differentiate yourself from what Home Depot is doing to gain more share of the pro customer?

  • And then just one last question for Bob Niblock.

  • Can he just provide some data on growth of special order business and in-store sales.

  • - Chairman of the Board and Chief Executive Officer

  • Peter, I'll see if I can address that first, I really don't want to do a comparison with what Home Depot is doing because there again I'm not inside of Home Depot and don't understand everything they're doing but we certainly do compete against them in a lot of our markets or most of our markets.

  • I think a lot of things we're doing in terms of our product offering give us tremendous opportunity because Lowe's today in every store has top choice lumber products which means that we have a prime cut product in every market.

  • We are doing a lot of things that the professional customers now gravitating to our synthetic deck product or our choice deck product which we think is going to replace lumber in a lot of markets and, of course, we're out there today in most of our stores with that product and we have all of the associated ancillary products that make that work.

  • We have a program with PELO nationwide that we're rolling out PELO window stores in all Lowe's stores and we are getting tremendous leverage of that but I look at what the pros want.

  • In addition to our hardware department, we have dramatically expanded our hardware offering for both pro and DIY, and we are getting a great response from that we have some new initiatives getting ready to roll out which we can't talk about today in our power tool area which we think will be very, very positive for our pro customers, as well.

  • But that business, a key component of driving that business is being in stock.

  • And we believe we have a logistics capability that will keep us in stock better than anybody else in the country.

  • And the requirement of the pro is, yeah, we want great prices every day but we want to go one place and buy everything we need which means you always got to be in stock and we think that's a key driver for us and a key component of our success moving forward with that customer.

  • - Executive Vice President and Chief Financial Officer

  • Peter, this is Robert.

  • Installed sales and SOS, those initiatives still doing very well both on the tracking ahead of our plan for the year in secretary -- in the second quarter installed sales was up approximately 50 percent and SOS up approximately 40 percent over the second quarter of the prior year.

  • Okay, thanks.

  • Good luck in the next quarter.

  • Operator

  • And our next question will come from Arthur Weiss with [Symphony] Asset Management.

  • Good morning.

  • Wondering if you can talk about the capital expenditures that you are putting into each store for this latest quarter and what you see for that going forward?

  • - Executive Vice President and Chief Financial Officer

  • You know, Arthur, this is Robert Niblock.

  • On capital expenditures, you know, we normally average about 17 1/2 million on average, somewhere around there.

  • Of course, it's more than that in a more expensive in a metro market, less than that in a single store market.

  • As you go forward, we get more percentage of the stores in metro markets that could increase a little bit.

  • Our overall capital budget for this year is $2.8 billion, about 300 million of that will come from operating leases.

  • That gives us a net cash Cap Ex of about $2.5 billion.

  • That includes not only opening the 123 stores that we open this year but a couple distribution centers that also ongoing upgrades to MIS systems and technology and infrastructure, plus a little over $200 million that will go back and invest in the existing stores that are out there that's something that's always been a strength of Lowe's.

  • We spend a significant amount of money investing in our current store base out there to keep them looking fresh and updated because we want really a customer that goes in one of our newest stores to have a experience very similar to their shopping in another market and shopping in one of our stores that's a few years older.

  • So that gives you a pretty good idea of I think what we spend on average as well as in total and where we're headed.

  • So....

  • Okay.

  • Also, do you know what your appliance market share was in the second quarter?

  • - Chairman of the Board and Chief Executive Officer

  • Yes.

  • It finished at on a national basis 12.9 percent.

  • What was it in the comparable quarter last year?

  • - Executive Vice President and Chief Financial Officer

  • 22 percent.

  • - Chairman of the Board and Chief Executive Officer

  • The share grew about -- the share grew 22 -- I think share grew 22 percent over the last year.

  • - Executive Vice President and Chief Financial Officer

  • It was 10 and some change last year to 12.9 so up a couple of hundred basis points I think.

  • If you want to call back, we'll pull that number.

  • If you'll call back Investor Relations --

  • - Chairman of the Board and Chief Executive Officer

  • Published in track line.

  • - Executive Vice President and Chief Financial Officer

  • We pull that number for you.

  • Okay.

  • Great.

  • Thank you very much.

  • Operator

  • Up next we'll hear from Dan Bender with Buckingham Research.

  • Just a couple of questions for you.

  • You have shown tremendous gross margin performance in the front half of the year.

  • Just as we look to Q3, your guidance seems fairly conservative despite some of the things being seemingly more sustainable improvements.

  • I'm just curious, is that a conservative number or do you think there may be some up side to that, if we continue to see the kind of things we did in the front half?

  • That's the first question.

  • The other question was -- are you seeing any challenges on the service levels or in stocks in some of your higher volume stores?

  • - Executive Vice President and Chief Financial Officer

  • Okay.

  • I'll start off with, Dan, this is Robert.

  • I'll start off with the gross margin question and maybe turn it over to Dale and then we'll flip back to Larry for the service level stuff.

  • I guess in some of the stores.

  • Between Larry and Tom.

  • On gross margin, I think anytime we are talking 40 to 50 basis points improving the gross margin, when you are looking at -- over the past several years we have had strong gross margin improvement in the third quarter, think last year it wasn't as strong but the two years prior to that I think was 90 - 95 basis points.

  • Anytime we are talking 40 to 50 basis points improvement in gross margin I don't think we are being conservative especially this early in the quarter in the economic environment that we're in I don't think we are being conservative.

  • Plus, you know, there's also various things that we cycle against in our business that we're aware of internally that we don't talk about for competitive and other reasons that we know and we build those into the numbers, so we never go into a quarter thinking that we are being, you know, overly conservative, just like last quarter we gave guidance of 50 to 60, our original plan called for nowhere near the 137 basis points but we had a great sell-through in the second quarter, shrink came in good again.

  • There were a lot of factors that lined up.

  • Hopefully those all line up for us in the future but it's not something we go into a quarter banking on and so we try and go in with guidance that we think is at or near what we can achieve.

  • If everything lines up, I hope we exceed that but that's not -- we build it into our expectations and plans on what we are planning on delivering.

  • We are planning to deliver within our guidance.

  • Here's Dale to see if he any comments on margin.

  • The only thing I would add is that you're accustomed to hearing the finance is more conservative than the merchants.

  • Merchants remain confident that margin continues to grow and, uhm, we have line reviews scheduled throughout the course of the rest of the year.

  • We have resets that are coming on stream and we have some unknowns out there, as well.

  • We have a switch from the CCA lumber to the ACQ, which has an effect on the margin.

  • There are competitive issues that we don't know how to anticipate.

  • So we have lots of up side and have a migration to quality that Bob was talking to which is in the continuing shift in the mix and that obviously plays positive, as well.

  • - Executive Vice President and Chief Financial Officer

  • I'll add before I turn it over to Larry, I'll add on Dale talked about the changeout in the lumber.

  • That's something that obviously as we go through a significant changeout in a product category like that, that we certainly, uhm, you know, there can be some issues with trying to sell through the remaining lumber bringing in the new that could have an impact on margin as well, Dan.

  • Larry if you could talk a little bit about in-store service.

  • Dan, as far as service and as far as inventory levels go, we certainly have spent a lot of time working our models and making sure that we have the inventory and the new higher volume stores to meet the demand for customers.

  • We bring our management team from the field into the office to work with the logistics and the merchants and make sure that we get the initial inventory right because everything that our system does, you have to have the initial inventory right to drive the replenishment systems to make sure the stores are in stock.

  • I have been in quite a few stores in the last two or three months.

  • I feel very confident about the inventory levels that we have in those stores to meet customer demand and the service level in our stores in terms of customer service, very pleased with.

  • And we have this tracked by an outside group and our service levels in those stores are scoring very high in terms of how we measure customer service in our stores.

  • - Executive Vice President, Logistics and Technology

  • Dan, it's Tom Whidden.

  • I'll just mention that couple quick things.

  • One, just from a total company perspective, did not bring it up in the prepared comments, but our service levels from an inventory perspective as we measure and calculate constantly, are the highest they have been in many, many years.

  • They're actually about 30 to 35 basis points above the same time last year.

  • So at the same time we have been getting the turn improvement, we've been improving the service levels in the stores.

  • I was a week ago I was out in stores in our western division and was in one of the stores that is in the echelon of our higher volume stores in the entire company and our approach is to go in there and find out from the store managers what we can do better and, you know, let's just say I came back feeling very good about what we're doing there and Larry, talked about the new store process where we identify and have special processes going around stores that have been identified that are going to be opening and will fall into that category.

  • - Chairman of the Board and Chief Executive Officer

  • Dan, hopefully we have all your questions answered.

  • Operator, we have time for one more question.

  • One additional comment that I want to make to respond to an earlier question that I think, Dan Weaver had with regard to fourth quarter.

  • I want to highlight to everyone that in the fourth quarter of this year we will be opening 35 stores whereas last year in the fourth quarter we opened approximately 16 stores.

  • So you can see certainly that increase in the number of stores in store opening costs alone could have an impact of a penny or-to-a penny and a half on fourth quarter earnings on a year-over-year basis so as you're building your models be sure to take that into account when you are looking at growth in earnings with the fourth quarter.

  • With that Operator, we have time for one more question.

  • Operator

  • And that question will come from Wayne Hood with Prudential Securities.

  • Robert, just on that issue, I mean, some of these stores fell a little later in the year than I was looking at in the models.

  • There is something that is causing more openings in the fourth versus the third or anything we should think about there?

  • - Chairman of the Board and Chief Executive Officer

  • Bill Warden is in the room and I'll have him address that question for you.

  • Unfortunately, in that business, it's no signs.

  • There is a story behind each and every location.

  • And negotiations took longer, regulatory approval took longer, whatever.

  • There is no macro issue.

  • It's just a case-by-case base.

  • And I can't give you a trend line other than to say that we do each one as best we can and that's what happens.

  • The other thing, Bob, I just wanted to see, the appliance business last year was about 11 percent of your business, the largest category.

  • Is there a level that you feel comfortable letting that business represent of your business, particularly if there is a downturn in that part of the cycle?

  • An in the quarter, could appliances have added about a point to a point 1/2 to the comp number?

  • - Chairman of the Board and Chief Executive Officer

  • You asked me how large I think we have a cover level appliances.

  • We are growing our business at current rate, and appliances are certainly not out of balance with where we want to be, uhm, and we don't anticipate that occurring in the next few years at all, Wayne.

  • As far as the impact on appliances in the quarter, what was that?

  • - Executive Vice President and Chief Financial Officer

  • It's about -- appliances had a impact of approximately 90 basis points on over all comps for the quarter.

  • Thanks a lot, you guys.

  • - Chairman of the Board and Chief Executive Officer

  • Thank you.

  • Operator

  • And at this time I'll turn the conference back over to you gentlemen.

  • - Chairman of the Board and Chief Executive Officer

  • Thanks.

  • As always, thanks to all of you for your continued interest in Lowe's.

  • We look forward to speaking with you again when we report our third quarter results in November.

  • Goodbye, and have a great day

  • Operator

  • That does conclude today's teleconference.

  • Thank you for your participation.