勞氏公司 (LOW) 2005 Q1 法說會逐字稿

Good morning, everyone, and welcome to Lowe's Companies first quarter earnings conference call.

This call is being recorded.

Statements made by management during this call may include forward-looking statements and as such are provided for by the Privates Securities Litigation Reform Act of 1995.

Although the Company believes the expectations, opinions, projections, and comments reflected in such statements are reasonable it can give no assurance that they will prove to be correct.

A wide variety of potential risks, uncertainties, and other factors could materially affect our ability to achieve the results expressed or implied by our forward-looking statements, and those risks and uncertainties are detailed in the Company's earnings release and other filings with the SEC.

Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and CEO, Mr. Greg Bridgeford, Executive Vice President Business Development, and Mr. Bob Hull, Executive Vice President and CFO.

Please note the call will conclude promptly at 9:45 a.m.

Eastern time.

I will now turn the program over to Mr. Niblock for opening remarks.

Please go ahead, sir.

Good morning and thank you for your interest in Lowe's.

Today I'll provide my thoughts on the results we delivered for the first quarter and highlight a few drivers of our performance.

Following my comments, Greg Bridgeford will discuss the macroeconomic trends we're seeing, how the home improvement customer is holding up, and what our research is telling us about the macroenvironment going forward.

Finally, Bob Hull will review in detail our first quarter financial results.

First, a few highlights of the quarter.

Sales were $9.9 billion, a 14% increase over last year, and comparable store sales increased 3.8% compared to last year's first quarter comp of 9.9%.

While comp sales fell short of our 5 to 6% expectation at the beginning of the quarter, it should come as no surprise that we experienced weak sales during a weather-effected March and early April, but strength in February and the last three weeks of April allowed us to deliver solid performance for the quarter.

In addition, the sales we experienced when the weather broke reaffirms our confidence in the strength of the home improvement environment.

We reached a milestone during April when we achieved $1 billion in sales during a single week for the first time in Lowe's history.

We also delivered a 100 basis point increase in return on invested capital, exceeding 17% for the first time in our modern history.

Earnings per share of $0.74 is a 32% increase over 2004.

However, as a result of the negative impact that weather had on our sales, our earnings per share for the quarter did fall slightly below our original EPS guidance of 75 to $0.77.

The impact of weather can be seen in our sales results across the quarter, as monthly comps varied from positive high single digits in February to negative low single digits in March, and then back to positive high single digits in April.

We also saw a weather effect in product category performance, divisional performance, and customer traffic trends.

First, our product category performance.

We had positive comp sales in 16 of 19 product categories.

Sales in nursery, seasonal living, and lumber experienced negative comps for the quarter.

Similar to the trend for the overall Company, our results in nursery and seasonal living were strong in February and April, but weak in March.

As an anecdotal example of the weather impact, seasonal heating products delivered a 97% comp in March, a number that would excite us in November but not in the spring, and a clear indication of the cooler than normal weather experienced in this year's first quarter.

In addition, our lumber category experienced negative comps for the quarter as many projects were postponed because of inclement weather.

Offsetting the performance in seasonal categories was an appliance category that continued to perform well, posting high single digit comps.

We continue to gain share in appliances, reaching a 15% unit share for the first time in our history, by enhancing our offering to better serve customers and working to improve the components of the Lowe's appliance advantage.

Another strong category in the quarter was kitchen cabinets, continuing a trend of several quarters of outperformance.

Great products, knowledgeable employees, and the benefit of our new installed sales model are the drivers of this category.

Finally, our flooring category delivered a solid quarter.

The results in this category clearly reflect the investment we've made in installed sales.

Our strong comps in the quarter show the consumer appreciates the fact that they can get great prices and exceptional service from a retailer they know will stand behind them.

Encouragingly, each of these outperforming categories is a larger ticket category, indicating the underlying strength in the home improvement consumer.

Looking at our first quarter performance on a geographic basis, it's apparent that spring was late to arrive in the Northeast and North central areas of the country.

The effect of weather was clear in our results as these two divisions delivered solid positive comps in both February and April, but negative comps in March, yielding essentially flat comps for the quarter.

Finally, from a traffic standpoint, comps in February and April were driven by increases in both traffic and ticket.

This compares to March where a strong increase in ticket was more than offset by negative traffic as a result of unfavorable weather patterns.

So, as we analyze our first quarter performance, we clearly believe that weather was the single largest factor impacting our sales and preventing us from achieving results in line with our original guidance.

Our big three sales initiatives of installed sales, special order sales, and sales to commercial business customers, remain core to our comp sales performance.

Our new installed sales model continues to deliver great results with comps significantly outperforming the Company average.

We continue to leverage our established model by enhancing our offering with installation services for products such as roofing and siding, which are now being offered in many of our stores, with the confidence that our installed sales teams can provide the service and experience customers expect.

Our special order sales initiative also continues to perform well, delivering comps above the Company average.

We're conducting an ever increasing percentage of our SOS transactions electronically, continually adding new vendors catalogs to our online data bases, making the selection and ordering process easier for our customers and more efficient for our stores and our vendors.

Finally, our efforts to capture more sales from commercial business customers continues to be successful, delivering solid results for the quarter.

Over the past year, we've added a regional commercial sales manager to each of our 21 regions, helping facilitate consistent execution of our CBC initiatives.

In addition, our targeted marketing message to commercial customers continues to drive results.

Another program that made great progress in the first quarter was our rapid response replenishment, or R3 initiative.

Inventory levels, while slightly deleveraging to sales, have improved significantly from fourth quarter levels as we continue the implementation of this initiative.

Our stores now receive an average of five deliveries from our RDCs per week, up from four a year earlier, as we work to reduce lead time variability by handling additional products such as appliances and paint through our distribution infrastructure.

This increased frequency is allowing us to keep more safety stock at the distribution centers and hold less in our stores, while at the same time enhancing our in stock levels.

We expect to make continued progress with the implementation in the coming months resulting in flat to slight inventory leverage in the second quarter, and additional leverage in the back half of the year.

So, despite the abnormal weather we experienced during the quarter, our stores delivered a solid comp increase and sound earnings growth.

The investments we're making in our business, as well as the underlying trends we're experiencing, indicate a strong and resilient home improvement consumer which keeps us optimistic about the future for Lowe's.

Now, here's Greg Bridgeford to highlight some of the underlying trends we're seeing in our business and ultimately the broader macroenvironment.

Greg.

Thank you, Robert, and good morning.

I'd like to take a few minutes to share with you our thoughts on three things.

First, our thoughts on the current economic issues that may impact our business.

Second, the status of market indicators and the forces behind those indicators that we believe reflect the health of our business.

And third, important industry changing demographic shifts that need to be considered in order to fully understand the opportunities in this sector.

As you've just heard from Robert, weather impacted our first quarter performance.

I know many of you are probably hypothesizing other short-term variables that could affect our results including rising fuel prices, increasing interest rates, et cetera.

Today I'll provide our view point on those issues.

Yes, obviously, fuel prices are up year-over-year.

According to the U.S.

Department of Energy, consumers are paying anywhere from 6 to $8 more per week for gasoline relative to April 2004.

We do believe lower income consumers shopping behavior has been impacted by this increased household expense.

We also think that upper income consumers have been less impacted and helped to some extent by the estimated year-over-year $14 rise in average weekly earnings according to the Bureau of Labor statistics.

We also get many questions, and I'm sure you're thinking about it right now, surrounding rising interest rates.

Our response is consistent.

The prime interest rate has not historically correlated tightly with the mortgage rate.

In fact, mortgage rates are more correlated to the ten-year treasury bond.

Data from the National Association of Realtors suggests that mortgage rates above 8% could dampen housing turnover, but given the current bond market right now this seems unlikely over the midterm.

Overall, the fed increasing rates from the current historical low levels is more an indicator that the economy is improving.

Further, rates are still low, back below 6%, and not likely to rise beyond 7% by the end of 2006.

When asked what economic factors drive your business, we've shared a consistent message over the last three years, and subsequent events have strengthened these points.

We've answered that whether it is an individual store's defined market area or our total domestic marketplace, household incomes and employment are the two main drivers, as these two factors have consistently correlated highest with our sales performance.

Naturally, we watch other factors such as housing turnover.

We closely monitor all three of these metrics, employment, household incomes, and housing turnover, which individually and in combination indicate a very favorable climate for the future growth of Lowe's and the home improvement industry.

First, the return of business confidence is reflected in the improving job market.

The Bureau of Labor Statistics reported widespread employment growth across almost every major sector.

Since May of 2003, 3.5 million jobs have been added to the payrolls.

Unemployment rates continue to decline from their peaks seen in 2003.

Employment looks favorable in the future.

Second, while wage growth is modest, employment gains should support rising income over the short-term.

In fact, change in real disposable income has been on a steady increase, up 3.5% in 2004, and estimates are on track to see a similar range increase for 2005, so household incomes look favorable in the future.

Finally, the combination of new and existing home sales compared year-over-year culminates into a key measure of housing activity, total housing turnover.

Given the dynamic nature of the market, monthly fluctuations are not uncommon.

However, over the past five years, total housing turnover has followed an upward trend surpassing the ten-year monthly average increase of 5.6%.

First quarter '05 has been relatively strong.

January saw an increase of 10.9%, February 6.6%, and March 6.0%.

As you know, our industry does not usually see an immediate response in sales with this metric.

There is typically a two to three quarter lag for this positive factor to impact home improvement retail sales.

In addition, housing stock inventories on the market have stayed in check, and purchase mortgage applications are relatively healthy.

Existing home sales continue to rise as March sales were the third highest level on record, and up 4.9% over March 2004.

Housing starts had explosive growth in February.

It cooled in March partly due to weather, but it also indicates the builders are maintaining inventories at reasonable levels.

Overall the demand for housing looks favorable for the future.

I've just shared with you the macroeconomic indicators of employment, income, housing turnover, which appear to most affect our business, all of which look favorable.

And yet every day we read commentary from pundits who are somewhat surprised by the continued strength in the housing market.

As you probably know, these economic metrics only tell part of the story regarding the strong outlook in the home improvement sector.

There are other factors that make up the housing fundamentals that are playing a big part in driving the demand for housing.

Specifically, the wave of second home sales, as well as the increase in the number of consumers entering into household formation.

These large demographic shifts don't get nearly the attention as the monthly economic metrics do, but they are driving and transforming our industry, and their importance should not be underestimated.

Let's start by highlighting a few of the more measurable trends that exist today.

The first is the generational impact of second home ownership.

Boomers are reaching peak earnings years and Xers have been demonstrating savvy financial strategy relative to home ownership.

As such, second home sales have been growing at record rates.

The National Association of Realtors recently reported second home sales were up 16.3% in 2004 compared to 2003.

What's behind the housing phenomena?

Investment.

In fact, 85% of Americans agree that a home is a more secure investment than the current financial market.

And just when we're starting to understand the impact of this trend, the market is beginning to see the influx of the third home.

Amazingly, just over a third of second homeowners who bought in 2004, indicated it is very likely that they will purchase another home within two years.

This market segment represents an interesting fit for Lowe's.

These homeowners are not buying property cross country, rather, cross county.

The median distance between a buyer's vacation and primary residence is 49 miles.

About 60% of their home improvement purchases are made near the second home, and almost two-thirds of the work is completed in a DIY mode.

Now, the second major demographic shift is the large number of consumers entering the household formation life stage.

We see three drivers to this industry keystone.

First, home ownership rates of U.S. minorities are on the rise.

While total home ownership grew 1.1 percentage points to a high of 69.1 in 2004, Hispanic home ownership grew at three times that rate.

Second, the impact of the eco-boom generation, also known as Generation Y. They have just started to enter home ownership and global insight estimates the housing market will begin to see their true impact at early as 2007.

Today this group is an estimated 72 million strong, and when immigration trends are factored in, it will likely be the first 100 million plus generation, far outnumbering the boomers, which leads us to the last driver, immigration.

Over the next ten years, the Harvard's Joint Center for Housing Studies estimates that immigration will represent 40% of total household formation.

And this is considered a conservative estimate.

The housing market is already reflecting the impact of foreign-born homeowners.

In 2003 they purchased approximately 8% of all new homes, and 11% of existing homes sold.

I hope these macroeconomic trends, marketplace developments, and large-scale demographic trends demonstrate why we have long-term confidence in housing, the home improvement market, and most importantly, Lowe's.

An increased emphasis on the home is fueled and will continue to fuel strong sales in the large and dynamic home sector.

Lowe's is poised to meet the needs of today's demanding and multifaceted consumer.

Given the market and consumer indicators that I've shared with you today, we remain optimistic about our prospects regarding our future performance.

Now I'd like to turn this over to Bob Hull to provide the details of our financial results.

Bob.

Thanks, Greg.

And good morning, everyone.

As Robert indicated, sales for the first quarter were $9.9 billion, representing a 14.2% increase over last year's first quarter.

Comp sales were 3.8% for the quarter on top of 9.9% comp sales increase in last year's first quarter.

As Robert noted, weather negatively impacted our sales in March and contributed to our below plan performance for the first quarter.

Our monthly comp sales performance illustrates that a strong February and April could not carry the quarter.

Our comp sales by month for Q1 were 7.5% in February, negative 2% in March, 7.5% in April.

As a reminder, we are on a four-five-four calendar so March is a five-week month.

Inflation in lumber and building materials resulted in a favorable impact on first quarter comps of approximately 75 basis points.

With regard to product categories the categories that performed above average in the first quarter include millwork, rough plumbing, building materials, hardware, appliances, home environment, fashion plumbing, flooring, cabinets, countertops, and home organization.

In addition, paint and lighting performed at approximately the overall corporate average.

Home environment is a new product category that we have segregated from appliances.

Home environment is comprised of air conditioners, water heaters, kitchen wares, and vacuum cleaners.

Our appliance category now contains only major appliances.

Gross margin for the first quarter was 34.4%, which is a 139 basis point improvement over last year's first quarter.

EITF 02-16 impacted gross margin in the first quarter of last year as vendor funds, associated with co-op advertising and in-store service were capitalized into inventory and recognized into income when the product was sold.

This year we received the benefit of comparing against a reduced Q1 2004, which added $205 million, or 207 basis points to gross margin over last year.

In Q1 2005 there was a 40 basis point negative EITF 02-16 impact due to the addition of new products and new vendors.

The net EITF 02-16 impact on Q12005 versus Q1 2004 was a positive 167 basis points.

Also, we had a 7 basis point positive impact associated with changes in product mix.

These items were offset by higher distribution costs, higher fuel rates, a reduction in cash discounts, and higher inventory shrink as a percentage of sales.

SG&A for Q1 was 21.6% of sales and deleveraged 20 basis points driven by payroll, occupancy, insurance, and bank card expenses.

As previously mentioned, we had a negative comp sales in the month of March.

Given our February sales performance, we were fully staffed going into what is typically the beginning of the spring selling season.

We maintain this level of staffing through the month of March which drove the payroll deleverage for the quarter.

The occupancy deleverage was driven by our sales shortfall to plan, an increase in the number of ground leases, higher utility costs, and property taxes.

Insurance expense, which includes employee health, Workers' Comp, and general liability, deleveraged due to rising healthcare costs and expansion into higher cost states.

The higher bank card expenses in the quarter were caused by a higher mix of bank card sales and increases in interchange rates charged by bank card associations.

These items were offset slightly by leverage in gross advertising expense in the quarter.

Operating margin, defined as gross margin less SG&A and depreciation, increased 114 basis points to 10.4% of sales.

Store opening costs of $25 million were flat to last year as a percentage of sales.

In the first quarter we opened 25 new and two relocated stores.

This compares to 29 new stores opened in Q1 last year.

Depreciation at 2.5% of sales totaled $248 million and deleveraged 5 basis points due to our store expansion program and additional technology investments.

At the end of first quarter we owned 82% of our stores versus 80% at the end of the first quarter last year.

Interest expense at $47 million was down slightly to last year's first quarter and leveraged 8 basis points as a percent of sales.

For the quarter, total expense were 24.8% of sales and deleveraged 17 basis points.

Pretax earnings for the quarter were 9.7% of sales.

The effective tax rate for the quarter was 38.5% versus an effective tax rate of 38.4% for Q1 last year.

Diluted earnings per share of $0.74 increased 32.1% versus last year's $0.56.

As mentioned last year, EITF 02-16 had a $0.16 negative impact on earnings per share, slightly offsetting the beneficial comparison to a suppressed Q1 2004 was a negative impact of EITF 02-16 on Q1 2005 of $0.03 per share.

We do not anticipate any significant EITF 02-16 impact for the balance of 2005.

Weighted average diluted shares outstanding were 805 million for the quarter.

The computation of diluted share takes into account the effect of convertible debentures, which increased first quarter weighted average shares by 26.3 million.

In computing first quarter diluted earnings per share, the after-tax add-back to net income for interest on convertible debentures was $3.4 million.

For the second and third quarters the after-tax interest add-back is also $3.4 million.

For the fourth quarter interest add-back is 3.7 million since it is a 14-week quarter.

For the second quarter, we are projecting diluted shares outstanding of 805 million.

For the year, we are also projecting diluted shares outstanding of 805 million.

In January of 2005, our board of directors authorized a $1 billion share repurchase program.

In the first quarter we repurchased 2.4 million shares at an average price of $56.87, for a total repurchase amount of $135 million.

In Q1 average ticket increased 6% to $66.33.

Total customer count increased 8% during the quarter.

Comp transactions were down 1.5% driven by the unseasonable March weather.

Comp transactions were positive in both February and April.

In fact, our comp sales increase of 7.5% in April was balanced between both ticket and traffic.

Now to a few items on the balance sheet.

Our cash and cash equivilants balance at the end of the quarter was $900 million.

Inventory turnover was 4.19, a decrease of 27 basis points from Q1 2004.

Our first quarter inventory balance increased 1.1 billion over the same period last year.

$600 million of this increase was in our stores, which translates to an 11.9% increase in store inventory, compared to our 13.1% increase in square footage.

The remaining growth was in our distribution network.

The inventory growth in distribution was driven by below plan sales performance, new facilities, including two new RDCs, and our rapid response replenishment, or R3 initiative.

As Robert indicated, the goal of R3 is to add more inventory in a distribution network so that we are able to increase the frequency of deliveries from our distribution facilities to provide our stores with the right product at the right time.

While inventory is higher than planned, we believe that we are well positioned for when spring does break in the weather-effected markets.

In addition, we are reducing inventory levels in our stores and expect the leveraged inventory growth to sales in Q2 and improved inventory turnover by year-end.

Return on invested capital measured, using beginning debt and equity and a trailing four quarters earnings, increased 100 basis points for the quarter to 17.1%.

Our first quarter performance drove return on assets, determined using beginning total assets and a trailing four quarters earnings, to 11.2% representing an increase of 49 basis points.

For Q1 cash flow from operations was $1.2 billion.

Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook.

Our second quarter sales increase of 15 to 16% incorporates the opening of 27 new stores including one relocation and a comp assumption of 4 to 6%.

We plan to open five stores in May, nine stores in June, and 13 stores in July.

Operating margin for the second quarter is expected to be approximately flat to last year.

The sales growth and operating margin I described is expected to generate diluted earnings per share of $1 to $1.02, which represents an increase of 15 to 17%.

For 2005, we expect to open 150 stores, including three relocations, resulting in an increase in square footage of 13 to 14%.

We're estimating a comp sales increase of approximately 5%, and a total sales increase of approximately 17%.

As a reminder, our fiscal 2005 is the 53-week year.

For the entire fiscal year we are anticipating an operating margin increase of approximately 20 basis points, which coupled with our sales increase, should drive diluted earnings per share of $3.25 to $3.34.

Regarding current sales trends, I mentioned earlier that our business outlook for the second quarter anticipates 4 to 6% comps.

For the first 16 days of the quarter, our comps are at the bottom end of this range.

May is our toughest comp comparison from Q2 last year.

Before I turn the call over to the Operator for questions, I'd like to mention that in addition to Robert, Greg and myself, Larry Stone, Dale Pond, and other members of our management team are present for the question-and-answer session.

David, we are now ready for questions.

Ladies and gentlemen, we are now ready for questions. [Operator instructions] And our first question comes from Bill Sims of Citigroup Smith Barney.

Congratulations on a decent quarter in a difficult environment.

I have one question and one quick follow-up.

The first one's on the commodity-driven business of appliances.

Can you tell me how consumers are responding to the slight price inflation they are seeing because they've been trading down to lower end appliances or are they still maintaining the purchasing habits, and maybe you can comment on traffic versus ticket in the category?

Thank you.

Bill, this is Robert Niblock.

With regard to appliances and the price increases that have occurred at the retail level, no, we're not really seeing any trade down, we're still seeing growth in average ticket and our traffic in that category as we saw, or as we explained, appliance was one of our better performing categories for the quarter.

We're continuing to add new products into the category.

We still see consumers having strong interest in a lot of the high efficiency-type products, particularly with what we're seeing with fuel and energy prices, so, no, we haven't really seen a shift down the continuum in the appliance area.

And just, you mentioned shrink providing a drag on gross margin.

Can you comment on what has changed in some shrink perspective, and will that have a drag for the next several quarters or how you're addressing it?

Thank you.

Bill, this is Bob Hull.

I'll take that question.

Shrink did deleverage slightly as a percent of sales to last year.

As you know, we're very pleased with our shrink performance and our shrink levels.

While it was 2 basis points lower than last year, it actually beat our plan by 6 basis points so we don't feel like we have any issues as related to inventory shrink going forward.

Thank you very much.

Our next question comes from Michael Baker of Deutsche Bank.

Thanks.

I would ask the question, on the R3 initiative can you remind us what the ultimate benefit of this program will be?

What we should expect in terms of inventory growth relative to sales growth later in the year and then through next year and how that might flow through the P&L?

Sure.

This is Mike Mabry.

Be happy to address that.

The key parts of the strategy were optimizing our total supply chain cost and decreasing our cycle time and variability.

We're seeing good progress on both these fronts, and I'll just share some metrics with you that demonstrate that.

Cycle time, the time from demand for an item is created at the store until it is back on the shelf, has improved by 30% year-on-year.

That's down 2.25 days.

And our best DCs are operating at 3.75 days from the time demand at a store happens until it's back on the shelf.

And that's right at our goal of 3.5 days.

Full truckload inbound cube is up 8.4%, so we're utilizing our transportation better.

This number is understated because as we have implemented economic order quantity, we have seen our full, our less than truckload shipments drop.

LTL shipment tonnage to our DCs is down 22%.

So we've seen a migration of less than truckload shipments into full truckload shipments.

And on average it's about a third less to ship full truckloads versus less than truckload.

And then our collect shipments, direct to our stores, are down 34%.

We're using more [faith]-based receiving which is going to reduce labor at the stores, or not reduce, but we'll be able to redeploy that labor to selling.

So that's kind of where the benefits are, and as you can see we're making good progress along all the metrics.

That makes sense.

Just as a quick follow-up, what percentage of your inventory is now shipped full truckload and where can that go to?

Well, we're shipping about, just over 50% of our freight through our distribution network at this time.

Where we're heading with this longer term is 75%.

You've got to remember, we're implementing, through the quarter we're implementing new volume through the DCs, so that's weighted heavier towards the back end of the quarter, and as we stated early seasonal sales through the month of March were down.

Got it.

Makes sense.

Okay.

Thank you.

Our next question comes from Colin McGranahan, of Bernstein Investments.

Good morning.

You didn't mention anything about the credit portfolio performance and I know that was one of the things that was dragging on margins here in the first half of the year.

Can you just comment on how that turned out versus your plan and what you see going forward as well?

Sure, Colin, this is Bob Hull.

As we talked about in the Q4 call, we had a fabulous credit year in 2004, and again in the first quarter we had a good credit performance.

It did not have the drag on our performance that we anticipated.

However, we still believe that there are factors that will contribute to it having a negative impact on the remainder of the year, so we're still pleased with the performance of our credit portfolio.

It did not have the negative impact on Q1 that we anticipated, but we still believe that bankruptcies and losses will increase over the remaining three quarters and have a negative impact Q5 over Q4, I mean, 2005 over 2004.

Bob, was that better than anticipated results on the bankruptcy side or on the yield side or just on the percentage of sales?

What turned out to be better than you expected?

Kind of all of the above.

We had fewer losses, and, unfortunately, because we had fewer sales, the loss reserve came down as well.

Obviously, we will take the higher sales and the higher reserve going forward, which is what we hope to see in the remaining quarters.

Thank you.

Our next question comes from Budd Bugatch of Raymond James.

Good morning.

Could we get a little bit of a update on the three projects, the three initiatives, special order sales, installed sales, and CBCs, and maybe some metrics and penetration of sales on those?

Bud, this is Robert Niblock.

As we mentioned, all three of those categories performed ahead of overall comp performance for the Company.

We continue to see great receptivity to our new installed sales model, as we mentioned, we're adding new categories such as roofing and siding at some of our stores, so we're still seeing great receptivity there, we're still seeing great feedback from a customer satisfaction standpoint, the customer would use us again for future installation.

And also, you know, on the commercial business customer, particularly where the weather was strong, we saw good performance there.

Obviously, if you think about a lot of those product categories are outdoor categories, so it was somewhat impacted by the weather, so it didn't perform quite as strong as installed sales and special order sales did for the quarter, but overall, all of them did exceed our overall comp of 3.8% that we had for the quarter.

And that's been that way for awhile, Robert, but you continue to tell us I think CBC is still 20% of sales is that still about right, or has that moved at all?

As you know, a lot of the CBC business is a cash-based business.

There's some of it we have to do from an estimation standpoint, and when you look at it, [inaudible] we can actually track with our various credit vehicles and then layer on what we believe to be cash from our customer surveys on top of that we think it's somewhere in the 20 to 25%, but you've got to understand, the overall business is growing as well.

Okay.

And just last follow-up.

Can you make any comments about new store productivity?

It looks like it might have ticked up a little bit in the quarter?

I'll let Bob Hull address that.

Bud, it was about, just shy of 80% for the quarter.

It's hovered at about 80% new store productivity for the past 13 quarters so we continue to be pleased with performance and productivity of our new Lowe's stores.

Okay.

Thank you.

Our next question comes from Dan Wewer of CIBC.

Hey, Robert.

You and your competitor put together a fabulous trend of eight consecutive years of rising gross margin rates.

It appears that that cycle may be beginning to dissipate.

Curious on your views as to whether or not margins are now at such record levels that future gains will be difficult to achieve.

Well, certainly, Dan, the margins are at pretty high levels when you start talking about margins north of 34%.

So I think as far as the large jumps that we had in prior years, I think we've cycled through a lot.

I think there still is opportunity for margin growth when we look at first cost opportunities.

We move more and more towards direct sourcing of products out of China and other areas.

Over the past 12 months we've gone from 7% to about 8% that we're sourcing through our Lowe's global sourcing.

Obviously, you know, we did have some impacts year-over-year, as Bob Hull mentioned, on new programs that come in through EITF 02-16 as we front-loaded the distribution centers with additional inventory and had to absorb the cost of running that it's layered into our product categories.

And you did have, obviously, we talked about price increases that have occurred, a lot of it from a commodities standpoint.

We did, a majority of that were able to pass through to consumers but there are some categories, some of those commodities that are pretty price sensitive where you do get hung up with a little bit of that additional cost in the layers in the market, other retailers are slower to move.

So with our price matching policy it's a little slower to get those retails up and maintain that margin.

So, yeah, but I think there is still opportunity but I don't think you're going to see the opportunity that we saw in the past that you're going to see in the future.

I think there is, just to summarize, I think there is some from first costs as we go out and do additional direct importing.

I think there's also opportunity as we fully implement R3 and continue to drive greater efficiency out of the supply chain network, I think there's opportunity there for us to be able to pull down our costs, which will allow us to be able to expand those margins.

And also one of the pickups, as Bob Hull kind of alluded to was, in the past, over the past several years we've had a big pickup in inventory shrink.

Now, as I think Bob mentioned, was 2 basis points negative, it would have been about flat if we had achieved our sales results for the quarter, but when you look at going into more and more metro markets, if we can maintain shrink levels about where they are, the as we've mentioned we did slightly beat our plan for planned inventory shrink in dollar terms for the quarter, but with the shortfall in sales it did have a 2 basis point negative impact.

So to summarize it, I think there is opportunity but not near the opportunity that we have seen over the past several years when we had huge increases in gross margin.

And just real quickly, with the sales month-to-date running at the low end of plan do you think that pent up demand that originated in March with poor sales results was satiated during the month of April and that perhaps that's the reason why May is running at the low end of the forecast?

I think certainly there was some pent up demand that moved over into April, but as far as May running at the low end of the forecast, we're going up against not only strongest month for the quarter, but the first half of May had the strongest sales within the month of May from a year ago so you have tough comps, I think May last year was overall an 8.2% comp for the entire month, but the first two weeks of that were double digit comps, so obviously we're going up against the strongest numbers.

We're seeing great performance in the West, the South central, the Southeast areas of the country, but the North central and the Northeast have still gotten hammered with weather over many of the days in the first 16 days of May, it's a pretty short period of time so you get that large an area of the country, I know the weather was pretty tough in the North central, Northeast over Friday and Saturday and part of yesterday, so I think it's merely the fact that spring hasn't fully broke in those parts of the country.

I think obviously as we sit here and we're 16 days in the quarter, we try to be, trying to be somewhat conservative I believe in our guidance but we're optimistic thinking the spring breaks will continue to move up and hopefully be able to move well within that range pretty quick.

Thanks and good luck.

The next question is from Gregory Melich of Morgan Stanley.

Just wanted to follow-up in a little more detail on the inventory.

Bob, I think you mentioned that we should leverage inventory in second quarter, I think In the past you had said in the second half.

I was wondering why the acceleration of that?

Are you, is there potentially some inventory you think you can get rid of this quarter that you have or has the R3 rollout happened faster?

Just sort of break down the shift there.

Let me take the first part of that, Greg, and let Mike maybe jump in if he has anything to add.

When you look at the first quarter, coming into the first quarter with our Q4 inventory balance, we were heavy coming in, we were able to somewhat moderate our purchase activity coming into the quarter.

In fact, our purchases of inventory in Q1 '05 were basically flat to Q1 '04, which translates to a flat AP balance at the end of the quarter.

So we did moderate our purchases somewhat because of the factors we described, principally below plan sales performance, were over our inventory plan at the end of Q1 but we do believe that we can leverage inventory growth as a percentage of sales growth in Q2.

The only thing I would add is the closer we get to the quarter we have more clarity on where our inventory position are, what our plans are as we go forward, so I mean that forecast was six months out, this one's 90 days out, so we get more confident as we get closer.

And, Mike, in terms of the number of SKUs that you're looking to switch over, I know appliances and paint are big categories, have you switched over all the SKUs, or how should we look at it in terms of percentage of volume?

Have you switched over 80, 90% already?

No, we have not.

And as we roll it out, we're rolling it out through our network, so it's not going to all DCs at the same time.

So as I stated earlier, we're running a little over 50% for the quarter, that's heavier weighted towards the end of the quarter.

We'll be shipping appliances out of our fourth DC this month and we just continue that roll out.

So our longer term goal is 75%.

We figure through the year we'll ship around 60% through our network for the full year so we're just continuing to roll out and it's hard to put it as far as a number of SKUs, because it's rolling out to different distribution centers at different times.

Maybe, Bob, in a different way, if you think about it over several years, gain up to 75%, should we expect as we add new categories and new regions over time that we'll have other periods where inventories run above sales, or this first part was the big hurdle?

I think it's the first part.

As I think about it, Greg, we're really adding distribution capacity faster than our sales growth.

We'll reach a point in time where that levels off and I think that's evidenced by the fact that we have basically two, I'll call them non-comp RDCs this year.

Our productivity in the comp RDCs is very good, we're very pleased with that, but we have two RDCs that are coming up to speed that next year, hopefully, will perform consistently with their peer RDCs.

So we think the big blitz has already occurred and we think, as we add items to the network, that it will be a smooth transition.

And then, because it's a linked question, the gross margin where you cited the two things that were up, fuel and the distribution center costs, I mean, it looks like that was pretty much 30 basis points, the change really that hit the gross margin.

Is that a fair assessment?

Greg, I provided four items that impacted gross margin.

There's a number of other items that impact the gross margin that I did not mention.

Robert alluded to one of those, which is the price increases that we attempt to pass through to the consumers.

You don't always get it in the same quarter.

There's some competitive pricing that we have to match from time to time.

There's reset activity.

All of that's a part of retail, it just happened to impact us somewhat in Q1.

But there are a variety of factors beyond just the four I mentioned in my comment.

Thanks.

David, I think we have time for one more question.

And our last question comes from Matthew Fassler of Goldman Sachs.

Thanks a lot and good morning.

I'd like to take a look at operating margin as you look at the rest of the year.

Your operating margin, even after you back out, or when you back out EITF 02-16, was down quite a bit in the first quarter and you said it would be and you gave us a bunch of reasons, and for the rest of the year you're projecting flattish to perhaps slightly higher operating margin.

Can you just sort of un through the items that hit you in the first quarter, planned or otherwise, and just talk about, or confirm for us do you expect that they'll be resolved or that they are resolved and we're not going to see them again I guess, over the remainder of the year?

Sure, Matt.

I'll talk about the items.

I mentioned several of them in my comments.

A few of those will continue on for the rest of the year.

One of those is rent.

As we continue to grow in the Northeast, the main way to get a hold of land is through ground leases which is having an impact.

That, coupled with change in lease accounting that we noted in the fourth quarter call is having an impact.

So if you think about it, we're going to add 47 ground leases in 2005.

That's going to have, it had an impact in Q1, will have an impact for the rest of the year.

As I mentioned, the credit performance was not negative in Q1, but we expect that to be negative for the remainder of the year.

Distribution costs should moderate and hopefully flatten out in the back half of the year.

Insurance, unfortunately, that's the reality with increasing costs of healthcare and our expansion into states like California, Florida, et cetera, that are higher cost states that.

That will have an impact in the back half of the year.

And the last one I'll mention is the bank cards.

That's reality.

The rates increased in April, and we're stuck with those for the rest of the year.

Hopefully they won't go up again.

Gotcha.

Just a quick follow-up.

You talked about the impact of EITF 02-16 on gross margin.

I might just not get it in terms of understanding the accounting impact, but how should we think about SG&A year-to-year and the impact of EITF 02-16 there?

Really, no impact on SG&A as relates to EITF 02-16.

The expenses were basically there in 2004.

What was moved was the offset to the expenses last year, it was moved from an offset of expense into cost of goods.

SG&A should be fairly comparable '05 versus '04.

Gotcha.

So the 20 basis point impact on operating, rather increase on operating in admin expenses is apples to apples?

Correct.

Thank you so much.

Thanks.

And 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 second quarter results in August.

Thanks.

Have a great day.

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