勞氏公司 (LOW) 2008 Q3 法說會逐字稿

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  • Operator

  • Good morning everyone.

  • Welcome to Lowe's Companies third quarter 2008 earnings conference call.

  • This call is being recorded.

  • Statements made during this call will include forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995.

  • Management's expectations and opinions reflected in those statements are subject to risks, and the Company can give to no assurance they will prove to be correct.

  • Those risks are described in the Company's earnings release, and in it's filings with the Securities and Exchange Commission.

  • Also during this call, management will be using non-GAAP financial measures in discussing the Company's performance and financial condition.

  • You can find a presentation of the most directly comparable GAAP financial measures, and a reconciliation of the differences between the two, posted on Lowe's Investor Relations website, under Corporate Information and Investor Documents.

  • You will also find a statement of the reasons management believes this presentation of these non-GAAP financial measures provides useful information to investors, regarding Lowe's financial condition and performance.

  • Hosting today's conference call will be Mr.

  • Robert Niblock, Chairman and CEO, Mr.

  • Larry Stone, President and COO, and Mr.

  • Bob Hull, Executive Vice President and CFO.

  • I would now like to turn the program over to Mr.

  • Niblock for opening remarks.

  • Please go ahead, sir.

  • - Chairman, CEO

  • Good morning.

  • Thanks for your interest in Lowe's.

  • Following my remarks Larry Stone will review our operational performance, including what we are doing to manage the business in today's challenging environment, then Bob Hull will review our financial results.

  • The third quarter continued what has been a very difficult period for our industry.

  • As many external factors weigh on home improvement sales.

  • Our negative 5.9% comp for the quarter was within our guidance, but short of what we hoped to deliver.

  • Contributing to our results, hurricane preparation and recovery spending aided comps by an estimated 100 basis points in the quarter, and as we anticipated, outdoor categories benefited for more seasonal weather, as we cycled last year's drought conditions in many part of the US.

  • In addition, in the tough sales environment, we continue to gain market share, a function of our commitment to great service, and our ability to capitalize on the evolving competitive landscape.

  • But the pressures on the consumer have intensified over the past 90 days, as unemployment has risen, equity markets have spiraled downward, and concerns about the broader economy have grown.

  • When combined with falling home prices, driven by excess supply and weak demand, and exacerbated by tight credit markets, it paints a challenging picture for consumers in the near term.

  • Highlighting those challenges and likely compounded by the distraction of the equity markets and interest in the election, we saw a slowdown in sales in the last week of October, which has continued into the first two weeks of November.

  • We continue to see the greatest sales weakness in bigger ticket discretionary products, and the weaknesses most pronounced in areas hardest hit by the housing slowdown.

  • The bottom 20% of housing markets, those with the biggest home price declines, delivered double-digit negative comps, while the top 20% delivered nearly flat comps in the third quarter.

  • Although they are difficult to find there are a few bright spots, it seems housing turnover is bottoming, and September's housing numbers include the first year-over-year increase in the seasonally-adjusted annual rate of existing home sales in almost three years, and was driven in part by the distressed sales of foreclosed homes.

  • Estimates suggest that as many as one-third of September sales were related to foreclosures.

  • Based on data from our customer database, it appears purchaser of foreclosed properties spend similar to existing home purchasers.

  • In addition, energy prices have dropped dramatically in the last few months, with the price of gas dropping nearly 50% from the peak just four months ago.

  • Many other factors are impacting consumers today.

  • But we hope that falling energy prices will provide a steadying influence on consumers wallets and their confidence in the future.

  • And a Lowe's specific bright spot.

  • In October, Lowe's was named by J.D.

  • Power as the #1 appliance retailer in the US for customer satisfaction.

  • Measured on many attributes including, sales staff, installation and delivery service, store environment, product selection and price, this is clear evidence and just one example, of how our stores are providing unmatched service and selection to capture market share.

  • Nevertheless, since the balance of the macro factors that impact our business remain weighed to the down side, in at least the near term, signs indicating cob summers are retrenching further, we feel it is prudent to continue to take a cautious approach, displaying conservatively and insure we are well-positioned to capitalize on opportunities as they develop.

  • Despite the challenges of a weak demand environment, our employees did a great job controlling costs and improving efficiency, allowing us to deliver third quarter earnings per share of $0.33, which exceeded our guidance.

  • If these efficiency gains, with a continued committment to great service, that ensure we will be will-positioned for an eventual improvement in demand.

  • Our focus today is on the fundamentals of retailing, while we must always keep an eye on the future, now is not the time to stray from the basics of providing great service, great products, and great value for consumers.

  • As many economists are forecasting a recession, we are confident in our ability to continue to capture market share, as weaker players struggle in the current environment.

  • We are also hopeful that early signs of stabilizing housing turnover, an eventual loosening of credit in the mortgage market, and declines in fuel and commodity prices, will lead to stabilization and demand for home improvement products.

  • But regardless of the external environment, we continually strive to become more efficient, and remain nimble enough to react appropriately in an uncertain environment.

  • Finally, I would like to congratulate Jimmie Johnson, Chad Knaus, Rick Hendrick, and the entire team at Hendrick Motorsports on winning their third consecutive NASCAR Sprint Cup Championship.

  • Only the second time in NASCAR history that the title has been won by the same driver three consecutive years.

  • Lowe's is proud to be partners with such a great organization, and have them represent the Lowe's brand each week, on and off the track.

  • Thanks again for your interest, and I will now turn it over to Larry Stone, to provide a few more details on the quarter.

  • Larry.

  • - President, COO

  • Thanks Robert.

  • Good morning.

  • As Robert mentioned, the broad based macro pressures weighing on the industry will continue into 2009.

  • This morning, I will provide some details on our third quarter results, and discuss how we are managing through this challenging environment, while balancing our focus on maximizing near-term results, and driving long-term shareholder value.

  • As expected, our third quarter results reflect a tough sales environment.

  • Only four of our product categories had positive comps for the quarter, building materials, outdoor power equipment, seasonal living, and nursery.

  • Our performance in building materials and outdoor power equipment was driven by demand for hurricane related products, including asphalt roofing and generators.

  • Thanks to our storm recovery team, we were able to quickly reopen stores in hurricane effected areas, and our best-in-class distribution network ensured our stores were stocked and ready to assist customers with their clean-up and rebuilding efforts.

  • Driving results in seasonal living were strong sales of pellet fuel and pellet stoves, as consumers shifted towards alternative heating products in preparation for winter.

  • Also solid sales in our outdoor living products in our warmer year round markets, helped drive this positive comp.

  • Nurseries performed well, as homeowners continued to take on smaller projects that enhance their outdoor space.

  • Easier comparisons from last year's drought, in addition to strong demand for fountains and outdoor accessories, helped deliver positive comps for the quarter in this category.

  • Other categories that performed above the company average include lawn and landscape products, that also benefited from last year's drought, as homeowners completed some of the fall lawn maintenance that they put off last year.

  • Above average performance in hardware was driven by increased demand for flashlights and batteries from hurricane impacted markets.

  • And reflects the consumer's desire to make their home more energy efficient, and minimize winter heating bills, we had solid demand for air filters and programmable thermostats, which helped rough plumbing perform above the company average.

  • Despite the pressures weighing on consumers, they still appear willing to complete smaller projects that maintain and beautify their homes.

  • This is evidenced by the relative strength in our paint category, the #1 DIY home improvement project.

  • Additionally, our lumber category performed better than company average, driven by solid demand for fencing in hurricane impacted areas.

  • Despite the weak sales environment, our continual focus on inventory management, resulted in a decrease in comp store inventory for the quarter, and as we enter the fourth quarter we are comfortable with our inventory levels.

  • In August on our second quarter call, we highlighted the fact that outdoor products outperformed and aided our second quarter results.

  • For this comparison, we defined outdoor products to include not only nursery and lawn and landscape products, but any product predominately used outdoors.

  • We anticipated this performance would continue as consumers seemed willing to take on smaller outdoor projects, but as the year unfolded, we would see the typical seasonal shift away from these categories.

  • Outdoor products out-comped indoor products by approximately 800 basis points in the third quarter, but were approximately 30% of sales, versus 40% of sales in the second quarter.

  • This decline in mix of outdoor products contributed to our lower comps quarter-over-quarter.

  • Importantly, while many of our product categories were comping negatively, we maintained our long trend of market share gains.

  • Looking at our results on a regional basis, we continue to see a wide range of comp performance, as two regions achieved positive comps, while eight regions had double-digit negative comps.

  • Positive comping areas include one region in the Ohio Valley, and a region that includes southern Texas and Houston.

  • The solid sales sales performance we experienced last quarter in Ohio Valley continued in the third quarter.

  • This is an area that did not experience the overheated housing market that occurred in other regions of the country.

  • Our southern Texas stores have performed well for several quarters, but during the third quarter, we experienced increased demand for hurricane related products in these markets, which resulted in the strong comp performance for the quarter, but the negatives far outweigh the positives.

  • While there are recent signs that home price declines are bringing buyers back to the housing marks, the pressures of some of the weakest housing markets are significantly impacting our sales in our Western division, as all four regions had double-digit negative comps in the quarter.

  • Our Florida regions improved slightly during the quarter, but still posted double-digit negative comps.

  • And two of our Northeast regions also had double-digit negative comps in the quarter.

  • Consumers in these regions remain pressured by weak housing markets, but the recent volatility in the financial markets, and the uncertainty leading up to the election, appeared to have further impacted consumers willingness to tackle home improvement projects.

  • Driven by consumers hesitancy to tackle bigger ticket discretionary projects, especially sales performance of the quarter fell below the company average.

  • Our whole house carpet installation promotion continues to resonate with consumers, however, during the quarter, we saw demand soften in this product category.

  • This contributed to installed sales performing below the company average.

  • On the special order sales front, we saw pronounced weakness in cabinets and countertops, fashioned plumbing and lighting, leading to below average comp performance for the quarter, reflected by the macro pressures weighing on consumers, on a regional basis, we saw our largest year-over-year declines in both installed sales and special order sales in the West and in Florida.

  • Encouragingly commercial business sales continue to post comps above the company average.

  • Our focus on professional trades person, property maintenance professionals, and repair remodeler continues to drive solid sales results.

  • Despite the external pressures weighing on the industry, the promotion environment remains rational.

  • We continue to use our rolling 18-month promotional calendar, to support our marketing message that highlights basic home improvement projects, that consumers are doing to maintain their homes.

  • We have not wavered from our everyday low price strategy, which we will continue to emphasize going forward, and to further convey the value message many consumers looking for today, we will continue to use our new lower price initiative, as a tool to build traffic, transactions and ticket.

  • Despite the soft demand for discretionary projects, according to third-party estimates we increased unit market share in 13 of our 20 product categories in the third calendar quarter.

  • This is a clear indication that consumers continue to choose Lowe's for their home improvement needs.

  • As I stated earlier, we anticipate the external pressures weighing on the industry and consumers will continue into 2009.

  • We are navigating through these challenging times, cutting costs where we can, while maintaining our commitment to deliver excellent customer service and drive profitable growth.

  • In all sales environments, we are always working to identify ways to improve store productivity and operation efficiencies.

  • Our flexible staffing model provides us with the tool to match sales to hours, so we have the right people at the right time, doing the right job.

  • During this challenging sales environment, we are making continual efforts to match hours to sales.

  • However, driven by the soft sales environment, we deleveraged payroll by 81 basis points in the quarter.

  • In conjunction with our cost controlled efforts, we remain commitment to providing great customer service.

  • In fact our third quarter customer focus scores showed customer service and satisfaction continues to improve, demonstrating that while we are reducing payroll to match lower sales, we are also making the right decisions to insure our stores are ready to serve customers.

  • In tough times like we face today, we have a solid foundation on which to build, and we remain focused on executing the basics better than anyone else.

  • I am confident we are making the right decisions, focusing on the customer, and driving efficiencies that position us to increase market share, and maximize the opportunities in the marketplace.

  • Being consumers first choice for home improvement in every market is our driving goal, as we manage the business for long term success.

  • Thanks for your attention, and now I will turn the call over to Bob Hull to review our financial results.

  • Bob?

  • - EVP, CFO

  • Thanks, Larry.

  • Good morning, everyone.

  • Sales for the third quarter were $11.7 billion, which represents a 1.4% increase over last year's third quarter.

  • In Q3 total customer accounts increased 3.4%, but average ticket decreased 2% to $65.64.

  • Year-to-date, total sales increased 0.9% to $38.2 billion.

  • Comp sales were negative 5.9% for the quarter, which was within our guided range of negative 5 to 7%.

  • Looking at monthly trends, comps were negative 7.2% in August, negative 5% in September, and negative 5.7% in October.

  • For the quarter, comp transactions decreased 3.5%, and comp average ticket decreased 2.3%.

  • We estimate that hurricane-related sales positively impacted our third quarter comp sales by approximately 100 basis points.

  • In addition we believe that comps were positively impacted by approximately 50 basis points, due to favorable comparisons with last year's drought impacted third quarter.

  • We experienced building material inflation in the quarter driven by roofing, which had approximately 50 basis points positive impact on third quarter comps.

  • With regard to product categories, the categories that performed above average in the third quarter, include lumber, building materials, rough plumbing, hardware, paint, nursery, seasonal living, outdoor power equipment, and lawn and landscape products.

  • From a regional perspective, 8 of our 23 regions had double-digit negative comps for the quarter.

  • The double-digit negative comp regions were in the West Coast, Northeast, and Florida markets.

  • Gross margin for the third quarter was 34% of sales, and decreased 29 basis points from last year's third quarter.

  • The decrease in gross margin was driven by a number of factors.

  • The mix of items sold in the quarter had a negative 10 basis point impact on gross margin.

  • Higher fuel prices increased costs of goods sold, and negatively impacted gross margin by approximately 10 basis points.

  • Deleverage on distribution fixed costs caused approximately 9 basis points negative impact on gross margin in the quarter.

  • Lastly we review and reforecast our accrual for vendor programs on an ongoing basis.

  • Based on current and projected sales trends, we expect to achieve fewer volume rebate dollars than we originally predicted.

  • The reversal of these accrued vendor volume rebates negatively impacted Q3 margins by 8 basis points.

  • Slightly offsetting these was positive impact of 10 basis points from lower in inventory shrink.

  • Year-to-date gross margin of 34.3% represents a decrease of 24 basis points over fiscal 2007.

  • SG&A for Q3 was 23.2% of sales, which deleveraged 160 basis points, driven by store payroll, insurance, bonus, fixed expenses, and credit.

  • For the quarter, store payroll was deleveraged 81 basis points driven by negative comps.

  • In the quarter we experienced 46 basis points of deleverage in insurance expense, associated with comparisons to last year's self-insurance reserve adjustment for workers compensation and general liability.

  • However, this leveraged was less than the approximately 100 basis points of deleverage we expected, as we continue to see favorable trends in this area.

  • Bonus expense deleveraged by 36 basis points in the quarter, as we achieved more performance targets this year, versus missing many of our performance targets in 2007.

  • In addition, rent, property taxes, utilities and other fixed expenses, deleveraged approximately 20 basis points due to the comp sales decline.

  • Also as expected, we did experience 11 basis points of deleverage related to proprietary credit, due to higher losses than last year.

  • This deleverage was offset slightly by leverage in in-store service and advertising expense in the quarter.

  • Year-to-date, SG&A is 22.1% of sales, and deleveraged 96 basis points to the first nine months of 2007.

  • Store opening costs of $31 million, leveraged 9 basis points to last year, as a percentage of sales.

  • In the third quarter we opened 39 new stores with no relocations, this compares to 40 new stores with no relocations in Q3 last year.

  • Depreciation at 3.3% of sales totaled $385 million, and deleveraged 35 basis points compared with last year's third quarter, primarily due to negative comp sales, and the addition of 154 stores over the past 12 months.

  • Earnings before interest and taxes or operating margin decreased 215 basis points to 7.2% of sales.

  • Year-to-date operating margin of 9% represents a decrease of 153 basis points over the first nine months of 2007.

  • Interest expense at $65 million deleveraged 13 basis points as a percentage of sales.

  • This deleverage was caused by the additional expense associated with last year's bond deal, and lower capitalized interest costs associated with fewer stores under construction.

  • For the quarter, total expenses were 27.4% of sales, and deleveraged 199 basis points.

  • Pretax earnings for the quarter were 6.6% of sales.

  • The effective tax rate for the quarter was 37.3%, versus 37.6% for Q3 last year.

  • Earnings per share of $0.33 for the quarter exceeded our guidance, but decreased 23% versus last year's $0.43.

  • For the first nine months of fiscal 2008, earnings per share of $1.38 were down 13% to 2007.

  • Now to a few items on the balance sheet, starting with assets.

  • Cash and cash equivalents balance at the end of the quarter was $322 million.

  • Our third quarter inventory balance of $8.3 billion increased $552 million, or 7.1% versus Q3 last year.

  • The increase was due to square footage growth of 10.2% from this time last year, offset somewhat by 3.7% lower inventory in comp stores.

  • Inventory turnover calculated by taking a trailing four quarter cost of sales divided by average inventory for the last five quarters was 3.98, a decrease of 12 basis points from Q3 2007.

  • At the end of the third quarter we owned 87% of our stores, versus 86% at the end of the third quarter last year.

  • Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, decreased 275 basis points to 7.7%.

  • Moving on to the liability section of the balance sheet, we ended the quarter with Accounts Payable of $4.8 billion, which represents a 24% increase over Q3 last year.

  • The increase is attributable to ongoing efforts to improve vendor payment terms, and the timing of purchases in the quarter.

  • We ended the quarter with $249 million of short term borrowings.

  • This was comprised of $189 million of Canadian debt to fund our expansion there, and $60 million of commercial paper outstanding.

  • During the depths of the credit crisis with our A1/P1 commercial paper rating, we received daily indications from our banking partners, that the commercial paper markets were available to us at reasonable rates.

  • While we felt good about our financial position in Q3, we knew we would need to access the commercial paper markets in the fourth quarter.

  • Given the strain and uncertainty in financial markets, we decided to test the waters in Q3, and were able to confirm that the CP markets were available to us at attractive rates.

  • Our debt to equity ratio was 29.7%, compared to 35.1% for Q3 last year.

  • Our leveraged target remained 1.2 times lease adjusted debt to EBITDAR for the first three quarters, and due to the seasonality of our tax load 1.4 times at year end.

  • These targets were established based on our goals of maintaining a strong single A credit rating, and A1/P1 commercial paper rating, which has proved to be prudent in this environment.

  • At the end of the third quarter lease adjusted debt to EBITDAR was 1.35 times, which exceeded our 1.2 times target for Q3.

  • There were no share repurchases in the quarter, and our outlook does not contemplate any share repurchases for 2008.

  • We will continue to evaluate market conditions, and diligently evaluate our options to balance financial flexibility against the opportunities presented in the market.

  • Return on invested capital, measured using a trailing four quarters earnings plus tax-adjusted interest divided by average debt and equity for the last five quarters, decreased 378 basis points for the quarter to 11.5%.

  • Now looking at the statements of cash flows, year-to-date cash flow from operations was $4.4 billion, an increase of $573 million, or 15% over the first nine months of 2007.

  • The strong cash flow from operations growth versus last year is driven by the growth in Accounts Payable I noted earlier.

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

  • There continues to be a great deal of uncertainty related to the financial markets, housing, and state of the consumer.

  • In addition we did see a slowing of sales trends beginning in the last week of October, these factors are contemplated in our outlook.

  • We expect fourth quarter total sales to range from a decrease of 3% to an increase of 2%, which incorporates the opening of 33 to 38 new stores, comp sales are estimated to decline 5 to 10% to last year.

  • EBIT or operating margin for the fourth quarter is expected to decline by approximately 330 basis points to last year as a percentage of sales, driven by expected store payroll deleverage of approximately 180 basis points, as well as depreciation, fixed costs, and gross margin.

  • We are forecasting diluted earnings per share of $0.08 to $0.16, which represents a decrease of 41 to 71% compared to last year's $0.27.

  • For 2008, we expect to open 115 to 120 stores, resulting in an increase in square footage of 7 to 8%.

  • We are estimating a comp sales decrease of 6 to 7%, and total sales to range from flat to last year, to an increase of approximately 1%.

  • For the fiscal year, we are anticipating an operating margin decrease of approximately 190 basis points, driven by store payroll, as well as depreciation, fixed costs and gross margin.

  • We are forecasting an effective tax rate of 37.4% for 2008.

  • As a result, we expect diluted earnings per share of $1.46 to $1.54 for the year.

  • For the year, we expect cash flow from operations to be approximately $4.4 billion, up about 2% over fiscal 2007.

  • In addition, we forecast total capital expenditures of approximately $3.9 billion, with roughly $300 million funded by operating leases, leaving cash CapEx of approximately $3.6 billion for 2008.

  • Operator, we are now ready for your questions.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Our first question will come from Deborah Weinswig with Citi.

  • - Analyst

  • Good morning.

  • Bob, you had originally guided for the quarter EBIT margin to decline about 290 basis points.

  • You obviously came in better than that.

  • What were the major drivers there?

  • - EVP, CFO

  • Good morning, Deb.

  • The main driver of the better than expected EBIT performance was insurance expense.

  • We had guided to roughly 100 basis points of deleverage in the third quarter, second against the large self-insurance adjustment made in Q3 of 2007.

  • We continued to see favorable trends in that area this year, as a result we only had 46 basis points deleverage, versus the expected 100 basis points.

  • - Analyst

  • Okay.

  • Then Robert you had in your opening remarks talked obviously about the tight credit markets.

  • What are you doing to help your customers with regard to liquidity, and also what trends are you seeing with regard to credit card penetration et cetera in the store?

  • - Chairman, CEO

  • I will starting, and I will let Bob follow-up on it, our credit card penetration I think is down about 100 basis points from what we had seen previously.

  • We think part of that is obviously we talked in the second quarter conference call about the impact of stimulus checks coming in, and consumers using that versus credit availability, and then also I think your have consumers more and more maybe moving toward the upper end of their credit lines, so they don't have open to buy.

  • In the more robust economic times we did not loosen our credit standards, but certainly we have, our GE Capital has gone through a review and evaluation of our credit limits under certain FICO scores, and taken a look at that and on the lower end, they have actually pulled down some of the credit limits of some, which we think is prudent in the current environment.

  • I will let Bob give a few more specifics on what we have done along those lines.

  • - EVP, CFO

  • Thanks Robert.

  • As Robert indicated, proprietary credit as a percentage of total was down about 100 basis points Q3 this year versus Q3 last year.

  • We also saw a similar reduction in credit cards.

  • So as a result we have seen a pick up in cash, check and debit card transactions year-over-year, again consistent with what we saw in the second quarter.

  • As Robert indicated, we did GE came to us with some suggested changes in taking a look at the scoring they have, increased the FICO cut off score to extend credit to new applications, as well as did reduce balances to some of those lower end FICO scores, that did reduce the credit limits to the balances for a number of the consumers.

  • - Analyst

  • Great.

  • Thanks for the color, and best of luck.

  • - Chairman, CEO

  • Thank you.

  • Operator

  • Our next question will come from the line of Matthew Fassler with Goldman Sachs.

  • - Analyst

  • Thanks a lot.

  • Good morning.

  • I would like to focus on the guidance for the fourth quarter.

  • Based on the work that we did kind of trying to back into your implied fourth quarter EBIT guidance issued on the second quarter call, it would have seemed like you would have expected about a 200 basis point decline, now you are looking for something somewhat greater than that.

  • I would like to know how much of that relates to the fact that the sales bend is wider, down 5 to 10, instead of down 5 to 7.

  • And then specifically is the vendor rebate issue a big issue for the fourth quarter, and is the insurance line item that you cited in answering the prior question, factoring into that movement at all?

  • Thank you.

  • - EVP, CFO

  • Sure, Matt.

  • This is Bob.

  • Certainly dropping the sales guidance is a factor that contributes to the lion's share of the greater expected deleverage than you might have implied on the Q2 call.

  • Store payroll [dealer] rate goes up about 100 basis points, entirely driven by the decrease in sales, as you know from a cyclical standpoint our Q4 is our lowest volume quarter, and we are going have our third straight year of negative comps in the fourth quarter.

  • The volume rebates we anticipate a margin impact of 5 to 10 basis points in the fourth quarter.

  • So not dissimilar to what we saw in the third quarter.

  • Other items we had about 10 basis points of advertising leverage in Q3.

  • That flips to about 10 basis points of deleverage in Q4, really just based on the timing of how the calendar was laid out for the year.

  • Those were the big drivers of really going from your number of 200 basis points of EBIT decline, to roughly 330 as outlined in our guidance.

  • - Analyst

  • It is basically SG&A, rather than gross margin, and it is primarily volume driven?

  • - EVP, CFO

  • Correct.

  • Gross margin may be slightly worse in Q4 than Q3, but nothing dramatically, the lion's share of the change is in SG&A.

  • - Analyst

  • Just to follow-up, doing the arithmetic on that it would look like your expenses per store would essentially flatten out, to get if you were to look at I should say the low end of the sales guidance, to get to the low end of the earnings guidance your SG&A per store would probably need to be essentially flat with last year, having declined something like eight out of the past ten quarters.

  • Do you feel like you still have more room in absolute terms to take SG&A dollars out if sales remain difficult?

  • - EVP, CFO

  • We think there is still plenty of opportunity to reduce costs, but we are going to do it in a prudent manner, not going to sacrifice the Lowe's brand, we are not going to sacrifice the relationship with have with consumers.

  • We do feel like there are a lot of things out there we are looking at, testing, and studying regarding cost reduction, but we are going to do it in a prudent manner.

  • - Analyst

  • Got you.

  • Thank you so much.

  • Operator

  • Our next question will come from the line of Chris Horvers with JPMorgan.

  • - Analyst

  • Thanks.

  • Good morning.

  • Can you dis-aggregate your comp outlook in 4Q, and compare that to 3Q?

  • How much of it is the trend, minus 5 to minus 10, the trend at the end of the quarter, versus how could you quantify how the seasonal shift, the mix of seasonal business changes in 4Q, how much that might pull your comp down for 4Q.

  • And also, the factors that you mentioned previously on the drought, the hurricane, and so forth.

  • - EVP, CFO

  • I will start and let others add color as appropriate.

  • From an outdoor category perspective, Larry gave the color around how that is defined which is products primarily used for outdoor application, that is roughly 30% of the mix of business in Q3, it drops to 20% in Q4.

  • In addition as I mentioned in my comments we had about a 50 basis point benefit from drought impact in the third quarter, we are expecting no impact in the fourth quarter, and finally, the biggest result of the change in outlook is the slowing trends that started the last week of October.

  • - Chairman, CEO

  • This is Robert Niblock, just a couple of other things.

  • As we look to what we are comping up against from the fourth quarter of last year, our comps got more negative through the quarter.

  • So our easiest comparisons are ahead of us, so certainly right now we are going up against our toughest comparison from the year ago period.

  • If you also layer on top of that the fact that the Thanksgiving Holiday has shifted about a week, so that delays the kick off to the Holiday selling season, of Holiday-related products.

  • So there is a little bit of calendar shift there from that standpoint, and then just as we mentioned in the comments, the disruption you saw around the interest in the election, everything that was going on in the financial markets caused an impact in our comps, in the last week of October, and into the first two weeks of November.

  • So taking that all into account, we think it is appropriate to be cautious, we think it is appropriate to give a wider range, because certainly we expect things to improve as the consumer moves back to normal, as we get closer to that Thanksgiving key kick-off date for the Christmas and Holiday selling season.

  • And as we get easier comparisons, but given that all of those are future items, and there seems to be much more negative than positive macro economic news coming out on a daily basis, we think it is prudent be cautious, widen the range, and adjust the other guidance line items of guidance accordingly.

  • - Analyst

  • So then, just to check that math, the drought benefit of 50 basis points, that goes away, and then the, this outdoor seasonal mix, that is 80 basis points that comes in to a drag in 4Q, is that right?

  • - Chairman, CEO

  • Roughly.

  • - Analyst

  • Okay.

  • Got you.

  • And then, from the expense perspective to follow-up on previous questions, how should we think about SG&A dollar growth going forward, you have been able to pull that down over time, are you getting to that point next year where it will get a lot more difficult, and how should we think about the change in inflation and commodity costs, and other wage costs going forward?

  • Thank you.

  • - EVP, CFO

  • I guess I will provide the same answer I provided Matt.

  • We still think there ares a number of opportunities to reduce costs, we are very active in a number of initiatives, it is just very tough for this to be reflected when you are in a negative comp environment.

  • - Chairman, CEO

  • And Chris, it is Robert.

  • Certainly things like, if fuel prices continue to decline, the cost of moving goods reduces fuel and commodity prices, that helps reduce our operating costs, certainly there is a big component of that in a lot of what or vendors manufacture, so to the extent you continue to see that you hope that some of the price increases that we have experienced over the past year to 18 months, would lessen and certain situations potentially start to reverse, depending on the extent of those drops in fuel and commodity prices.

  • Operator

  • Our next question will come from the line of Gregory Melich with Morgan Stanley.

  • - Analyst

  • Hi.

  • Thanks, guys.

  • Two questions.

  • First, Bob on the payables you said it was basically extending terms, and also timing.

  • Could you get a little more specific on that, given the importance of that Payables growth for the cash flow?

  • - EVP, CFO

  • Sure.

  • There the timing of purchasers within the quarter did have an impact, later purchase in the quarter, you don't have the opportunity to pay for it.

  • When we think about forecasting year end, we think payables will be up roughly 10% Q4 over Q4.

  • Inventory will be up 5 to 6%.

  • Again that is driven by a 7 to 8% increase in square footage for the fourth quarter.

  • As a result, we are forecasting AP to inventory to be roughly 51% at year end, which compares to roughly 49% for the fourth quarter of 2007.

  • - Analyst

  • Okay.

  • Great.

  • And then the second question is you talked on the release, and I think Robert, you talked about as well, Larry, how the project sales have pretty much just gone away.

  • Can you give us something that put a number on that, like what, how many tickets you do, what percentage of your sales are on tickets above $1,000, just to get a sense of how close that is to actually being zero?

  • - President, COO

  • We don't give out the information of the sales by the ticket size, but certainly the pressures in the third quarter really came in several areas namely kitchen cabinets, we had a really tough quarter on kitchen cabinet sales in the third quarter, and certainly we had a couple of things we kicked off in the latter part of the third quarter of kitchen cabinets that did show positive response in terms of sales, but overall for the quarter those categories were down quite a bit.

  • As you head into the fourth quarter, the large ticket installed items normally declined, just due to seasonality, we will do carpet jobs up until next week, and then carpet kind of levels out as people try to get ready for the Holidays, and the same with kitchen cabinets, that business always declines in the fourth quarter compared to the other quarters, but we are looking at all of the different categories that we install.

  • Certainly as I mentioned in my comments, the whole house carpet installation program has worked well, our whole house blind installation program has worked well, but you look at some of those ticket sizes, especially on blinds they are not as large as a carpet job, and certainly not as large as a whole house or kitchen cabinet job.

  • We have got a lot of plans and programs in place, and there again, we just think that consumers right now are just sitting back and waiting to go see how things play out, before they tackle those larger projects.

  • - Chairman, CEO

  • Great question Greg, it is Robert Niblock, don't think that those large tickets, tickets over $500 or $1000 have completely dried up.

  • There are certain things that Larry talked about, such as cabinets and countertops and those areas where the consumer has kind of pulled back kind on the discretionary side of the home, remodeling home repair business, but as we talked about in our overall comments, you look at outdoor power equipment, a lot of that being storm related, in response to better seasonal conditions this year versus last year's drought, you saw a substantial increase, buying big tickets in that category.

  • If you look something like building materials, driven by roofing installation and some of the other things we talked about, you saw a substantial increase in large ticket purchases in those areas so overall yes those large tickets are up, it is being more impacted in kind of those discretionary type purchases and major purchases, there are still customers out there that are putting in new kitchens, but there are many of them are also sitting on the sidelines and impacting those areas of the business.

  • - Analyst

  • Just a follow-up from before, just to confirm, these last three weeks in November, you are running below that 5 to 10 comp for the quarter?

  • - Chairman, CEO

  • We did not say that.

  • - Analyst

  • Okay.

  • - EVP, CFO

  • We talked about the slow down in October, Greg.

  • So, if the month of October was negative 5 to 7.

  • Last week was negative 8.5, but I will tell you that to start the quarter we are closer to the negative 10, than we are the negative 5.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Our next question will come from the line of Eric Bosshard with Cleveland Research.

  • - Analyst

  • Good morning.

  • You commented that the gross margin expectation in 4Q is similar, perhaps a little worse than 3Q, can you give a little more color within gross margin, what you see going on in terms of costs from suppliers, especially in an environment now where commodity and input costs are changing pretty meaningfully for them.

  • - President, COO

  • This is Larry Stone.

  • I will start, and let Robert and Bob weigh in on it.

  • Certainly, with the decrease in fuel price, we see, costs have potentially started to come down.

  • But as we capitalize fuel costs and our inventory, we have got to sell through those layers of higher costs.

  • So we really think it is probably going to be the first quarter of '09, before we start to get a lot of impact from that.

  • But we have worked our suppliers and pushed back on the increases we were getting 12 to 18 months ago, and certainly the decreases have started a lot of, anything fuel-related you can certainly see it.

  • So we think there are a lot opportunities as we head into next year.

  • Fuel prices continue where they are at, or stabilize, we don't have that dramatic swing, like we had back at the early part of this quarter.

  • Operator

  • Our next question will come from the line of Stephen Chick with FBR.

  • - Analyst

  • Hi.

  • Thanks.

  • Maybe for Bob.

  • The operating cash flow guidance for the year ticked down, if I heard you correctly to 4.4 billion that is kind of where you are trending, where you are year-to-date actually, so it looks like you are predicting a pretty minimis level of operating cash flow for the fourth quarter, if I heard you right.

  • I was wondering if you can speak that?

  • And secondly if your targeted leverage ratio which I think was 1.4 times, if that is what we should still be looking for for the year as well?

  • - EVP, CFO

  • On the cash flow you are right, the expected cash flow from operations in fourth quarter is roughly flat.

  • Two items impacting that, first a decline in earnings of roughly $200 million, second is as I mentioned earlier the timing of purchases.

  • So as the AP, the inventory percentage flattens out from 58 to 51% Q3 to Q4, that is impacting the cash flow from operations in the fourth quarter.

  • Second question regarding the debt target, were you asking about where we are forecasting for year end?

  • - Analyst

  • Yes, I think your targeted leverage ratio was 1.4 times, for the year, I think.

  • And if --

  • - EVP, CFO

  • Yes it is.

  • Actually forecasting it to be close to 1.6 times at the end of the fourth quarter.

  • - Analyst

  • Okay.

  • That is a little higher?

  • - EVP, CFO

  • It is actually right where we thought we would be when we first planned the year, it would be about 1.6 times.

  • The only thing is because we have done a relatively good job with working capital throughout the course of the year, we are able to call the convertible debentures in the second quarter, otherwise, a little bit worse earnings offset by lower debt because of the convert and call.

  • - Analyst

  • Okay.

  • Thanks, Bob.

  • - EVP, CFO

  • Thank you.

  • Operator

  • Our next question will come from the line of Michael Lasser with Barclays Capital.

  • - Analyst

  • Good morning, thanks a lot for taking my question.

  • On the weakness that you started to see in the last week of October, and extended into November.

  • What did is the distribution look like from a market perspective, was it mostly in the weak housing market, or did you start to see some of the other markets that had been holding up well decline, just in that, the macro economic concerns that are start to go overweigh housing issues in other areas?

  • - President, COO

  • This is Larry Stone.

  • Basically the weakness we found in the last couple of weeks of October is pretty much across the whole US, and I really think it had had a lot to to with the election, upcoming election, and fuel prices were finally starting to trickle down a little bit, which was helping consumers, but I think just the uncertainty of the election and then the real impact of the financial markets I think had a lot of people kind of in a sit on the sidelines, and see what is going to happen.

  • Those two issues had more to do with it than anything the last couple of weeks of October.

  • - Analyst

  • Okay.

  • And then a real quick follow-up on the foreclosures, you made a comment you are seeing investment from buyers of foreclosed properties that was similar to what you seen with non-foreclosed properties, but what are you seeing in regards to the amount the message that banks are willing to put in, such that it might change the relationship between housing turnover, and your comps moving forward?

  • - EVP, Business Development

  • Michael, this is Greg Bridgeford.

  • We are seeing spend rates from the research that we have done into our customer transactions, from the standpoint of a housing turnover related to a change of ownership from foreclosure, is similar to a normal change of ownership spend, post-possession of the house.

  • We haven't been able to dive in, and detect bank spend, to fix up a house, for example, for sale.

  • But we can tell you that we have been tracking this for about nine months, and we are trying to get a feel but right now our research tells us that the spend post-possession of the house in a foreclosed situation in our markets, seems to be a very similar spend to what we are finding from a normal turnover of housing.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Our next question will come from the line of Colin McGranahan with Bernstein.

  • - Analyst

  • Good morning.

  • Two question, first for Larry, I hope you could speak a little more about the appliance category, given that it is kind of one of the big ticket categories, but has an interesting mix of both discretionary and nondiscretionary pieces in it, so what have you seen in that category, especially as you went into late October and November, and how are you thinking about the promotional environment there, looking especially at some of your competitors, especially Sears?

  • So first question there for Larry.

  • - President, COO

  • In the Appliance category, we still had a pretty descent quarter overall in appliances.

  • We still gained according to third party measures in terms of dollar share and unit share, and draw rate versus the competition.

  • We think the fourth quarter I mean so far, we have not seen anything irrational, in terms of advertising, and so forth.

  • We think that our plans we have in place for the quarter are real solid.

  • As we always state all the time that we will react if things come out, and certainly we have got our 10% price guarantee on major appliances, that we will not only match the price but beat it by 10% if called to our attention, but we think the fourth quarter should be pretty solid.

  • The weeks leading up the Thanksgiving are normally pretty good appliance weeks, and traditionally those purchases will tail off a little as you get near Christmas, but we think business is still pretty good out there.

  • The products like high efficiency laundry, as we have talked about many times, continue continue to main share as consumers still will pay a couple thousand bucks for a high efficiency washer and dryer.

  • We think that ties into this whole thing about energy efficiency, and at the same time the higher ticket purchases are driven by that.

  • Overall, it is mix, but it is still pretty solid compared to the other parts of our business.

  • - Analyst

  • Great.

  • Then second question for Greg, what have you been able to gather or what have you done in terms of your pricing in regards to Home Depot's portfolio pricing moves, and what kind of data were you able to gather there?

  • - EVP, CFO

  • Portfolio pricing.

  • Colin, we have looked very hard at what kind of impact we are seeing in the marketplace from a price perception standpoint for all of our competitors, we were able to track it pre-campaign, campaign, and post-campaign.

  • What we have not seen is a material change in price perception of the part of customers from the standpoint of any of our competitors campaigns run that have run recently, and that is as recent as a month ago.

  • - Analyst

  • Okay.

  • Did you actually make any price changes in your own portfolio, in response?

  • - President, COO

  • This is Larry Stone.

  • Certainly we have had NLPs for the last five years, and when the competition did come out with their program, our price shoppers looked at the markets, and there are a few items that we did have to make adjustments on, but there again, it is a program that we have had in place for several years.

  • Consumers have reacted well to it.

  • But nothing that was out there that we had to overreact to.

  • There are always items, there are price shoppers going up, going down, and so forth, but nothing that really gave us a lot of heartburn on the new program that was announced by the competition.

  • - Analyst

  • Very helpful.

  • Thank you.

  • - President, COO

  • Thank you.

  • - Chairman, CEO

  • We have time for one more question.

  • Operator

  • Our final question will come from the line of Scott Ciccarelli with RBC Capital Markets.

  • - Analyst

  • Hey, guys.

  • I guess I wanted to follow up a little bit more to Colin's question, can you guys just talk about the competitive environment, specifically your assessment regarding consolidation activity with the huge number of smaller players out there.

  • I know a lot of questions tend to focus more on your biggest competitor, but what are you seeing in early throes of the financial strain, that must be occurring with all of the other smaller players that are out there?

  • Thanks.

  • - President, COO

  • Scott, it is Larry Stone.

  • I will take the question.

  • There are a lot of publicly traded companies that we can track, and certainly there is some competition in Stock Lumber and 84 Lumber have announced quite a few closings.

  • Those are really two companies that sell a lot to new home builders.

  • So kind of understand what is happening there.

  • We get a lot of field intelligence from our store managers in the various markets of smaller independents that are going out of business, it could be a carpet store, an appliance store, a hardware store, a lawn and garden shop, or so forth, but most of those companies are not publicly traded.

  • So it is all anecdotal information that we get from the field.

  • Greg Bridgeford compiles all of this, and we keep a running list of what is happening in each market.

  • So it really is us better understand the markets, what is taking place, and helps us really understand the more opportunity we have, and how we might want to mix differently in those markets, and go after the business that is being left in the market by that door closing.

  • - EVP, Business Development

  • Scott this is Greg Bridgeford, if you look at I agree with what Larry said, if you look at the trends we are seeing out there.

  • The businesses, and Larry is right, it is anecdotal, and a lot of information we are getting market by market, especially on local independents.

  • Businesses and entities associated with new residential markets, and businesses associated with large project sales, especially dealers, we believe are under considerable strain right now.

  • We take all of that information in.

  • We understand what opportunities that affords us, and the ability to be there for the customer during these times.

  • - Analyst

  • Is it fair to assume you have actually seen an acceleration in that process, just given the anecdotal evidence you are hearing at the store level?

  • - President, COO

  • I don't think an acceleration, I think just a continual closing of smaller businesses as things tighten up, and quite frankly with the way things have been the last few weeks, and so forth, we think it will probably accelerate as we go into '09.

  • But as far as you know, thinking it is we can list all of those different suppliers, and so forth, and come up with a hard fast number right now, it would be pretty tough to do but we look at it on what basis on a weekly bay, and really try to take into consideration the opportunity that presents for Lowe's in those markets.

  • - Chairman, CEO

  • Scott, this is Robert Niblock.

  • I think the information we get back from our field organizations and store managers about what they are seeing change in the competitive landscape in their market, you generally hear about more changes, closures, those types of things taking place in those areas that have been most heavily hit by the decline in housing prices.

  • California, Florida, the areas in the upper Midwest that have been heavily impacted by the automotive industry, you generally hear more entries coming back in as far as local competitors that are struggling, going out of business, liquidation sales, whatever the case may be.

  • - Analyst

  • Okay.

  • Very helpful thanks a lot, guys.

  • - Chairman, CEO

  • Thanks, and as always, thanks for your continued interest in Lowe's, we look forward to speaking with you again, when we report our fourth quarter results on Friday, February 20th.

  • A few days earlier than our typical release date, and in conjunction with our Annual Sales meeting that begins that weekend.

  • Thanks.

  • Have a great day.