Lowe’s - Earnings Call - Q1 2012
May 16, 2011
Transcript
Speaker 5
Good morning, everyone, and welcome to Lowe's Companies, Inc.'s first quarter 2011 earnings conference call. This call is being recorded. Please note, if you pressed star one to enter the question queue prior to the start of today's call, your signal did not register. You will need to press star one again to enter the queue. Statements made during this call will include forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission. Also, during this call, management will be using certain non-GAAP financial measures.
You can find a reconciliation to the most directly comparable GAAP financial measures and other information about them posted on Lowe's Investor Relations website under Corporate Information and Investor Documents. Hosting today's conference will be Mr. Robert Niblock, Chairman and CEO, Mr. Rick Damron, Executive Vice President of Store Operations, and Mr. Bob Hull, Executive Vice President and CFO. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Speaker 2
Good morning, and thanks for your interest in Lowe's. Following my remarks, Rick Damron will review our operational performance, and Bob Hull will review our financial results. Our performance for the quarter did not meet our expectations. Sales for the quarter declined 1.6%, and comparable store sales declined 3.3%. Comp average ticket was essentially flat in the first quarter, while comp traffic declined 3.4%. We had solid gross margin improvement and delivered earnings per share within our guidance, despite lower than expected sales. I would like to thank our more than 234,000 employees for their hard work and dedication. We faced tough comparisons in the first quarter as a result of last year's government stimulus programs, such as cash for appliances and the home buyer tax credit, as well as favorable weather conditions last year.
We knew the bar was high, but we had a reasonable plan in place heading into the quarter, and we executed against that plan. In fact, our performance was solid through about week eight of the quarter, and then we were impacted by the unseasonably cold, wet weather in the Northeast U.S., North Central U.S., and Northwest regions of the U.S., and the severe storms in the Southern U.S., in particular the unprecedented tornado season. The Lowe's store in Sanford, North Carolina, was struck by a tornado in mid-April. Fortunately, there were no customer or employee fatalities or injuries. However, the store sustained severe damage, resulting in the need to demolish and rebuild the store. Our thoughts are with the families impacted by the numerous tornadoes and widespread flooding throughout the country.
As we've done in the past when natural disasters strike, Lowe's stores around the country, as well as Lowe's.com, became official donation sites for the American Red Cross Disaster Relief Fund, with Lowe's also contributing $750,000 to the relief efforts. Overall, the economic recovery is continuing, but uncertainty remains, and consumer confidence sagged during the quarter in response to increasing concerns around inflation, unrest in the Middle East, and the impact of potential budget cuts at the federal, state, and local levels. U.S. GDP growth slowed to 1.8% for the first quarter after a 3.1% rise in the fourth quarter. More specifically, with regard to home improvement spending, the drivers are mixed. Employment and disposable income are slowly improving, while housing turnover is restrained, and home prices continue to decline.
The implications for our business is that customers may feel better about their employment situation, but are uneasy due to higher fuel, clothing, and food costs, as well as geopolitical issues around the world. In addition, decreasing home prices and low housing turnover mean consumers remain cautious when it comes to big-ticket discretionary spending on their homes. According to our first quarter consumer survey, rising gas and energy prices are cited by homeowners as the top factor affecting future spending plans, followed by the state of the overall economy and inflation in general. While housing values remain a concern, we did see positive trends in home improvement affinity and project plans in our survey, which may suggest that homeowners are beginning to look for ways to enhance their homes.
That said, our survey indicates that 84% of planned spending in the next six months will be small ticket, less than $500, and 43% of that planned spending will be discretionary. As we shared with you previously, our business has historically been 60% maintenance and 40% discretionary. During the downturn, that mix shifted closer to 70% maintenance and 30% discretionary. As consumers have focused increasingly on maintenance projects, and as the cost of fuel has increased, convenience of store location is playing a growing role in consumers' choice of where to shop. Differentiation is key to combating this convenience factor, in addition to our targeted store expansion strategy. These two factors, convenience and differentiation, as well as the opportunity to close more sales, are driving our transformation from a home improvement retailer to a home improvement company.
As we discussed at our analyst conference in November, we are working diligently on our commitment to deliver better customer experiences by pulling together the best combination of possibilities, support, and value for customers, wherever and whenever they choose to engage. We're building momentum behind this transformation in 2011. Research has shown that there are seven stages in home improvement spending: inspiration, planning, getting supplies, getting started, making progress, finishing, and enjoyment. Each stage differs in length based on the type of project the customer is undertaking, and the level of emotional engagement is generally higher in the beginning and ending stages than it is in the middle. Traditionally, our industry has focused on getting supplies, where emotional engagement is relatively low. Our focus for the future is on all seven stages as we strive to provide customers with a better and differentiated experience.
As I said, we're building momentum behind our transformation, so let me give you some examples. During the quarter, our store employees began using a business community portal that puts them in touch with fellow employees throughout our chain. Through this portal, they're able to communicate with one another and offer solutions to the questions they encounter every day. We also launched a tool on Lowe's.com that gives customers the ability to ask product-specific questions and receive answers from a variety of sources, including Lowe's employees, other customers, and product vendors. With these systems, our employees can provide more in-depth advice in-store or wherever customers choose, thus allowing customers to more easily complete their projects.
A little over a year ago, we completed our Lowe's.com platform redesign, and since that time, we've been making incremental improvements, fueling a 19% increase in traffic year over year and a 78% increase in online conversion rates. We also saw a substantial increase in customer satisfaction according to third-party data. We have over 170,000 items available online, with significant expansions planned for the remainder of the year. We plan to launch the Spanish-language site of Lowe's.com this summer in an effort to better resonate with this very important demographic. We will also deliver further improvements in our multi-channel presence and launch our first new mobile app, as well as foundational capabilities to support MyLowe's, our customer-focused portal that will allow customers to more efficiently manage projects and improve their homes. Finally, we will roll out the repair services concept to outdoor power equipment, or OPE, in the second quarter.
Having after-sales service for this product category is expected to increase our share position while positively affecting customer satisfaction, resulting in incremental repeat customer visits and allowing us to realize cost savings through lower OPE return rates. This initiative will also increase our ability to identify product quality concerns that we can work with our vendors to resolve. This transformation is about living up to our vision to provide the customer value solutions necessary to become the first choice in home improvement. It's about bringing Lowe's to the consumer on their terms, regardless of the physical store presence, and making the experience relevant and personal. Make no mistake, this effort is as much about maintenance items and small projects as it is larger-ticket, discretionary projects.
In the second quarter, we expect to take advantage of delayed seasonal opportunities as weather patterns improve and consumers are finally able to move outdoors and tackle traditional projects, as well as repair damage caused by the harsh weather. We continue to expect the second half of the year to be stronger than the first half, given the challenging comparisons from the first half of last year as a result of government stimulus programs. However, stabilization of home prices and solid progress working through the inventory of distressed housing will be key milestones to recover. Thanks again for your interest, and now I'll turn it over to Rick Damron to provide more details on the quarter. Rick?
Speaker 3
Thanks, Robert, and good morning. I will review our first quarter performance, discuss some new programs underway to drive sales, then update you on ways we continue to learn and improve. As Robert mentioned, we finished the first quarter with negative 3.3% comps. Performance exceeded the company average in the Southeast, South Central, and Desert Southwest regions of the country, where temperatures and rainfall were close to normal. On the other hand, performance lagged the company average by over 200 basis points in the Northeast U.S. and North Central U.S. regions of the country, where colder and wetter conditions prevailed.
Looking at a detailed analysis of our indoor and outdoor performance, specifically characterized by hundreds of product groups as indoor or outdoor, comp store performance of our indoor categories were essentially flat, while our outdoor categories declined 9% for the quarter and 21% over the last five weeks of the quarter. Some categories actually benefited from the wet weather. For instance, rough plumbing performance benefited from strong sales of pumps and tanks and air filters. There were some additional factors affecting category performance in the quarter. On the positive side, cabinets and countertops performed well, driven by strong performance of our special order kitchen cabinets. Inflation drove high single-digit comps in rough electrical and helped paint to comp positively, overcoming slow sales of exterior stains, sealers, and applicators. On the negative side, millwork was impacted by the pull forward of sales into 2010 from expiring energy tax credits.
Further, as expected, appliances were unable to overcome a very difficult comparison to last year's cash for appliances program, but achieved a two-year comp of roughly 9%. Installed sales generated low single-digit comps, driven by strong promotions in special order kitchen cabinets, improved special order lead times in appliances, and customers' continued enthusiastic response to Stainmaster carpet. Not surprisingly, our comp store performance was driven by April transactions, not ticket. Comparable store average ticket was essentially flat and was flat to positive in 12 of 21 domestic regions, even though we were comping against the favorable impact to ticket of last year's cash for appliances program. On the other hand, comp transactions decreased 3.4% year over year, increasing in February, declining low single digit in March, and declining high single digit in April. The weakest April transaction comps occurred within the Northeast U.S. and North Central U.S.
areas of the country. Our ending first quarter inventory is 2.4% lower than the first quarter of 2010, which, as a reminder, ended 9.8% higher than the first quarter of 2009. Last year, we attributed our higher inventory to opportunistic purchases of appliances and flooring. While our inventory is lower than last year, we have the right inventory to meet customer demand in the second quarter. Further, even though our first quarter sales of seasonal products struggled, we have confidence in our ability to sell through these inventories in the second quarter and avoid significant markdowns. As expected, with negative comp performance, our expenses deleveraged. Bob will share more details regarding our overall expense performance, but I'd like to point out that we were able to partially offset other expense deleverage through operating salaries leverage, while maintaining our strong customer service scores.
Although we hired aggressively for our weekend teams, we adjusted hiring of seasonal and temporary employees to forecasted sales trends. Now, I'd like to discuss a few programs we undertook during the first quarter to close more sales and build ticket. As mentioned on last quarter's call, we streamlined the store management structure and implemented weekend teams to provide more customer-facing hours on the weekends, and we adjusted our media mix to obtain better efficiency from each advertising dollar. I'd like to share with you some more details about these programs. First, we are pleased with the initial results of our weekend teams, who provide additional customer-facing hours from Friday through Sunday. We have filled more than 90% of our weekend positions. Unlike our seasonal hires, our weekend teams will remain in place throughout the year. These teams have increased our weekend-to-date total selling hours by 150 basis points.
One indication of the effectiveness of this program is that our first quarter growth of comparable store sales and transactions on weekends were over 140 basis points higher than for weekdays. Additionally, we have received positive feedback from our stores that the weekend teams are enhancing the customer experience and providing the staffing flexibility needed to support weekend traffic and sales. Next, we realigned our media spend, placing more emphasis in online media, the same media that more of our customers are moving to. Online media is also much more efficient, as we can dramatically increase our media impressions per dollar versus print. Additionally, we shifted weight from local to national radio, where once again we can gain more impressions per dollar spent. We also rolled out three programs that were not discussed on our fourth quarter call. First, we entered into a gift card mall program with Blackhawk.
Blackhawk manages over 85% of the gift card mall distribution in the U.S., and we now have our cards available for purchase in grocery stores and other high-volume retail channels, which will significantly increase our total gift card sales. In addition, gift card malls will be in all of our stores beginning late in the second half of the year. Second, we introduced a tax refund card at the beginning of the first quarter. This promotion coincided with the timing of many customers' tax refunds, as cards were purchased from February 8th through March 14th. On March 18th, 10% of the original purchase amount was added to the card. We wanted to give customers another reason to make their initial purchases at Lowe's and then return for additional purchases. Customers and stores responded positively to these cards.
However, we found that many of the cards were used on purchases that customers had already planned to make at Lowe's, so the incremental sales from this program were not as significant as we had planned. Third, we launched a program at the end of April that provides Lowe's consumer credit card holders with 5% off every day. For purchases above $299, we continue to offer card holders the option of no-interest financing instead of the 5% discount. You might wonder why we did this. Over the past year, we have experienced declines in our proprietary credit penetration, the result of regulatory changes that preclude companies from offering no-payment promotions. Those regulatory changes dramatically reduced the value proposition of our proprietary card. Since our proprietary credit programs provide a lower cost of tender, we evaluated a number of options to drive customers back to this program.
We have used credit promotions ranging from our everyday six-month zero-interest offer to periodic use of 12-month and 18-month zero-interest offers for key promotional periods. Last fall, given consumers' increasing focus on maintenance projects, we tested percentile programs to determine whether we could drive a greater proportion of smaller-ticket purchases. After evaluating our test, we concluded that a combination offer would enhance the card's value to customers by giving them another choice to make their purchases even more affordable every day. Now, I'd like to discuss with you a few ways in which our organization continues to learn and improve. We have previously discussed our efforts to go local with our pricing using base price optimization and patch area expansion, and in market assorting using integrated planning and execution, or IP&E.
We have fully implemented base price optimization and patch area expansion, and IP&E is being rolled out across all of our merchandise categories this year, with the benefits coming in 2012 and beyond. There is another near-term effort to go local. I believe we have an opportunity to unleash more of the creativity and market-specific knowledge of our store personnel. During our rapid growth over the past decade, we needed more of a command-and-control approach to ensure our new stores represented the Lowe's brand. As our growth has slowed, the tenure of our store managers and associates has increased, giving them greater experience and knowledge to make their stores better to serve their specific markets. We will always have a centralized approach to ensuring consistent standards for merchandising, store environment, and customer service.
I know we can maintain our high standards while also giving more latitude to our store teams to creatively address local market needs. I call this flexibility within the framework. Since assuming my role, I often blog within our business portal community, which is accessible for the entire Lowe's organization. I encourage our store employees to share examples of what they have done within their own stores to better serve customers and to drive sales. For instance, we recently introduced a new paint tray coated with Teflon. While the price is higher than a traditional tray, it makes cleanup easier and is more likely to be reused, which ultimately is a better value for the customer and more environmentally friendly.
Despite strong messaging on the package, customers were not able to see the value until one associate put a simple idea into action: take one tray, pour paint in it, let it dry, and leave it for customers to see how easy it is to pull the paint right out of the tray without washing or scrubbing. This simple display worked so well that the employees shared the idea on our business community portal. This display is now being used across most of the company, and sales of these trays have improved. Likewise, on a larger scale, we continue to measure and improve our merchandising programs and find ways to better serve customers. One great example is our tools category. We took a category that was losing share and had lower comps and overhauled the offering by introducing a channel exclusive in PORTER-CABLE handheld power tools.
We also expanded our offering of DEWALT and now offer the largest assortment in our channel. We rationalized our offering at each price point, adjusting our assortments based on significant differences in market preferences, and we offered more innovative products. Our tools category has gained unit and dollar share, and we continue to drive more sales, which has led to positive low single-digit comps for the first quarter. We have also improved the performance of ceramic tile flooring by increasing our offering in the warmer Southern U.S. states, expanding the wall tile assortments, bringing the samples to the floor, and making take-with-inventory for high-volume items more readily available for purchase. To improve service and attachment rates, we moved grouts, mortars, and sealers closer to the tile so customers can easily access everything needed for the job. Like tools, ceramic tile produced low single-digit comps in the first quarter.
We continue to learn and improve across all facets of our day-to-day operations, and we will continue to add company-wide tools and new processes to fulfill our promise to provide better customer experiences. Thanks for your interest in Lowe's, and I will now turn the call over to Bob Hull to review our first quarter financial results. Bob?
Speaker 4
Thanks, Rick, and good morning, everyone. Sales for the first quarter were $12.2 billion, which represents a 1.6% decrease from last year's first quarter. In Q1, total customer transactions decreased 2.1%, while average ticket increased one-half of 1% to $62.51. Comp sales were negative 3.3% for the quarter, which is below our guides of essentially flat. For the quarter, comp transactions decreased 3.4%, and comp average ticket increased one-tenth of 1%. Looking at monthly trends, comps were positive 2.7% in February, negative 1.9% in March, and negative 8.3% in April. The monthly comp trends reflected difficult comparisons we had versus last year's positive 8.8% April comp, which was driven by both favorable weather and government stimulus. Q1 was our most difficult comparison to last year due to the impact of cash for appliances. In Q1 2010, cash for appliances aided comps by 65 basis points.
We knew this going into the quarter and felt that we had a reasonable plan in place. In fact, we were ahead of our sales plan through our fiscal week eight. As Rick described, unseasonable weather over the last five weeks of the quarter had a significant impact on our exterior categories, which represent about 40% of our sales for that five-week period and was the primary driver of our below-planned sales for the quarter. With regard to product categories, the categories that performed above average in the first quarter include rough electrical, rough plumbing, cabinets and countertops, tools, lighting, paint, flooring, home fasten storage and cleaning, hardware, and fashion plumbing. Seasonal living performed at approximately the overall corporate average. Gross margin for the first quarter was 35.44% of sales and increased 26 basis points over last year's first quarter.
The increase was driven by 34 basis points of margin rate improvement with base price optimization and patch area expansion accounting for approximately 25 basis points of the margin rate improvement. Additionally, gross margin benefited 28 basis points from the mix of items sold, the result of strong sales in rough plumbing, as well as lower sales in outdoor power equipment and appliances. These improvements were partially offset by de-leverage in distribution expenses, primarily the result of increased fuel costs and higher inventory strength. SG&A for Q1 was 25.6% of sales, which de-leveraged 62 basis points. The largest driver of the SG&A de-leverage was insurance, both casualty and employee, which de-leveraged 32 basis points. The increase in casualty was related to a favorable actuarial adjustment in last year's first quarter. The de-leverage in employee insurance relates to increased claim costs and higher dependent enrollment.
We also experienced approximately 15 basis points of de-leverage related to investments made to improve customer experiences. The expenses related to staffing up our contact center to support the insourcing of appliance repairs last year and contract labor for additional Lowe’s.com capabilities, advancing the MyLowe’s concept and continued efforts to build out our customer relationship platform. In addition, advertising expense de-leveraged approximately 10 basis points, largely due to the timing of spend versus last year. Lastly, but only about five basis points each de-leveraged for the following items is worth noting: delivery due to higher fuel costs, payroll taxes related to higher state unemployment tax rates, bank card due to higher interchange rates, and proprietary credit associated with lower sales as a result of a lower receivable related to the prohibition against no-payment promotions. Somewhat offsetting these items was leverage in bonus expense.
We fell short of our sales and earnings plan for the quarter, and as a result, we reduced our expected bonus payout amounts accordingly. Depreciation for the quarter was $371 million, which was 3.05% of sales and leveraged 15 basis points compared to last year's first quarter due to slower square footage growth and assets becoming fully depreciated. Earnings before interest and taxes decreased 21 basis points to 6.79% of sales. Interest expense of $88 million for the quarter de-leveraged six basis points to last year as a percentage of sales. For the quarter, total expenses were 29.3% of sales and de-leveraged 53 basis points. Pre-tax earnings for the quarter were 6.07% of sales. In fact, the tax rate for the quarter was 37.7% versus 37.8% for Q1 last year.
Earnings per share of $0.34 for the quarter were at the bottom end of our guides of $0.34 to $0.38 and were flat to last year's $0.34. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.5 billion. Our first quarter inventory balance of $9.7 billion decreased $238 million, or 2.4% from Q1 last year. The decrease was due to a 5.6% decrease in comparable store inventory offset by square footage growth of 1.6% and a slight increase in distribution inventory. Inventory turnover, calculated by taking a trailing four quarters cost of sales divided by average inventory for the last five quarters, was 3.5, a decrease of six basis points from Q1 2010.
Return on assets, determined using a trailing four quarters earnings followed by average assets for the last five quarters, increased 44 basis points to 5.63%. Moving to the liability section of the balance sheet, accounts payable of $6.7 billion represents a 5% decrease from Q1 last year. The decrease in accounts payable is higher than our 2.4% decrease in inventory, which relates to the timing of purchases in the quarter versus last year. Our debt-to-equity ratio was 37.7% compared to 31.9% for Q1 last year. At the end of the first quarter, lease-adjusted debt EBITDA was 1.72, which is higher than our target of 1.8 times. 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, increased 75 basis points for the quarter to 8.91%.
Now looking at the statement of cash flows, cash flow from operations was $2.4 billion, which was $313 million lower than Q1 2010 due to the timing of income tax payments versus last year and the decrease in accounts payable related to the timing of purchases. Cash used in property acquired was $313 million, up $30 million over last year due to an increase in information technology spending on Lowe's.com, store infrastructure, and the ongoing build-out of our customer relationship platform. As a result, first quarter free cash flow of $2.1 billion was down 14% versus last year. During the quarter, we repurchased 37.9 million shares at an average price of $26.42 for a total repurchase amount of $1 billion. We have $1.4 billion remaining share repurchase authorization.
The remaining $31 million of the $1.013 billion of share repurchase of common stock shown on the statement of cash flows relates to the shares repurchased from employees to satisfy either the exercise price of stock options or the statutory withholding tax liability upon vesting in restricted stock awards. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. We expect second quarter total sales to increase approximately 4%, which will incorporate some comp sales increase of approximately 2% and square footage growth of approximately 1.5%. As we noted, our Q1 sales shortfall was driven by poor seasonal sales as a result of weather. In the second quarter, as the weather has improved, so have our sales. In fact, sales trends for the beginning of May are much better than April, which gives us confidence in our Q2 sales outlook.
Depreciation for Q2 is expected to be approximately $370 million and leverage about 30 basis points to last year's second quarter. Earnings before interest and taxes for the second quarter are expected to increase 20 to 30 basis points to last year as a percentage of sales. For the quarter, interest expense is expected to be approximately $90 million. The income tax rate is forecast to be 37.6% for the quarter. We expect earnings per share at $0.65 to $0.69, which represents an increase of 12 to 19% over last year's $0.58. In 2011, we expect to open approximately 25 stores, resulting in an increase in square footage of approximately 1.3%. We're estimating 2011 comp sales to be flat, a positive 1%, and including the 53rd week, a total sales increase of approximately 4%. For the fiscal year, we're anticipating EBIT to increase by approximately 10 basis points.
For 2011, depreciation expense is expected to be $1.47 billion, and interest expense is expected to be approximately $350 million. For the year, we expect the effective tax rate to be 37.6%. Some of these inputs should yield earnings per share of $1.56 to $1.64, which represents an increase of 10 to 15% over 2010. We have a temporary outlook for the second half and for the year due to the uncertainty, the impact of gas prices, and overall inflation we'll have on consumer spending. In addition, the correction in housing continues to play out, and there is the potential that home price declines extend into 2012. For the year, we're forecasting cash flows from operations to be approximately $4.6 billion.
Our capital expenditures for 2011 are forecasted to be approximately $1.8 billion, with roughly $100 million funded by offered and leases, resulting in cash capital expenditures of approximately $1.7 billion. As a result, we are forecasting free cash flow of $2.9 billion for the year. Our guidance assumes approximately $2.4 billion in share repurchases for 2011. We repurchased $1 billion in Q1, with the remaining $1.4 billion expected to be spread evenly across the next three quarters. Regina, we are now ready for questions.
Speaker 5
To ask a question, press star one on your telephone keypad. To withdraw your question, press the pound key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from the line of Christopher Horvers with JP Morgan.
Speaker 0
Thanks, and good morning. First, could you perhaps give some quantification of what you're talking about in May? Are you comping within that 2 to 3% range that you're guiding for the second quarter? Big picture on sales, you talked about the second half being better than the first half. You seem to be looking to maybe 1.5% comps in the back half of this year. A, is that reasonable? B, on the margin side, it's hard to get into your range unless you assume that gross margin is down. Perhaps some color there as well. Thanks.
Speaker 4
This is Bob Hull. First, our outlook for the second quarter was approximately 2% comps. I think you mentioned 2 to 3%. We don't normally provide updates to start the quarter based on how poor our April sales trends were. As I said in my comments, we are performing much better than April. In fact, we're performing better than we did in the first quarter, and we are confident in our Q2 outlook. We did miss some seasonal sales in Q1. We expect to recover some of those in Q2, which leads to our 2% comp outlook for the second quarter. As it relates to margin, we are expecting some nominal margin decline in the back half of the year. Some of that comes from fuel costs. Fuel was up early in the year, still is up relative to last year.
We'll see that as it sells through cost of goods, negatively impacting gross margin Q2 and into the back half of the year. In addition, our shrink rate was up slightly, about 10 basis points in the first quarter. We expect it to be up roughly 5 basis points for the rest of the year, which is contributing to the decline in margin for the year.
Speaker 0
Thank you. As a follow-up, on the 5% off card, are you anticipating any margin rate pressure as a result of this program?
Speaker 4
Thanks, Chris. This is Bob again. Based on how the 5% off is accounted for, it will contribute to some gross margin rate pressure. The promotional financing hits SG&A as a tender cost, so there will be some flip between the margin pressure and expense benefit between the two. It should be, however, because of the tender shift from bank card to proprietary credit, it should be accretive EBIT for the year.
Speaker 0
Okay, thank you.
Speaker 5
Our next question comes from the line of John Zelitis with the Buckingham Research Group.
Speaker 0
Hi, good morning. Can you quantify how appliances did in the quarter and what the outlook is for the comps for appliances going forward? Secondly, can you just talk about why shrink is rising and why the outlook for shrink to continue to rise is out there? Thank you.
Speaker 4
Sure, John. As Rick talked about in his comments, appliances had roughly a 9% two-year comp, so we were down roughly 6% Q1 this year on top of a 16% positive comp Q1 last year. We had strong appliance comps in Q2 last year, so we expect a decline as well, with it being somewhat flat in the back half of the year. As it relates to the second part of your question regarding shrink, I really don't have any concerns as it relates to inventory shrink. Our shrink was at historically low levels in 2010. Some of the increase in shrink as a % of sales was really based on the comp decline in Q1. We'll have a nominal increase in shrink as a % of sales in the back half of the year.
Speaker 0
Thank you.
Speaker 4
Thank you, John.
Speaker 5
Our next question comes from the line of Brian Nagel with Oppenheimer.
Speaker 0
Hi, good morning.
Speaker 4
Morning, Brian.
Speaker 0
First question, if I could, any commentary on market share trends for the quarter? Clearly, as you indicated throughout the prepared remarks, sales were impacted by weather, but maybe some of the data you look at, any indications on market share? Thanks.
Speaker 4
The honesty is, Robert Niblock, you look at overall from the track line numbers that were out there on a rolling four-quarters basis, we did see kind of slight improvement in our market share on a rolling four-quarters basis. We end up equal to anybody else out there in the industry. We don't really think there were any declines in market share. As you are aware, track line only relates to retail sales. It does not impact or it does not track commercial sales. We think the biggest impact, as Bob and Rick described during the quarter, was primarily weather-related conditions. Secondly, we are starting to see in our consumer survey that consumers are mentioning the impact of fuel prices starting to impact their purchase decisions.
When you think about discretionary income and the fact that when fuel prices go up, it does limit their ability to spend on a discretionary basis. Part of that is what we've taken into account as we've looked at over the balance of the year. I think Bob also alluded in his comments that as we look over the balance of the year, what's going on with housing, with fuel prices, those types of things, you're starting to hear some of the economists talk about potentially the bottoming in home prices extending beyond the second half of the year and potentially into the first half of 2012. Overall, from a market share standpoint, we think we're executing well and continuing to maintain and gain share in a lot of categories, but it's really more macro things rather than the impact that we saw in the quarter plus weather.
Speaker 0
Okay. It's very helpful. If I could just one follow-up, looking at the guidance for 2011, specifically the changes you made to the guidance, and some of the prior questions kind of asked this too, I'm going to give a little more clarity. Now you're assuming what, 10 basis points of improvement in your EBIT margin versus a prior estimate of 30. How is the split in just looking at that variable in your guidance, how should we think about the split between gross margin and then SG&A margin?
Speaker 4
Brian, really, the decrease in the comp estimate for Q2 in the back half of the year means less fixed cost leverage. We expect both gross margin and SG&A to be down slightly, offset by depreciation leverage, which gets us to the roughly 10 basis point decline in EBIT for the year.
Speaker 0
Okay, just to be clear, the change in EBIT guidance you gave us today reflects solely the change in sales guidance?
Speaker 4
Largely, yes.
Speaker 0
Okay, thanks a lot.
Speaker 4
Thank you, Brian.
Speaker 5
Our next question comes from the line of Peter Benedict with ISI.
Speaker 0
Great. Thanks, guys. First, I want to get into the SG&A a little bit more. Bob, you mentioned that bonuses helped you leveraging. Could you just give us a bigger number on that or just quantify that in that last five because it was over 50 bps in the fourth quarter? I wanted to see what the run rate is there.
Speaker 4
It helped us 28 basis points in the first quarter.
Speaker 0
Great. Going forward, is that a run rate for the next two quarters, or is that it bounces around just based on sales?
Speaker 4
It moves it around based on sales and level of performance last year. Leverage is about 10 bps in Q2 and roughly 20 for the year.
Speaker 0
Okay. Great. In terms of what we're trying to say, just to make sure we have it clear, because there was such a big shift last year when April was up 8.8% and then May was flat, when you say it's a lot better, is it better as much as just a two-year comparison would suggest, or is it we're building back to that sort of level?
Speaker 4
Again, Greg, we don't provide commentary on the beginning of the quarter. Normally, we only did so because of the severe downturn in the month of April. Let us allay any fears that that level of performance was continuing into May. Our trends are running better than we did for both April and Q1, which gives us confidence that as the weather improves, we'll be able to recapture some of the lost seasonal business in Q1 and achieve our 2% comp outlook for the quarter.
Speaker 0
Great. I can't blame you for trying. Lastly, on the 5% program, it sounds like this program is really more about getting credit penetration back up and building loyalty as opposed to just simply driving sales, given that net and net, you think it's a slight benefit to EBIT. Am I missing something here?
Speaker 4
I think that's right, Greg. We already had a value proposition in place, which was no interest financing. Previously, it was no interest, no payments. Government regulations decreased the value that the customer saw in that. The 5% is really just to give the customer a choice. They can choose the 5%. They can choose 6, 12, or 18 months, no interest, depending upon what we're running at that point in time. It is an opportunity to get more of those consumable purchases on the proprietary credit to affect a tender shift and to increase the value proposition of the proprietary program.
Speaker 0
That's great. Thanks a lot.
Speaker 4
Thank you, Greg.
Speaker 5
Our next question comes from the line of Daniel Binder with Jefferies.
Speaker 0
Hi, good morning. Just following up on that 5% off program, can you give us a little bit more of a sort of a profile on that program? In other words, is it affecting primarily larger ticket, more frequent customers, or is it something that lower ticket customers are taking advantage of as well?
Speaker 4
Again, it's a little bit of all of the above. As we said, it initially was designed to try to garner some of those smaller repair maintenance purchases, those convenience purchases. We are seeing the customer even above $299 take advantage of the 5% off. Again, it's their choice. We're giving them that option. What we are seeing, Dan, is a little bit different customer. We are seeing a little bit higher FIFO score coming into the program, which tells us we are seeing some shift from bank card. We are pleased to see that. That's part of the design was to, in fact, have that tender shift. Customers are using it for small purchases and large purchases. Is it a creative simply because?
Speaker 1
One of the points in what Bob was just saying, this idea is really a longer-term customer relationship program. You heard Bob, Robert Niblock, and Rick Damron talk about working on that customer relationship management platform. This is just a key piece to that over a long period of time.
Speaker 0
Is the accretion that you get a combination of the cost of the tender type plus some sort of SG&A leverage on the incremental sales, or is it strictly on the switch in the tender type?
Speaker 4
Incremental sales will drive some improvement, and the shift in tender will help as well.
Speaker 0
I know it's early, but in your tests, what kind of a sales lift did you get with those customers?
Speaker 4
In the test, we saw sufficient application lift, sales lift, and tender transfer to roll it out this last month.
Speaker 0
Okay. Just my final question was regarding guidance. It seems like your lower comp guidance on the year essentially is what you lost in Q1. It seems you probably lost close to a point. If you missed the midpoint by $0.02, I guess I'm just trying to understand why the midpoint is coming down $0.06 on the year, since most of the pressure seems to have fallen in Q1.
Speaker 4
It just takes basically Q2, three, and four down a half % or so comp estimate, which is driving the EPS decline.
Speaker 0
Okay. Thanks.
Speaker 4
Assume basically 2% comp for quarters two, three, and four.
Speaker 5
Our next question comes from the line of Gary Balter with Credit Suisse.
Speaker 0
Thank you. I was just following up on some of the questions. You have for the second half of the year base price optimization still kicking in. How do you account for that within the gross margin guidance that you just gave us? That would seem like that would be a positive.
Speaker 4
Yeah, Gary, this is Bob. We started rolling out base price optimization in Q2 of last year, got some benefit in Q3 last year, and then started seeing roughly 25 basis points in Q3 running forward in base price optimization and patch area expansion combined. We will cycle against that in Q3 this year. We do expect some benefit this quarter as we cycle against last year's implementation. We'll continue to refine it, and it should be additive. Greater proportion of private label should be additive to gross margin for the balance of the year. However, we do have the fuel negative impact I mentioned, some modest shrink on impact, and then it's just kind of the unknown what takes place with inflation, which is why we're somewhat cautious on our margin outlook.
Speaker 0
Okay. I have a second follow-up, but just before saying that, I've been in your stores a lot on weekends, and you could see the service. You've done a great job in that shift to add the Friday, Saturday, Sunday help. They're all over you when you go in, and that's when the stores are crowded. Good job on that. Just one follow-up. If we take your buyback $0.4 billion that you talk about for the next three quarters, and you take your guidance on top line and margins, we get to a number that's slightly above your range. What are we doing wrong?
Speaker 4
That's a wide open question, Gary. I'm not sure what your model looks like.
Speaker 0
We get to 166, just taking your sales guidance.
Speaker 4
I didn't provide you all the pieces in the outlook. We can certainly have you follow up with the investigation after the call.
Speaker 0
Okay. Thank you.
Speaker 5
The next question comes from the line of Michael Lasser with UBS.
Speaker 0
Good morning. Thanks a lot for taking my question. I'm wondering how the conversion rate trended over the quarter. I understand that, or was there any fallout from the shift to more staffing towards the weekend? Might you have seen an impact during the week?
Speaker 4
I'm sorry, Michael, you're saying conversion shift?
Speaker 0
The overall conversion rate. Did you get your comp transactions were down 3.4%? Do you believe that that was the same rate that your traffic was down for the quarter?
Speaker 4
Yes.
Speaker 0
See.
Speaker 1
I think Mike gave the numbers that on comp traffic, did you say traffic was down 3.4% and ticket was up a tenth of a percent to come back to the 3.3% negative comp?
Speaker 0
Let me ask it another way. Do you think that there was any negative fallout from the change in the staffing models?
Speaker 3
No, we don't. You know, Michael, the big thing with the staffing model was to put more customer-facing hours on the weekend when the customer traffic and the sales dictated they were there. Keep in mind, when we made the shift to the weekend hours, that was funded by a management structure change, not that we moved hours from the weekdays to the weekends. Those hours are still stable and still reflect last year's numbers. The weekend hours and weekend teams were incremental to that base hours based on that management restructure.
Speaker 0
Okay. That makes a lot of sense. Quick follow-up question. On the 5% off everyday offer, what have you factored in for a competitive response to that within your assumption for the financial impact?
Speaker 4
Michael, we've taken a look at all potential competitive responses from a variety of offerings. We try to understand what the marketplace looks like. At the end of the day, we try to run our game plan and deliver on our outlook that we just provided.
Speaker 0
Sounds good. Thanks a lot.
Speaker 5
Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Speaker 0
Good morning, guys. I guess my first question is, you know, it sounds like comps are still negative. Why are you expecting such a snapback in the balance of the quarter? Is it just pent-up demand on the seasonal side, or is there something else that we should be thinking of?
Speaker 4
The biggest impact, as we said, during the quarter, we thought was the unseasonable weather that took place over many parts of the country, primarily in April. As I said in my comments, I think through like week eight, we were running in line ahead of our plan. Bob took you through the comp trend for the month, and we've actually seen, you know, for the first two weeks of May, we've seen seasonal categories bounce back very strong, where we've had, and which was where the biggest shortfall was in Q1. Seasonal categories bounced back very strong as weather improved in May. This weekend was a little bit of a challenge when you look at the weather across the country.
When we see the weather improve, not only just the fact of improved weather, but also the opportunity to pick up some of those sales that were delayed from the first quarter into the second quarter, leads us to be comfortable with the guidance that we've provided today. We think we've been sufficiently conservative in that guidance to take into account the impact of fuel prices and everything else that is impacting the customer's mindset today. We've put a lot of rigor into coming up with the outlook and believe that it's achievable based on what we see out there and what we've seen quarter to date in the performance, particularly as we look at where that performance is coming from.
Speaker 0
All right. That's helpful. I guess the second question is related to home prices. It was referenced a couple of times, but obviously, we have weather and maybe gas as a bigger near-term impact. I guess the questions are, you know, what are your assumptions for home prices in the second half? If we do get kind of a double dip on home prices, you know, what kind of risk does that present going forward? Thanks.
Scott, this is Gregory Bridgeford. I said, we, you know, I think we've seen, you know, some economists say we've already seen the double dip in home prices. You have economists today who are forecasting home prices to begin stabilization in the fourth quarter of 2011, now begin to stretch that stabilization period into 2012. The risk that we're trying to monitor is really the impact of foreclosure sales in the marketplace today and how that's impacting market by market the stabilization of home values. We're definitely being conservative when we try to understand what will happen to home prices on a regional and a market basis across all the areas that we operate in. There are some mitigating factors out there. Robert touched on it earlier.
All of our affinity scores when we do our own customer sentiment research are coming in at significantly higher than we've seen over the past couple of years. These are affinity statements such as, you know, I enjoy conducting home improvement projects. I'm willing to spend more on home and invest in home improvement both time and money. We're seeing some pretty interesting strong upsurges in all the affinity areas. If you look at, if you break apart your University of Michigan consumer sentiment research that just released, the difference between current situation and expectations is beginning to create two different interesting vectors. I think that's what we're trying to understand is the consumer seems poised, given certain macroeconomic factors, to be able to invest time and money into home improvement as we move into the second half of the year and into the beginning of 2012.
Obviously, the number one thing on their mind, and we're hearing this from both outside research and from our own consumer sentiment surveying, is gas prices. It can affect as much as two-thirds of homeowners in terms of their willingness to spend, and that's where they're going to be watching their budget. The other factor, of course, is the factor of, is my home value increasing or decreasing? Is my local housing situation improving or not improving? We're seeing pretty strong sentiment today on the current situation that most people feel their home values in their local market are not improving. Those are the two watch-outs, but we are also keeping an eye on the fact that from a standpoint of affinity with home improvement, we're seeing scores we haven't seen in years.
Great. Thanks a lot, guys.
Gina, we've got time for one more question.
Speaker 5
Our final question comes from the line of Dennis McGill with Zelman.
Speaker 0
Hi, good morning, and thanks. I think you mentioned in the Southeast, South Central, and Southwest where you had better weather, it was better than average counts for the quarter. Can you put that in absolute terms just to understand the order of magnitude where weather wasn't too big of an issue?
Speaker 4
What we can tell you, Dennis, is that for the exterior categories in the Northeast U.S. and North Central U.S., they were down roughly 19% for the quarter. That was really driving most of the impact. As Rick described, the categories that performed better were 2 to 3% better, so closer towards where we're confirmed for the overall company average for the quarter.
Speaker 0
Okay. On the seasonal items, I think you said the way you broke it out, the outdoor was 40% of the business for the five weeks where it was most impacted. Can you give us that same number for the first quarter, and then what it would typically be in the second quarter?
Speaker 4
Yes. That number is closer to, I think, 37%, 38% for the, excuse me, it's 34% for the first quarter. It's probably 35% to 38% for the second quarter. One other thing I'll mention regarding the second quarter is, you know, we did have a strong April last year, which means our seasonal categories performed really well last year, which means our seasonal categories struggled in Q2 last year with nursery being our worst-performing category at a minus 6%, along with outdoor power equipment and seasonal living also being negative, which is why we think we can have improved performance in Q2 this year.
Speaker 0
Okay. That's helpful. Thank you very much.
Speaker 4
Thank you.
Speaker 1
As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter results on August 15th. Have a great day.
Speaker 5
Ladies and gentlemen, this does conclude today's conference. Thank you all for participating, and you may now disconnect.