Lowe

123jump.com Staff
02 Mar, 2009
New York City

The home improvement retailer quarterly sales dipped 3.8% to $10 billion on comparable store sales fall of 9.9%. Net earnings plummeted 60% to $162 million in the quarter and earnings per share declined to 11 cents from 28 cents a year-ago quarter. The company opened 33 stores during the quarter.

Lowe’s Companies, Inc. ((LOW))
Q4 2008 Earnings Call Transcript
February 20, 2009 9:00 a.m. ET

Executives

Robert Niblock – Chairman & Chief Executive Officer
Larry Stone – President & Chief Operating Officer
Robert F. Hull, Jr. – Executive Vice President & Chief Financial Officer
Gregory Bridgeford – Executive Vice President, Business Development

Analysts

Brian Nagel – UBS
Matthew Fassler – Goldman Sachs & Co.
Christopher Horvers – JPMorgan
Scot Ciccarelli – RBC Capital Markets
Mitch Kaiser – Piper Jaffray & Co.
Alan Rifkin – Banc of America/Merrill Lynch
Deborah Weinswig – Citigroup

Presentation

Operator

Good morning everyone and welcome to Lowe’s Companies fourth quarter and fiscal year 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 no assurances 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 use certain non-GAAP financial measures. You can find the presentation of 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 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 will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.

Robert Niblock

Good morning and 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.

We ended 2008 knowing a challenging environment would pressure our results. As the year unfolded, it became increasingly clear that the economic pressures on consumers including falling home prices, rising unemployment and tightening credit markets were even greater than anticipated. Those pressures came to head in the fourth quarter and are reflected in our results. As unemployment swelled, confidence plummeted and consumer spending continued to contract at the fastest rate in over 25 years.

Sales for the quarter were down 3.8% versus last year and comp sales were negative 9.9%. Comp sales were weakest in November, relatively better in December, but weakened again in January. While comp results were disappointing, we continued to gain market share as industry sales contract.

According to third party estimates, we gained 110 basis points of total store unit market share in the fourth calendar quarter, evidence of our compelling product offering and commitment to customer service during this prolonged industry downturn.

During the quarter as consumers pulled back substantially across all of retail heading into the holiday season, we knew in certain categories such as holiday decorations as well as what we call giftable categories like tools, the competition for sales would be intense. Since we compete with the broader group of retailers in these categories, we were also competing for share of wallet during one of the most promotional holiday seasons in memory. We chose to be proactive, and moved quicker and deeper than originally planned for the seasonal markdowns. These more aggressive markdowns pressured gross margin in the quarter, but improved our inventory position heading into 2009. Larry will provide additional detail on gross margin. But it’s important to note that many of the pressures on gross margin was unique to the fourth quarter or one time in nature. While we do expect gross margin to be down slightly in the first quarter, this will be a significant improvement from the fourth quarter due to less promotional activity.

For the year, total sales declined fractionally and comp sales declined 7.2%. Sales for the year were nearly $1.5 billion less than our original plan, but our earnings per share of $1.49 fell only a $0.01 below the low end of our year ago guidance, reflecting our diligent effort to control expenses during the third consecutive year of soft sales in our industry.

Given the unprecedented turmoil in the financial markets as well as a significant slowdown in the economy and the housing market during 2008, I’m proud that we delivered earnings per share within $0.01 of our original guidance for the year. This speaks for the dedication and hard work of our 220,000 plus employees as well as our focus on making necessary and appropriate adjustments in an environment of uncertain and ever-changing business and economic conditions.

To that point, our centralized structure has allowed us to remain relatively lean during the good times and gives us visibility to areas where we can scale back as sales slow. Over the past three years, we’ve managed our corporate staffing to match the slowing environment primarily through attrition.

By filling only the most needed positions, we have effectively had a corporate level hiring freeze for nearly two years. As a result, we have frozen or left unfilled almost 400 positions at the corporate office in 2008. In addition, in certain cases we have made even further cuts including a recent reduction in our real estate department reflecting our significantly low work store opening plans. As a measure of our efforts to ensure appropriate management of our corporate infrastructure, over the past two years, our store count and selling square footage have both grown by over 19% but our corporate staff has grown by less than 5%.

Looking ahead, we know that during the past two years we have experienced stronger sales trend in our outdoor categories. And as we move into the spring selling season and weather warms around the country, we are optimistic that consumers will continue their outdoor projects providing some support to sales. But the potential for recovering demand in 2009 is dependant on factors that are out of our control, with improving employment statistics being one of the most important and restoring consumer spending.

The recognized sales will remain pressured and we continue to take decisive action to manage expenses. Larry will provide more details, but as an example for the actions we are taking, we decided to freeze the salaries of all Vice Presidents and above for 2009. In addition, we reduced the level of our planned merit increases for the rest of the organization in light of the current economic environment. These actions will save in excess of $40 million for the year and are evidence of our commitment to manage expenses.

On the capital spending side, we have further reduced our store opening plans to 60 to 70 for the year including five stores in Canada and two stores expected to open late in the year in Monterrey, Mexico.

Our revised 2009 store opening plan is down approximately 15 stores from our plan in September and down some 40% from the 115 stores opened in 2008. We are also rationalizing other capital spending including our store remerchandising efforts to ensure an appropriate return on investment. These changes have reduced our capital plan to $2.5 billion, a reduction of nearly $600 million from just a few months ago and down $1.1 billion from 2008.

We’ll continue to work diligently to draw sales and capture profitable market share in this very difficult environment. The stimulus efforts recently passed will provide some support to the consumer, but today the macroenvironment shows few positive signs and therefore we continue to plan conservatively for 2009.

Now, I will turn it over to Larry Stone to provide more details on the quarter. Larry?

Larry Stone

Thanks Robert and good morning. As Robert mentioned, we experienced further deterioration in the sales environment in the fourth quarter and had negative comps of 9.9%. Only one region and two product categories experienced positive comps for the quarter.

On the regional front, our Western division continues to experience very weak demand with all four regions delivering double digit negative comps, although comps in the quarter were only slightly worse than the divisions here to date.

We also saw double digit negative comps across much of the Southeast in the quarter as housing pressures continue in Florida and other parts of the Southeast. We are still experiencing lower sales for big ticket projects in this part of the country.

In addition, our sales in the Northeast continued to slow and part driven by the extreme winter weather. On the more encouraging side, we had positive comps in the areas of our Southcentral Division, most impacted by last year’s hurricanes as rebuilding continues. We also had relatively better comps along the Gulf Coast and in parts of Ohio Valley.

On the product side, product categories including cabinets and countertops, millwork and flooring had double digits negative comps in the quarter. Our carpet sales remained strong as sales for hard surface floor remained soft and customers are not taking on the larger kitchen and millwork projects that were driving positive comps a couple of years ago. In fact, in fiscal 2008 these three categories were approximately 17% of our total sales, a similar percentage mix as 2002 after having peaked at nearly 18.5% in 2006. We also saw continued weakness in what we call style categories, products that are typically more discretionary in nature. At home organization, fashion plumbing, lighting, and windows and walls categories all posted double digit negative comps in the quarter and in total are at decade lows as a percent of the total mix.

Double digit negative comps in tools resulted from more aggressive than planned promotions and deflation in copper contributed double digit negative comps throughout electrical. On the positive side our building materials category had positive comps in the quarter driven by hurricane rebuilding and many of our outdoor related categories had a relatively strong quarter with our lawn and landscape category delivering positive comps.

Our negative 9.9% comp for the quarter is driven by 5.3% decline in transactions and 4.9% decline in average ticket. The sales weakness we experienced is most pronounced in discretionary bigger ticket purchases. Based on customer research, we estimate that the discretionary component of our sales has declined approximately one-third of our total, down from approximately 45% in 2006 as the number and size of discretionary projects continue to decline.

One consistent trend during this sales slowdown has been strengthening our smaller ticket comps highlighting this fact while total comps were negative 7.2% in fiscal 2008. Comps for tickets below $50 were only negative 2%, and comps for tickets above $500 were negative 9%. Perhaps a good barometer for discretionary and project based spending is installed sales, which historically had an average ticket of approximately $1000.

We had a negative 14% comp in installed sales in the quarter and a negative 6% comp for the year. We saw customers respond during the year that easily understand value based offers like our whole house carpet and window treatment installed programs, the combination of many negative macro factors intensified as the year progressed and left many consumers especially in the most pressured markets hesitant to invest in larger projects related to their homes.

Also our special order sales had a negative 20% comp in the quarter and a negative 10% comp for the year as many of these special order sales were also project driven. But sales to the commercial business customer was one of the relative bright spots for both the quarter and the year delivering above average comps throughout this down cycle.

As industry sales declined, our comp results were pressured. It’s hard to find many positives. But, we continued to view our market share gains as a clear signal we are providing compelling products at a solid value and great customer service.

In the fourth calendar quarter, we gained unit market share in 15 out of 20 product categories according to third party measures, and during the three-year downturn for the industry we gained approximately 300 basis points of total store unit market share.

Our goal remains to draw profitable market share gains during these challenging times, taking advantage of opportunities created by competitor store closings.

Our gross margin rate was lower than we expected during the quarter as we took aggressive steps to ensure seasonal inventory remained clean and accelerated their sell through plans as we exit a majority of our wallpaper category.

In the fourth quarter, we have additional category of seasonal products that are sold primarily around the holidays and we compete with more retail channels for sales of those products. When we entered the fourth quarter, there were clear signs that the holiday season will be a tough one and probably more promotional than we had expected when we planned sales, inventory, and margin many months before.

Our sales slowed dramatically in the last few weeks of our fiscal third quarter and the slowdown continued in to November. As the quarter unfolded, we chose to take early and deeper markdowns on our seasonal merchandise than planned.

In our (inaudible) category, we entered the season with a markdown planned that anticipates discounts of 50% and 75% to deliver sales of the left over inventory. We also wrote-off any remaining inventory at the end of the fiscal year in this category rather than carry anything into next year.

Considering the promotional and retail landscape and the strained consumer, we chose to execute our markdown plan early to ensure we sold through the inventory. The acceleration of these markdowns impacted gross margin approximately 30 basis points in the quarter.

Our tool category experiences a relatively steady demand for most of the year, but consistently sees a spike in demand in November and December as a popular gift giving category. While we had a conservative inventory plan, we bulked product to prepare for the seasonal spike. Similar to our (inaudible), we knew the personal stance for retail landscape measured the pulse of the consumer and made a conscious decision to markdown our tool category faster and deeper than planned to ensure we ran clean old inventory heading in to the New Year.

Markdowns in our tool category impacted gross margin approximately 20 basis points in the quarter. In addition to the pressure on gross margin falls for seasonal products, we entered the quarter executing an exit strategy for wallpaper.

Wallpaper sales has slowed in recent years as consumers shift to other wall treatments and we felt this space could be better utilized. Our original plan included selling through the remaining inventory over a 6-month period, but in November we decided to accelerate the clearance activity to ensure all stores would be other category and stay with our expanding cleaning supply offering by spring. Decision to accelerate our wallpaper exit impacted gross margin by approximately 15 basis points in the quarter. In total, these changes culled 65 basis points of our fourth quarter gross margin shortfall. But in the sales environment like we experienced in the fourth quarter, I think we made prudent decisions to clean seasonal inventory and remain clean as we start the new fiscal year.

Since May, these pressures for gross margin were substantially great till the fourth quarter, or one time in nature, we expect our first quarter gross margin rate to recover and only be down slightly compared to last year. Our efforts to manage expenses in this difficult environment continue and I would like to describe several things we have done over the past year to manage expenses as well as additional steps we are taking in 2009.

First, our largest expense is payroll. We work hard to closely tie up payroll hours with sales volume in our stores and more specifically to the sales volume in individual store departments. The goal is to manage payroll expense without sacrificing service, and we do that with the staff and metrics we built over many years.

Payroll averaged 125 basis points in the fourth quarter and 70 basis points for the year, driven by an increasing number of store attrition of base hour’s threshold as sales remained weak. In the fourth quarter, which is our lowest sales volume quarter 80% of our stores reached that base.

We review our staff and metrics at least every 12 months in conjunction with improvements and efficiencies we have implemented that have allowed us to move non-selling hours to selling hours. Examples of such improvements in 2008 include our freight flow initiative to best practices and receiving process and implemented them across the chain. We also reduced store hours in some slower sales markets when Daylight Savings Time ended, allowing us to reallocate about 36 hours week on average at affected stores in the busier times of the day. These efforts among others accrete of more hours for customer service.

Based on every view, we have to update our staff and metrics for 2009, reduce the required hours across the metrics and reducing the base hour’s threshold without reducing customer facing hours. Looking at our sales level in the fourth quarter, on the new metrics only 40% of our stores would have been at the base staffing level.

We don’t make a change like this without significant forethought and analysis to ensure we maintain service levels in our store. Today, our customer service scores measured by our quarterly customer focused process have never been higher and we are up across the board in the fourth quarter, but we will continue to monitor service levels very closely throughout 2009 to ensure the staff and metrics change does not impact service.

We are finding other savings too and tightening our belts to control cost during this environment. One way is our ongoing effort to find efficiencies in our marketing plan. Over the last two years, we’ve reduced our marketing spend by using more target advertising and frankly by reducing programs that simply were not providing adequate return.

We’ve also looked at our physical inventory process. Historically, the majority of our stores had two physical inventories per year, but we have had solid strength results for the past several years as many of our other initiatives on that front had paid off. As a result, back in 2005, we began a test conducting only one-tenth of physical inventory in our better performing stores.

Over the past four years, we slowly increased the number of stores, saving several million dollars in the process and we see no increase in those stores results. Based on our positive experience, we are moving additional stores with one inventory per year in 2009. This move will save us approximately $10 million.

Robert mentioned the benefits of our centralized structure and as we gain more store density across most of the US, we have been able to leverage our district and regional staff. During the past two years, we’ve added 268 stores but only added 1 region in 15 districts. So an average store count for district from 8 to 9, and average count for region from 66 to 75.

We’ve also been able to expand the coverage of our area operations manager and our area loss prevention manager positions. Over the past two years, we haven’t added any additional headcount in these positions, which increased the average number of stores covered by each manager by more than three stores.

In the end, while we made numerous cuts and search for efficiencies to respond to the difficult sales environment, we know the foundation of our success is our people. None of us relishes in an environment like we are in today, but one benefit is opportunity to both hire and retain great people.

Over the past two years, we’ve seen the average tenure of the low store manager increase by almost 8 months from an average of little over 7 years to almost 8 years. We’ve also seen the average tenure of the other members of store management team increased by nearly 9 months over that time period. I’m confident we’ll build a solid and experienced foundation to provide excellent service and drive sales when the macro environment does begin to improve.

We enter 2009 with a conservative plan concerning the current environment; we have also made efforts to build additional flexibility in where we can. We know entry sales will remain pressured this year and we are keenly focused on managing inventory, improving gross margin, controlling expenses, effectively deploying capital, and capturing profitable market share.

Thanks for your attention. Now, I’ll turn the call over to Bob Hull to review our financial results. Bob?

Robert F. Hull, Jr.

Thanks Larry and good morning everyone. Sales for the fourth quarter were $10 billion, which represents a 3.8% decrease over last year’s fourth quarter. In Q4, average ticket decreased 4.6% to $61.05 and results set slightly by 0.9% increase in total customer count.

For 2008, total sales of $48.2 billion were essentially flat to last year. Comp sales were negative 9.9% for the quarter which was at the low end of our guidance of negative 5% to negative 10%. Looking at monthly trends, comps were negative 12% in November, negative 7.9% in December and negative 9.9% in January. For the quarter, comp transactions decreased 5.3% and comp average ticket decreased 4.9%. We estimate that hurricane related sales positively impacted our fourth quarter comp sales by approximately 100 basis points.

We experienced building material inflation in the quarter driven by roofing which had approximately 50 basis point positive impact on fourth quarter comps. With regard to product categories, the categories that performed above average in the fourth quarter include building materials, rough plumbing, hardware, paint, nursery, outdoor power equipment, lawn and landscape products, appliances and home environment. Lumber performed at approximately the overall corporate average.

For the year, comp sales were negative 7.2%. For 2008, comp transactions decreased 4.1% and comp average ticket decreased 3.1%. For the year, the categories that performed above average include building materials, rough plumbing, hardware, paint, nursery, outdoor power equipment, lawn and landscape, appliances and home environment. In addition, flooring and seasonal living performed at approximately the overall corporate average.

Gross margin for the fourth quarter was 33.7% of sales and decreased 115 basis points from last year’s fourth quarter. The decrease in gross margin was driven by a number of factors. Given the state of the consumer and the retail environment Larry described we saw elevated promotional activity in many categories as a number of retailers initiated inventory clearing promotions in the quarter. These included everything from 20% off in major appliances and kitchen cabinets to a significant reduction in the installation price for carpet. To protect our customer franchise and our price image, we matched various competitor offers in the quarter. We estimate this negatively impacted gross margin by approximately 50 basis points.

In addition, our efforts to clear the seasonal inventory (inaudible) in tools negatively impacted gross margin by 30 basis point and 20 basis points respectively. Also, markdowns associated with our decision to accept wallpaper reduced gross margin by 15 basis points in the quarter.

However fuel prices increased cost of goods sold and negatively impacted gross margin by approximately 10 basis points. Slightly offsetting these items was a positive impact of 14 basis points from lower inventory shrink. For the year, gross margin of 34.2% represents a decrease of 43 basis points from fiscal 2007.

SG&A for Q4 was 26.2% of sales which deleveraged 218 basis points driven by store payroll, write-offs associated with discontinued projects, store impairment charge and fixed expenses. For the quarter, store payrolls deleveraged 125 basis points driven by negative comps and our lowest volume quarter of the year.

During the fourth quarter, we incurred $19 million in expense associated with the write-off of new store projects that we are no longer pursuing compared with $2 million in Q4 2007, which caused 17 basis points of deleverage in the quarter.

In addition, we had 16 basis points of deleverage in the quarter related to a long life asset impairment charge for open stores. The $16 million charge represents the write down of the carrying value of the assets of three under-performing stores to their estimated fair value. There was no impairment charge for open stores in the prior year.

Lastly rent, profit, cash, utilities and other fixed expenses deleveraged approximately 50 basis points due to the comp sales decline. This deleverage was offset slightly by leverage in store service and bonus expense in the quarter.

For the year, SG&A was 23% of sales and deleveraged 118 basis points to 2007. Store opening costs of $32 million leveraged 27 basis points to last year as a percentage of sales. In the fourth quarter, we opened 33 new stores. This compares to 72 new stores opened in Q4 last year.

Depreciation at 4% of sales totaled $397 million and deleveraged 40 basis points compared with last year’s fourth quarter, primarily due to negative comp sales and the addition of 115 stores over the past 12 months.

Earnings before interest and taxes decreased 346 basis points to 3.3% of sales. For the year, EBIT of 7.9% represents a decrease of 189 basis points from 2007. Interest expense at $70 million for the quarter deleveraged 25 basis points as a percent of sales. This deleverage was caused by lower capitalized interest associated with fewer stores under construction. For the quarter, total expenses were 31.1% of sales and deleveraged 256 basis points. Pre-tax earnings for the quarter were 2.6% of sales.

The effective tax rate for the quarter was 37.5% versus 37.5% for Q4 last year. For the year, the effective tax rate is 37.4%, compared with 37.7% for 2007.

Earnings per share of $0.11 for the fourth quarter were within our guidance but decreased 61% versus last year’s $0.28. For fiscal 2008, earnings per share of $1.49 were down 20% 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 $245 million. Our fourth quarter inventory balance of $8.2 billion increased $598 million or 7.9% versus Q4 last year. Increase is due to square footage growth of 7.2% from this time last year, and an increase in distribution inventory associated with the opening of our 14th RDC in Pittston, Pennsylvania.

Comp store inventory was down 2.9% in Q4 versus last year. Inventory turnover taxes like taking a trailing four quarters cost of sales divided by average inventory for the last five quarters was 3.91, a decrease of 15 basis points from Q4 2007. At the end of the fourth quarter we owned 88% of our stores versus 87% at the end of the fourth quarter last year. Return on assets determined using the trailing four-quarters earnings divided by average assets for the last five quarters decreased 268 basis to 6.8%.

Moving on to the liability section of the balance sheet, we ended the quarter with $987 million of short-term borrowings. This was comprised of $789 million of domestic commercial paper and $198 million of Canadian debt.

We ended the quarter with accounts payable of $4.1 billion which represents a 10.7% increase over Q4 last year. The growth in accounts payable is higher than the 7.9% increase in inventory, which is attributable to ongoing efforts to improve vendor payment terms.

Our debt-to-equity ratio was 33.6% compared with 41.5% for Q4 last year. At the end of the fourth quarter, our lease-adjusted debt to EBITDA was 1.57 times, which exceeded our 1.4 times target for Q4, but was in line with our expectations. There were no shares repurchased in the fourth quarter or for fiscal 2008.

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 359 basis points for the quarter to 10.3%.

Now, looking at the statement of cash flows, for the year cash flow from operations was $4.1 billion and cash used in property acquired was $3.3 billion resulting in free cash flow of $856 million, which was a $519 million – which was $519 million higher than 2007.

While 2008 didn’t turn out as we expected, in this challenging environment, we still managed to earn $2.2 billion and generate almost $900 million in free cash flow which speaks of the strength of our operating model.

Looking ahead, I would like to address several of the items detailed in Lowe’s business outlook. In constructing our 2009 plan, we have attempted to take into account the external factors influencing the consumer and our business, the competitive landscape and the internal initiatives that Larry described. We feel is a prudent plan given this environment.

We expect first quarter total sales to range from an increase of 1% to a decline of 3% which incorporates the comp sales decline of 6% to 10% and the opening of approximately 21 new stores in the quarter, 13 in February, five in March and three in April. We expect gross margin to decrease slightly in Q1 as a percent of sales which is the mix of products sold and the remaining impact from our exit of wallpaper.

For SG&A, we anticipate store payroll to deleverage of approximately 80 basis points in fixed cost deleverage of approximately 50 basis points. In addition, we expect about 50 basis points of deleverage associated with our proprietary credit program in Q1 due to an increase in losses, which is higher than the expected 10 basis point impact for fiscal 2009.

Depreciation for Q1 is expected to be approximately $404 million and deleverage about 30 basis points to last year’s first quarter. As a result, earnings before interest and taxes for the first quarter are expected to decrease by approximately 310 basis points over last year as a percentage of sales.

For the quarter, interest expense was expected to be approximately $85 million. The income tax rate is forecasted to be 37.3% for the quarter and for the year. We expect earnings per share of $0.23 to $0.27 which represents a decline of 34% to 44% over last year’s $0.41.

For 2009, we expect to open 60 to 70 stores resulting in an increase in square footage of approximately 4%. Our 2009 stores expansion plan is more evenly balanced across the year relative to the 2008 opening schedule. As a result, we plan to open more stores in the first half of the year than the second half.

We are estimating 2009 comp sales to be negative 4% to 8% and as a result total sales should range from an increase of 2% to a decline of 2%. For the fiscal year, we are anticipating an EBIT decline of operating approximately 170 basis points. The decrease is smaller for the year relative to the first quarter due to the expected improvement in gross margin as we cycle last year’s elevated fuel prices, and as we described today, the one time negative items impacting Q4 2008.

Also, the impact of losses associated with proprietary credit and fixed cost deleverage will be the highest in the first quarter. For 2009, interest expense is expected to be approximately $310 million. The sum of these inputs should yield earnings per share of $1.04 to $1.20, which represents a decrease of 20% to 30% from 2008.

For the year, we are forecasting cash flow from operations to be approximately $3.7 billion. Our capital plan for 2009 is approximately $2.5 billion with roughly $300 million funded by operating leases resulting in cash, capital expenditures of approximately $2.2 billion.

Our guidance for 2009 does not assume any share repurchases. We know that 2009 will be another challenging year. However, we still expect to earn $1.6 billion to $1.7 billion and generate free cash flow of almost $1.5 billion. This represents a free cash flow increase of approximately 75% over 2008.

Dennis, we are now ready for questions.

Question-and-Answer Session

Operator

To ask a question, press “*1” on your telephone keypad. To withdraw your question, press the “#” key. In order to allow questions from as many individuals as possible, please limit yourself to one question. And your first question comes from the line of Brian Nagel with UBS.

Brian Nagel – UBS

Hi, good morning.

Robert Niblock

Good morning, Brian.

Brian Nagel – UBS

A couple of quick questions if I could. First off, on the inventories, you mentioned in your prepared comments that inventory in Q4 was up 7.9%, and you highlighted DC is a piece of that, but maybe if you could help me better understand that, how much of that 7.9% increase in Q4? How much of that specifically related to DC? So, if I look over the last four quarters, Q3, Q4 were higher versus Q2 and Q1.

Robert F. Hull, Jr.

Sure Brian, I’ll give you a little bit more color on that. That new DC itself was about $50 million or about 0.6% of the year-over-year growth. Also, due to the timing of in-transit purchases at quarter end some of which was trying to avoid the Chinese New Year, that was about $100 million of the increase year over year. And then lastly, as I talked about in my comments with our goal to open up stores sooner in the year, we’ll actually have more stores open in February ’09, 13 relative to February ’08, 4. So, 9 additional stores at about $4 million each was the last factor that contributed to the increase in inventory year over year.

Brian Nagel – UBS

Okay. Thanks. And then the second question much more from a strategic point of view. We obviously have your new guidance. Some thoughts on how you are looking at -- there’s been a lot of noise lately, a lot of government intervention, let’s say with the housing market. How are you thinking about the impact of some of these programs may help in housing and ultimately demand for home improvement products of Lowe’s? Thanks.

Robert Niblock

Brian, this is Robert Niblock. I’ll start and then I’ll let Greg Bridgeford, he is in the room with us jump in. I think certainly when you look at the forecast that lot of the economists had prepared for 2009, which is kind of we try and base things off of --- but they took into account that there would be some government intervention to try and improve the issues we are faced with regard to employment, with regard to housing and the overall economic situation including the severe impact we are getting from the banking and financial sector. So, I think certainly, it’s little different than what we talk about when fuel prices dropped. Any time if you can put the consumer in better financial shape by having either more disposable income in their pockets, lessening their debt burden, giving them greater confidence in the ability to be able to meet their ongoing obligations, all of those things I think help. Now, what you are seeing will be enough to cause a dramatic turnaround in the environment? No, we don’t think so. We think it just makes the environment less bad. So, I want to call it that. But all those things help – it helps improve what situation otherwise would have been and – but you know this one, it’s a point in time when a guy gets employment back in the country really to be able to drive the turnaround that we would all like to see. Greg, I’ll let you to jump in.

Gregory Bridgeford

Thanks Robert. And Brain we are focused on the more changeable aspects of what we are understanding and certainly try and understand recovery and reinvestment – some of them that we are again analyzing and looking for opportunities is to be able to serve customers in the areas of extending and expanding the tax credits with energy efficient products window stores, for instance insulation for example. A $5 million program to improve the energy efficiency to give the modest income comes through weatherization, the $6.3 billion program for energy efficiency improvements and federally supported housing, the $2 billion for the neighborhood stabilization plan, and obviously the $8,000 credit for first time home buyers. These are all pro parts of the Recovery and Reinvestment Act that we are analyzing and making sure that we are available to be there for customers as they take advantage of these different parts of the stimulus plan.

Brian Nagel – UBS

Thank you.

Operator

Your next question comes from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler – Goldman Sachs & Co.

Thanks. Excuse me, thanks a lot, two quick questions. First of all, if you could clarify why you expect your credit experience to improve throughout the year, the counting dynamic does reflect your expectations for actual losses or any other drivers? And the second question relates to the competitive dynamic over holiday. Clearly, it sounds like you felt more competition in some of your categories than in the past, if you could be a little more precise as to the kinds of channels that popped up as being more competitive and in sort of the exposure that you think you might have on more of a year around basis, understanding that it could be severe as in the fourth quarter? Thank you.

Robert Niblock

Hi, Matt, it’s Robert Niblock. I’ll start with competitive dynamic, your second question and what we are forecasting around the holidays and I’ll let Bob talk about the impact of the credit losses first quarter versus rest of the year. I think about heading into the fourth quarter, particularly when we saw the disruption that took place in the financial markets for many retailers out there, the fourth quarter is really their prime selling season, particularly by selling a lot of soft goods retail. So, we saw the market unfold, we knew that we were really competing for a limited amount of discretionary dollars available with the consumers, so a year after competing on a broader scale with 75% of clothing in a lot of clothing retailers’ association. So, we knew that we had to move early in order to try and sell through some off these categories that Larry spoke of in order to make sure that we had a clean inventory position in those categories when we got to the end of the season. On the same vein, Bob talked about in his comments; we saw some more aggressive promotions like I mentioned 20% off in appliances and cabinets. Once again, I think it was our competitors out there trying to draw foot traffic into their store because we were all competing for foot traffic during that key holiday selling season. And obviously, as you move forward, you are moving into an area where at a time of year when retailers are (inaudible) to the environment, they are pretty balanced, their inventories and their inventory buyers and we don’t have – we are also not stocked enough against those broader retailers in their prime selling season where they are having to clear that inventory that they bought after that season. So, as we went into the fourth quarter and we saw things unfold, we made some decisions. We said, we would rather be aggressive, move quicker and deeper and may be give up some of the margin at the end of that selling season and look back and say, “Wow!, we wish we acted quicker”. So, it’s a good decision we made. I believe it was the right decision because for those categories that we went through, we did a great job of cleaning through the inventory and a lesser margin impact than we potentially would have had, had we not reacted quick enough and threw some footsteps in the door and allowed us to sell some other carry on categories as well. With that Bob, if you would address credit losses?

Robert F. Hull, Jr.

Thanks Robert. The dynamics involving the spread of the credit losses in 2009 is really a function of our agreement with GE. As you know, GE owns receivables. However, Lowe’s bears the first lights of losses. As you know, losses have an increasing impact over the years. As a result that agreed upon loss cap will be hit in early – we are forecasting early second quarter. Therefore, we’ll experience similar in magnitude of about $50 million worth of losses in the first quarter with the balance of that being incurred by GE going forward. So, $50 million worth of losses in Q1 relative to our expectation of about $60 million of losses for the year, which is causing the spike in Q1 and really a leveling off through the balance of the year.

Matthew Fassler – Goldman Sachs & Co.

So, there is no risk even if the actual credit experience on the program goes up, you do not bear an incremental risk?

Robert F. Hull, Jr.

We don’t bear an incremental loss risk that is correct.

Matthew Fassler – Goldman Sachs & Co.

Loss risk. Is there any other kind of exposure just to make sure again I understand this completely?

Robert F. Hull, Jr.

We have a couple other pass through cost, one of which is money cost which is favorable.

Matthew Fassler – Goldman Sachs & Co.

Yes.

Robert F. Hull, Jr.

I don’t think that’s going to change in 2009, and that’s really about it. The real risk we’ve got is if there’s any risk tightening, as people take a look at the strains on the consumer, that consumers have changes in their FICO scores, and further tightening of credit would potentially impact us from a sales perspective not from a credit loss perspective.

Matthew Fassler – Goldman Sachs & Co.

And finally, Robert, just to follow up, in terms of where you saw the competition from, was this from other Home Centers; home depot series guys or is the guys from outside your traditional competitive set who got meaningfully more aggressive over holiday?

Robert Niblock

I think everybody was slightly more promotional and aggressive over the holidays. The point I was trying to make is, yes, from the typical competitors that you would expect when we are competing for foot traffic, yes, you would have seen incremental promotional activity from those competitors. Secondly, the issue was that when it comes time for gift giving, you only – the consumer had extra amount of discretionary dollars to spend on gifts this year, and we want to try and get them in early, at least get our share of those dollars. So, for example the soft goods retailers. They were discounting early and we knew that we want to be able to get our share of wallet from the consumer and the amount they had allocated or budgeted for their Christmas spends.

Matthew Fassler – Goldman Sachs

Got you. Thank you very much.

Robert Niblock

Okay.

Operator

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

Christopher Horvers – JPMorgan

Thanks and good morning. Just to follow up on Matt’s question, do you – clearly Sears has been very aggressive on the appliance side and Craftsman, is a big gift giving time for – during the Christmas season. As you enter into spring has that competition from the big box Home Centers abated at all? And then I have some follow ups.

Robert Niblock

Yes, we don’t expect to see the same level, that’s what we saw around Christmas. If you take about Sears, they sell more than just appliances and tools, so there’s now a likelihood that they will use this as a drawing card to get the consumer in to sell other categories. And so, but obviously those are the categories that we compete with. So, we in certain cases would match some of the promotions that they had going on. So, I think every retailer that’s out there in a time like this is going to use what they have for the drawing card in order to be able to pull the consumer in. And also these – everyone had seasonal inventory that they had in the fourth quarter, you had to sell through in the fourth quarter. And it is, I think all of us, as we are trying to compete on that giftables category as I call it, bulk of our inventory as we are trying to partaking the gift-giving process around the holiday season. And so, certainly we think that that is something – is somewhat unique after the fourth quarter. Now, as I’ve said before any time you’ve got a slower retail environment, it’s going to be more promotional, we are competing for footsteps. I think that’s situated and it’s a greater issue in the fourth quarter, particularly given that everyone had the inventory buyers in place. We saw a dramatic slowdown after the disruption in the financial markets and the dramatic slowdown in for traffic. So, as we said, we still expect margin to be down in the first quarter year over year but not to the extent with what we saw in the fourth quarter.

Christopher Horvers – JPMorgan

Okay. So, and then as a follow on to that, have you seen, I mean there was always a lot of consternation about Home Depot’s new lower price program and it was viewed I think by both companies as a bit more of an advertising play, in key categories they can run category play. Is that – do you see that initiative taking on I guess more teeth than what was initially expected?

Larry Stone

Chris, this is Larry Stone. We have stated in a couple of calls. We have had a new lower price program in the market for about 4 years. And certainly, we treat new lower prices from competition just like we do in any other market shop and look at what they are doing. In some cases you match prices, in some cases you don’t match prices, but certainly I don’t think that really drove a lot of dynamics in the fourth quarter. New lower prices in a lot of categories bring in more footsteps and certainly mix average ticket much better for you overall. So, we use ad just like any other program we use to make sure that we are driving more footsteps into stores and increase our average tickets. At the same time have that value equation for the consumer that’s so important today to make sure that you are getting you share expanded in view of today’s tough environment.

Christopher Horvers – JPMorgan

Okay. And then one final one. As you did pull back your store growth again here about 15 stores in 2009, was that I guess minimized by the amount of sites that you could back out from and how are we thinking about 2010 for this growth?

Gregory Bridgeford

This is Greg Bridgeford. No, it really wasn’t – we look at each site independently and Robert -- just a day before Robert, Larry and Bob and myself sit on the real estate committee and review every site and we’ve actually gone through a re-approval process of every site that comes before us to make sure that even under the – we recast the revenue forecast to look for ability to use cost of the sites through re-bidding, through strong negotiation. We’ve gone back and combed through all the previously approved sites before we put in place this year’s expansion plan. We have flexibility I think towards the end of 2009 and certainly in 2010, 2011 to adjust the number of stores that we put in the market appreciably as we judge the macroeconomic climate going forward.

Christopher Horvers – JPMorgan

Thank you.

Operator

Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli – RBC Capital Markets

Hi, guys. Just a quick housekeeping item first. Did you guys say the store traffic was up in the quarter?

Robert Niblock

Store traffic in total was up in the quarter, comp traffic was down.

Scot Ciccarelli – RBC Capital Markets

I got it. Okay. That’s helpful. And then can you just help me, you guys have provided guidance and obviously that’s helpful in a way to think about. But can you provide some of the key macro assumptions you guys are making to get to your sales and earnings guidance?

Gregory Bridgeford

Scot, this is Greg Bridgeford. We look at the macroeconomic climate and look at the consensus forecast up here by the Blue Chip Economic forecast. We also work pretty closely with certain economic teams such as Moody''s Economy.com to take a look at both the general growth in domestic product, looking hard at housing; our assumptions about housings are pretty conservative as we have seen in most economic forecasts. We anticipate that housing turnover itself will trough sometimes towards the end of the first half of this year. We believe that starts will trough in that same time period and that we’ll see some movement towards trough in home values and home pricing between the second half of fiscal 2009 with the ability towards stabilizing in 2010. So, our economic forecast assumptions are on the conservative side and that’s built into the modeling that you are seeing.

Scot Ciccarelli – RBC Capital Markets

Just a last question on employment. Is there a specific unemployment number you guys are targeting or looking at as you are trying to create a model?

Gregory Bridgeford

I think those assumptions too are gone very conservative. We’ve seen estimates that we think are fairly credible that estimate the peak of unemployment in the 9% range and that seemed to be credible from our standpoint.

Scot Ciccarelli – RBC Capital Markets

All right. Thanks a lot guys.

Operator

Your next question comes from the line of Mitch Kaiser with Piper Jaffray.

Mitch Kaiser – Piper Jaffray & Co.

Thanks guys. Good morning. I know that you lowered your CapEx assumption for 2009 by about $700 million. I think in September you talked about doing $2.8 billion to $3 billion in 2010 through 13. Could you just help us think about how that adjusts based on your thinking for 2009?

Robert F. Hull, Jr.

Hi, Mitch, this is Bob. Certainly a lot has changed since September. We are not prepared to give you any update beyond 2009 at this standpoint. But I think it’s safe to assume that with the step down in CapEx relative to the fewer stores in ’09, there are also fewer stores planned for 2010 relative to what we said in September.

Mitch Kaiser – Piper Jaffray & Co.

Okay, fair enough. And then I’m sorry Bob, could you just go through the components of the SG&A for the first quarter? I know you said payroll was 80, fixed expense was 50, credit card losses were 50 and then I think deprecation was 30. So, that’s about 210 basis points but you said that EBIT was going to deleverage by about 310 so the delta then the gross margin?

Robert F. Hull, Jr.

A couple on this. Some of that margin will be down 10 to 20 basis points in the quarter. We expect to deleverage bonus by about 20 basis points in the first quarter really just relative to how bonus was accrued Q1 last year. We expect insurance expense to be down 30 basis points in the quarter. And then as a whole we had small items, bank card and other smaller things that just deleverage on a negative 6%, negative 10% comp.

Mitch Kaiser – Piper Jaffray & Co.

Got you. Okay. Thank you.

Operator

Your next question comes from the line of Alan Rifkin with Banc of America.

Alan Rifkin – Banc of America/Merrill Lynch

Thank you very much. A couple of questions for Robert or Greg. There’s probably a lot of economists out there who would argue that your assumptions as you call conservative may not be conservative enough, and that housing may not bottom until way past the early part of the second half of this year. If that in turn, turns out to be correct and that this downturn lasts a lot longer than that, what is your ability to potentially cut back on growth going forward and for the longer term and focus more so on preservation of cash flow?

Robert Niblock

Alan, I’ll start. This is Robert Niblock and then I’ll turn it over to Greg. Yes, it’s clearly true, I mean in the past couple of years some of the predictions that were out there, the reality is coming worse than the predictions. So, we certainly understand that. That’s the case why we have – as Greg said we are viewing projects on an ongoing basis and on ongoing basis we are looking on market by market and making decisions whether we want to go forward or not before we get to the closing on the real estate side of the project. I think we’ve done a good job over the past couple of years, have shown how we can manage our expenses throughout as we need to in order to be able to preserve cash flow. We just like going from September to now, taken another 15 stores of the new store opening pipeline. So, I think we have shown the ability to do that. I think somewhere of an offsetting factor keep in mind is that assuming the things are worse and the downturn is more prolonged than will say what the consensus estimate assumes we also believe that that will lead to from those that are – those competitors that are less well capitalized more closings to take place. And so, therefore, we believe that there would be some market share to be gained which would help soften the impact we would otherwise see, all else being equal. So, Greg with that if you have anything else to add.

Gregory Bridgeford

Yes. I think specifically to your question, Alan, about if, having values for example don’t – there’s the delayed frost and certainly the delayed leveling off and therefore delayed return to any growth in housing values. The way that we have been able to build that into our real estate process is that we have been very, very sensitive. We look at the microeconomics of the markets, and again working with outside economic consultants to look at the microeconomics in markets that we consider for expansion in real estate. And we have leaned away in future expansion from those markets that are very, very sensitive to housing value improvement; we have to maintain our top line revenue forecast. So, you’ll see as the year rolls out and we unveil where we are putting this expansion capital, you’ll see much more of a focus and a skew towards those markets that have been less affected by a housing bubble so to speak and less dependent upon how the economics to meet our top line estimates. That goes for 2009 and certainly for those markets that we look at for 2010 and 2011.

Alan Rifkin – Banc of America/Merrill Lynch

Just a follow up if I may. Greg, obviously you are privy to a lot of data not only on market-by-market bases but a store-by-store basis. Do you look at that data with respect to areas of the country that were either first to enter the housing lows or some of the deepest declines? Is there any evidence that you are seeing today on a specific market basis that points to some stabilization or even an improvement in the environment?

Gregory Bridgeford

Alan, as you know, there is certainly evidence out there that there is existing home sales occurring in some markets that have been very distressed from a housing standpoint. It is foreclosure sales. It is certainly speculators and in some cases homeowners sitting on the sidelines who’ve been waiting for housing values. We are seeing it as markets that have experienced downturns before and have that – using that experience recognizing there are bottom levels that are willing to jump in. California is a good example; Florida is not a good example. So, we see slight signs of that in the marketplace today, and what we also see which is much more emphatic is the announcement how much today to lean much more towards do-it-yourself involvement than do if for me, which is really placed some of our strength areas and I see we are trying to take advantage of that knowledge and track how that plays out and opportunities for the customer today.

Alan Rifkin – Banc of America/Merrill Lynch

Okay. And then just a quick one for Bob. I understand the effect on gross margins of the heavy couponing and promotions. Was that a benefit to comps in any way, Bob?

Robert F. Hull, Jr.

Not necessarily Alan. Just a rough math, if you discount something 10%, you need 11% more unit to get to the same sales. So, we didn’t necessarily sell more units which is evidenced by the decline in traffic in the quarter. So, it actually hurt both sales and margin in the quarter.

Alan Rifkin – Banc of America/Merrill Lynch

Okay. Thank you very much.

Robert Niblock

Dennis, we have time for one more question.

Operator

Yes sir. This morning’s final question will come from the line of Deborah Weinswig with Citi.

Deborah Weinswig – Citigroup

Thank you so much. So few question with regards to guidance. Can you help us understand Bob the difference between first quarter versus all of 2009 from a comp perspective?

Robert F. Hull, Jr.

Sure. Certainly, we think things are going to be toughest at this point in time. We do believe there’s an opportunity for improvement as the year progresses mainly because of the factors Greg described, some stabilization in housing, not that housing improves but it gets less bad year over year on a relative basis. So, we think Q1 improves cyclically from fourth quarter due to a couple of factors. First, the mix of outdoor categories, our outdoor categories improved outperformed the indoor categories by about 400 basis points over the course of 2008. We look at first quarter outdoor categories, about 35% of the mix relative to 20% for fourth quarter. So, sequentially there’s about 15% mix improvement which we think helps the first quarter. We are optimistic about outdoor in 2009. We still see people taking on smaller projects. Larry talked to you about the decline in larger projects which we certainly expect to continue in 2009. We do see people willing to take on smaller projects and that was contemplated in our outlook for 2009.

Deborah Weinswig – Citigroup

Okay. And then with regards to your refined store opening plan, three different questions. A, have you renegotiated any of those openings? Two, are any of those takeovers are they all greenfields? And then three, how many of those are the 66,000 corporate prototype?

Gregory Bridgeford

Deb, this is Greg Bridgeford. On one, we’ve actually put every site that hasn’t closed as of almost a year ago back up for negotiation from a land standpoint. Certainly from a construction standpoint we re-bid every project and we see some interesting changes in the positive direction in that in most regions of the country has been material. From the standpoint of the small market prototype, we see – we have the number of 94s in the 2009 plan, and we have a 66k working on that model right now. It’s in development. We have another 66k that we are going to test rolling out this year. And then we have others that are lined up, other sites that are lined up behind it and as we improve that model and tweak that model.

Robert Niblock

And Deb, the other question on takeovers, none of these stores are takeovers. They will all be low stores that we built, and we also have one 80k that we’ll be opening this year.

Deborah Weinswig – Citigroup

Are takeovers an opportunity thus far an opportunity in 2009?

Gregory Bridgeford

They are and it’s actually something we always do, actually the store just opened two weeks ago is a takeover store but that’s second new space and there’s always second new space available, we constantly comb for it. And we will – we – a matter of course for us we don’t view it as a takeover. We view it as a takeover of something where with these existing operations we buy it, close it down and reconvert it to a low store, but second new spaces is available today. We think it’s going to be more available in the future and we will certainly incorporate it into our plans as we look at markets where we have opportunity to – we know we have opportunity to grow from a share standpoint and from a market cap standpoint.

Deborah Weinswig – Citigroup

Okay. And then final question is for Bob. Bob, with all of these I would say intense cost reduction efforts, how should we and obviously, this is – hopefully sooner than later but when we return to positive comps, how should we think about your new leverage plan?

Robert F. Hull, Jr.

I think as we tried to describe we’ve done a lot of work to continue to take cost out of our operation to become more efficient, more productive while maintaining our customer service standards. I think our opportunity to have positive leverage, once we turn somewhere between 1% and 2% comps.

Deborah Weinswig – Citigroup

Okay, incredibly helpful. Thanks so much for providing all the color.

Robert Niblock

Thanks Bob for those comments. And as always thanks for your continued interest in Lowe’s. We look forward to speaking with you again when we report our first quarter results on May 18th. Have a great day.

Operator

Ladies and gentlemen, this does conclude today’s call. You may now disconnect.