Good morning, everyone, and welcome to Loews Company's Third Quarter 2010 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 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 Loews' Investor Relations website under Corporate Information and Investor Documents. Hosting today's conference will be Mr. Robert Kniblock, Chairman and CEO Mr. Nick Kanter, Executive Vice President of Merchandising and Mr.
Bob Hull, Executive Vice President of Investor Relations. I will now turn the program over to Mr. Kniblock for opening remarks. Please go ahead, sir.
Good morning and thanks for your interest in Loews. Following my remarks, Nick Canner will review our operational performance and Bob Hull will review our financial results. Sales for the quarter increased 1.9% and comparable store sales were slightly positive. Comp traffic and comp average ticket were also positive for the quarter. New store cannibalization reduced comps by approximately 30 basis points in the quarter.
Although sales for the quarter trended below our guidance, our merchandising strategies helped us deliver 85 basis points of gross margin expansion in the quarter. Nick will provide more details on those efforts in a few minutes. As detailed in today's release, we recognized a charge which reduced pre tax earnings for the quarter by $50,000,000 and diluted earnings per share by $0.02 The charge was associated with impairment of long lived assets and write offs related to store sites we no longer intend to pursue. Even with these charges, we leveraged expenses for the quarter and delivered earnings per share of $0.29 which was within our guidance for the quarter. Our Q3 sales were impacted by the continued sluggishness of the economic recovery, driven by ongoing uncertainty in employment and housing.
As we've seen over the past several quarters, consumers are not yet willing to consistently take on larger discretionary home improvement projects. They remain cautious and continue to rationalize the scope of their projects or in many cases delay projects until they have better clarity about their personal financial situations, the value of their homes and the overall macroeconomic outlook. In our Q3 consumer survey, homeowners indicated that half of the home improvement projects they have planned in the next 6 months are discretionary in nature. However, the majority of that discretionary spend is expected to be on projects under $500 We continually evaluate our operating model and look for opportunities to work more efficiently and better position Lowe's for the future. As a result, we closed 2 regional offices during the quarter.
Our districts have been realigned such that we now operate 21 regions in the U. S. Versus the previous 23. Although 11 of our 21 U. S.
Regions generated positive comps in the quarter, the economic fundamentals of the housing market. Sales were also affected by the prolonged extreme heat across much of the U. S. In August September, which delayed consumers' fall lawn and garden plans, causing sales of live goods to suffer. However, when temperatures began to cool in October, we experienced better performance in our lawn and landscape and nursery categories as consumers restored their lawns.
Throughout the quarter, we saw strength in categories supporting smaller projects such as tools and paint, and we were also pleased with our performance in seasonal living and appliances. During the quarter, commercial and installed sales exceeded our overall sales trends, continuing to reflect the investment we made in our district commercial account specialists and project specialist exteriors positions. In fact, installed sales produced double digit comps for the quarter, driven in part by categories such as windows, doors and fencing, which are a focus of our project specialist exteriors position. I'm pleased with our inventory position at the end of the 3rd quarter, which was up only 1.4% year over year. You will recall that our inventory position grew earlier in the year due to opportunistic purchases in categories such as appliances and paint.
We made those purchases to pursue opportunities to drive sales and capture profitable market share. We use third party data to gauge our retail market penetration. And on a rolling 4 quarters basis, we gained 20 basis points in total store unit market share with gains in 10 of our 20 product categories, including appliances and paint. We also maintained our unit market share in additional 4 product categories. On the expansion front, we opened 10 stores in the quarter, 4 of which were in Canada, including our first store outside Ontario in the Calgary market.
As we said
on our 2nd quarter earnings call, we don't expect consistent improvement in core demand until the fundamentals of the labor and housing markets improve. However, we are prepared to operate effectively in a slow growth environment, focusing on operational efficiency and prudent expense management. We are ready to respond if demand is better or worse than expected. In addition, we continue to solidify plans to enhance our market share gains as the macroeconomic environment slowly improves. At our Analyst and Investor Conference later this month, we will update you on the initiatives we are working on to drive sales and market share gains.
Thanks again for your interest, and I'll now turn it over to Nick Cannon to provide an update on successes in the quarter as well as how the merchandising team is focused on profitably gaining market share.
Nick? Thanks, Robert, and good morning. This morning, I'll review our Q3 performance and then update you on our strategies to profitably grow market share. I am pleased with how we've continued to manage for profitability in an uncertain environment. As Robert mentioned, comps for the quarter were slightly positive, but we were able to expand our gross margin by 85 basis points and our inventory ended the quarter only 1.4% above last
10 of
our 20 product categories generated positive comps. We continue to see strength in categories supporting smaller projects, including tools, paint and lawn and landscape. Within tools, we are capitalizing on our partnerships with great brands such as Porter Cable, Rockwell, Hitachi Bausch and DEWALT. And our store teams continue to drive additional power tool accessory sales, yielding higher margins and repeat traffic. Both interior and exterior paints performed well, and we have received a strong response to our launch of Valspar Signature Colors paint with high def advanced color system technology.
Some larger ticket items such as appliances, patio and grills also performed well. Appliances continue to benefit from our knowledgeable associates, our wide selection of brands and free next day delivery and haul away. And we have the most items in stock for take home today of any major retailer. Lawn and landscape benefited from particularly strong sales of watering products, grass seed and lawn repair products as homeowners work to restore lawns damage from the summer drought. On the other hand, nursery, which we had expected to perform well as our customers planted trees and shrubs after an unseasonably hot second quarter continue to struggle as excessive heat lingered into August September.
We saw strong positive comps in October when the heat finally broke, but nursery still ended the quarter below our expectations. Weather patterns also affected home environment, which was our lowest performing category for the quarter. Early heat throughout the Northeast and the Midwest pulled air conditioning sales forward into Q2 from Q3. Gross margin grew by 85 basis points as a result of coordinated efforts across a number of areas, including refinement of our pricing strategy, carefully managed a seasonal sell through and our response to customers' increasing demand for the value offered by private branded products. 2 important changes to our pricing strategy were fully implemented prior to the beginning of Q3.
First, we increased the number of patch areas or competitive pricing zones from just under 90 to more than 210. This allowed us to price more competitively in each market. In addition, we implemented base price optimization, which adds to the capabilities we have benefited from with markdown optimization. Just as markdown optimization has helped us to better tailor our markdown approach to each store based on specific demand for an item, base price optimization determines the best price by item and patch area to optimize our positive price perception and total basket profitability. Improved seasonal sell through allowed us to take lower clearance markdowns for grills, patio and air conditioners.
In grills and patio, we leveraged more market specific assorting in our advanced supply chain capabilities to ensure we had the right product in the right markets. Consequently, we were able to uniformly meet demand and end the season with very little excess inventory, which reduced the margin impact of seasonal markdowns. So for both patio and grills, this approach translated into both higher sales and improved margins. For air conditioners, we decided early in the year to enter the summer with a moderate number of units in order to minimize the markdowns we would need to take at the end of the season. With warmer weather, we were able to sell through most of all of our units with minimal markdowns and we ended the quarter with our inventory in great shape.
Finally, our increasing penetration of private branded products also contributed to our margin improvement. We will always be predominantly a house of national brands, but over the next few years, we expect to further increase our penetration of private branded products from approximately 15% to 18%. This strategy will provide great value to our customers, while giving us opportunity to improve margins. In the Q3, we continued to gain share according to an independent third party assessment. And on a rolling 4 quarter basis, we grew share in 10 of our 20 product categories and maintained share in 4 categories.
We made noticeable progress in appliances, hardware, seasonal living, tools and paint. Gains were driven by our continued focus on 4 simple principles for growing profitable market share. Go local, focus on everyday value, first to market and what we call the why low shopping experience. Go local means that we tailor our assortments to each market we serve while always adhering to the fundamentals of customer service and store environment that make Lowe's unique. For instance, as front load washing machines became increasingly popular, we began to carry more inventory in the front load machines than in the more traditional top load machines.
However, ongoing store level analysis has shown us that in many markets, our customer preference had shifted back to top load machines as the efficiency and the capacity of these units have improved. So we have rebalanced our by market inventory accordingly. Another example is market customer appreciation days event. We select markets where we have opportunity to gain share, then we invite commercial customers to an event to showcase what we can offer them with product demonstrations from key vendor partners. These events have received great feedback from customers and our stores and help generate strong commercial customer sales.
We have always gone local, need but we get better at this every year and as we mentioned at our last quarter's call, we expect to implement integrated planning and execution or IP and E in 2011. IP IP and E will complement the judgment and the creativity of our merchants by helping them better target the stores within the markets we serve. In simple terms, these tools and processes will help us to get the right product to the right place at the right time even more efficiently and effectively than we
do today.
We will use IP and E to more specifically determine what products and quantities to offer in each store based on market requirements, demographics and customer shopping preferences. We have begun piloting IP and E in 7 merchandise subcategories and we expect to begin realizing the benefits of IP and E's clustering and assorting capabilities as we reset products during 2011. Further benefits should be realized when we tie together the assortment planning, the store layout and planograms, as well as our financial models and logistics systems to ensure that we have the right products and inventory to meet customer demand. Go local no longer means just within our stores. Local is wherever our customers need to tap into our resources and our expertise.
It includes the projects specialist exteriors who make in home visits to sell exterior categories or the district commercial account specialist who meets with commercial customers at their place of business or loews.com where customers can now find over 350 how to videos to start them on their next project or help them recover from one they've already started. We're looking forward to sharing more about this concept with you at our Analyst and Investor Conference. The second principle is everyday value, and the value is more than just a low price. We have to offer something more than a competitive price, like low price plus innovation or low price plus compelling style or low price plus unmatched service. One way we are bringing value plus style
to the marketplace is with our Allen and Roth brand of
home decor products. Place is with our Allen and Roth brand of home decor products. This line offers customers the ability to coordinate across many product categories, including window treatments, paint, lighting, bath vanities and accessories, closet organization and more, Allen and Roth delivers a classic style with a modern flair and provides our customers with a specialty store look that fits both their style and their budget. The 3rd principle is first to market. We want to be the 1st home improvement company to offer something new and different to our customers, like the new heat pump water heater from GE, which won the Popular Science Best of What's New Award in 2,009.
In fact, our desire to work with vendors to offer environmentally responsible and cost saving products has resulted in the U. S. EPA and the Department of Energy honoring Lowe's with the 2019 ENERGY STAR Sustained Excellence Award. Lowe's is the 1st retailer to win the Sustained Excellence Award and it is our 8th consecutive ENERGY STAR STAR honor. Additionally,
we are
the 1st retailer to win the WaterSense Partner of the Year in consecutive years. Our research indicates that these designations play an important role in our customers' purchase decisions. Another example of first to market is our exclusive launch of Valspar's signature colors paint with high def advanced color system technology, which delivers ultimate hide, exceptional color accuracy and superior fade resistance. This great new product simplifies our customers painting projects and gives them another compelling reason to shop Lowe's for their painting supplies. The 4th and final principle, the why Lowe's shopping experience, captures the many things that we do to differentiate us from our competitors.
It's what convinces customers that they should come to Lowe's the next time they need to complete the home improvement project, no matter how large or how small. That can mean visually inspiring customers with a wide array of paint colors or ensuring we carry enough plumbing parts to finish a job or providing an uncluttered inviting shopping environment both in our stores and increasingly on our website or merchandising fashion plumbing items together so a customer can better visualize the final appearance of their bath project, what I like to call putting it all together for the customer. Or it could mean offering our customers something they can't find at other large home improvement retailers. In fact, one great example of the why Lowe's experience is our channel exclusive on Stainmaster carpet. Combine this well known and trusted brand with our $39 whole house installation and our customers have a compelling reason to buy their carpet from Lowe's before looking anywhere else.
We are excited about our current and expanding capabilities for providing differentiated value to our customers. We continue to improve our market share and when the market rebounds, we look forward to taking further share and growing profitably. Thanks for your interest in Loews. And I will now turn the call over to Bob Lowell to review our Q3 financial results. Bob?
Thanks, Nick, and good morning, everyone. Sales for the Q3 were $11,600,000,000 which represents 1.9% increase from last year's Q3. In Q3, total customer count increased 1 0.6%, while average ticket increased 0.3 percent to $61.59 Comp sales were positive 0.2% for the quarter, which was below our guidance of 1% to 3%. Looking at monthly trends, comps were flat in August, negative 0.5% in September and positive 1.2% in October. For the quarter, both comp transactions and comp average ticket increased 0.1%.
With regard to product categories, the categories that performed above average in the Q3 include millwork, tools, lumber, paint, rough electrical, seasonal living, lawn landscape products, rough plumbing and appliances. In addition, home organization performed essentially in line with the company average. Year to date, sales of $38,300,000,000 represent a 3.5% increase over 2,009, driven by new and a comp store sales increase of 1.4%. Gross margin for the 3rd quarter was 35% of sales, an increase of 85 basis points from last year's Q3. As Nick described, the increase in gross margin was driven by a number of factors.
We estimate that the favorable impact from base price optimization and patch area expansion on the quarter was approximately 25 basis points. In addition, the impact of seasonal sell through, both the benefit of lower markdowns this year in patio furniture and grills and the comparison to last year's air conditioner markdowns have gross margin by approximately 25 basis points. Lastly, inflation in commodity categories and a higher proportion of private label products aided gross margin in the quarter. Year to date gross margin of 35% represents an increase of 18 basis points over the 1st 3 quarters of 2,009. SG and A for Q3 was 25.3% of sales, which leveraged 4 basis points, driven by a number of expense lines.
For the quarter, bonus expense leveraged 31 basis points due to lower attainment levels versus plan. In Q3, we incurred $39,000,000 we incurred $839,000,000 charge related an evaluation of the carrying value of long lived assets, including 2 stores that closed on November 7. In addition, we incurred $11,000,000 in write offs related to the pipeline of potential future store sites we are no longer intending to pursue. As a result of these two items, SG and A was negatively impacted by $50,000,000 which reduced earnings per share in the quarter by approximately $0.02 This compares to $57,000,000 in expense for similar items in last year's Q3, resulting in 6 basis points of expense leverage in Q3 this year. Also, we experienced modest leverage in both store payroll and payroll tax expenses.
Slightly offsetting these items, we experienced deleverage in the following expense lines, insurance, proprietary credit, bank card and fleet. Year to date, SG and A is 24% of sales and leveraged 16 basis points to the 1st 9 months of 2,009. Depreciation at 3.4 percent of sales totaled $399,000,000 and leveraged 10 basis points compared to last year's Q3. Earnings before interest and taxes for operating margin increased 99 basis points to 6 point 3% of sales. Year to date, operating margin of 7.9 percent represents an increase of 49 basis points over 2,009.
Interest expense at $80,000,000 deleveraged 1 basis point as a percentage of sales. For quarter, total expenses were 29.4 percent of sales and leveraged 13 basis points. Pre tax earnings for the quarter were 5.6% of sales. The effective tax rate for the quarter was 37.9%. Earnings per share of $0.29 for the 3rd quarter were within our guidance of $0.28 to $0.32 and increased 26% versus last year's $0.23 Now, I'd like to comment on the balance sheet, starting with assets.
Cash and cash equivalents balance at the end of the quarter was $1,100,000,000 Our 3rd quarter inventory balance increased $119,000,000 or 1.4 percent versus Q3 Q3 last year. The increase was due to 36 new stores opened over the past 4 quarters. Inventory turnover calculated by taking a trailing 4 quarters cost of sales, but in my average inventory for the last 5 quarters was 3.6%, a decrease of 5 basis points from the Q3 of 2,009. Return on assets determined using a trailing 4 quarters earnings, but our average assets for the last 5 quarters increased 39 basis points to 5.6%. Next, I'll points to 5.6%.
Next, I'd like to highlight a few items from the liabilities and shareholders' equity section of the balance sheet. At the end of the Q3, our accounts payable balance was 5 $1,000,000,000 or about 2% lower than last year. The reduction in accounts payable relates to the timing of purchases. As we noted earlier in the year, our inventory was higher than planned due to some opportunistic purchases. As we work to get inventory in line with plan, our inventory purchase activity moderated, resulting in a lower AP balance at the end of Q3 relative to last year.
Our debt to equity ratio was 29.5% compared with 20 6.1% in Q3 last year. At the end of the 3rd quarter, lease adjusted debt to EBITDAR was 1.58 times. We are increasing our previously stated lease adjusted debt to EBITDAR target from 1.5x to 1.8x, while reiterating our commitment to protecting our A1P1 commercial paper rating. This change provides improved flexibility to return value to our shareholders, while maintaining strong liquidity and lowering our weighted average cost of capital. Return on invested capital measured using a trailing 4 quarters earnings plus tax adjusted interest divided by average debt and equity for the last 5 quarters increased 54 basis points for the quarter to 8.6%.
Now looking at the statement of cash flows. Year to date
cash flow from operations was $3,800,000,000 which
was down about 12% from operations was $3,800,000,000 which was down about 12% versus the 1st 9 months of 2,009 due in large part to the lower accounts payable balance. Cash used and profit acquired was $1,000,000,000 for the 1st 9 months of 2010, compared to $1,400,000,000 for the same timeframe last year. As a result, year to date free cash flow was just over $2,800,000,000 During quarter, we repurchased 29,000,000 shares at an average price of $20.72 for the total share repurchase amount of $600,000,000 We have $3,400,000,000 remaining under share repurchase authorization. We estimate that the 3rd quarter repurchase activity helped the current quarter's earnings per share by approximately 0.4p. Looking ahead, I'd like to address several of the items detailed in Loews' business outlook.
We expect 4th quarter sales to grow by 2% to 4% over last year, which incorporates the opening of 17 new stores, 4 in November, 5 in December and 8 stores in January. Comstar sales are estimated to flat to positive 2% versus last year. EBIT, our operating margin for the Q4, is expected to increase by approximately 80 basis points to last year as a percentage of sales. The increase is driven by gross margin improvement as well as SG and A and depreciation leverage. The anticipated sales and operating margin results are expected to generate diluted earnings per share of $0.16 to 0 point 1 $9 which ranges from an increase of 14
percent to
36% compared to last year's $0.14 For 20 10, we expect to open approximately 42 stores, resulting in an increase in square footage of roughly 2 percent. We're estimating our comp sales increase of 1% to 2% and a total sales increase of 3% to 4%. For the fiscal year, we're anticipating an operating margin increase of 50 to 60 basis points. We are forecasting an effective tax rate of 37.8 percent for both Q4 and the year. As a result, we expect diluted earnings per share of $1.37 to $1.40 for the year.
For the
year, we expect cash flow from operations to be approximately $4,200,000,000 We forecast total capital expenditures of approximately $2,000,000,000 with roughly $400,000,000 funded via operating leases, leaving cash CapEx of approximately $1,600,000,000 for 20.10. As a result, we are forecasting free cash flow of approximately $2,600,000,000 for the year. Our outlook does not contemplate any share repurchases for the Q4. Regina, we're now ready for questions. Regina, are you there?
We are now ready for Our first question comes from the line of Steven Shick with FBR.
Hi, thanks.
I guess for Bob, it looks like the comps for the quarter as they progressed really were helped out by the last month of the quarter. And I was wondering if you could speak to how much of that might have been driven by like outdoor and some of the pent up lawn restoration activity that occurred and may have helped out the last month there?
I think as Nick described in his comments, we did have some pressure early in the quarter based on the heat. Nursery business came back, in fact was double digit comp in October. So that certainly helped. But as Nick stated in his comment, nursery was still below the before the quarter. So certainly that did help having improved or more normal weather in October relative to the 1st 2 months of the quarter.
Okay. So kind of as you look at your outlook for the Q4 and kind of the November December, January timeframe, I mean, you could look at the guidance and maybe indicate I mean, because I think that some of the outdoor product categories become a lower piece of the mix in the Q4. So are you kind of, I guess, assuming that some of the other categories pick up as the end of the year comes in here?
You're right. The outdoor categories are a lower percentage of our mix of total business in the Q4. That's certainly contemplated in our outlook. We feel good about our plans for the upcoming holiday season. We think the more typical products for this season will be the drivers of comp improvement.
As you
think about the trifectory category, as you think about tools and appliances, things of that nature, more typical focuses versus your nursery category.
Okay. And did you give the ticket breakout of the comps for your bigger ticket comp for the quarter and the items that are the $50 or less that you typically speak to?
Steve, we did not I can give those to you. The tickets below $50 were essentially flat, tickets above 500 were up just shy of 1%.
Okay. All right. Thanks, Bob.
Thank you.
Our next question comes from the line of Mike Baker with Deutsche Bank.
Hi. Thanks. So, my questions are more on the expense line. We're even adjusting for those charges. You were able to lever your expenses at essentially a flat comp.
So I think that's better than in the past. Is there something that you're doing on the expense line differently than in the past areas where you found some cost savings that might continue? And I guess along the same lines, store closings, you've closed a couple here. Are there more over the next year or so that you think can be closed to further save some costs? Thanks.
Good morning, Mike. This is Bob. I'll start out with some comments on expenses, let others chime in, then we can move on to the second part of your question. So, really two thoughts. First, a large portion of the leverage in this quarter came from bonus leverage 31 basis points.
As you know, our sales came in below our guidance and earnings came in at the lower end of our guidance. Our bonus plans are largely predicated on plan. So, we performed a little lower than we expected versus plan. 2nd, a lot of work has been done by the store operations team regarding store payroll, real focus on decomposing processes, leveraging thoughts from the field, how we can do things better. As a result, we have a greater proportion of hours in customer facing activities and the stores have been able to reduce the number of stores number of hours to run a Lowe's store by almost 400.
So, a lot of work by the store operations team continue to refine the payroll model, which is going to help us in the back half of twenty ten and beyond. On the store closing question, we did close 2 stores in November 7, just after quarter end. As we noted in the past, we continue to evaluate our
stores and the markets are in,
both current and evaluate our stores and the markets are in both current and expected performance. After a thoughtful valuation of these two stores, their markets and projected growth for the next 5 plus years, we felt like the best decision was to in fact close some stores.
Okay. Thanks. And as a true follow-up, that number you just gave, that reduction in hours by 400, that's over 400 fewer hours over what timeframe? And then what is that as a percent of total hours to run a store? In other words, the 400 fewer hours, I guess, a month or a year or
so, yes, if
you could help
with that.
Okay. So, roughly a quarter hours per week. And I'm not going to provide you the percentage, which would give you the base hours, which we choose not to provide. Okay. Thank you.
The next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Hi, guys. Scot Ciccarelli. I guess my question is, if we look at kind of a 3 year stack here, it seems to have been a pretty good indicator for kind of what the run rate of the business is. So your comps were essentially flat from the Q2 basically about to the basis point. What is it that you see in your business at this stage that gives you confidence we should see an acceleration in that metric as we head into the Q4?
Scott, this is Larry Stone. We feel real confident about our Q4 plans in terms of the promotions we have planned for Black Friday and other events into the Q4. And certainly, the previous calls talked about nursery not being a big driver in the Q4, which is correct, but our trimetry products, our seasonal heating products, our trimetry products and all lot interior categories really have a much stronger Q4 than they do in previous quarters. So we feel confident that our 4th quarter numbers are very obtainable and we feel confident about our plan that we have put together as we head into this quarter.
Okay, that's helpful. And then just philosophically, if comps were to go negative, is there a point where you would actually slow your buyback program?
We would evaluate that cash available. As I mentioned, free cash flow is forecast to be $2,600,000,000 for the year. We continue to evaluate, as I mentioned earlier, our expenditures, specifically payroll, we continue to evaluate CapEx. So, Scott, I think all that would come into play. What's the cash generated by the business, less cash required for CapEx and dividends and that's the cash left over for share repurchases.
So, we would go through the process to determine the cash that's available given the new leverage target of 1.8 times we suggest debt to EBITDAR.
All right. Thanks a lot, Bob.
Thank you.
Our next question comes from the line of Budd Bugatch with Raymond James.
Good morning and thank you for taking my question. Bob, you normally, I think, call out Canadian comps versus U. S. Can you give us those numbers?
Yes. So the Canadian comps were negative 8% really due to a change in tax legislation. There was an additional sales tax added to installed sales. So, we saw a huge ramp up in installed business ahead of that change, which took effect in July. That was really contemplated in our Q3 outlook.
So, our consolidated comps were 0.2% and the U. S. Comps were also 0.2%, given the fact that we only had 14 comps Canadian locations really didn't have an impact on the consolidated total.
I got you. Thank you. And just as you look at the discretionary product, I was pleased to see that, you said we're up 1% for tickets above 500. What's the promotional environment looking like for cabinets and appliances? And maybe you could give us kind of some color on what you're seeing out there for the consumer?
Hey, Budd, this is Robert Nedbloch. Yes, to date, I don't think we've seen anything dramatically ramp up in promotional environments. You have seen a few things as it pertains to Black Friday, a few competitors starting to signal either advanced Black Friday promotions, those type of things. So we do think that between now and certainly Black Friday getting into the rest of the holidays that you may see a little bit of an elevated promotional impact. We've taken that into account in our guidance as we've looked at what we think will happen from an EBIT margin standpoint in Q4 Q4 compared to Q3.
And so that is contemplated in our guidance. So, in an environment like this where unemployment is at 9.6%, the consumer is still as it pertains to large projects, still having to be kind of enticed to spend on those large projects. We think that we will see probably a slightly elevated impact over the balance of the holiday season. But as I said, we think we've adequately taken that into account in the guidance that we've provided today as it pertains to the Q4.
But Robert, haven't we seen some of the appliance manufacturers also have fairly heavy inventories, which would indicate to be a more promotional environment in that side of the business?
Yes, you saw obviously coming out of the first half of the year where we had all the cash for appliances programs, you saw obviously they were ramping up to try and build back the inventory that was depleted from that. We've continued to see good performance in our appliance category. Once again, one of the categories that was above our overall company comp, and we're expecting a good appliance sale through in the Q4 as well. So yes, I mean, I think that is to the fact that they have ramped up inventory and probably have inventory to move, that also leads to some of that my comments with regard to probably slightly enhanced promotional activity over the balance of the quarter.
Understood. Thank you very much and good luck on the Q4 and the balance of the year.
Thanks, Ben.
Our next question comes from the line of Michael Lasser with Barclays Capital.
Good morning. Thanks a lot for taking my question. So as you think about the relationship between housing turnover and your comps, what do you think the correlation is going to be moving forward? Is that going to become decoupled? Are we reaching and why might that be?
Is it because we're reaching a base level of demand? How are you contemplating that?
I'll start, Michael, and then I'll ask Greg Bridgeford to join in. I think, as in the past, housing turnover has been important in the past. I would think still important today and will be important in the future because, as you know, it provides that natural incident for the homeowner to need to come and buy products related to the home in our industry. Obviously, what's been challenging is even though there's been still continued positive correlation associated with that, the bigger issue is the more than offsetting fact that the pullback you've seen in overall demand with unemployment where it's at and with home prices continuing to drop. Home prices down about were down about 29% when they bottomed in January or so earlier this year.
When you had the stimulus programs for the home buying tax credit, you saw a little bit of a pickup, but now home prices are falling again and probably anticipated to fall through at least the middle of next year. So you probably got another 4% to 8% or so potentially on home price decline. And even though we're gaining jobs are still not growing fast enough to drop the unemployment rate on the jobs front. So even though you're seeing fundamental improvement, majority of the decline in home prices behind us, we are gaining jobs, all those type of things are positive sign. Those 2 halo effects, employment and the continued decline in home prices probably offset or kind of watered down what you would normally see as that correlation you've been able to draw in the past to an housing turnover and our sales.
So housing turnover is still important, but it gets offset by some of these other factors. Greg, did you add?
I think Robert covered it
well, Michael. I think that we're watching very carefully employment incomes and then spending, consumer spending. I do think Robert is right that that's going to be the first factor. I mean, if you combine those factors, that entire scenario has to strengthen for us to see some spend in our category. And where we've seen housing turnover spike regionally and market by market, we've seen some moderation and some bottoming on a market basis of home values.
And that's unfortunately, that situation has been a little more variable lately. So you saw some markets seem to stabilize 6 months ago and all of a sudden seem to have fallen off again. So I think Robert's right, the factors to watch most carefully now are employment incomes and spending.
I guess I was thinking about more prospectively than you haven't seen necessarily the pop in your comps from the spike in housing turnover from a couple of quarters ago, does that suggest you may not see the fall off now that housing turnover has moved down quite significantly over the last couple of periods when we get into the spring selling season?
I think, Michael, what we're saying is that over the long term, housing turnover is a strong correlator, both what's taking place now and the impact on the consumer mindset and how that's impacting their spending that's even more important today given that house prices like to decline modestly into 2011 and unemployment rises from here, that's still going to be a driver of our business into 2011. Longer term, as we think beyond 2011, then I think the housing turnover would be a stronger correlator as it has been in the past.
Okay. And just a quick follow-up on the gross margin. It seems like some of the improvement from the current quarter sustainable. A, how should we think about that, at least the half that came from the pricing frat patches and private label penetration? And B, should we actually see that portion accelerate as there's more time to incorporate that into the business?
Michael, this is Nick Shanter. I'll comment on that and let others jump in. On the base price optimization rollout, yes, we think that is sustainable. We think we see some opportunity as we wrap that next year. We got that rolled out in August throughout all categories.
We certainly see more opportunity for the private branded product margin. As I said on my comments, we're increasing the penetration of private branded products, which offer great value to our customers and enhance margins for us going from about 15% penetration to about 18%. The only thing is that's not sustainable in Q4 versus Q3. We did have some great seasonal sell through upside as we said, Bob said earlier, on the 25 basis points that we on a great sell through program with limited markdowns, that would be the only thing that we wouldn't see repeat itself probably in Q4.
Okay. Thanks a lot and good luck. Thank you.
Our next question comes from the line of Brian Nagel with Oppenheimer.
Hi, good morning. Thank you. The first question I have on the appliance category, in your prepared remarks your commentary around appliances seem relatively upbeat. And that seems at odds with what we've heard from a number of appliance manufacturers as well as some retailers lately. So I guess the question I have there is, maybe you can help quantify what you saw in the appliance category through the quarter and then help to kind of sort of say bridge a gap with some of this other weaker data we've seen recently?
Brian, this is Bob. I'll take kind of the first piece of it. As we talked about in the first half of the year, we bought
a lot of appliances. So, for us
to get our appliance inventory back in line, we had to slow our appliance purchases. So, that's what you'd see in conflict with some of the manufacturers is our purchases for them would have been skewed towards the first half of the year. As we work to get our inventory back in line, we would have moderated our purchases, which would have been a negative for them. Our appliance inventory is in great shape. We're talking about where we are today, but our appliance inventory hasn't moderated from the first half of the year.
Okay. And then, so follow-up to that, I mean, do we see any lumpiness with the government stimulus earlier this year and then obviously expiration of that later? Was there what type of effect did that transition have on your sales trends?
Brian, this is Robert. We talked earlier in the year, we had strong double digit positive comps in appliances through the first half of the year, heavily driven by the stimulus program, the cash for appliances program, as we saw the early indications on a state by state basis of those appliance sales. We bought did some opportunistic buys because we were concerned how much production capacity would be out there. Secured that inventory from our major manufacturers, which then provided us the inventory to be able to sell through. But even without the cash for appliances program, we still have seen very strong comps over the first half of the year.
Now we did expect that to soften some in the Q3 and that was part of the reason when we gave our guidance from Q2 going to Q3 of the increase that we thought we would see on gross margin was because of the mix impact. Mix from very strong double digit appliance comps in the 2nd quarter negatively impacted our margin. We expected them to soften, but still run above company average in the Q3, which then improved from a mix standpoint. We didn't have that drag on gross margin that we had in the Q2 because it kind of rebalanced. And then we're still expecting from our plans to have strong appliances, appliance sales in the Q4, which we still expect appliances to lead our overall comp guidance for the Q4.
Okay, helpful. Then just one follow-up kind of maintenance question, Bob. The $0.02 charge you had here in Q3, is that reflected in the updated annual guidance you gave for the year?
Yes, it is. Okay. Put on GAAP when we guide the GAAP. Great.
Thanks a lot.
Thank you.
Your next question comes from the line of Peter Benedict with Robert W. Baird.
Hey, guys. Two quick ones. First, Bob, how quickly do you plan to get to the 1.8 leverage ratio benchmark that you've laid out here this morning?
We're going to be very thoughtful about our approach to navigate going from the 1.5 8 today to the 1.8. So, it's no specific timetable. It's not contemplated in our guidance if that's what you're asking.
Okay. And then, when we think about the IP and E initiative, there are 7 categories in pilot today. How long have they been in pilot? And when I think about 2011, does it go to all categories or how is the rollout of this going to look?
Peter, this is Nick Canner. Good morning. We started piloting some of these subcategories beginning early October, late September, early October. We've been working on the project for quite some time. There's many legs to this initiative.
The clustering tools and assortment planning tools that are in pilot today will start a full rollout early 2011. We hope to roll we will hope to roll all those clustering and assorting tools to all merchandise divisions during the year. The other pieces to that such as the financial planning, the store layout planning and thus will be subsequent projects after that.
Great. Thanks, Nick.
Thank you. I think we've got time for one more question.
Our final question comes from the line of David Strasser with Janney Montgomery Scott.
Thank you very much. I have two questions, one regarding inflation and one regarding big ticket trends. The first one on inflation, when you guys with Lowe's Global Sourcing, obviously, you have a pretty good read into what's going on over particularly in China, if not all of Asia. What are you seeing there from that trend across your various product cycles, taking out lumber obviously from an inflation standpoint as you head into 2011?
Dave, this is Robert. You're taking out lumber. Yes, you probably are going to some slight inflation trends. You're seeing a lot of increase in commodity prices that are out there. We are starting to hear, particularly on the wage front, as China and Asia and those other areas, it's just probably going be fairly strong wage inflation.
In the short term, I think basically all of our contracts are denominated in U. S. Dollars, but certainly as you're doing your rebuys and redoing those contracts, then certainly there will be some inflation that will creep in. So yes, as you look at it over the next several quarters, you probably will have some slight positive impact on comps as it pertains to inflation.
So what you're basically saying though is using that disinflation comps, you're pretty confident that you could pass through sort of that inflation, that type of Asian wage inflation to your customer?
At this point, yes, we think that we should be able to pass all of the majority of that through.
Okay, great. Thanks. And the second question, just you talked about big ticket being up for the quarter. I'm just getting a sense as the home buying credit expired, which seemed to have a fairly positive impact across a lot of impact across a lot of parts of retail, what did did you see that have an impact on that trend throughout the quarter? Or how did that trend as we went through the quarter, the bigger ticket?
Not much changed in the quarter. That big ticket higher average comp was driven by the appliances. As Nick talked about, the patio furniture and grills, less markdowns there. So that contributed to big ticket performance relative to last year and the last piece of that was inflation in lumber building materials. So all that was fairly consistent throughout the Q3.
David, also we talked about the strength in our commercial business and our installed sales business, driven by some of the investments that we made last year heading into this year with our district commercial account specialists and our project specialist exteriors, which focuses on installation of those key exterior projects around the home. And as you know, both of those businesses generally run a higher average ticket. So a little bit of a remixing there between that and our retail business would have also helped that as well.
All right. Thanks. That was great. Thank you very much.
Great. Thanks. And as always, thanks for your continued interest in Loews. We look forward to speaking with you again when we report our Q4 results on February 23. Thanks, and have a great day.
Ladies and gentlemen, this does conclude today's conference. Thank you