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Lowe's CEO: Legacy price increases weighed on Q1 gross margin

Problems pricing products pulled down Lowe's Cos. Inc.'s fiscal first-quarter earnings as the home improvement retailer dealt with cost increases that its new merchandising executives had not been aware of.

Despite posting an increase in comparable sales for the quarter ended May 3, the Mooresville, N.C.-based company reported lower-than-forecast adjusted EPS and pared back its guidance for its 2020 fiscal year. President, CEO and Director Marvin Ellison told analysts during a call May 22 that the culprit was price increases that former members of the company's merchandise team had arranged in 2018 and early 2019.

Ellison, who joined Lowe's in July 2018, said that Lowe's has replaced two senior vice presidents and 11 of its 13 vice presidents within merchandising over the last six months as part of a broader effort to rejigger the company's operations.

"Our new merchants simply did not have a clear line of sight to the cost increases that were accepted by prior merchants as we transition," the executive said, later adding that Lowe's senior executives are still "trying to understand the logic of the cost increases."

Shares of Lowe's were trading 11% lower at $98.80 in morning trading May 22.

Lowe's prior merchandising team did not pair those increases with adjustments elsewhere, creating the hit to first-quarter profit that the company reported. Lowe's gross margin declined to 31.46% of sales from the 33.11% it reported for the year-ago period.

"If you take a cost increase for any reason, you've got to offset that within the portfolio with actions to protect gross margin," Ellison said. "All these things sound basic, but didn't exist in [the first quarter]."

In addition to reviewing the cost increases, Lowe's is also establishing a new cloud-based system for managing on-the-shelf prices. The company's planned acquisition of Boomerang Commerce Inc.'s Retail Analytics platform will also help it analyze prices, Ellison said.

Fallout from the pricing problems is likely to extend into the second quarter before abating during the second half of the company's 2019 fiscal year, Executive Vice President and CFO David Denton said during the May 22 call.

Since taking the helm of the retailer, Ellison has outlined plans to turn around operations at Lowe's, which has long underperformed rival Home Depot Inc. Ellison has spoken in recent months about tackling items that are chronically out of stock at the company's stores as well as attracting a greater number of professional customers, such as contractors.

Ellison said hiring new merchandising executives was necessary to help execute that broader turnaround. At the same time, the price increases have prompted Lowe's executive team to reexamine their systems, an effort aimed at "making sure we limit the number of surprises" that appear in the future, he said.