勞氏公司 (LOW) 2005 Q2 法說會逐字稿

Good morning everyone and welcome to Lowe's Company's second quarter earnings conference call.

This call is being recorded.

Statements made by management during this call may include forward-looking statements, as such are provided by the Private Securities Litigation Reform Act of 1995.

Although the Company believes the expectations, opinions, projections, and comments reflected in such statements are reasonable, it can give no assurance that they will prove to be correct.

A wide variety of potential risks, uncertainties, and other factors could materially affect our ability to achieve the results expressed or implied by our forward-looking statement and those risk and uncertainties are detailed in the Company's earnings release and other filings with the SEC.

Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and CEO;

Mr. Larry Stone, Senior Executive Vice President, Merchandising and Marketing; and Mr. Bob Hull, Executive Vice President and CFO.

Please note the call will conclude promptly at 9:45 a.m. eastern time.

I will now turn the program over to Mr. Niblock for opening remarks.

Please go ahead, sir.

Good morning and thank you for your interest in Lowe's.

Today I will provide my thoughts on our second quarter results and highlight a few drivers of our performance.

Following my comments, Larry Stone will highlight the merchandising and marketing initiatives that have been critical to our success and provide his plans for the future.

Finally, Bob Hull will review in detail our second quarter financial results.

First a few highlights of the quarter.

Our store employees focus on serving customers drove sales of $11.9 billion, a 17% increase over last year and comparable store sales increased 6.5% compared to last year's second quarter comp of 5.1%.

Our comp sales were above our guidance of 4 to 6% driven by the continued success of our big three sales initiatives and great service focused on meeting customers' needs.

Our expansion efforts continue as we open great stores in great markets around the country.

And, in fact, we added our first store in New Hampshire this quarter, the 49th state now served by Lowe's store.

In June, we also announced our intention to enter the Canadian market with plans for six to ten stores in Toronto in 2007.

Toronto is the fourth largest metro market in North America and provides a great untapped opportunity for expansion.

In addition to the strong performance of our 116,000 square foot prototype, our 94,000 square foot store for smaller markets continues to perform well.

Our first 94k store opened a little over two years ago.

As we watch our 94k stores move into their second and third year of operation we continue to be pleased with their performance as they deliver strong comps and solid returns.

Earnings per share of $1.05 increased 21% over 2004 driven by a strong sales environment and exceeded our guidance of $1.00 to $1.02.

We remain committed to driving sales and controlling costs in order to expand operating margin.

As a result of our strong performance, return on invested capital exceeded 18% for the first time in our modern history and return on assets grew to 12.5%.

Building on strong April sales results our stores delivered solid midsingle digit comps in each month of the second quarter as consumers completed weather delayed spring projects. 18 of 19 product categories delivered positive comp sales with only lumber, which was impacted by deflation having a slightly negative comp for the quarter.

Outperforming categories include appliances where double digit comps were driven by solid performance across the category with particular strength in high efficiency products.

We continue to drive market share gains as independent data shows Lowe's gained 160 basis points of unit share in major appliances in the second calendar quarter versus last year, and 180 basis points of dollar share in the quarter.

In both cases more than any other retailer.

We continue to strengthen our appliance offering and in June we announced the addition of Samsung to our already strong lineup of well-known brands.

Samsung refrigeration products will be in our stores this fall with additional products slated for 2006.

Our home environment category also delivered solid sales and double digit comps for the quarter.

Of particular note and driven by the heat wave experienced in most of the country in July, we saw great sell-through of air conditioners, driving category performance, and leaving us in great inventory position in this seasonal category.

Outdoor power equipment continued its consistently strong sales performance with strong generator and riding mower sales leading the way to double digit comps for the quarter.

Our product lineup will be enhanced with the addition of John Deere branded products in the spring of 2006.

Giving us confidence the strong performance this category has delivered over the last several quarters will continue.

Finally, cabinets and countertops also put up another strong quarter, delivering double digit comps on top of double digit comps last year.

Continued success in this category has been driven by our emphasis on keeping our kitchen department updated with the latest styles and products, including our exclusive offering of diamond reflection cabinets and Zodiac by Dupont quartz countertops.

Our new installed sales model is also helping drive cabinet and countertop sales.

18 of 21 regions comped positive in the quarter.

Some of our northeastern most regions experienced a cold, wet start to the quarter, followed immediately by extreme heat which resulted in us missing some of the typical spring sales in those areas of the country.

Encouragingly, for the period, we saw over 1/4 of our comp sales driven by an increase in transaction count.

You'll hear more from Larry about what drove that increase.

But our customer focus and our employees' efforts to meet every customer's need is apparent in our growing transaction counts.

Our big three sales initiatives of installed sales, special order sales, and commercial business customers remain central to our comp sales performance.

Installed sales continued its rapid growth, outpacing total company growth as more customers demand installed services, driving leverage in the investment we made in a new execution model for installed sales.

Our special order sales business also outpaced overall company growth as consumers continue to look for unique products for their homes and our efforts to simplify the ordering process are paying dividends.

Finally, sales to commercial business customers continue to grow as we offer great service, abundant selection, and ever increasing convenience to our business customers.

We continue to make progress implementing our rapid response replenishment or R3 initiative.

We've added safety stock in the DCs and we're actively reducing store level safety stock.

We're seeing evidence of the success of R3 and increased frequency of delivery from our regional distribution centers to our stores, resulting in a full day reduction in our replenishment cycle, continued transition from less than truckload to full truckload shipments from our vendors to our DCs and flat comparable store inventory levels while driving 6.5% comp sales in the quarter.

We're confident this initiative will allow us to be better in stock with the right products in the right stores at the right time and drive sales to more satisfied customers.

Our employees focus on customers executed our plan and delivered a solid second quarter.

We continue to have opportunities to manage expenses, but not at the expense of customer service.

Ensuring we continue to capture market share and drive sales over the long term.

During the quarter, Dale Pond announced his retirement.

Dale's leadership of our merchandising and marketing organizations clearly contributed to Lowe's differentiation strategy and our success over the past decade.

I would like to personally thank Dale for his contribution to Lowe's and wish him well in his retirement.

Larry Stone moves from his role as head of operations to lead merchandising and marketing.

He'll utilize his 36 years of Lowe's experience in both merchandising and store operations to ensure that our merchandising and marketing programs are operationally efficient and impactful in stimulating customer demand.

Nick Canter steps into his new role and we'll draw on his 31 years of Lowe's experience to lead our stores as we continue to enhance our ability to meet our customers' needs.

The fact we had the internal bench strength to fill these senior roles is is a testament to the team of experienced leaders at Lowe's.

This experienced leadership and a culture of customer service, combined with solid employment trends, a strong housing and home improvement market and favorable demographic trends give me great confidence in the future for Lowe's.

Now here's Larry Stone to highlight the initiatives driving our merchandising and marketing organization and discuss his thoughts for making a successful area of our business even better.

Larry?

Thanks, Robert.

I'd like to start by saying I am excited about the opportunity to lead our merchandising and marketing organization and I'm confident that with the experience gained during my long tenure with Lowe's, I will bring a new perspective to this area and ensure the continued evolution of our already successful merchandising and marketing strategies.

What I'd like to do this morning is provide a quick assessment of merchandise and marketing and then move on to three areas of focus.

Balanced growth of traffic and average ticket, continued operation margin improvement and our efforts to ensure Lowe's is the customers' first choice store for all their home improvement needs.

These are the topics that are shaping our priorities in merchandising and marketing and ultimately initiatives we are focusing on.

First in merchandising, my goal is to take a strong program and make it better.

Working closely with our merchant teams, our vendors, and store operations we will improve our focus on operation efficient merchandising to make our stores easier to shop, drive profitable sales, and better serve our customers.

You won't see a change in our core merchandising strategies.

We have held the same merchandising philosophy since 1989 when we launched our good, better, best, premium line design.

Today, that successful concept has evolved into a price continuum strategy and we continue to believe it is the right strategy at a great point of differentiation for our company.

And in our marketing, our improving home improvement theme is connecting well with our customers.

We will continue to emphasize innovation, great values, inviting stores, worry-free installation and great customer service to inspire customers, drive traffic, and build the Lowe's brand.

While leading merchandising and marketing it's a new role and new challenge for me.

I have been part of the merchandising and marketing team for a long time.

Not only did I spend four years as a general merchandising manager but I have also led the store planning group which is responsible for store layout and design for the past 12 years.

I believe store operations and merchandising are two sides of the same coin, committed to providing our customers the best shopping experience in home improvement.

In the past year, we focused on enhancing our linkage between the operators and merchants.

We created cross-functional teams with their operators and merchants to ensure open dialogue between the two groups which leads to the operationally efficient merchandising sets we're striving for.

Nick Canter and I certainly plan to ensure that this teamwork continues as we strive to improve our store presentation and service to our customers.

I have spent a lot of time with the various merchandising groups over the past several years, walking stores, reviewing line designs, product presentation, and packaging.

However, in the past 60 days I have done very detailed walks with each of the general merchandising managers and the merchandising vice presidents to review bay by bay our product presentation and our plans for future growth in each product category.

We talked openly about what's working and what needs to change, which brings me to the three areas of focus I mentioned earlier.

First, traffic and average ticket.

We know balance is the key.

Growing one at the expense of another is not a sustainable strategy and merchandise and marketing play a critical role in driving traffic, closing transactions and growing average ticket.

Driving average ticket growth has clearly been a strength for Lowe's.

Since 1994, when we started building only large format stores we have reported a compound annual growth rate in average ticket of over 3%.

Our success in growing average ticket is being driven by product innovation, great line design and the success of our other merchandising strategy.

Our successful specialty sales initiatives of installed sales special order sales and our focus on the commercial business customer are also key drivers of higher average tickets.

And finally, initiatives in store operations designed to prompt sales specialists to sell the complete project have helped contribute to the growth and raise in our average ticket.

In the second quarter our comp store average ticket increased nearly 5% and we're confident that our marketing and merchandising initiatives will continue to support average ticket increases well into the future.

While maintaining our ED/LP pricing strategy and continuing to offer great values at all price points.

So, how are we doing in growing our efforts to grow traffic?

Early last year we began to see a larger share of our comp sales driven by increases in average ticket.

After looking closely at the results we knew radical changes were not needed.

We fine tuned our marketing message to ensure we were effectively highlighting the traffic driving opening price points in our merchandising offering and we implemented slight changes in store presentation and the line design of traffic generating products.

Following the change we saw positive transaction growth return in both the third and fourth quarters.

That momentum is continuing in '05.

As Robert mentioned, this quarter, one-fourth of our comp sales gain was driven by increased transaction count.

Coming closer to the balance we're working to achieve.

In traffic, it's just not getting people into the store.

Traffic means transactions at the register and we know that our in stock levels, signage, displays, neat in product packaging could help us close more sales to our customers.

By working in store operations I received a unique education walking the stores and constantly interacting with customers.

I'm going to bring a focus to improving the job we're already doing in this area to make smart operationally efficient merchandising decisions.

A great looking merchandising display is not always easy for customers to shop or for employees to maintain.

An inspirational look is very important but not at the expense of function.

A customer should be able to easily identify features and benefits, compare product choices, and shop for related purchases nearby.

This space should have enough holding power to satisfy weekend demand and store employees should be able to keep the displaced stock in looking good with minimal effort.

That's by definition the operationally efficient merchandising an approach that drive sales and leverage in our stores.

So if we continue to execute these merchandise and marketing strategies properly ensuring we're providing our customers great value and inspirational product at every price point in the price continuum we know that we will see balanced growth in traffic and average ticket driving our comp sales results.

Moving on to my second area of focus.

Operating margin.

We stated that we expect to grow operating margin by 20 to 30 basis points a year for the foreseeable future.

Some of that will come from the SG&A line and in merchandising we have opportunities to grow gross margin by lowering our product acquisition cost.

We can do this by working strategically with our vendors to take cost of the production and delivery processes and also by seizing the opportunities provided by direct sourcing programs.

Our R3 distribution initiative is a new tool to work with vendors to take costs out of the product acquisition process.

By utilizing our world class distribution infrastructure, we can more efficiently move product from our suppliers to our customers, more accurately flow product from our distribution center to our stores and in some cases reduce costs by minimizing markdowns all leading to opportunities to increase gross margin.

Direct source program -- direct source programs also represent opportunities for gross margin growth.

In 2004, products from these programs accounted for over 3 billion in sales and our goal is to maintain a growth rate for direct source programs at two times our total sales growth.

Through our line review process we are able to identify opportunities to strengthen our merchandise offering with direct source products and certain categories or price points for the customers less brand system.

Private label programs also give us product and design exclusivity and in many cases a better value and superior product, as well as an opportunity to expand margins due to lower product acquisition costs.

Ultimately we are confident that by working with our vendors to reduce our first cost in identifying global sourcing opportunities through our line review process, we will contribute to our corporate goal to drive an operating margin of 20 to 30 basis points per year.

Finally this morning I want to talk about our customers.

Specifically, what Lowe's is doing in merchandising and marketing in addition to what I already talked about to make Lowe's our customer's first choice for all their home improvement needs.

Not surprisingly, we know that our most satisfied customers return more often and we capture a greater share of that customers home improvement spent.

Those satisfied customers are also likely to recommend Lowe's to a friend or family member, driving even more sales.

In the second quarter, two important satisfaction measures, our customer satisfaction with their most recent visit and satisfaction over the past three months continue to track higher versus last year.

Core to achieving higher customer satisfaction and higher sales is delivering on our promise of offering a great selection, great values and every day low prices.

In the second quarter, our various marketing themes including our appliance advantage, outdoor living, summer projects, father's day and great summer values were successfully utilized to drive store traffic and sales.

We're becoming better and more efficient at reaching customers.

Year to date our television advertising has been targeted to the best shows that we know our customers are allocating their time to watch.

Our tab circulars are delivering a higher sales lift than the first half of 2004.

Our direct mail marketing programs are also working, driving a strong ROI and showing improved closed rates for key projects, including kitchens, outside decks, and door and window replacements.

In addition, our customers are signing up to receive Affinity Group marketing materials as we have added over 0.5 million club members so far this year.

These programs will continue to evolve to strengthen our relationship with customers and communicate that Lowe's is working hard to make home improvement in the home environment more enjoyable for friends and family.

Along with great marketing initiatives that highlight Lowe's offering our best impression of home improvement products we're committed to enhancing our stores to remain the best in the industry.

We constantly receive feedback from customers on our store environment.

We are passionate about creating a store environment that is inviting, easy to shop, inspirational and efficient.

And we do our research, in fact, executive management and members of research group meet each month to discuss a continual evolution of our store based on current consumer trends.

So inspiring customers and making them loyal Lowe's shoppers drives merchandising and marketing priorities from the selections of products you'll find in our stores to our customer friendly environment, to our marketing message of improving home improvement.

Our consistent financial results show our success, but our culture of improving home improvement drives us to look for better ways so we can be even better.

In summary, in my new role I feel confident and I can bring a valuable perspective that will forge an ever increasing link between merchandising and operations.

The three areas of focus I have described highlight our merchandising and marketing priorities.

Our balance -- our focus on balanced traffic and average ticket growth is an approach that translates into tangible sales growth.

Continued evaluation of our product offering through line reviews, taking costs out and identifying ways to grow our direct source programs will contribute to our operating margin expansion goals.

And I'm convinced that with continued focus on what matters most, our customers, inviting them into our stores with compelling marketing, ensuring they have a great shopping experience when they get there, Lowe's will continue to deliver solid results.

Now I liked to turn the call over to Bob Hull to provide the details of the financial results.

Bob?

Thanks, Larry.

Good morning, everyone.

As Robert indicated, sales for the second quarter were $11.9 billion, representing a 17.3% increase over last year's second quarter.

For the first half of 2005, sales increased 15.9% to $21.8 billion.

Comp sales were 6.5% for the quarter on top of 5.1% comp in Q2 2004.

Inflation in building materials was offset by deflation in lumber, resulting in a net favorable impact on second quarter comps of approximately 25 basis points.

With regard to product categories, the categories that performed above average in the second quarter include rough plumbing, rough electrical, hardware, outdoor power equipment, appliances, home environment, paint, nursery and cabinet to countertop.

In addition, Millwork, building materials, and home organization performed at approximately the overall corporate average.

Year to date, comp sales were 5.2%.

Comp sales for the first half of 2004 were 7.2%.

Gross margin for the second quarter was 33.8%, which was an improvement of 52 basis points over last year's second quarter.

The improvement was attributable to better margin rates associated with lower inventory acquisition costs and a 5 basis point reduction in inventory shrink.

These items were offset slightly by 3 basis points of negative impact associated with product mix.

Year to date gross margin of 34.1% represents an increase of 91 basis points over fiscal 2004.

SG&A for Q2 was 19.8% of sales and deleveraged 45 basis points driven by bonus, insurance, rent, store remerchandising, and our credit portfolio.

The bonus deleverage is driven by strong sales and earnings performance for the first half of the year and our customer focus program.

As Robert mentioned, our employees are focused on customers.

Our customer focus program rewards store employees for providing great customer service which is driving great sales results.

Insurance expense which includes employee health, workers comp, and general liability deleveraged due to rising health care costs and expansion into higher cost states.

As we continue to penetrate metro markets we are entering into a greater number of ground lease agreements.

This is contributing to higher rent expense as a percentage of sales.

As Larry indicated, we are consistently -- we consistently receive praise from customers on our store environment.

As you know, Lowe's continues to invest in our existing stores.

The expenses associated with our 180 store remerchandising project, ongoing resets, and the catch-up of exterior products that were delayed due to a wet first quarter drove the store remerchandising deleverage.

As we've mentioned previously, we had a great credit year in 2004.

In 2005, we expect to have a good year, but credit will be leveraged as a percent of sales.

Year to date SG&A's 20.6% of sales.

Operating margin defined as gross margin less SG&A and depreciation increased 18 basis points to 12% of sales.

Year to date operating margin of 11.3% represents an increase of 63 basis points over the first half of 2004.

Store opening costs of $25 million deleveraged to last year as a percentage of sales.

In the second quarter, we opened up 26 new and one relocated store.

This compares to 17 new and 3 relocated stores opened in Q2 last year.

Depreciation at 2.1% of sales totaled $247 million and leveraged 11 basis points.

At the end of the second quarter, we owned 82% of our stores versus 80% in the second quarter last year.

Interest expense at $39 million was down to last year's second quarter and leveraged 11 basis points as a percent of sales.

For the quarter, total expenses were 22.4% of sales and deleveraged 27 basis points.

Pretax earnings for the quarter were 11.4% of sales.

The effective tax rate for the quarter was 38.5% versus an effective tax rate of 38.4% for Q2 last year.

Diluted earnings per share of $1.05 increased 20.7% versus last year's $0.87.

For the first six months of fiscal 2005, diluted earnings per share were up 24.5% over 2004.

The year to date growth in gross margin, net income, and earnings per share was aided by the comparison to reduce 2004 figures associated with the adoption of EITF 0216.

To the end of our second quarter, $252 million or approximately 37% of our February 2001 convertible debentures have converted from debt to equity.

This has no impact on diluted shares outstanding as these convertible debentures are already deemed to be diluted.

Weighted average diluted shares outstanding were 803 million for the quarter, computation of diluted shares takes into account the effect of convertible debentures which increased second quarter weighted average shares by 24.2 million.

And computing second quarter diluted earnings per share the after tax add back to net income for interest on convertible debentures was $3.3 million.

Considering the effect of the conversions to date, the third quarter after tax interest add-back is $2.5 million; for the fourth quarter, the interest add back is $2.7 million which is slightly higher due to the extra week in the quarter.

For the third quarter we are projecting diluted shares outstanding of 803 million.

For the year we are also projecting diluted shares outstanding of 803 million.

In the second quarter, we repurchased 2.9 million shares at an average price of $59.39 for a total repurchase amount of $165 million.

For the year we have repurchased 5.2 million shares at an average price of $57.16 for a total repurchase amount of $299 million.

At the end of the second quarter, our debt to total capital was 20.8% compared with 26.2% for the same period last year.

In Q2 average ticket increased 5.6% to $67.40 and total customer count increased slightly more than 11%.

Comp transactions were up 1.7% continuing the positive trend that we have seen from second half of last year.

Now to a few items on the balance sheet.

Our cash and cash equivalents balance at the end of the quarter was $1.1 billion.

Inventory turnover 4.29 a decrease of 24 basis points from Q2, 2004.

Our second quarter inventory balance increased 19.9% or $1.1 billion over the same period last year. $600 million of this increase was in our stores which translates to a 13.1% increase in store inventory compared to our 13.7% increase in square footage.

The remaining inventory growth was in distribution and was driven by our rapid response replenishment or R3 initiative.

New facilities including two new RDCs and the initial trim-a-tree shipment for 2005.

The trim-a-tree order shipped the last week of Q2 this year compared with the first week of Q3 in 2004 which contributed to approximately 1.6% of the year-over-year increase in inventory.

Return on invested capital measured using beginning debt and equity in the trailing four quarters earnings increased 101 -- 191 basis points for the quarter to 18.1%.

As Robert mentioned this represents the first time in our modern history that our ROIC has eclipsed 18%.

Our second quarter performance drove return on assets, determined using beginning total assets in a trailing four quarter earnings to 12.5% representing an increase of 129 basis points.

Year to date cash flow from operations was $2.2 billion, an increase of $500 million for 30% over the first half of 2004.

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

Our third quarter sales increase of approximately 16% incorporates the opening of 34 new stores and a comp assumption of 4 to 6%.

We plan to open 4 stores in August, 5 stores in September and 25 stores in October.

Operating margin for the third quarter is expected to increase approximately 10 basis points to last year.

The sales growth and operating margin I described is expected to generate diluted earnings per share of $0.76 to $0.78 which represents an increase of 19 to 22%.

For 2005 we expect to open 150 stores including three relocations, resulting in an increase in square footage of approximately 13%.

We're estimating a comp sales increase of approximately 5% and a total sales increase of approximately 17% as a reminder our fiscal 2005 is a 53-week year.

For the entire fiscal year, we are anticipating an operating margin increase of 20 to 30 basis points which coupled with our sales increase should drive diluted earnings per share of $3.31 to $3.37.

Regarding current sales trends, I mentioned earlier that our business outlook for the third quarter anticipates 4 to 6% comp.

For the first 16 days of the quarter, our comps are at the lower end of this range.

Before I turn the call over to the operator for questions I'd like to mention that in addition to Robert, Larry, and I, other members of our management team are present for the question and answer session.

Dennis, we are now ready for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Greg Melich with Morgan Stanley.

Thanks.

Two questions Bob.

One on the inventories and then Robert or Larry on some merchandising stuff.

The numbers question is the 600 million that was in store inventory increase, should we then basically be assuming that now that R3 is up and running that the other, say, 4 or 500 million has been basically due to the changeover and that that will start to come out over the next couple of quarters?

Greg, I think it's a combination of things.

I think we have an opportunity to continue to take inventory out of the stores.

As you mentioned, we were adding safety stock to the RDCs.

And would begin to gradually take safety stock out of the stores.

That is still in process.

In addition, we are adding -- we added two new RDCs within the past 12 months and an import lighting facility.

That's contributing to the year-over-year increase in inventory and distribution.

Greg, this is Robert Niblock.

Keep in mind that we're in the rollout process of the R3 initiative.

For example we talk about appliances and running those through the RDCs.

We've talked extensively about that.

W have today appliances in four of our RDCs and we'll continue the roll out plan over the back half of this year and into next year to continue to put those appliances in the remaining RDCs and then as we do that obviously continue to pull down that safety stock in the stores.

So if we were to look at it from a year ago, we were up a little over a billion in inventory. 600 million is due to growth of the store base and now 400 million is due to the R3?

And additional DCs as Bob talked about.

And the fact as Bob talked about trim-a-tree inventory shipped earlier this year versus last year.

But ultimately we should -- we still -- we should expect inventory to be growing less than square footage when?

In the back half of the year.

Okay.

And then the second question, actually adds on to that.

We've had a lot of talk about, and a lot of shifts going on in the appliance business.

How would your take be on further consolidation there, particularly between Whirlpool and Maytag?

Would that be good or bad for you guys?

Well, we talk about the consolidation of Whirlpool and Maytag.

Obviously, we have both brands.

We have both brands in our store, both good partners for Lowe's.

I think we certainly think that Whirlpool can probably bring some things to assist Maytag with their continued investment in the brand.

I mean, it's a great brand that they have out there.

They probably have struggled in the past with a few things and investing in technology and maintaining that brand.

So we think the merger of those two would help continue that investment and certainly both of the brands are in our store today.

We would expect that to continue in the future.

We would be pleased to see the merger.

Okay.

Thanks.

Your next connection comes from the line of Michael Baker with Deutsche Bank.

Two questions if I may.

First, for Bob, I was wondering if you could break down the SG&A impacts.

What were the biggest negatives?

Is it simply just an order of the way you talked about them?

And then what kind of -- do you expect to leverage SG&A at some point this year?

What kind of comp would you need to generate that kind of leverage?

Mike, the items I mentioned in my comments were generally between 5 and 10 basis points of deleverage, they weren't presented in any particular order.

In addition, we've got the things we spoke about in the past, bank card expenses had slightly leveraged in the quarter and the impact of higher fuel prices had an impact upon our costs to deliver products to customers.

So those are a couple of other smaller items that I'd mention.

If you recall, last year our expense growth was masked by the implementation of EITF 0216, in fact, when you exclude the impact of 0216 we actually leveraged expenses 51 basis points last year.

So we expect some deleverage of expenses in the back half of the year, but that's on top of a pretty good comparison last year.

Okay.

Fair enough.

And then, one more question.

This is for Larry Stone.

You said that when you walked the stores you came up with things that you think need to change.

What do you think are the biggest areas, and I think you've talked about your focus areas but are there one or two things that you really think you guys can show some improvement on?

Greg -- or excuse me, Michael, I think the biggest thing is we walk our stores and we look at the way that we present product and the signage and the collateral material that goes with it.

I think we can take that and make it much more impactful to our customers and make it much easier for the customer to shop the store.

So if I talk about making it operationally efficient merchandising.

I'm talking about ways that the customer can come in and look at a display and pretty much walk through the line structure we got in that display.

By doing that, we cannot take help off the floor but we can provide service to people that need it on projects and the customer just wants to come in and look at things it would be a much more inviting way for them to shop our stores.

Cool.

Makes sense.

Thanks.

Appreciate it.

Your next question comes from the line of Danielle Fox with Merrill lynch.

Thanks.

Good morning.

You mentioned that you were on the low end of your comp range.

Could you just remind us -- well, sort of let us know how to think about lapping last year's hurricane?

Maybe any benefits, any costs?

And whether you feel like you're through some of the pent up demand that was related to weather in the first quarter?

Danielle, this is Bob Hull.

I'll take the question.

Last year our comps in the third quarter were 5.2%.

They were largely balanced across the three months of the quarter.

We did see an impact early August last year by the storms in Florida.

As you recall in our Q3 call last year, we talked about the impact the storms had on margin, the pressure that put on margin.

But from a sales standpoint our comps were relatively balanced across all three months of the quarter last year.

This is Robert Niblock.

If you look a year ago, hurricane Charley was hitting this week a year ago.

So if you think about last week and over the weekend particularly in the southern markets off Florida there would have been a lot of preparatory sales getting ready for that hurricane.

So when you have a couple days of preparatory sales out there.

When you only got 16 days in the period.

It doesn't take much to move the numbers around.

Certainly I think we were in the same position last quarter.

We were with the lower end of the range going into the quarter and we'd ended up delivering a 6.5 comp.

We're still very optimistic about the quarter.

Bob said we are at the lower end.

But we still feel good about what we'll be able to deliver over the balance of the quarter.

One quick follow-up question.

What is the EPS impact from the 53rd week?

Danielle, we think the impact is approximately $0.2 per share.

Thank you very much.

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

Thanks a lot.

I'd like to ask two questions.

First of all, just following up on the inventory point, I hear you on the fact that inventory is in great shape in the stores and trim-a-tree came in a little bit early.

I guess given that you had expected to -- for turns to track flat or to leverage a little bit this quarter, other than trim-a-tree, what was different from plan, given that sales obviously deviated a bit to the upside?

We talked about the trim-a-tree.

We talked about -- you got to realize too that we're making a lot of changes here.

If we see opportunity, we're going to continue to drive sales.

We talked about the share we picked up in the major appliance area.

We look at the prebuild of Samsung appliances coming in.

That's something obviously which we are already in the receiving mode for Samsung.

That's something we didn't announce, obviously until, I think, the June time frame.

We look at also the prebuild for putting appliances in other of the RDCs, we'll continue that rollout over the balance of the year.

And in certain situations as we go in and look, we look at our presentation levels in the store once we've made our changes in our inventory levels and we come back and decide whether or not we want to have more inventory in there than -- to have a different presentation level than what we could actually get away with from a sales standpoint.

So we've always said that -- we thought that we could leverage inventory in the second quarter, we didn't say we would improve inventory turns.

Because as you know inventory turns is four rolling quarters and we have the inventory build from the end of last year.

We came up a little bit short of that.

The biggest single contributor to that was the trim-a-tree coming in early.

We're still optimistic it will be able to leverage inventory in the back half of the year and have it grow at a lesser rate than our sales growth.

Got you.

That's great.

And the second question, if I could, you showed, I think, the biggest gross margin pop that we've seen in some time as we began to cycle the user compares for a year ago.

If you could give us a sense whether, given the third quarters gross margin compared you'd expect that to be a significant source of leverage.

And Larry, as you step into the merchant seat, can you give us a sense for what you think about the secular gross margin opportunity, whether you think you can resume long-term growth on that line item?

Matt, this is Bob.

In our third quarter guidance, we certainly are aware of the EV Q3 comparison again, without impact of EITF we think we'll have good margin growth in the third quarter.

We think we'll have some SG&A deleverage in the third quarter.

The other thing to mention, is we had some depreciation leverage in Q2.

We think we'll have some depreciation deleverage in Q3.

So those are the three moving pieces as relates to the operating margin guidance for Q3 10 basis point expansion that I mentioned in my comments.

Got you.

Matt, it's Larry Stone.

Things we're going to continue to work on in the merchandising side, I've talked about our direct source programs.

Certainly we are evaluating different products to see where there's opportunity there.

I also mentioned working with our vendors to take cost out of the pipeline.

I think that's one thing we can really do to try to pick up some gross margin as we go forward.

So there's a lot of calls to a lot of things we've factored in and I think we can do a much better job in improving that.

As far as trying to quantify that today, there's no way that we're going to attempt to do that.

Certainly, we see room for expansion as we go forward.

Got you.

Thank you so much.

Your next question is from the line of Dana Telsey with Bear Stearns.

Good morning everyone.

On John Deere, Samsung, how is the rollout of that going?

What's the timing of it?

If I look at your operating margin up around 63 basis points year to date, what expenses or what's changing in the back half of the year to bring it for the year to being up to around 20 to 30 basis points?

How are you looking at it?

Lastly, any impact on energy prices in any of those expenses assumptions?

Thank you.

Hi, Dana, this is Larry Stone.

I'll take the first part of the question.

On John Deere we plan to roll that out for our spring selling season in '06.

We're working with the Deere folks now, and we're working on displays.

And on purchase material and so forth.

That will be ready to roll out in spring of '06 with that complete line of tractors we'll be selling.

Samsung products are coming across now.

We'll have Samsung refrigeration in our stores later in the third quarter this year.

Hopefully, more products by early '06 and probably some laundry products.

Dana, I'll take the second part of that.

From a gross margin standpoint, if you recall, we implemented or adopted EITF 0216 in Q1, '04.

So we had a relatively comparison in Q1, '05 versus Q1, '04.

That drove basically the difference in the 63 basis point expansion in the first half of the year relative to what we expect to report in the back half of the year.

Just on the energy prices?

From an energy standpoint we think that will continue to put pressure on our fuel costs to deliver products to customers.

Interestingly, we are seeing the impact in inbound freight to our distribution centers but one of the key things to the R3 strategy is we have greater consolidation of inbound freight.

And in the second quarter, the savings from that actually slightly offset the increase in fuel rate increase in the second quarter.

So, that's one of the benefits of R3 is the freight consolidation in Q2 help more than offset the increase in fuel costs there.

Thank you.

Operator, I think we have time for one more question.

Today's final question will come from the line of Eric Bosshard with Midwest Research.

Good morning.

Two things I'd love some better insight on.

First of all, in terms of the promotional environment can you just talk a little bit about what you see going on promotionally on both the category and a no-interest financing store-wide basis.

Secondly a little bit more color into leveraging SG&A and the factors that you need either on the expense line or the sales line to be able to create some SG&A leverage rather than the deleverage we're dealing with now?

Eric, this is Larry Stone.

I'll start off with the promotional aspect.

Quite Frankly, we're not seeing anything different in the last few months.

Occasionally we will see a 12 months no pay ad or somebody come out with 10 off or something along those lines.

Certainly no more than we have experienced in the past and certainly we think the third quarter and fourth quarter, we -- we don't think it's going to get any more promotional than it has been in the past couple years.

So no major changes there.

As far as 12 months no pay, we're like other retailers.

We run it occasionally, but you see a lot of promotions out there for 18 months and 24 months no pay.

But then when you read the small print, certainly it's not as good a value for our customers.

So we've been very consistent with our message.

If we run 12 months no pay, it's 12 months with no payments.

So our customers are getting a true value and we promote that.

We have no plans to get any more promotional going into the third and fourth quarter this year.

Eric, this is Bob.

I'll take the second part of your question.

I can tag on to tend of Larry's response.

We actually leveraged some -- we leveraged some expenses in Q2.

Advertising was one of them and store payroll was another.

We are working hard to leverage expenses.

But as we've said continuously, we're going to invest in our business.

That's from a store we're merchandising.

That's from a customer service standpoint.

We have a lot of initiatives that allow us to free up hours, for example.

We're going to reinvest those back into customers facing time.

So you won't see any immediate SG&A leverage.

But, hopefully, we'll see an increase in our sales per hour which would drive future leverage.

We are working on a number of initiatives to continue to increase productivity, some of it will come later than sooner.

Thank you.

Thank you.

As always, thanks for your continued interest in Lowe's.

We look forward to speaking with you again when we report our third quarter results in November.

Thanks and have a great day.

This concludes today's Lowe's Companies second quarter earnings conference call.

You may now disconnect.