勞氏公司 (LOW) 2005 Q3 法說會逐字稿

Good morning and welcome to Lowe's companies third quarter earnings conference call.

This call is being recorded.

Statements made by management curing this call may include forward-looking statements, as such are provided for 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 out forward-looking statements and those risks 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. Mike Mabry, Executive Vice President, Logistics and Distribution; 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 thanks for your interest in Lowe's.

Today I'll review our third quarter results and highlight the drivers of our performance.

Following my comments, Mike Mabry will provide an update on our logistics and distribution initiatives.

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

We achieved strong results for the quarter driven by consumers continuing to invest in their homes, great execution, and excellent customer service.

Total sales of $10.6 billion increased 16.9% over last year.

We experienced an increasing trend in comp sales during the quarter leading to a total comp sales increase of 6.2% on top of last year's third quarter comp of 5.2%.

And we exceeded our third quarter guidance of 4 to 6% comps.

This quarter was also marked by an unprecedented hurricane season.

Hurricanes Katrina, Rita, and Wilma were disruptive to thousands of lives, impacting many of our customers and employees.

We know our success is driven by the relationships we have with customers and the communities where we do business.

So when disaster strikes, Lowe's responds.

Our emergency command center was activated before the storms hit to prepare our stores to meet increased product demand in the days leading up to and following the storms.

As a result, customers in need found Lowe's stores stocked with emergency products.

Following hurricane Katrina, 35 stores were temporarily closed or operated under reduced hours due to damage or evacuation orders.

But most stores reopened within 24 hours to help local residents repair their homes and rebuild their communities.

Only one location remains closed, our store in central New Orleans which will reopen during the first week of December.

After hurricane Rita, 55 stores were closed or had reduced hours, and during hurricane Wilma, 17 stores were closed or had reduced hours.

Again, after the storms passed, the majority of impacted stores were open within hours to serve customers.

In the aftermath of Katrina, as we've done in the past, Lowe's stores around the country became official donation sites for the American Red Cross disaster relief fund.

And Lowe's pledged $2 million to match customer donations.

Community support was remarkable, and together with our customers, we've raised more than $8.4 million for the relief effort.

In addition, Lowe's and our employees gave generously to the Lowe's employee relief fund, raising $1.6 million to help more than 1300 Lowe's employees and their families get back on their feet after suffering the devastation caused by the storms.

We're extremely grateful to our employees for the extra effort they've put into helping customers, communities, and fellow associates during this hurricane season.

In many cases, they went above and beyond expectations, traveling many miles to assist impacted stores.

Our employees worked long hours to ensure Lowe's stores were open to serve their communities and we attribute our success to their efforts.

Despite the distractions and operational challenges caused by the storms our profitable growth continued.

During the quarter we opened 33 new stores to strengthen our national footprint and our presence in the nation's top metro markets.

Over 60% of our expansion in the quarter was in the nation's top 100 metro markets, and our future expansion plans will continue to focus on these larger markets.

In smaller markets, our 94k prototype stores continued to post strong sales gains.

In the third quarter comp sales for 94k stores exceeded the Company average and we continue to be pleased with the returns of this prototype.

Driven by strong sales and excellent customer service, earnings per share up $0.81 increased 25% over 2004, exceeding our guidance of $0.76 to $0.78.

We remain confident in our big three sales initiative of installed sales, special order sales, and commercial business customer sales.

These well-defined and ever improving strategies continue to drive more volume through our stores and drive comp sales performance well above the Company average.

Our new installed sales model is efficiently serving customers in a market estimated at $150 billion in labor alone.

Successfully executing installed sales is a critical step in capitalizing on the growing do-it-for-me segment and strengthening our customer relationships.

Our special order sales business continues to excel as our offering of unique SOS products continues to inspire customers.

Enhancements to in-store ordering systems and investments in distribution and warehousing allow us to improve product visibility, streamline the ordering process, and reduce the lead time for customer orders.

Finally, our CBC business representing approximately 25% of total sales, posted another quarter of strong double-digit comp growth.

Strengthening relationships supported by targeted marketing and market-specific merchandising assortments continues to drive this segment of our business.

19 of 21 regions delivered positive comps in the quarter.

We had particular strength in the hurricane affected regions of Florida and the Gulf Coast, but our western regions also continued to perform very well.

As a reminder, our Florida region is cycling the strong sales environment created by last year's hurricanes.

Despite that difficult comparison, those stores delivered a positive comp for the quarter as consumers continued to repair and restore their homes.

Our expectation is that a similar long tail of increased demand will be created by this year's hurricanes in the Gulf.

All of our 20 product categories delivered positive comp sales for the quarter, and we've continued to gain market share in key categories previously dominated by other channels, including appliances, outdoor power equipment, and rough plumbing.

In appliances, double-digit comps were again driven by demand for innovative design and high-efficiency products, demonstrating that consumers are still shopping up the continuum in this category.

Independent measures of market share show Lowe's gained 190 basis points of unit share in major appliances in the third calendar quarter versus last year.

Our dominant appliance offering, enhanced by the addition of Samsung during the third quarter, has allowed us to continue to capture appliance unit share faster than any other retailer.

Outdoor power equipment has been another consistently strong category, delivering double-digit comps in the third quarter on top of double-digit comps last year.

Leading this category was demand for riding mowers, where our strong performance was driven by product selection and great in-stock levels that allow us to capitalize on demand through the extended summer selling season.

Rough plumbing also posted double-digit comps.

In addition to our efforts to provide job-lot quantities in what is traditionally a commercial category, sales were aided by strong consumer desire to conserve energy with products such as programmable thermostats and pipe insulation.

Our financial results demonstrate that the consumer is still shopping for home improvement projects in addition to ongoing home maintenance and repairs.

Along with you, we watch economic indicators closely.

Rising gasoline and home heating prices do impact discretionary income and pressure consumer confidence.

While every consumer is impacted on the margin, we continue to believe home owners who generally have higher median income are less impacted by elevated fuel prices.

In addition, Lowe's is in a unique position to help customers better manage home heating costs through energy conservation education and product sales that dramatically reduce home heating costs.

Lowe's has established itself as a valuable resource for consumers to learn about cost saving energy solutions.

Our October in-store how-to energy clinics attracted customers to our stores, which contributed to the significant rise in energy efficient product sales we experienced across multiple product categories.

For example, we saw solid double-digit comps in products like insulation and weather stripping.

Comp sales of portable heaters exceeded 100%, and comp sales of wood stoves and pellet stoves climbed nearly 200%.

We're continuing to monitor economic data in the home improvement marketplace, and the most significant indicators for our industry point to continued strength in consumer demand.

The favorable employment landscape, which is a strong indicator of home improvement sales, is providing stability for American consumers.

Real household earnings continue to grow, boosted by ongoing employment gains.

Data from the department of commerce shows that real total wage and salary levels in the U.S. have grown over 4% year to date.

Also, housing turnover remains at record levels, driven by strength in both new and existing home sales.

And importantly, record U.S. home ownership levels provide an established customer base for home maintenance and repair projects.

The vast majority of our customers are homeowners, and they are simply not willing to let what is often their most valuable asset deteriorate.

Given three hurricanes, high fuel prices, and weakening consumer sentiment, there's been a lot of speculation on the impact to the home improvement consumer.

But our stores remain focused on our customers and delivered a great quarter.

The positive landscape for employment, household income, housing turnover, and homeownership provides favorable drivers for our business.

Our confidence also stems from our proven ability to execute and constantly improve our internal strategies, from great marketing and merchandising an inviting store environment and superior customer service to strategic investments in technology and distribution and improved sales and profitability, we remain optimistic about the future.

One of those investments is our R3 minor active, which has significantly changed our approach to logistics and distribution.

After a nearly two-year implementation phase, R3 is helping us meet store level demand with improved accuracy and efficiency as well as creating opportunity for significant inventory leverage.

To tell you more about R3, I'm going to hand the call over to Mike Mabry, Executive Vice President of Logistics and Distribution.

Mike.

Thank you, Robert.

Good morning.

I'd like to take a few minutes this morning to provide an overview of rapid response replenishment, or R3, then update you with the progress we're making and the results generated by implementing this strategy.

I know many of you who attended our analyst and investor conference this past September heard me discuss R3 objectives.

They remain the same.

R3 is the strategy that will improve customer service, optimize supply chain profitability, and improve inventory management.

As Robert mentioned, we began the implementation of R3 approximately two years ago.

With the intention of leveraging our industry leading distribution and logistics infrastructure.

Our current distribution network consists of 11 regional distribution centers, 13 flat-bed distribution centers to handle building products, three millwork facilities, two import facilities, and one special order sales Internet facility.

We are in the process of expanding three of our smaller regional facilities to accommodate the implementation of R3, and we recently announced the opening of two new facilities in 2007.

One in Oregon and one in Illinois.

The majority of R3 was focused around the RDCs.

Lowe's has always believed in centralized distribution.

In 1994 we opened our first modern distribution center in Indiana.

Since that time we have continued to evolve the network, and we invested more than $1 billion in our distribution infrastructure, and it is a competitive advantage.

This network, combined with shortening cycle time, is enabling us to aggregate inventory upstream and provide better in-stock with less overall inventory.

Remember that our primary objective is to improve customer service, and we are confident we are accomplishing this by having the right products in the right stores at the right time, and by creating efficiencies at the store level freeing up employees to help customers.

Because we all know that in the home improvement industry, our customers come into the stores expecting help with their projects.

Let's first look at improving service.

Our goal here is to improve in-stock and to reduce inventory handling in the stores so that our employees can focus on customer service.

We believe it should take approximately three and a half days for orders from our stores to a DC to be on the shelf.

When we started, we were averaging seven days with four days of variability.

We needed to shorten the lead time to fill demand from the store.

We identified that the biggest opportunity was the time spent waiting to fill a trailer at the DC.

So we're moving more products through our network instead of direct to the stores.

This is enabling us to fill trailers faster.

With the right infrastructure and processes, he have reduced lead time by a full day across the network.

Let's look at the new volume we channel through our DCs.

We now have appliances in eight RDCs and riding mowers flowing through all of the RDCs.

We currently have one paint vendor in the facility and are adding paint top seven more RDCs by early '06.

We've moved additional fashion plumbing items through the entire network and added various flooring items such as ceramic and porcelain tile and laminate this year.

We also moved selected lawn and garden product through the RDCs and we'll continue to add other items throughout 2006.

When we began our R3 initiative about 50% of our product was moving through the network.

Today, with these changes, we are running approximately 65% of our product through the network.

We expect to be at 70% by year end and are well on our way to our goal of 75%.

The increased frequency of store deliveries translates to more good faith receiving which eliminates manually counting freight and reduces inventory handling and down stocking at stores.

This efficient process allows us to better serve our customers.

Our success in having the right inventory at the right store is key to satisfying customers and growing sales.

For instance, during the third quarter we had robust sales in riding mowers because we were able to take advantage of demand by channelling the product to the right markets at the right time.

In the past, with a direct delivery system we had large investments of inventory in our stores based on anticipated demand.

In some instances, stores had too much inventory.

In others, not enough.

Our centralized approach enabled us to flow mowers to the right stores.

That drove higher seasonal sell-through with fewer markdowns.

With this infrastructure, we are well positioned to continue to drive the strong comps.

Turning to in-stock levels.

As a result of increased DC volume, we are averaging about five deliveries per week from our DCs to stores, up from four per week a year ago.

This translates to better in-stock, more satisfied customers, and more sales.

Since we implemented R3, we have experienced sequential improvement in our in-stock levels.

In some instances, we have found we need to carry more inventory in the stores, not less.

That was the case with rough plumbing and rough electrical.

These products are in high demand from our commercial customers and are low cost.

By cross-stocking these items and adding inventory at store level, we were able to minimize handling costs and satisfy customer demand, which led to strong comps in both these categories this quarter.

Moving on to the second objective of optimizing supply chain costs.

We conducted a thorough review of all components of our supply chain, including handling, transportation, and inventory carrying costs.

First, handling.

A lot of our SKU base is in expenses.

On these items handling makes up a significant portion of the product's landed cost.

There is cost associated with every time a product is touched.

Our analysis found that in some cases we were shipping product in too small a pack.

For example, inexpensive picture hangers.

We were sending them to the stores in one's and two's.

We were not managing the right thing, handling costs.

After reviewing the supply chain cost we knew that in order to profitably sell picture hangers, we had to minimize handling costs.

Therefore, we increased the pack size and placed more inventory in our stores, and that's just one example.

I cited earlier where we made channelling decisions to reduce handling in rough electrical and rough plumbing which also resulted in increased sales and profitability.

Turning to the second component, transportation costs.

We reviewed the capacity of the trailers coming from our vendors to the RDCs.

We were about half as efficient on the inbound side as on the outbound side.

Our analysis highlighted opportunities to improve transportation costs by receiving more full truckloads.

By improving inbound transportation cube and weight we have experienced a 34% decline in our rate of total network LTL shipments, and now we are receiving more full truckloads which costs between half and two-thirds left on a pure cube basis.

We continue to work with our vendors to ensure we're managing the weight and cube on each truck.

Although we've increased the frequency of deliveries to our stores from our RDCs, the number of direct shipments to our stores has decreased approximately 30% in both full trucks and LTL tonnage year to date, which more than offsets the cost of incremental DC deliveries.

The third cost component in the supply chain is inventory carrying costs.

I've highlighted instances where we were too focused on inventory costs, but in some cases we had inventory in too large a pack.

We identified situations where master packs over $100 were shipping in packages of two or three, when, in many cases, one was sufficient.

We began channelling these products through our break pack modules or worked with vendors to reduce these pack sizes to one package unit.

When we're delivering a truck a day, there's no reason to over ship.

For example, in fashion plumbing and power tools where inventory costs are the major lever, we have reduced the pack size to help better manage inventory carrying costs for these expensive items.

We've highlighted a lot of new volume moving through our distribution network and many new processes.

To help us better manage these facilities, we are implementing E2, or execution excellence.

This is an engineered standards initiative that's designed to increase throughput and lower operating costs.

E2 has been partially rolled out in two distribution centers, and we are seeing productivity improvement of 30% or more in functional areas where it's been implemented.

Because of the outstanding results we are seeing from E2, we are accelerating the rollout and expect to complete this initiative in all facilities by the end of 2006.

Overall, these distribution -- these efficiencies, driven by R3, increase gross margin by approximately 10 basis points for the quarter.

Higher prices of fuel negatively impacted gross margin by 7basis points.

As you can see, we have an ongoing process to evaluate and reduce handling, transportation, and inventory carrying costs across our supply chain.

Turning to the third objective, inventory management.

We have taken a measured approach when implementing R3.

Remember that our primary focus is on customer service and growing sales.

We are passionate about creating a store environment that's inviting and efficient.

One way in which to create this inviting environment is to set our stores with credible display quantities, or minimum stock levels, and add safety stock based on the rate of sales.

That way, a $50 million store will have the same fill as a $30 million store, which gives customers the confidence that we have adequate inventory to support their needs.

For example, in some stores, our nail display wasn't as robust as we would like when we replenished to rate of sales, we made small, easy to implement changes to our display such as moving top stock down and making the face-out heavier.

These minor changes resulted in an improved merchandising display.

We made a conscious decision not to over manage inventory and risk potential of having poor display quantities or out of stocks, particularly when we are experiencing strong sales in most categories and regions.

So by continuing to execute a measured approach, we are confident that inventory leverage will continue to improve.

This quarter we leveraged inventory 409 basis points while growing sales 16.9%.

Several of you have asked me what we are doing to support our import growth.

In March 2006, we will open a transload on each coast to help better manage inventory flows.

We expect to see three things from these transloads.

Better in-stock, fewer markdowns, and improved transportation costs.

This will allow us to order at aggregated levels and delay allocation of that product until it reaches the port.

Today we place orders at the RDC level.

This will result in a steadier flow of goods that will be shipped exactly where we are seeing sales.

So, what's next?

Continued execution of R3 and E2.

In the fourth quarter we expect to significantly leverage inventory by at least 1,000 basis points.

Remember, we are aided by a 53rd week of sales.

We expect to reach our stated goal to move 75% of inventory through Lowe's distribution network in 2006.

In summary, we are continuing to make progress, with the majority of implementation phase behind us we are positioned to achieve our objective of improving customer service, optimizing supply chain profitability, and leveraging inventory.

R3 as a strategy, has Lowe's well positioned to support strong growth into the foreseeable future.

Now I'd like to turn the call over to Bob Hull to provide the details about our financial results.

Bob.

Thanks, Mike.

And good morning, everyone.

As Robert indicated, sales for the third quarter were $10.6 billion, representing a 16.9% increase over last year's third quarter.

For the first nine months of 2005, sales increased 16.2% to $32.4 billion.

Comp sales were 6.2% for the quarter.

Sales were positively impacted by the three hurricanes that hit the Gulf Coast and Florida in the quarter, which aided comps by approximately 100 basis points.

Comp sales were 5.2% in Q3, 2004.

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

With regard to product categories, the categories that performed above average in the third quarter include millwork, rough plumbing, rough electrical, outdoor power equipment, appliances, paint, fashion plumbing, flooring, and cabinet countertops.

In addition, building materials, home environment, and lawn and landscape products performed at approximately the overall corporate average.

Lawn and landscape products is a new category that we recently segregated from nursery.

Lawn and landscape products includes garden chemicals, fertilizer, mulch, and patio block.

The new nursery category now only includes live goods such as trees, shrubs, and plants.

Year to date comp sales were 5.5%.

Comp sales for the first nine months of 2004 were 6.6%.

Gross margin for the third quarter was 33.9%, which was an improvement of 28 basis points over last year's third quarter.

The improvement was attributed to better margin rates associated with lower inventory acquisition costs including the impact from additional imported goods, the positive impact from R3 that Mike noted, and a 5 basis-point reduction in inventory shrink.

These items were offset slightly by approximately 10 basis points of negative product mix impact from the hurricanes.

Year to date gross margin of 34.1% represents an increase of 71 basis points over fiscal 2004.

SG&A for Q3 was 20.9% to sales and leveraged 15 basis points driven by store services, advertising, and a number of miscellaneous expense lines such as cleaning and maintenance, supplies, and postage.

Last year we described a process to gain greater visibility to our in-store vendor service expense.

This greater visibility has allowed us to right-size the service level in our stores and -- to leverage in the store services line for the quarter.

We spent more advertising expense dollars in the third quarter of this year versus last year, but with enhanced messaging and refined marketing mix our programs are more productive, and we were able to leverage advertising expense as a percentage of sales.

The leverage I just described was slightly offset by deleverage in rent, credit, store remerchandising, which represents our ongoing investment in existing stores, and higher home delivery cost associated with increased fuel prices.

Year to date SG&A is 20.5% of sales.

Operating margin, defined as gross margin less SG&A and depreciation, increased 56 basis points to 10.6% of sales.

Year to date operating margin of 11.1% represents an increase of 60 basis points over the first nine months of 2004.

Store opening costs of $35 million leveraged to last year as a percentage of sales.

In the third quarter we opened 33 stores this compares to 35 stores opened in Q3 last year.

Depreciation at 2.4% of sales totaled $257 million and leveraged 13 basis points.

At the end of the third quarter we owned 83% of our stores versus 80% at the end of the third quarter last year.

Interest expense at $36 million was down to last year's third quarter and leveraged 10 basis points as a percent of sales.

For the quarter, total expenses were 24% of sales and leveraged 40 basis points.

Pretax earnings for the quarter were 10% of sales.

The effective tax rate for the quarter was 38.5 percent versus an effective tax rate of 38.6% for Q3 last year.

Diluted earnings per share of 0.81 increased 24.6% versus last year's $0.65.

For the first nine 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 02-16.

Through the end our third quarter, $302 million, or approximately 44% of our February 2001 convertible debentures had converted from debt to equity.

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

In addition, during the third quarter, our October 2001 senior convertible notes met the closing stock price criteria for conversion at the option of each holder.

These notes are potentially convertible into 10 million shares which are already included in a calculation of diluted earnings per share.

Also, in the third quarter, we repurchased 3 million shares at an average price of $64.38 for a total repurchase amount of $196 million.

For the year, we have repurchased 8.3 million shares at an average price of $59.81 for a total repurchase amount of $495 million.

Weighted average diluted shares outstanding were 804 million for the quarter.

The comparison of diluted shares takes into account -- excuse me, the computation of diluted shares takes into account the effect of convertible debentures which increased third quarter weighted average shares by 20 million.

In computing third quarter diluted earnings per share the after-tax add-back to net income for interest on convertible debentures was $2 million.

Considering the effect of conversions to date, the fourth quarter after-tax interest add-back is estimated to be $2 million.

For the fourth quarter, we are projecting diluted shares outstanding of 804 million.

For the year, we are also projecting diluted shares outstanding of 804 million.

In Q3, average ticket increased 8% to $68.81, and total customer count increased 8.2%.

Comp transactions were down 1% for the quarter, with negative comp transactions in August and September due to hurricane activity and the possible impact of the resulting spike in gas prices.

Comp transactions were positive in October and that trend continues in November.

Now, to a few items in the balance sheet.

Our cash and cash equivalents balance at the end of the quarter $1.6 billion.

Inventory turnover was 4.26, a decrease of 18 basis points from Q3, 2004.

Our third quarter inventory balance increased 12.8% compared with our 16.9% increase in sales.

Our Q3 inventory balance was $749 million higher than the same period last year driven by the addition of 141 new stores and the opening of new distribution facilities since Q3, 2004, offset by a decline in comp store inventory.

At the end of the third quarter, comp store inventory was down 2.8% versus Q3, 2004 as we continued to remove store-level safety stock as part of the R3 initiative.

In the third quarter, we issued $1 billion in senior unsecured notes split evenly between a 10-year issue at 5% interest rate and a 30-year issue at a 5.5% interest rate.

The proceeds of the notes will be used to repay outstanding indebtedness for general corporate purposes and to finance repurchases of our common stock.

Also during the quarter, Fitch ratings raised our senior debt rating from A to A+ and our commercial paper rating from F-1 to F-1+.

At the end of the third quarter our debt to total capital was 22%, compared with 25% for the same period last year.

Return on invested capital measured using beginning debt and equity and a trailing four quarters earnings, increased 222 basis points for the quarter to 18.3%.

Our third quarter performance drove return on assets, determined using beginning total assets and a trailing four quarters earnings to 12.7%, representing an increase of 141 basis points.

Year to date, cash flow from operations was $3.4 billion, an increase of $1.2 billion or 58% over the first nine months of 2004.

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

A fourth quarter sales increase of approximately 22% incorporates the opening of 63 new stores and the reopening of our central New Orleans store.

Combined with a comp assumption of 4 to 6%.

We plan to open 7 stores in November, 20 stores in December, and 36 stores in January.

As a reminder, our fourth quarter includes 14 weeks.

We expect the extra week to aid sales growth in the quarter by approximately 7%.

Operating margin for the fourth quarter is expected to decrease approximately 20 basis points to last year due to the 53rd week, store remerchandising costs associated with our ongoing investment in stores, a lower return on our credit portfolio relative to Q4, 2004, and a difficult comparison to a strong fourth quarter of last year where operating margin increased 68 basis points.

The sales growth and operating margin I described is expected to generate diluted earnings per share of $0.77 to $0.80 which represents an increase of 20 to 25%.

We expect the extra week in the quarter to aid earnings per share by approximately $0.03.

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 5 to 6%, and a total sales increase of 17 to 18%.

For the entire fiscal year, we are anticipating an operating margin increase of approximately 40 basis points which, coupled with our sales increase, should drive diluted earnings per share of $3.37 to $3.40.

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

For the first 16 days of the quarter, our comps are exceeding the top 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, Mike, and I, Larry, Nick, and other members of our management team are present for the question-and-answer session.

We're now ready for questions.

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

Thanks, guys.

One question on the ticket, that 8% growth and when the comp transactions were down.

Was the ticket being driven by more items in the basket, or the price of the products than the items in the basket?

Greg this is Bob.

It is more to do with the nature of the products themselves, not necessarily from additional items or for higher prices.

It was more the mix of the basket primarily related to some of the hurricane-related items we saw in the Gulf Coast.

The second question, on the inventory, I'm sure -- I don't know who wants to touch this either Larry or Mike, where -- if we get to the 75% of the self-distributing, now that you have more visibility on how it's actually functioning in the stores should we -- is there a number or dollar amount of inventory we should expect to come out of the whole company once we get to that 75%, against all else equal?

This is Bob.

I'll take the first pass at that and let Mike or Larry add any color that they choose to.

We've stated that our goal is to grow inventory at about 75% the rate of sales growth going forward.

We believe that we can do that in 2006 and beyond, and as we communicated at our analyst meeting in September we believe that will translate to about 20 basis points of turn improvement beginning in 2006.

Greg, this is Robert Niblock.

We haven't gone out and targeted the specific dollar amount of inventory we're pulling out of network.

We're continuing to layer in the R3 strategies.

We're continuing to look at any adjustments we need to make to that channelling the additional products through the RDCs.

We're looking at the E2 execution excellence program that Mike talked about, and also -- we're also maintaining the flexibility as we see opportunity in the competitive environment to gain share like some of the product categories that I've talked about, to be aggressive and go after that with additional inventory if needed.

So we think we gave the numbers on the fourth quarter on the leverage, we had good leverage in the third quarter, we expect to have good leverage in the fourth quarter, and we expect by 2006 for our inventory turns on a rolling four-quarter basis to start to improve once we've cycled through the large buildup in inventory that we in the fourth quarter last year getting prepared for R-3.

Congrats to everyone.

A very tumultuous quarter.

You got through it great.

Your next question is from the line of Deborah Weinswig with Citigroup.

Thank you.

Congratulations on a great quarter.

In terms of, I think when you reported last quarter you talked about the potential to deleverage expenses in the third quarter, can you talk about the kind of key differentials that were able -- that really allowed you to leverage in the quarter?

Sure.

First, we did exceed our sales guidance, so that certainly helps us leverage expenses.

We had talked about a few other factors including the credit portfolio, with the change in bankruptcy law that was effective October 17.

We had anticipated a rush to bankruptcy ahead of that.

We did, in fact, see that very late in the process.

We will realize some of that impact in the fourth quarter, but the expected impact in the third quarter was not as much as we had anticipated.

In addition, I talked in my comments about the store services line.

We had plans in place to continue to right-size those services.

We're able to make the progress, a little bit more progress than we anticipated 90 days ago.

And then just adding onto that in terms of the thing you had in the fourth quarter with respect to advertising expense dollars should we expect to see similar levels in fourth quarter or what's the plan there?

We can expect to see some additional leverage from advertising in the fourth quarter.

Again, we'll spend more advertising dollars, but as a percent of sales we'll recognize some leverage.

Great.

Thanks again.

Your next question is from the line of Dan Wewer with CIBC.

There's always a lot of volatility in your bonus accruals.

Bob, I was wondering if could you talk about what that accrual has been looking like year to date, and what you're expecting in the fourth quarter, then also was wondering if you could elaborate on what's generating the more efficient advertising program.

Sure, Dan.

The year to date, our bonus accruals are comparable to where they were last year.

We did have some slight bonus deleverage in the third quarter but if you recall, third quarter last year we had some slight bonus leverage.

In the fourth quarter we think we might have some slight bonus leverage this year with total bonus payments being -- growing about the same percentage as sales for the year.

As it relates to advertising, we continue to take a look at our mix of advertising be it tab, radio, ROP, and direct, and refine that mix to targeted customers in different markets.

It's something we have started over the past year or so and think we can continue to make strides to make our advertising dollar more productive.

Great.

Thanks.

Good luck.

Thank you.

Your next question comes from the line of David Schick with Legg Mason.

Hey, good morning.

Could you just delve into the installed sales and commercial customer market a little bit?

Are any of the local areas that I guess we all read about, where they say sort of inventory on the housing side is piling up, are you seeing anything different in the installed sales or commercial sales to either prove or disprove how those businesses will act if housing is a little slower in a regional or a local market?

Thanks.

Dave this is Robert Niblock.

We're talking about installed sales we're really not talking about with regard to new housing.

Generally when we're doing work for customers it's with regard to existing homes, not so much in the new housing market.

So I don't think that those two necessarily go hand in hand.

I think it's just a matter of -- we talked about the new model that we rolled out over the back half of 2003, and all of 2004.

We now have that model in place.

We're very pleased with how it's performing, and we're now able to go out and advertise those services to the customer, and we're continuing to add additional categories to our installation program.

For example this year we've added roofing and siding and those type of categories to installation programs, so really more and more -- the overall majority of what we're doing is with regard to existing homes, not in the new home construction area.

No, I meant related to areas where existing has been a little bit softer or slower.

So you're not seeing anything there as well?

Existing home sales have been strong.

You look at it on a year-over-year basis, sometimes people get confused, they look at the trend, how it was last month versus this month but if you look at it on a year-over-year basis it's still running between 6 and 7% increase in existing homes sales on a year-over-year basis.

So it's still strong.

Dave, this is Larry Stone.

Just one thing to add on commercial customer.

We added some infrastructure last year, you might recall, in terms of regional commercial sales manager, certainly that initiative has paid off as we've got better focus in all the regions and certainly work with our merchants on programs that we want to roll out to the commercial customer.

So there again no noticeable trends in anywhere across the country in terms of our commercial, our special order, or installed business.

It remains very vibrant all across the country.

That's very helpful.

Thank you.

Your next question is from the line of Budd Bugatch with Raymond James.

Good morning and my congratulations as well.

Bob, you've leveraged -- you've shown improving gross margins in the last couple of quarters, obviously very well, but the rate of growth looks like it's coming down.

Fourth quarter, I don't recall if I heard you say what you expected gross margins to be and how about going beyond?

I think it was 51 basis points improvement in the second quarter, 28 in the third what do we look like going forward?

Budd, as you know, we've said we expect to grow operating margin about 20 to 30 basis points per year.

As you know, each quarter has its own challenges and opportunities.

We don't manage the business a quarter at a time.

If there's an opportunity to take market share is as Robert described, we'll make the necessary investments to garner that share.

So 20 to 30 basis points over time split roughly in half between gross margin and SG&A, that would imply a little bit lower growth rate going forward.

We think in the fourth quarter, we'll have some gross margin expansion offset by expense deleverage in the quarter.

Okay.

So that was what I was trying to get to.

And the source of that margin is still primarily pricing, acquisition cost improvement?

It's a combination of lower acquisition costs, which is aided by increase in mix of imported goods.

We think the line of view process still has legs as well so, yes, there's still margin opportunities.

Budd, this is Larry Stone.

Some of the things Robert mentioned in appliances and so forth, some of the high efficiency appliances certainly can aid in some of that margin growth, as these new lines brought in with Samsung and other products that are coming on line certainly have a little bit better margin than some of the lower efficiency type products.

That's interesting, Larry, because some of the better products you have had -- where you've had success above corporate average seem to be historically lower margin products, appliances being one of them, OPE being another one.

Budd, Larry's talking about the mix within the mix.

Not the overall mix.

Understood.

Yes, the appliances are lower and as we always stated, I'm saying some of the mix that we get now at the higher efficiency, has a better mix than some of the lower efficiency products.

Understood.

Again, my congratulations.

Thank you.

Your next question from the line of Eric Bosshard with Midwest Research.

Could you talk a little bit ab out what you see going on with the promotional environment, number one.

And then secondly, you talked about the improving sales momentum in the beginning of November.

Can you give a little more color on what you see behind that?

Eric this is Larry Stone.

I'll take the first crack at it.

The commercial activity is no more or no less than it's been in the past several quarters.

Certainly a lot of different promotions, especially you see installed carpet, that percent off and things like that, and certainly we've had categories that people have discounted but overall we don't see anything really changing in the fourth quarter compared to what we've been up against for the last couple of years, and as Bob mentioned earlier, we're really trying to leverage advertising, really trying to go after those key market drivers and offer great values for the customers as we roll into the fourth quarter.

And as far as sales momentum, basically August, September, when the gas prices were going real high and everything, we did experience a little bit softness in transaction counts but October is -- things kind of normalized, transactions picked up, sales momentum has really continued to be strong.

I think initiatives like R3 and some of the other things we've mentioned on the call are certainly drivers of that plus the service in the stores that Nick and his team is providing is really helping drive those higher average tickets.

Eric this is Robert Niblock.

Couple things too, as we saw the weather turn and get cool as I mentioned in my comments, things that consumers were buying to help them go to alternate fuel sources, such as wood and pellet stoves, insulation, things that they're trying to do to help minimize home heating costs I think certainly has helped push some of those sales, and also when we look at the fourth quarter of 2004 and the way comp sales occurred during the fourth quarter of 2004, November was our lowest comp month a year ago.

So we are going up against our easiest comparison so far in the month of November.

Thank you.

Your next question is from the line of Colin McGranahan with Bernstein.

Good morning.

Two questions actually.

First, just on the capital structure with the addition of the 995 debt, looks like you're trying to keep the debt-to-capital ratio above 20%.

Is that a realistic way to think about it going forward that you will add debt as other debt comes due and you'll repurchase shares accordingly?

Colin, we haven't set specific targets, as far as debt to cap.

We do have $600 million of debt maturing in December.

It's a very, very attractive environment, a little bit more attractive a month or so ago versus today.

When you can borrow ten-year money at 5% and 30-year money at 5.5% we thought it was prudent to go out there in the market to use that to refinance the maturities coming due next month as well as allow us to potentially increase share repurchases going forward.

Okay.

So more opportunistic just given the environment.

Second question, just following up on the operating margin in the fourth quarter, you mentioned the difficult compare in the credit portfolio performance, it sounds like it was a timing issue, some of that -- the bankruptcy didn't occur until the end of the third quarter into the fourth quarter.

Are there other timing issues that benefited the third quarter but are detracting from the fourth quarter and ending up with that deleverage on what sounds like it's going to be a relatively similar comp?

No other issues other than the 53rd week.

That's the only thing that's probably different about Q4 than Q3.

The 53rd week is certainly additive from an operating margin dollar standpoint, as I indicated in my comments, it will add about $0.03 a share, it's just a lower productive week.

When you look at the last week of January, the first week of February, even with decent weather it's likely to be our lowest sales volume week of the year.

If you think about payroll, for example, even at a base staffing level, to open up stores, we're going to run a payroll percent of sales that's about 300 basis points higher than the average for the quarter.

So it's a -- just a lower productive month for us.

It does add to the bottom line, but it's a lower productive month, which does dampen operating margin.

So the all-in rate in that week is maybe half of an average week?

From an operating margin standpoint?

Yes, from a rate standpoint.

Yes, I would say it's closer to 70%.

Colin, this is Robert Niblock.

Just like as went into the third quarter our guidance I think was for like 10 basis points of operating margin expansion, and we wound up with 56 basis points, we try to be fairly conservative.

Obviously if you look at coming in at a projection the middle of the range versus at the beginning of the quarter versus landing above the range at the end of the quarter, then obviously as Bob said not all quarters are equal.

The way that things land between quarters, sometimes it can be lumpy, and it's not always -- we don't always have the control of the timing on that.

So we try to good in and give reasonable expectations of what we think we'll do for the year, or for the quarter or for the year, then hopefully we'll exceed those expectations if everything falls in line.

It's just like for the fiscal year, even though we're guiding down on operating margin in the fourth quarter, our original guidance for the year was up 20 basis points, and our most recent guidance coming out of this release is up 40 basis points because obviously we have better visibility now than when we had at that the beginning of the year.

I figured as much, best of luck.

Dennis we have time for one more question.

Today's final question will come from the line of Danielle Fox with Merrill Lynch.

Thanks.

Good morning.

Part of Lowe's strategy to drive traffic has been to emphasize more opening price points.

I'm wondering if that's still the case, and are you finding that there's been a shift in favor of these opening price points or are they just doing a better job getting customers in the door?

You mentioned favorable trends in the mix shift within product categories for appliances.

I'm wondering what's happening elsewhere in the store?

Danielle, it's Larry Stone.

Certainly that strategy has really paid off in the third quarter as we've got our advertising more targeted on those values.

It brings in traffic.

Certainly with the rise in gas we also tried to make sure we were targeting more of a project completion items as well because we felt like people were going to make fewer trips to the stores and I think it also aided in the higher average tickets.

As we were selling more projects versus items, but certainly our strategy is going to continue to bring the traffic into the stores and certainly with the values we have in the stores, we can also work to sell up to continue as Robert spoke of in some of those other categories once people come in there and see what we have to offer.

So you've been able to get people in without a degradation in the mix shift within the categories it sounds like?

For the majority, yes.

Just one actual final quick question on the hurricane impact.

You mentioned 100-basis-point benefit to the comp.

Was there any EPS impact from the hurricanes and the store closings?

I didn't hear whether or not you'd explicitly mentioned, particularly in the SG&A line.

Danielle, did not mention it specifically.

Had about a negative 10 basis point impact to SG&A in the quarter.

Costs associated with clean-up, hurricanes associated with moving people to assist the hurricane areas, and the uninsured losses, about 10 basis points impact.

Thanks very much.

Thanks, Bob.

I'm very pleased with our results this quarter and feel confident about our ability to serve our customers, execute our initiatives, and continue to achieve our goals in the future.

Thanks for your continued interest in Lowe's, and we look forward to speaking with you again when we report our fourth quarter results in February.

Good-bye and have a good day.

This concludes today's Lowe's companies third quarter earnings conference call.

You may now disconnect.