勞氏公司 (LOW) 2006 Q2 法說會逐字稿

Good morning, everyone, and welcome to Lowe's Companies second quarter 2006 earnings conference call.

This call is being recorded.

Statements made by management during this call may include forward-looking statements, as such are provided for by the Private Securities Litigation Reform 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 can materially effect our ability to achieve the results expressed or implied by our 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. 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.

This morning, I'll provide my thought on our second quarter results and highlight a few drivers of our performance.

Following my comments, Larry Stone will discuss his priorities for our merchandising and marketing organization that continued to strengthen our relationship with customers.

Then, Bob Hull will describe our second quarter financial results in more detail.

But first, a few highlights from the quarter.

Despite the fact that consumer spending slowed in June and July continued execution of our customer focus strategies, drove sales of $13.4 billion, a 12.2% increase over last year.

Diluted earnings per share of $0.60 increased 15.4% over the second quarter of 2005.

Comparable store sales increased 3.3% over last year's second quarter comp of 6.5%.

Operating margin fell short of our expectations for the quarter.

A more promotional environment negatively impacted second quarter gross margin.

In addition, we elected to discount and clear certain seasonal merchandise earlier than we originally planned.

As a result, we entered the third quarter in a good position on seasonal inventory.

I was pleased with our SG&A performance in a slowing sales environment as we adjusted payroll hours and worked to manage expenses while maintaining customer service levels.

As we've described in the past, our staffing plan flexes up or down with volume and going forward we will continue to balance the objectives of great service and prudent expense management.

Looking at our performance geographically, extreme heat kept many shoppers indoors during July, but our stores in the South Central U.S. delivered another solid comp sales performance in the quarter.

Strength in these regions was driven in part by customers who continued to repair damage from last year's devastating hurricanes.

Stores in our Southeast division also posted solid comp gains for the quarter with the exception of Florida, which is cycling two years of very strong comps driven by active 2004 and 2005 hurricane seasons.

In the North Central division we are cycling relatively easy prior year comparisons, and as expected, our store performance improved as the employment picture in the Midwest stabilizes following several years of employment pressures in the region.

Some of our West Coast regions experienced weak sales results this period.

California was hit especially hard by a severe heat wave in the second quarter.

In addition, we continue to carefully monitor some of the [bubblet] markets such as parts of California, Florida, and the Northeast, where other factors such as elevated fuel prices, increasing interest rates and slowing housing turnover are impacting sales.

Irrespective of these current challenges we remain very optimistic about the longer term opportunity in these markets.

Across the country where momentum is moderated, we have the processes in place to capture share, control expenses and drive performance.

Turning to our performance by category, 17 of 20 categories delivered positive comps in the quarter.

Lowe's continues to capture market share in key categories including appliances, outdoor power equipment, flooring, and kitchen cabinets and countertops.

Larry will provide more detail on our category performance in a few minutes.

Our big three sales initiatives of installed sales, special order sales and commercial business sales remain an important part of our growth strategy and are drivers of our business.

We continue to improve our offering in these specialty sales categories and strengthen our relationship with customers.

In addition to our big three initiatives, innovative merchandising programs and great customer service contributed to average ticket growth of more than 4% over last year reaching $70.21 for the quarter.

We entered the second half of the year confident we have the programs, processes, and people in place to meet our customer's needs and to continue to capture market share.

Our optimism comes from the fact that we're adding great stores in great locations across the country, staffed with customer focused employees and offering customers a great selection of products and services in an industry leading shopping environment.

We are supporting our stores with traffic driving and differentiating marketing programs that Larry will elaborate on later in the call.

At the same time, shifting macroeconomic variables and continued pressures on the consumer have prompted us to temper our outlook for the year.

The Blue Chip Economic Indicator's Forecast for personal income growth in 2006 has declined from 3.4% growth in April to 2.3% growth into the August forecast.

In addition, the prolonged period of high fuel prices and concerns about increasing geopolitical conflict are weighing on the consumer.

It is difficult to isolate and measure the impact of these pressures, but we will be prudent with our expectations as the macroeconomic environment evolves.

Our expectations for a soft landing in the housing market remains unchanged.

The National Association of Realtors continues to forecast a decline of approximately 8% for total housing turnover and data confirms expectations of a moderating housing environment leading to a soft landing.

Housing turnover, while slowing from record highs, remain strong on historical basis driven by strong household formation trends which support a continued healthy outlook for housing over the long-term.

In addition, an encouraging employment picture for most of the country creates a stabilizing force for consumer confidence and consumer spending.

Importantly, home ownership remains at historical highs and homeowners continue to show a willingness to maintain their homes and preserve the value of their investment.

According to the latest census and the National Association of Homebuilders, the U.S. housing stock is approximately 124 million units, with about 1.5 million homes added to the base each year.

With an average age of 32 years and rising, the stock of homes in the U.S.

Is older than at any time in history, driving ongoing non-discretionary home maintenance purchases.

The Federal Reserve's recent decision to hold the federal funds rate at current levels suggest the stabilizing economic environment.

The 30-year mortgage rate at about 6.6% remains attractive for home buyers and at historically low levels with only six of the past 35 years offering a 30-year mortgage rate below 7%.

Looking ahead, we will continue to closely monitor the headwinds and tailwinds affecting the home improvement consumer.

We will also execute strategies to insure we provide the great products, merchandising, and knowledgeable service our customers have come to expect from Lowe's.

In addition, we remain focused on controlling expenses, enhancing productivity across all areas of our business, and managing our stores for optimal efficiency.

Now I'd like to hand the call over to Larry Stone to elaborate on our merchandising and marketing initiatives.

Larry?

Thanks, Robert, and good morning.

It's been a little bit more than a year since I moved over from the operations side of the business to lead our merchandising and marketing organization.

During that time I've had the opportunity to bring my perspective to this area.

This morning, I'll provide an update on the three merchandising priorities I outlined last year, continued market share growth, balanced growth of average ticket and traffic, and programs designed to enhance margins.

Additionally, I'll describe how our marking programs are driving traffic and sales.

So, what have I been doing for the past year?

I've been focused on strengthening merchandise and [market] and take already strong programs and make them even better.

As Robert mentioned, great people who embrace our customer service culture are the foundation of our continued success, and bench strength is key to continued evolution of our successful merchandising and marketing strategies.

Our bench is strong.

Our four general merchandising managers have over 100 years of combined retail experience.

We continue to strengthen our bench by insuring our Merchandising Vice Presidents, or MVP's, gain experience in multiple product areas.

Last year, several MVP's were assigned new product categories to broaden their merchandise and knowledge and help build continuity.

The experience of this team has certainly made my transition to merchandising and marketing very smooth.

The first of the priorities I outlined last year was to grow market share.

In addition to our store expansion strategy of opening 155 stores this year, we'll continue to gain market share by improving the shopping experience and adding innovative products and services that provide great value to customers.

We have tremendous opportunity to capture additional market share in each of the 20 merchandising categories by insuring Lowe's meets the needs of the home improvement customer.

Our research shows that as of the end of 2004 the home improvement channel holds a dominant share in only seven of our 20 merchandising categories.

As the competition landscape continues to evolve we have opportunity to capture greater market share from other channels.

The core to achieving this is having innovative products and services at every day low prices and being in stock with job lot quantities to meet customer demand.

We continue to add new products and merchandising sets and enhance our offering and differentiate us from the competition.

The additions to our clients offering with new high efficiency and innovative product lines from Whirlpool, Maytag, Bosch, Fisher & Paykel and Samsung demonstrate our commitment to offering brands that are compelling and inspiring for the home improvement customer.

Although we've seen increased promotional activities in major appliances we continue to capture market share, reinforcing and enhancing Lowe's appliance vantage.

According to independent measures, we gained 130 basis points of unit share in major appliances in the second calendar quarter compared with last year.

This [technical problems] a strong appliance offering delivering new, innovative products and at the same time offering price points that drive demand across the value continuum.

Outdoor power equipment continues to be an important category.

During the quarter, OPE sales were negatively impacted by the dry spring that we experienced in the southeast and other parts of the country, however, when the conditions improved, so did our sales in outdoor power equipment.

According to independent measures, we gained unit share of 130 basis points in OPE in the second calendar quarter, more than any other major retailer.

This is evidence that our strong outdoor power equipment offering, which includes John Deere mowers, one of the most recognized brands in the world, continues to attract customers.

Also of note, our home environment category delivered solid sales and strong comps for the quarter.

Driving category performance was demand for air conditioners as customers sought relief from the heat wave experienced in most of the country in July and early August.

As Robert mentioned, 17 of 20 merchandising divisions delivered positive comps in the quarter.

Additionally, all 20 of our merchandising divisions gained unit share in the second calendar quarter according to independent measures.

Customer focused employees, great stores within innovative product selection and strong in stock levels helped deliver comps of 3.3% for the quarter and year-to-date comps of 4.4%.

My second area of focus is continue to drive traffic and ticket.

Balance is key.

Growing one at the expense another is not a sustainable strategy and we're working hard to convert traffic into transactions.

We'll continue to use our national advertising campaign to strengthen our relationship with customers by investing more across a wider base of relevant media.

This year we launched our new broadcast campaign, "Let's build something together".

It was fully implemented across all media during the second quarter.

Our new tag line is a call to action for the home improvement customer.

Additional tests indicates that these ads connect the customers as purchase intent and buying power scores have increased since the launch of this new campaign.

Also, we continue to become more efficient in reaching customers.

Our tab circulars delivered higher sales lift in the first half of the year compared with last year as we get better at targeting our marketing spend.

These marketing programs will continue to evolve and strengthen our relationship with customers by driving traffic and continuing to build the Lowe's brand.

Traffic isn't just about getting people into the stores.

It's about converting footsteps into transactions at our registers.

We continue to make operationally efficient merchandising decisions to convert traffic into transactions.

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

We design displays that are easy for customers to shop and easy for employees to maintain, therefore, enabling them to spend more time serving customers.

For example, we're doing a better job merchandising our seasonal sets.

The customer research indicated customers prefer to purchase patio chairs in sets of two instead of sets of four.

Our merchandising team worked with our vendors and we changed this for our '06 patio program.

This also helped reduce damages because we had less open box inventory compared to previous years.

Additionally, we tried some different merchandising techniques in this area which made it easier to shop and allowed customers to see the entire line of product.

This resulted in strong comps for this very important seasonal category.

I feel the program that we have in place for '07 will be even better which will allow us continued growth in this category.

We will continue to stay focused on what is important for our customers and use new merchandising display techniques to make this area easier to shop for our customers and easier for our stores to maintain.

Another example of a merchandising reset enables customers to compare product choices and shop for related products nearby is our mix and match lamp program.

This program provides customers easy access to see different styles and colors of lamps and lampshades by maximizing the space in our fashion lighting department.

Improved packaging and better profit adjacencies are part of my definition of operationally efficient merchandising, and by making our stores easier to shop, we better serve customers, drive more profitable sales and convert more footsteps into transactions.

Since 1994 when we began building only large formatted stores, we've reported compounded annual growth rate and average ticket of over 3%.

As Robert mentioned, our average ticket reached $70.21 in the second quarter.

Our continued success in driving average ticket is a function of our innovative product selection, our big three sales strategy, and [inaudible] continuing merchandising strategy.

These strategies connect with customers and help drive traffic and a higher average ticket.

Second quarter comp transaction count was also positive and we posted positive comp store transaction growth in six of the last eight quarters.

While we're making progress, it's not as high as we'd like and we'll continue to focus on ways to drive traffic and transactions.

Although it appears some consumers may be rationalizing their spending up the continuum is still the right strategy for us and a great point of differentiation.

Our research indicates that customers continue to shop and find value at all price points along the continuum.

One specific example in the quarter is stock bath faucets where we saw a continued stream in our high-end offering.

As a reminder, up to continuum is not about high-end price points but a well constructed product line with value at all points along the line.

Moving on to my last area of focus is margin expansion.

Over the year, we expect to improve operating margin by approximately 20 basis points.

Some of this growth will come from the SG&A line and some will come from improved gross margin.

The list of opportunities is the same as I discussed last year, but I'll update you on the progress we're making.

First and foremost, in merchandising we have the opportunity to increase gross margin by lowering our product acquisition cost.

We know that increasing retail prices is not typically a viable option in today's competitive environment so we continue to work strategically with vendors to identify opportunities to take cost out of the supply chain.

I've spent a lot of time this year with our merchants and vendors trying to find better ways to supply products to our customers.

In a recent vendor meeting we decided that we could both take costs out of the supply line by the way we physically receive product in the stores.

We're beginning to test this, and if it's successful, it will allow us the opportunity to lower our prices and at the same time create additional margin for both companies.

Most of our vendor meetings result in a savings for both companies, a win/win, and more importantly, a better value for our customers.

Direct sourced programs present another opportunity for product differentiation and margin expansion.

Through our [liner you] process we're able to identify opportunities to strengthen our merchandise and offering with direct sourced products in certain categories.

In 2005, products from this program accounted for approximately $4 billion in sales.

Foreign sourced product, both indirect and direct increased 170 basis points in the second quarter.

By the end of this fiscal year we expect foreign sourced products to represent approximately 10% of total sales and continue to grow at twice the rate over total sales growth.

While not specifically related to merchandising, our world-class distribution system represents another opportunity to take costs out of supply chain.

With R3 we can more efficiently move product from suppliers to our stores and our vendors ultimately share those savings with us through lower first cost.

Looking forward, in part thanks to R3 and our logistics and distribution infrastructure, we had solid sell-through of seasonal products and we are in great inventory position heading into the third quarter.

In summary, we will continue to capture more of the home improvement spend with our inviting and easy to shop stores as well as our compelling merchandising selection that provides great value at all price points along the price continuum.

Our marketing initiatives continue to connect with customers helping us to drive traffic and our operationally efficient merchandising sets make our stores easier to shop and enable employees to spend more time in the aisles helping customers and closing sales.

Better sourcing of our products through our ongoing line review process and our growth in our foreign sourced programs as well as our operationally efficient merchandising sets will help drive gross margin.

Focused execution of our merchandising marketing priorities help insure we continue to drive market share gains, meet the needs of the home improvement customer and build the Lowe's brand.

Now I'll turn the call over to Bob Hull to provide the details of our financial results.

Bob?

Thanks, Larry.

Good morning, everyone.

As Robert indicated, sales for the second quarter were $13.4 billion representing a 12.2% increase over last year's second quarter.

As a reminder, fiscal 2005 contained 53 weeks which resulted in a counter shift for fiscal 2006.

The counter shift positively impacted first quarter sales by $340 million, but negatively impacted second quarter sales by $190 million, or 1.6%.

This weak shift has no impact on comparable store sales.

For the first half of 2006 sales increased 15.9% to $25.3 billion.

Comp sales were 3.3% for the quarter on top of a 6.5% comp in Q2 2005.

For the first half of 2006 comp sales were 4.4% on top of a 5.2% comp for the first half of 2005.

In Q2 average tickets increased 4.2% to $70.21 and total customer count increased almost 8%.

Comp transactions were slightly positive in the quarter.

Inflation in building materials driven by gypsum, roofing and cement products was slightly offset by deflation in lumber and plywood which resulted in a favorable impact on second quarter comps of approximately 20 basis points.

With regard to product categories, the categories that performed above average in the second quarter include rough plumbing, building materials, rough electrical, home environment, paint, flooring, and lawn and landscape products.

In addition, hardware, fashion plumbing, nursery and seasonal living performed at approximately the overall corporate average.

Gross margin for the second quarter was 33.4% which is a 32 basis point decline compared with our 49 basis point improvement experienced in Q2 2005.

The decline in gross margin was attributable to a number of factors including inventory shrink, a more promotional environment, markdowns to sell-through seasonal inventory and higher fuel costs.

Each of these factors negatively impacted gross margins in the quarter by approximately 10 basis points.

These items were offset slightly by a positive product mix impact and a higher mix of imported goods.

Year-to-date gross margin of 34.2% represents an increase of 17 basis points over fiscal 2005.

SG&A for Q2 was 19.5% of sales and leveraged 27 basis points driven by bonus, retirement, and credit portfolio expenses.

As we have described in the past, our bonus and retirement expenses move up and down with the Company's sales and earnings performance.

The leverage experienced in the second quarter was a result of adjusting our accruals based on our current forecast.

Leverage from our credit portfolio was driven by improved loss performance following the October 2005 bankruptcy legislation.

In the second quarter of last year, bankruptcy losses trended higher in advance of the new law and we have seen a much improved loss trend since the legislation was enacted.

In addition, in the second quarter we received our share of the Visa-Mastercard anti-trust settlement which was approximately $14 million.

These items were slightly offset by deleverage in utilities and fuel expenses.

Year-to-date SG&A is 20.1% of sales and leveraged 51 basis points to the first half of 2005.

Operating margin, defined as gross margin less SG&A and depreciation decreased 19 basis points to 11.8% of sales.

Year-to-date operating margin of 11.9% represents an increase of 64 basis points over the first half of 2005.

Store opening cost of $28 million was flat to last year as a percentage of sales.

In the second quarter we opened 24 new stores including one relocation.

This compares to 27 new stores including one relocation in Q2 last year.

Depreciation at 2.1% of sales totaled $283 million and deleveraged 14 basis points.

Interest expense at $30 million was down to last year's second quarter and leveraged 10 basis points as a percent of sales.

For the quarter total expenses were 22.1% of sales and leveraged 23 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 38.5% for Q2 last year.

Diluted earnings per share of $0.60 increased 15.4% versus last year's $0.52.

For the first six months of fiscal 2006 diluted earnings per share were up 27% over 2005.

Weighted average diluted shares outstanding were $1.57 billion for the quarter.

The computation of diluted shares takes into the account the effect of convertible debentures which increased second quarter weighted average shares by $22 million.

In the second quarter we repurchased 20.2 million shares at an average price of $31.04 for a total repurchase amount of $626 million.

For the year, we have repurchased 38.1 million shares at an average price of $32.20 for a total repurchase amount of just over $1.2 billion which exhausted our prior share repurchase authorizations.

As we announced this morning, our Board of Directors has approved a $2 billion increase to our current share repurchase program.

Now, to a few items on the balance sheet.

Our cash and cash equivalents balance at the end of the quarter was over $300 million.

Inventory turnover was 4.49, an increase of 8 basis points from Q2 2005.

Our second quarter inventory balance increased 16.4% driven by the addition of 143 new stores over the past year which accounted for 9% of the increase.

Inventory in comp stores was up 3% versus last year contributing to 3% of the year-over-year increase in inventory.

This is driven by OPE with higher inventory levels in generators and other emergency related products as we stand prepared for the balance of the hurricane season.

We also saw a year-over-year increase in our seasonal living inventory as we doubled the number of stores in our year-round program.

In addition, inventory dollars in certain commodity categories were higher as a result of significant inflation experienced during the year.

Finally, 4% of the increase in inventory was in our distribution centers as a result of our decision to ship appliances and other products through our network.

We ended the quarter with select appliances shipping throughout all of our RDCs versus only four RDCs last year, a significant milestone for our R3 initiative.

As Larry mentioned, we had good sell-through of our seasonal products and our inventory is clean heading into the back half of the year.

At the end of the second quarter we owned 84% of our stores versus 82% at the end of the second quarter last year.

Our debt to total capital was 18.7% compared with 20.9% for Q2 last year.

Return on invested capital measured, using beginning debt and equity and trailing four quarters earnings, increased 132 basis points for the quarter to 19.4%.

Our second quarter performance drove return on assets determined using beginning total assets and a trailing four quarters earnings to 13.6% representing an increase of 104 basis points.

Year-to-date, cash flow from operations was $2.6 billion, an increase of almost $400 million, or 17% over the first half of 2005.

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

Our third quarter sales increase of approximately 11% incorporates the opening of 48 new stores and a comp assumption of 0 to 2%.

We plan to open 11 stores in August, five stores in September and 32 stores in October.

Operating margin for the third quarter is expected to be approximately flat to last year as a percentage of sales.

The sales growth and operating margin I described is expected to generate diluted earnings per share of 45 to $0.48 which represents an increase of 12.5 to 20% over last year's $0.40.

For 2006 we expect to open 155 stores including four relocations resulting in an increase in square footage of approximately 12%.

We're estimating a comp sales increase of 2 to 3% and a total sales increase of approximately 11%.

I want to remind everyone that fiscal 2006, a 52-week year, will be impacted by the comparison to 2005 which contained 53 weeks which is expected to impact sales growth by 7.6% for the fourth quarter and 2% for the year.

Earlier I noted the positive first quarter counter shift impact of $340 million and the negative Q2 impact of $190 million.

There is no significant impact expected in the third quarter, however, we expect a negative $150 million impact in Q4.

For the entire fiscal year we are anticipating an operating margin increase of approximately 20 basis points, which coupled with our sales increase, should drive diluted earnings per share of $2 to $2.07 which represents a 16 to 20% increase over our 53-week fiscal 2005, or 18 to 22% on a 52 versus 52-week basis.

Regarding current sales trends I mentioned earlier that our business outlook for the third quarter anticipates 0 to 2% comps.

For the first 16 days of the quarter our comps are within 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.

Luanne, we're now ready for questions.

[OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q&A roster.

And your first question comes from Deborah Weinswig with Citigroup.

Good morning.

In light of the opportunity for market share gains, that I think you outlined pretty well on the call, can you talk about your performance from a comp basis in the second quarter and also your outlook for the back half?

Deb, this is Bob.

Our comp performance in the second quarter, as we mentioned, was a 3.3%.

June was approximately flat, it was about equal to the Company average of about 3.3%.

May was about 1% higher and July was about 1% lower.

As we think about the back half of the year, we're obviously cognizant of current trends.

We do believe there is continued market share gains, as Larry outlined in his comments, but we're also cognizant of the challenging economic environment.

So it's more just macro driven, nothing that you're specifically seeing within your business?

Deborah, it's Robert Niblock.

It's part of what Bob just outlined.

It's the macro driven we talked about I think in my specific comments, some of the [bubblet] markets where I think consumers are challenged a little bit more so than they are in the other markets that we're seeing in the country.

And then also, as you're probably aware starting later in August and then in September, we'll start cycling a couple of the significant hurricanes that we experienced last year, those being Katrina and Rita, and so obviously, the pressure that we'll see on comp sales from the lift that we got last year from that hurricane activity, so we drill all of that together, we expect elevated fuel prices to continue, the [bubblet] markets, as we said overall soft landing in housing and still very healthy outlook overall for housing over the long-term, but there is some bigger impact in some of the [bubblet] markets and then the negative pressure on comps from the cycle of the hurricanes, that kind of leads us to temper what we expect over the back half of the year.

Okay.

Thank you.

That was very helpful.

Your next question comes from Greg Melich with Morgan Stanley.

Hi.

Thanks, guys.

Wanted to check on the SG&A.

You had a couple things, Bob, that you listed the accruals, you said bankruptcy losses are down since the change last year.

Is that an accrual or was there any sort of releasing of prior provisions you may have taken for some of your promotions?

No.

The bankruptcy law was enacted in October of last year, and as expected, middle of last year, there was a rush to bankruptcy ahead of that new legislation, so as we think about this year, we obviously had positive comparison in our losses, Q2 '06 versus Q2 '05.

Also, however, we are seeing higher money costs as interest rates tick up, so the positive loss performance we saw this year was offset slightly by increased money costs.

Okay.

And so that's what you're describing there?

That's correct.

SG&A?

It's not a prior period adjustment it's just what's happening now?

That is correct. [Inaudible] versus last year.

And in terms of services, can you just give us the number of how much those are growing?

You mean our installed services?

Installed services, yes.

Installed sales were up about 17% for the quarter and the comp was about twice the Company average.

Okay.

And then payables were up 22%.

Is that a normal trend or was there something funny going on with the calendar?

No, nothing funny going on.

We said we'd expect our payables to grow about two days, payables outstanding per year.

Q2 this year versus Q2 last year were up three days, we're a little ahead of schedule as of Q2 this year.

Okay.

Great.

Thanks a lot.

Thank you, Greg.

Your next question comes from Budd Bugatch with Raymond James.

Good morning.

My question has to do with the implication of, on fourth quarter comps, based on what your year is, if I did my math right based on just the mid point, it says flat comps for the fourth quarter and I think Bob, you said 150 basis points are impacted by the calendar change.

Can you give us any more color on that?

I know that you did give guidance one quarter out into the year but is that just about the right range?

Or the right way to think about it?

Yeah, without providing it, Budd, the outlook for Q4 is basically flat to 2% comp growth.

We are going against 14-week fourth quarter of 2005 and the weak shift negatively impacts fourth quarter this year by about $150 million, so it is approximately 1.5%.

But the, Budd, this is Robert Niblock.

There is no impact in comps for the weak shift.

We're still comparing the same 13 weeks this year to last year.

Okay.

So the comp, that 150 is just total sales?

That's right.

That's what I thought.

And just to make sure I understand it basically your comp outlook is, basically, just as I think you told Deborah, just basically macro driven?

Yeah, a combination of macro driven.

As I said, the impact of the hurricanes and the macroenvironment includes both elevated, you know, fuel prices, obviously, those that are on adjustable rate mortgages have seen a squeeze in their, or an increase in their monthly payments squeezing their disposable income and we're seeing a little bit heavier impact from those items in some of the [bubblet] markets that I mentioned in my call, but overall, expect a soft landing.

The housing environment is very healthy, long-term mortgage rates, you know, if you're talking about fixed mortgage rates are still very attractive on a historical basis even though they're up from where they would have been a year or two ago, but basically just tempering it based on the overall economic outlook we're seeing.

Thank you very much.

Your next question comes from David Schick with Stifel Nicolaus.

Good morning.

You talked about some of the factors on SG&A like bonus accrual.

Can you just tell us if there's anything going on with payroll, you know, on a rate basis or hours that you're planning as you soften your outlook a little bit here in the back half?

As we've said in the past, Dave, we've got a staffing model that flexes up or flexes down with forecasted level of sales, and our store operation folks, certainly, based on our comp performance relative to the guidance started flexing the payroll hours down in the quarter.

When we think about payroll performance, as well as the third-party assembly insourcing and the vendor service component, we still deleveraged payroll slightly in Q2, but it's certainly a focus of ours as we forecast our outlook for the back half of the year, right sizing the number of hours required to support that level of sales.

This is Robert Niblock.

As Bob, I mentioned it was slight deleverage in payroll during the quarter which you would expect, and as Bob gave the trends for comps during the quarter in a slowing environment we're constantly making adjustments.

Just like in a period where our comps would be trending up you would probably expect leverage.

So that's what we do every week is store operations group they're out constantly reforecasting the next three months to look at how their forecast is, looking at making sure they're going to make the necessary adjustments, but we're not going to sacrifice service.

So we will flex payroll up and down but not at the expense of customer service and all of our customer service scores tell us that we continue to be able to provide the level of service that customers expect.

I think our sales per hour have continued to trend up so we'll continue to trend in the right way.

Overall we're just managing based on what we're seeing in the current environment.

So just continue to expect roughly one for one?

You're not trying anything on payroll outside of the sort of like you said the planning unit?

That's correct.

Okay.

Secondly, just a little bit of a follow-up to the comments, Robert, you just made on those markets that have been sort of overheated from a housing standpoint.

Is there anything you're seeing, demand-wise or a shift that makes you think that you're going to change merchandising or marketing, if that phenomenon were to spread?

No.

I don't think we're seeing anything that is going to cause us to look at overall, the categories of merchandise we sell, the price points that we offer, range from opening price points to premium, we're still seeing in many categories, the customer is still buying at the high end.

As we said before, and remember this is a consumer's home, overall the majority of our customers own their home, they consider it an investment in their home.

Sometimes they may rationalize, you know, when do I make that decision to invest based on either the current economic outlook or the available cash flow that they have to be able to invest in the home, but probably 70 to 75% of what we sell each and every day is ongoing maintenance of that home.

As I said, an average age of 32 years and growing, that's what drives our business.

The consumer at a minimum is going to continue to do that and in most cases to the extent they have the wear with all to do it will continue to invest in upgrading their home.

That's what we're seeing.

In most areas in the U.S., like I said, some of these [bubblet] markets, you will see consumers taking a little bit of a breather and I think we'll cycle through that and we expect, let's say a good year, if we look at the overall, look at the year for 2006 with our guidance for comps on a 52 versus 53-week basis, I'm sorry, for earnings up 16 to 20% and 18 to 22% on a 52 versus 52-week basis, we think it will be a good year.

Obviously, not as strong as what we saw last year but still a good year and then we think things still start improving as we head into the middle part of, or at least probably after the first quarter of '07, we would expect things to start trending back up.

Great.

Thank you.

Your next question comes from Matthew Fassler with Goldman Sachs.

Thanks a lot.

Good morning.

I was hoping you could shed some light on the promotional activity that you discussed.

If you could fine-tune a bit to categories you're seeing it, give us a sense as to who might have been stimulating it, was it through 0% interest or through price and give us a sense as to where you chose to respond to be proactive and where you chose to kind of sit it out if in any instances.

Matt, this is Larry Stone.

We're still committed to our everyday low pricing strategy and certainly, we'll take promotions as they come along and compete with any competitor out there, but we did see an escalation in appliances, certainly, with free delivery, gift cards or purchase orders and then slight increase in percent off in some categories, mostly refrigeration.

But we're still committed to our basic program of everyday low prices, but we will be competitive and if we see something in the marketplace that we need to respond to, we'll certainly be out there, but we think that the second half we'll see some big ticket items possibly with more concern from the competition but nothing more so than we saw probably in the last half of last year.

And Larry, was the promotional activity basically limited major appliances?

It was the biggest one in the first half and, you know, credit, 12-months no pay is still pays big in certain categories when you get into appliances or outdoor power equipment and even some variable of higher end gas grills but nothing more so than we've been seeing for the last six or 12 months.

Got you.

And then just by way of follow-up, you mentioned shrink as a small item impacting gross margins.

Just any color on what might have been driving that and what you think the outlook is there would be helpful.

Matt, this is Bob.

What we saw as we started taking inventories for the stores impacted by the hurricanes last year, we saw some degradation in our shrink performance, so I think that will be a blip that will continue throughout the balance of this year but we expect that to normalize in 2007.

We take inventories in our stores twice a year so some of those stores are getting their first physical inventory subsequent to the storm in the second quarter so that's what caused the uptick of shrink in Q2.

Understood.

Thanks so much.

Thank you, Matt.

Your next question comes from Chris Horvers with Bear Stearns.

Thank you very much and good morning.

A follow-up on the margin structure.

As we think about your guidance for the back half of the year, can you give us a little color on how you view gross margin and SG&A?

How you look at the promotions versus mix on gross margin?

And on the SG&A line, clearly, you're doing a great job of controlling hours in the store.

How much benefit are you anticipating just from a reduced bonus comp accrual?

Thank you.

Well when we think about the back half here, we do believe there's opportunity for margin expansion in the back half of the year and think even at a flat to 2% comp that SG&A will be flat to potentially slightly positive in Q3.

Remember in Q4 we're [slicing] up against the 13 versus 14-week comparison as well as the headwind of the calendar shift, so that will pose a SG&A challenge to us in the fourth quarter.

Also, in a slowing sales environment some of our fixed costs, most notably depreciation, will cost fairly significant deleverage in both Q3 and Q4.

As it relates to the bonus, that's something we've talked about for quite some time.

As our performance has been strong over the past four years we've had a healthy level of incentive compensation and [in a] slowing sales and earnings environment, those levels of payouts will come down which will cause some leverage as it did in Q2 in the back half of the year.

Chris, this is Robert Niblock.

I think just to point you back to our guidance for the year, I think we're showing operating margin of being up about 20 basis points which is pretty much in line with our original guidance for the year.

As I've said before, with the calendar shift takes place this year, as well as the 52 going against 53 weeks, it does make it a difficult year to go in by quarter and look at the trends and try and get a feel for how we're trending overall because of items like the extra week in the fourth quarter that we're going up against from last year.

So we're back in line with our original guidance we gave for the year, we feel good about that, we think it will be a good year with good earnings growth.

We did talk about the headwinds from the hurricanes that we will be facing here over the next month or so.

Somewhat offsetting that, which is to what Bob eluded to, is the fact that in many cases when you're selling those preparatory and relief items with regard to hurricanes in many cases, those are lower margin categories.

So from a comparison standpoint, that provides a little bit of a relief on the margin side, all things else being equal which will help drive part of that margin improvement that Bob mentioned that we'll possibly see over the back half of the year, but then once again, you have the negative impact of the extra week in the fourth quarter and, obviously, with fixed expenses with one less week of sales, it puts pressure on being able to leverage on the SG&A side.

So, that's about the best way I can summit up for you.

Thank you very much.

It's very helpful.

Yes.

Your next question comes from Eric Bosshard with Cleveland Research.

Hello.

Hi, Eric.

Can you talk a little bit from a big picture perspective how you're thinking about the business in the slower comp environment?

And I guess specifically what I'm interested is in managing SG&A and managing labor, how you're going to insure and it sounded like you had a system or a newer system to manage service levels.

And then the same thing within product that sounded like you're trying to do something different in managing product acquisition costs.

Just talk a little bit about how, from a big picture perspective you're going to manage the consumer experience while also trying to manage the operating profitability of the business.

Eric, this is Robert Niblock.

There's no real major changes in what we do each and every day.

We build a plan for the year, obviously, we know what that plan is and what our comps and what our outlook is.

As we start seeing that the year is trending less than that, operators on a daily basis are sitting there looking at how they're trending in each one of their individual markets, they're adjusting their payroll forecast, the merchants in our logistics team are also looking at the various product categories and they are adjusting the forecast with our vendors for ongoing buys, obviously, seasonal type product that you already have executed the buy on is here and that's why, for example, my comments I mentioned that some seasonal categories we elected to markdown a little bit earlier than anticipated because we wanted to make sure that we had those inventories out and we were clean.

Larry, I think talked about some comments, in his comments about some things in the recent meeting with one of our vendors and some things that we were doing that came out of that meeting, but that was just to highlight what we do every quarter, every year is meeting with our vendors trying to make those changes that make both of us more efficient and drive profitability for both of us.

So bottom line is no, there's not any knee jerk reactions here.

It's the way we manage a business day in and day out where the sales are trending above plan or below plan, there's certain items we can look at and decide, you know, we're going to accelerate investing in something or pulling back a little bit, so there's some minor things like that we do.

But what drives the business day in and day out is managing details on a weekly basis and that's what we do in good environments or slowing environments and that's what allows us to be able to deliver results that pretty much track our guidance in both favorable and unfavorable conditions.

And then someone made the comment, maybe it was Larry or Bob, about the expectation going into 2007 that you sort of have the thought process that the comps will remain under some pressure at a little slower pace through Q1 '07 and then return to the sort of traditional mid single-digit range in mid '07.

Is that what you're thinking now and I know your crystal ball is not that different than everyone else's, but how do you think about that?

Yeah, Eric, it was me making those comments.

If I think about it, we obviously, we had a pretty healthy comp in the first quarter of this year so as you start to cycle against that and cycle some of the weaker performance, we think that by that time, really some of the shock factor of the gasoline prices and the slowing housing environment, all of those type of things you start to annualize against.

So we would anticipate probably, you know, by the second quarter some time of '07 we would start to hopefully see a trend that would be above the run rate, certainly, above the run rate that we're seeing today.

Fantastic.

Thank you.

Luanne, we have time for one more question.

Okay, sir.

Your final question comes from Dan Binder with Buckingham Research.

Hi.

It's Dan Binder.

Just a couple questions for you.

I guess when we look back to the earlier part of this decade, we had seen a little bit of a slowdown in housing which resulted in comps ultimately going negative.

I'm just kind of wondering given where we are today on, particularly on existing home sales, growth year-over-year, or declines I should say, why you think that the comp expectations maybe shouldn't be a little bit lower?

That was the first part of my question.

Dan it's Robert Niblock.

I think we're talking about, I think the 2000-2001 timeframe.

In that period of time one of the biggest things is we were going through the Eagle transition so, and I think that we provided, you know, that that had a substantial impact on our overall comp performance.

Yes, it was a slowing environment, we had the impact of converting those Eagle stores which we decided to do in a very rapid manner.

We knew that it had an impact on our overall comps and customer service in those stores, we wanted to go ahead and get it over with in a quick timeframe so that we could then convert those to the Lowe's format and move forward.

So that is one significant item that had a difference back then versus what we think we're seeing today.

[It's] like when you go back to that point in time, I think we may have had a couple quarters in the fiscal year that were negative but we never had a year that was negative.

So when you look back from that standpoint, when we look at where we're at today, we think those are things that are different, plus you know, if you look at interest rates, interest rates, as I mentioned, are still at historically low levels from fixed rates, you're still seeing improvement in income and improvement in employment both during this economic cycle.

So I think all of those things are items that lead us to believe that you're not going to have as negative of an impact as what we saw back during that timeframe.

Okay.

And then I was wondering, have you tried to figure out what kind of a comp benefit you've had from both one, that the Gulf rebuild effort this quarter and then two, given Home Depot's slower growth this year I was wondering if you've seen any substantial comp benefit from just lower cannibalization on that front?

And the third part of this would be whether or not you think square footage growth needs to slow in the coming years as the sector matures?

Dan, this is Bob.

The expected, or the hurricane impact for the second quarter was about 75 basis points positive.

As it relates to opportunity to take share, we think we've got programs in place to continue to take share from many people throughout the retail space, so we're not really focused on any one particular competitor.

We think there's opportunities to take share in a variety of different places.

Dan, this is Robert Niblock.

With regard to square footage growth that we really don't see a need to change our plans.

At our conference next month, we will update you on what our anticipated growth is for 2008.

Obviously, we've already given the 2007 numbers, but we're not going to be changing anything based on what we're seeing in the current economic environment that we're seeing out here.

We view this as a time to gain share in a slower economic time.

By the time you could meaningfully make a change as long as the lead-time is on your real estate expansion you'd already be through any potential slowdown in economic cycle.

As I've said a few minutes ago, we expect things to start trending up by the middle of next year.

So anyway, our view is we'll maintain the course, we've got a significant number of great sites in the pipeline and we plan on continuing to roll forward with those.

I guess the way I was thinking about the square footage growth is really if I look back over the last several quarters we've kind of had mixed traffic trends, and I guess even during good periods and was wondering if you think that might --

I think we have pretty consistent traffic trends.

Okay.

I thought there was a few quarters in there where you had slightly negative to slightly positive but I guess my point was that given the traffic trends in the industry overall, I mean we've been seeing this deceleration in the square footage growth rate, I was just wondering should we expect to continue to see this gradual deceleration or a more marked cut?

You would expect to see more gradual than a marked cut.

Okay.

Thanks.

All right Thanks, Dan, and thanks for all of you that had joined us on the call today.

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.

Have a good day.

This concludes today's conference call.

You may now disconnect.