勞氏公司 (LOW) 2006 Q3 法說會逐字稿

Good morning, everyone, and welcome to Lowe's Companies third 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 Act of 1995. Although the Company believes the expectation, opinions, rejections, and comments reflected in such statements are reasonable, it can give no assurance that they will prove to be correct. A wide variety of potential risks, uncertainties, and other factors could materially affect our ability to achieve the results expressed or implied by our forward-looking 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. Steve Stone, Senior Vice President and Chief Information Officer; and Mr. Bob Hull, Executive Vice President and CFO. 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 thoughts on our third quarter results and highlight a few drivers of our performance. Following my comments, Steve Stone will describe how our information technology organization is focused on delivering solutions that add value, enhance efficiency, and improve the shopping experience for our customers. Then Bob Hull will describe our third quarter financial results in more detail. But first a few highlights from the quarter.

During the quarter, we experienced a slowing sales environment. But our employees' focus on serving customers and the solid performance of our new stores drove sales of $11.2 billion a 5.8% increase over last year. Diluted earnings per share of $0.46 increased 15% over the third quarter of 2005. Comparable store sales declined 4% over last year's third quarter comp of 6.2%. Despite the slow sales environment, operating margin showed solid growth in the quarter. A targeted promotional strategy combined with a product mix shift led to an increase in gross margin for the quarter. In addition, prudent expense management and leverage from our performance-based compensation plan led to solid SG&A performance for the quarter. 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. The combined effects of a slowing housing market in parts of the U.S., significant deflation in certain commodity categories, and a difficult comparison to last year's hurricane recovery and rebuilding efforts have created a challenging sales environment for home improvement. It is difficult to isolate the impact of each factor, but our sales performance by region mirrored many of the external pressures we see in our business. While 7 of our 21 regions had positive comp sales, sales in many areas of the country were pressured. Greatest among these were locations that experienced a lift in sales over the past two years from intense hurricane rebuilding efforts.

This quarter as we cycled hurricanes Katrina, Rita, and Wilma, our lowest comping regions were in coastal markets impacted by these storms. We also experienced weak sales in the northeast and California. Many of these markets had significant home price appreciation over the past several years and today are experiencing slowing rates of appreciation or outright declining home prices. We're watching these markets closely as we project our near term sales performance. Importantly, we're also watching how other markets, those with more rational appreciation over the past few years react to the much publicized concerns about housing. Consumers in some of these markets appear to be taking a conservative approach to home improvement spending, especially for large projects despite any data suggesting a pullback in housing prices. We would expect consumers in these markets to return to traditional spending patterns as they gain confidence that the slow down in housing is near the bottom or at least not affecting their homes.

Turning to our performance by category. Cycling last year's hurricanes clearly impacted our sales performance. Generator sales were down significantly in the quarter which led to our outdoor power equipment category which includes generators, delivering the lowest comp of the quarter. Despite solid market share gains in the category. These results were more pronounced in our Southeast division which includes Florida and the Gulf Coast. Lumber and plywood deflation was a 70 basis point drag on comp store sales, offset to some degree by inflation in certain building materials. The wholesale price of structural lumber is down more than 20% over last year and down more than 15% versus historic 10-year averages. Wholesale structural panel prices which include plywood and OSB are down even more dramatically, off nearly 30% from last year and approximately 15% below 10-year averages. Unit sales of lumber and plywood were also pressured by slower building activity in the U.S.

Currently impacted by both deflation and lower demand in hurricane-impacted areas, our lumber category delivered the second lowest comp for the quarter. We also saw clear signs of a more cautious home improvement consumer in our results. Bigger ticket categories like kitchen cabinets, millwork, and appliances were weaker in the high home price appreciation markets of the northeast and west, but showed somewhat better results elsewhere. Despite these pressures, Lowe's continues to gain market share. In the third calendar quarter, Lowe's gained unit share in 18 of 20 categories versus the third quarter of 2005. Equating to an industry-leading 90 basis point unit share gain for the total store according to independent third party estimates.

The current sales environment has not impacted our store expansion plans, we remain on track to open 155 stores this year and a solid performance over new stores is a clear indication that our diligent site selection process is ensuring we're putting stores in the right markets around the country. With a backdrop of declining home values in some markets and evidence of a cautious home improvement consumer in others, we are taking a relatively conservative approach to the current environment. But despite housing related pressures on the consumer, the job market looks solid as we're at 5-year lows in employment, personal disposable income continues to rise, interest rates remain low, and gasoline, natural gas, and heating oil prices have come down from last winter's highs. These signs suggest continued strength in the U.S. economy and support our long-term optimism. But in the near term, they appear to be outweighed by commodity deflation, difficult hurricane comparisons and housing related pressures.

Looking ahead in periods of both expanding and slowing sales, our number one priority is providing great products and services to customers. In that regard, we won't make decisions that jeopardize our customer franchise or hinder our ability to continue to capture market share regardless of the sales environment. That said, we will work to drive operating margin through enhanced supplier relationships and continued direct sourcing opportunities, prudently managing expenses, but never to the detriment of service and ensuring our competitive position continues to strengthen. Finally, I'd like to congratulate Jimmy Johnson, Chad Knaus, Rick Hendrick, and the entire team at Hendrick Motorsports on winning the 2006 NASCAR Nextel Cup championship. Lowe's is proud to be partnered with such a great organization and have them represent the Lowe's brand each week on and off the track. Now I'd like to hand the call over to Steve Stone to describe the efforts of our IT organization and their focus on adding value to Lowe's. Steve.

Thanks, Robert. And good morning. I'm happy to have the opportunity to speak to you about the business value being delivered by Lowe's investment in technology. Today I will cover three topics. First I'll review some of the high-level financials associated with Lowe's use of technology. Second, I will cover some of the new technology solutions that have either been completed this year or are in the process of being deployed. Finally, I will cover Lowe'sposition on the use of technology as an enabler for future growth.

Lowe's capital investment in technology from 2002 through 2006 has increased at a 16% compound annual growth rate. During the same 4-year period, we've devoted more of our capital dollars to efforts that add the most value to our business. As a result our capital investments in those efforts have provided new business functionality, have increased at roughly a 30% compound annual growth rate, or nearly doubled the overall capital growth rate for technology.

Since 2002, we've managed our technology investments as a portfolio. Our technology portfolio contains a detailed 3-year forward look for technology investments that balances return on investment, strategic alignment, risk, and customer impact. With the benefit of the portfolio information, we have significantly increased our investment in customer facing applications over the past four years. These applications include such items as our specialty sales systems, point of sale improvements, kiosks, Lowes.com upgrades and credit programs. From 2002 to 2006 we increased our capital expenditures in customer facing applications at a compound annual growth rate of roughly 50%.

As business strategies emerge, we prioritized and realigned the portfolio to allow us to take advantage of business opportunities. By having a corporate philosophy of investing in the future, coupled with a stable technology plan, we have been able to steadily increase our ability to deliver business value for the Company. 2006 is a great example of this. In 2006, we've implemented a number of technology efforts for the business and are in the process of rolling out a number of others. I'll cover the highlights of recent technology deployments, grouping them into three major business classifications. Supply chain, store productivity, and store selling.

In our supply chain, we've been busy putting in additional technology to support our rapid response replenishment and execution excellence business initiatives. For example, store presentation management provides our logistics organization with greater inventory visibility and many additional controls to manage target inventory levels at the store. Our logistics planning personnel now have the tools necessary to ensure that each store's needs are appropriately addressed while still leveraging the power of centralized replenishment. By breaking inventory into specialized quantities such as those needed for job loss, presentations minimums, et cetera our sophisticated replenishment systems have even more power to keep our stores in stock or appropriately manage inventory in a slow sales environment.

Another example of new technology is the implementation of our Execution Excellence solution which provides engineering labor standards for the regional distribution centers. This system and process upgrade has helped our distribution centers get visibility to and manage labor in a complex and dynamic operation. We made significant investments in our proprietary warehouse management system to enhance its capabilities to control more functions, so that labor standards could be applied and monitored. We also implemented the market-leading labor standards management solution to support the tracking and performance measurement required to drive increased productivity. The integration of these two technology solutions has provided the distribution management team with greater visibility and control to ensure our distribution operations are as efficient as possible.

In our stores, we have focused on two core themes. Improving store associate productivity and increasing sales through an improved customer experience. In 2006, we have implemented systems to automate manual processes and provide better management reporting around a number of instore inventory related functions. We are also piling in a new store portal that provides store and department managers with quicker access to key store metrics such as sales, labor, and inventory information. This solution should roll to all stores over the next 3 to 4 months.

We are implementing a new return system that offers many new capabilities to assist both the store as well as our customers. The new system allows the cashier to pull up stored receipt information for returns with just a customer's telephone number, credit card, or checking account number. This streamlines the process for both associates and our customers yielding on average of 50% time savings versus past returns with no receipt, while at the same time allowing us to verify the authenticity of the initial purchase. This equates to a labor savings of about 15 hours per week per store that can be reinvested into serving customers and driving sales. On the back end of returns, new powerful analytics that leverage our data warehouse environment provides our loss prevention group with much more detailed tools to analyze return patterns and velocities to identify and prevent fraud.

On the sales side, we continue to deliver new functionality to enable our total closed loop selling model. The total closed loop is a comprehensive selling model that is designed to simplify the process of sealing specialty items for store associates, improve the experience for customers, manage the communication and processes with our service provider network and provide tools to manage the customer experience throughout the entire selling process.

During 2006, we have implemented new tools to manage the flow of product information from our suppliers into the Lowe's systems. These new tools will greatly improve the flow of electronic product information to Lowe's and shorten the lead time needed to deploy new product offerings. In fiber stores we focused our efforts on new tools to improve the selling of installed products. Our new installed sales tool will eliminate nearly 50 paper contracts from the stores, ensure the accuracy of installation contracts, shorten the time needed to process the sale, and automatically notify the installer of a sale. The new tool ensures the right questions are asked and provides links to additional products that may be needed to complete the installation. This tool is in pilot and will be rolling into all stores in the chain over the next several months.

We are also the first national retailer to offer an integrated counter top design module. The new module coupled with recent enhancements to our cabinet design software now allows a Lowe's cabinet specialist to build a complete kitchen detail, including cabinets, counter tops, and appliances from a single design tool. This too is the first in the industry. This tool is also in pilot in a number of stores and should be rolled out through the remainder of the chain by the end of the year.

As Rob mentioned in the past, we are focused on the integration of our store and online experience. We believe that retail customers demand a seamless experience between the web and our stores. We provide an example of this integration with the launch of our online kitchen visualization tool in January of this year. This tool allows customer to design their dream kitchen on Lowes.com and recall that any store in the chain to be used as a starting point for a final design in our 20/20 kitchen design tool. Another example was launched in late October with the introduction of Lowe's online gift registry. The gift registry is now available via Lowes.com and allows customers to create a registry for special occasions such as weddings, new homes, holidays, and even projects. We are also piloting kiosk and hand-held technology in two markets that allow customers to build their registry in the store. As with the kitchen design tools, all of this information is captured and centrally stored making it instantly available to any store in the chain and on Lowes.com.

As you can probably tell, 2006 has been an extremely busy one for our Lowe's IT organization. Our combined technology and business teams have spent countless hours delivering the functionality needed to support current and future company initiatives. And that's the final topic I would like to cover today. A glimpse into the future for Lowe's, specifically as it relates to technology.

Our vision for the future is built around the simple concept of customer choice. We believe customers will demand the ability to be able to interact with Lowe's in the manners that are most convenient for them. This can mean i the store, on the web, over the phone, at a kiosk, or even from their hand held cell phone or PDA. We will also expect -- they will also expect the same high-level of service and the seamless integration of the information across all channels. So imagine the following scenario. The customer is researching lawn tractors and he visits the Lowe's store to see our new product offering.

At home the customer continues his research by visiting the Lowe's website to do side by side comparisons on price and features. As the customer completes his research on Lowe's.com he's asked if he would like to receive information on future new products and offers. Customer clicks yes and builds a quick profile that allows Lowe's to contact him in the future. Lowe's soon sends an e-mail to the customer announcing a new line of zero turn radius tractors and special 12-month financing. The customer's enticed by the offer and decides to buy the Lowe's tractor on line. He creates a convenient delivery time, provides tender information, and completes the sale. The tractor's delivered to the customer's door. The customer now goes back to Lowe's.com and opens his profile to view his most recent purchases. He notices an option to enroll in a free Lowe's notification service.

Using customer supplied information, Lowe's builds a customized service plan and allows the customer to opt in to automatic notifications such as when to change the oil, when and how to winterize the tractor, et cetera. The customer has access to warranty data, owners manuals, and accessory and parts list online. As the manufacturers basic warranty is about to expire, the customer receives an e-mail notifying him of this and that the tractor is covered. A couple years later, the couple decides to replace the blade on the mower and goes back to his profile to pull up the parts list. The customer clicks on the parts needed and places the order selecting to have it delivered to his home. Hopefully this doesn't sound too far fetched. Needing some building blocks needed to deliver these services are already in place. To help us in our drive to provide this type of integrated service, we have developed a technology learning lab that looks not only at technology, but also relevant customer trends that we receive from our research group. This lab allows us to experiment with different technologies to match societal trends and fine tune the customer experience.

Focused execution on our technology priorities has allowed our IT organization to deliver value to our business and to our customers. The same sense of execution when matched with an obsession for providing the best customer experience is driving many of our new innovations. Hopefully this discussion has provided you with more insight into Lowe's commitment to use technology investments to build our long-term vision of being the home improvement retailer of choice. Now I'd like to turn the call over to Bob Hull to provide the details of our financial results. Bob?

Thanks, Steve. And good morning, everyone. As Robert indicated, sales for the third quarter were $11.2 billion representing a 5.8% increase over last year's third quarter. For the first 9 months of 2006, sales increased 12.6% to $36.5 billion. Comp sales were negative 4% for the quarter on top of a positive 6.2% comp in Q3 2005. As a reminder, last year's comp results included an estimated 100 basis point positive impact from the sales associated with hurricane-affected markets. Given the mild storm season in 2006, this resulted in a negative impact of approximately 100 basis points on this year's third quarter comp sales results.

Looking at monthly trends, comps were flat in August, negative 3% in September, down 8% for October. This compares to 2005 comps of 3% in August, 5% in September, and 10% in October. Last year's upper trend was driven in part by last year's hurricane activity. The two-year comp trend for Q3 was relatively constant at 2 to 3% for each month. For the first three quarters of 2006 comp sales were 1.7%. Comp sales for the same period last year were 5.5%. In Q3, average tickets decreased 1.3% to $67.97 while total customer count increased over 7%. Comp transactions were down 1.7% in the quarter.

Lumber deflation negatively impacted third quarter comps by approximately 70 basis points. This was somewhat offset by inflation in building materials. With regard to product categories, the categories that performed above average in the third quarter include rough plumbing, rough electrical, hardware, home environment, paint, fashion plumbing, lighting, flooring, nursery, seasonal living, home organization, and lawn, and landscape products. In addition, building materials, tools, and cabinets countertops performed at approximately the overall corporate average. As Robert noted, lumber and outdoor power equipment were our worst performing category and both had double digit negative comps for the quarter.

Gross margin for the third quarter was 34.5%, which was a 67 basis point increase compared with Q3 2005. Last year's third quarter gross margin was negatively impacted by the sale of hurricane-related products that typically have a lower margin than the Company average. This factor as well as the lower sales in lumber and OPE, which are lower margin categories resulted in a 42 basis point positive sales mix impact in Q3 this year. Also, on our second quarter earnings call, we described the impact associated with accelerated markdowns to sell through seasonal inventory, which reduced the impact of markdowns in the third quarter this year relative to last year.

Lastly, a greater proportion of imported goods aided margin in the quarter. These items were slightly offset by higher inventory shrink as a percent to sales in a slowing environment. Year-to-date gross margin of 34.3% represents an increase of 33 basis points over the first 9 months of 2005. SG&A for Q3 was 20.7% of sales and leveraged 18 basis points driven by bonus, retirement, and insurance expenses. As we have described in the past, our bonus and retirement expenses moved up and down with the Company's sales and earnings performance. The leverage experienced in the third quarter was a result of adjusting accruals based on our current forecast. We expect bonus and retirement expenses to be approximately $225 million lower in 2006 versus 2005, driving about 50 basis points of expense leverage for the year. In Q3, these items leveraged 99 basis points.

In addition, we saw insurance expense leverage in the quarter associated with our ongoing safety initiatives and the benefits of some regulatory changes. Our efforts over the past several years to maintain a safe shopping and working environment have resulted in a reduction in both claim incidents and severity. These efforts as well as state regulatory changes contributed to actuarial projections of lower costs to settle current and future claims which led to a reduction of our actuarially determined insurance reserves. This change drove 34 basis points of insurance expense leverage for the quarter. These items were offset by deleverage in store payroll.

As Nick Canter highlighted during our September analyst and investor conference, we have a store staffing model that adjusts hours by store, by department based on forecasted sales. The staffing model has a base level that is the minimum number of hours to operate a store to maintain our customer service standards. As sales slowed, our stores adjusted their hours accordingly. However, because of the base staffing requirement, we did not reduce payroll at the same rate at sales and put our customer service standards at risk. As a result store payroll expense deleveraged 62 basis points in the third quarter.

I would like to make one additional point regarding our store payroll and our staffing model. Thinking about two Lowe's stores with a similar product sales mix generating the same sales volume per week. These stores would have the same complement of hours under our model. This would be true in the first quarter or the third quarter. This would also be true if one store was comping positive and the other negative. The only difference here would be that the store comping positive would have more hours in the prior year and the store comping negative would have fewer hours due to the change in sales from the prior year. The bottom line is that our stores are expected to use their staffing model to determine the appropriate number of hours to support their forecasted sales and maintain service levels regardless of the sales environment.

Also in the third quarter, we deleveraged utilities, property taxes, and a number of other fixed costs due to the lower than expected sales. Year-to-date SG&A is 20.3% of sales and leveraged 42 basis points to the same period last year. Depreciation at 2.6% of sales totalled $297 million and deleveraged 33 basis points for the quarter. Operating margin defined as gross margin less SG&A and depreciation increased 52 basis points to 11.1% of sales. Year-to-date, operating margin of 11.7% represents an increase of 62 basis points over the first 9 months of 2005. Store opening costs of $44 million deleveraged 6 basis points to last year as a percent of sales.

In the third quarter, we opened 49 new stores, this compares to 33 new stores opened in Q3 last year. Interest expense at $45 million deleveraged 6 basis points as a percent of sales. For the quarter total expenses were 24.1% of sales and deleveraged 27 basis points. Pretax earnings for the quarter were 10.3% of sales. The effective tax rate for the quarter was 38.2% versus an effective tax rate of 38.5% for Q3 last year. Diluted earnings per share of $0.46 increased 15% over last year's $0.40. For the first 3 quarters of fiscal 2006, diluted earnings per share were up 23.3% over the same period last year. Weighted average diluted shares outstanding were 1.55 billion for the quarter. The computation of diluted shares takes into account the effect of convertible debentures which increased our third quarter weighted average shares by 22 million.

In the third quarter, we repurchased 18.8 million shares at an average price of $27.24 for a total repurchase amount of $511 million. For the year, we have repurchased 56.8 million shares at an average price of $30.56 for a total repurchase amount of just over $1.7 billion. We have $1.5 billion remaining share repurchase authorization. Now, to a few items on the balance sheet.

Our cash and cash equivalence balance at the end of the quarter was $657 million. Inventory turnover was 4.4, an increase of 1 basis points from Q3 2005. Our third quarter inventory balance increased $834 million or 12.3% versus Q3 last year. Of this increase, 84% was from new or noncomp stores and 16% in distribution with comp store inventory essentially flat to last year. The increase in noncomp store inventory is driven by the addition of 161 new stores opened over the past four quarters and the inventory builds associated with this year's Q4 openings. At the end of the third quarter, we owned 85% of our stores versus 83% at the end of the third quarter last year. In the third quarter we issued $1 billion of senior unsecured bonds in two tranches, $550 million of ten-year bonds with a 5.4% interest rate and a $450 million 30-year issue with a 5.8% interest rate. The proceeds of the bonds will be used for general corporate repurchases and to finance repurchases of our common stock.

Also, during the quarter Moody's raised our senior debt rating to A1 from A2. Our debt to total capital was 22.7% compared to 24.4% for Q3 last year. Return on invested capital measured using beginning debt and equity in a trailing four quarters earnings decreased 6 basis points for the quarter to 18.3%. Return on assets determined using beginning total assets and the trailing four quarters earnings increased 9 basis points to 12.8%. Year-to-date, cash flow from operations was $3.6 billion, an increase of almost $300 million over the first 3 quarters of 2005.

Before I get into our business outlook, I want to remind everyone that fiscal 2005 was a 53-week year, which will impact fourth quarter comparisons in two ways. First, the extra week added approximately $750 million in sales to Q4 last year. This is expected to negatively impact 2000 sales growth by 7.2% for the fourth quarter and 1.9% for the year. In addition, the additional week contributed $0.035 per share to last year's diluted earnings per share. Second, last year's 53rd week caused a calendar week shift from fiscal 2006. The calendar shift positively impacted first half sales by $150 million, but is expected to negatively impact fourth quarter sales by $150 million or 1.4%. This week shift has no impact on comparable store sales.

Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. We expect a fourth quarter sales decrease of approximately 4%, which incorporates the comp sales decline of 4 to 6%. Without the negative impacts of the comparison to the 14-week Q4 2005 and the week shift, we would expect a sales increase of 4 to 5% in the fourth quarter. We've planned to open 58 new stores in the quarter, 4 stores in November, 11 stores in December, and 43 stores in January. Operating margin for the fourth quarter is expected to decline by approximately 150 basis points to last year. As a percentage of sales. The decline in operating margin is attributed to expected lower sales volumes associated with the anticipated comp sales decline, the comparison to last year's 14-week Q4, and the negative impact of the week shift. The lower sales forecast will cause deleverage and depreciation and other fixed costs. In addition, we expect store payroll deleverage of approximately 70 basis points. The income tax rate is forecasted to be 38.2% for the fourth quarter.

We expect diluted earnings per share of $0.36 to $0.38, which represents a decline of 12 to 16% over last year's $0.43. Without the $0.035 positive earnings impact of the 53rd week on last year's fourth quarter we would expect a diluted earnings per share decline of 4 to 9%. For 2006 we expect to open 155 stores, including 4 relocations, resulting in an increase in square footage of approximately 12%. We're estimating comp sales to be essentially flat to last year and a total sales increase of approximately 9%. For the entire fiscal year, we are anticipating an operating margin increase 10 to 20 basis points, which, coupled with our sales increase should drive diluted earnings per share of $1.95 to $1.97, which represents a 13 to 14% increase over our 53-week fiscal 2005 or 15 to 16% on a 52 versus 52-week basis.

Regarding current sales trends, I mentioned earlier that our business outlook for the fourth quarter anticipates a comp sales decline of 4 to 6%. For the first week of the quarter, our comp sales were below this range but improved to the low end of this range for the second week of the quarter. Our comp sales in November of 2005 were 10%. Before I turn the call over to the operator for questions, I'd like to mention that in addition to Robert, Steve, and I, other members of our management team are present for the question and answer session. We're now ready for questions.

[OPERATOR INSTRUCTIONS] And your first question comes from Deborah Weinswig with Citigroup.

Good morning. In the second quarter call you talked about the more difficult promotional environment, can you compare and contrast that to what you saw in the first quarter? and can you also specifically discuss the appliance category? Also kind of as an addendum to that question, you had said that you had gained market share in 18 of 20 categories, can you give us specific market share increases in the top categories and once again, can you specifically focus on appliances?

Deborah, this is Larry Stone. On the promotional environment third quarter we didn't see anything much stronger than we had throughout the whole year. Certainly as we roll into the fourth quarter, we expect to see some promotional activity such in appliances and items like that. Our appliance business was good for the quarter and certainly one of the strong numbers that Robert and Bob boasted about last year in a lot of the hurricane-affected areas. We had very strong sales in the third quarter last year in refrigeration as an example. And overall our appliance and high efficiency products such as laundry and high efficiency refrigeration still remains very strong. So our strategy of selling to higher price points seems to still be working overall in our appliance categories.

And did you have anything in terms of specific market share gains? I think you said it was 90 basis points in total?

Deborah, it's Robert, it's 90 basis points in total on a unit share basis comparing the third quarter to this year to last year, where we saw some of the larger gains were categories such as fashion bath, flooring, lighting, lawn and landscape, and millwork. So those were some of the categories that we saw the largest share gains in. So and as Larry said, nothing significantly different from a promotional strategy we saw in the -- as far as the intensity of it. In an environment like this where the consumers pulled back a little bit. We're just trying to certainly watch all of the competitive promotions that are out there and being more diligent as the way we go to looking our promotional strategy to make sure that we are putting promotions out there that we think the consumer will respond to so that we're driving enough incremental sales from those promotions to justify the promotion and also as I said my comments balancing the impact of those promotions on margin and sales.

Okay. Well, thank you, and good job in managing in a tough environment.

Thanks.

Your next question comes from Mark Rowen with Prudential.

Thanks, good morning. I was wondering on the lumber deflation and I assume the other building materials deflation, does it look to you like that's bottomed out, at least for now? And how much impact do you expect that to have over the next three quarters on your comps? Thanks.

Mark, this is Bob Hull. It looks like it may in fact be close to bottoming out. The average lumber deflation in Q3 was about 23% and 37% for plywood. As of last week, lumber's about the same place and plywood is only down 29%. We've seen some improvement there. We think it'll be some additional head winds in the fourth quarter, maybe 50 basis points or so impact on Q4. Some slight negative impact in the first half of next year, and hopefully flat to positive in the second half of 2007.

Okay and then just to follow-up on the competitive environment. Given the fact that sales are weak and comps are negative, are you planning that -- in your numbers, are you looking for more promotional activity in the first half of next year? I guess you sort of have to see what the competition does for the fourth quarter. But generally, do you think you're going to have to stimulate sales with better pricing?

Mark, this is Larry Stone, we're still very committed to our every day low pricing strategy, but certainly we'll respond to competitive pressures in the market. We anticipate some competitive pressures, possibly in the fourth quarter in certain categories, but overall it seems to be very rational when looking at all the competition that we go against each and every day. We really don't anticipate anything different than we've had in the past couple years in the fourth quarter. As you know, it's a large category for special items like power tools and certain other home improvement type items like appliances and small appliances and vacuum cleaners and even some of our larger purchases like flooring early in the fourth quarter. As you get closer to Christmas, a lot of those items have a tendency to slow down as people get ready for the holidays. We will respond as needed, but overall we haven't seen anything on the horizon that gives us any more concern than it did, say last year, at this same time.

Okay. Great. Thank you.

Your next question comes from Michael Baker with Deutsche Bank.

Hi, guys, thanks. Just wondering if you could comment on where this, what we're thinking numerically for next year. Clearly it sounds like what you talked about September for '07 is probably too high. Any idea of the order of magnitude? And then I guess related to that, what does give you the confidence that things will get better in the back half of the year? Is it just easy comparisons? Love your comments on that. Thanks.

Mike, this is Robert Niblock. We're finalizing our plans now for next year. The final detailed operating plans for 2007. Obviously we've got some strong numbers we're going up against in the first quarter. When you look at housing turnover out there running down currently about three times what we'd anticipated going into the year. But as we look out in some of the markets, we think some of them will start bottoming, first to second quarter of next year from a pressure on housing, in some of those markets, the West Coast is probably going to lag a little bit. It's probably later 2007 maybe first part of 2008. But as we get, so we think we are going to still see some pressure in the first half, but as you get into the second half, certainly we don't think we're going to have the tough comparisons to go up against. You're not going to have the hurricane related activities that we'll be going up against and certainly as Bob just went through on commodity price deflation and lumber and building materials we think at a minimum it's going to be flat to maybe even slightly positive. We put all those together. It just shouldn't be a challenging of an environment.

That gives us the confidence that all else being equal, second half of next year, we should start trending more favorably from a comp sales standpoint. So that's the way we're approaching the year. We're approaching it very conservatively in our planning now. As I said, still probably have pressure on comps first half, but then a little bit of a rebound there in the second half. From a housing market, as I said, other than California, we think you'll cycle through most of those next year. Whether or not it bounces along the bottom there for a little bit, I don't know, I don't know, but we think that the most of the deflation, the negative impact on housing turns so on so forth will be behind us halfway through the next year.

Okay. That makes sense. If I could follow-up real quick just a couple things. November a year ago, Robert, or Bob Hull you said was down -- up 10%, is that the toughest comparison of the quarter? And then also for Mr. Hull, the bonuses that helped you this quarter. Have you caught up in your accruals? I imagine that doesn't help in the fourth quarter?

As it relates to the fourth quarter last year, monthly comps last year were 10 in November, 4 in December, and 10 again in January. So that helps you with last year's trends. As it relates to the bonus accrual, basically every month we go through a process to evaluate where we expect to pay out relative to our sales and earnings performance. And we true up our accrual accordingly. As I mentioned 99 basis points of leverage in Q3, 50 basis points or so for the year, that will be somewhere in the neighborhood of 40 basis points in the fourth quarter, so continued leverage in the fourth quarter, just not to the extent that we saw in the third quarter. And it's actually if you combine bonus and retirement, it's actually 70 basis points of leverage in the fourth quarter relative to the 99 basis points.

Okay. Thanks a lot.

Certainly.

Your next question comes from Eric Bosshard from Cleveland Research.

Good morning.

Morning.

Two things, first of all, inventories you reported look like they're up 12% and sales are up 6, can you help us just understand how you're comfortable with your inventory position and how that might trend or how you might manage that as we go through 4Q?

Sure, Eric, this is Mike Mabry. Obviously when you go through that sales trend we saw in that third quarter, we were chasing the inventory down. Overall we feel we're in good position with our inventory, quality's good. If you look at, Bob covered 85% of our inventory growth was in new stores, or 84%, 16 was in our DCs, that's our opportunity, and if you look at that, two big buckets that drove that. One was our bet on the buying inventory to support the hurricane. That did not appear this year.

The biggest bucket of that is OPE generators, we're deploying that up to the northeast, that's not inventory we're concerned about. The other big bet we made was on the year round markets with our seasonal product. That inventory's good inventory, it's inventory we'll stock in our stores this next year, and we intend to sell through it. Those initiatives that I covered with you at the analyst meeting are still going well. We have both our trans holds open, which should help us with our imports and deployment of inventory, our warehouse express initiatives, especially concerning appliances that allow us to deploy appliances using our distribution center without the same level of inventory investment continues to roll out and do well. And our process of opening new stores with less inventory continues to do well. Overall we feel good about the quality of our inventory and don't see anything that gives us a concern.

Eric, if I could follow-on. If you think about the fourth quarter if you exclude the comparison impacts of the 53rd week and the week shift. We should see normalized -- comparable sales growth of 4 to 5% in Q4, inventory should be up 10 to 11%. We'll deleverage inventory again in Q4, but we are committed to our longer term goal of growing inventory at 75% of rate of sales and think that's achievable in 2007.

Eric, this is Robert Niblock, just want to add that, part of the thing that we try is we manage the Company and pride ourself on is as we see changes out there in the market, we try and react, but not over react to those changes. Bob Hull obviously took you through our comp sales trends for the quarter. So as Mike Mabry and his team are sitting there looking at, we are constantly reprojecting and forecasting sales trends, some of the stuff has longer lead times on the buying that we're doing, so we're making the necessary changes to those trends. We did take you through the impact from the hurricane related inventory and certainly we're redeploying some of those generators to the northeast and driving some sales up there as we're seeing adverse weather in some of those markets.

So we are approaching inventory in a very disciplined manner. It's something we started on midway through the quarters as we saw sales trend changing starting -- adjusting the forecast and pulling back on the buying and actually for the first two weeks of the fourth quarter, inventories continue to trend down each week. We're doing it in a very disciplined manner, nothing out there that we think we've got any inventory that's going to be a concern for us from a writeoff or anything like that.

But Bob Hull, I'm correct that inventory should grow faster than normal sales in 4Q? Is that right? Q4 would be up 10 or 11% in sales excluding the calendar would be up 4 to 5, so we'll see the same drill in the fourth quarter?

That's correct. And as Mike said some of the items that contributed to the Q3 increase generators, similar buys for year-round seasonal markets that's inventory that will continue to sell through in the fourth quarter and into spring of 2007. So some of the -- some of the items that contributed to the deleverage this quarter will continue into next quarter just at a lesser degree.

Thank you.

Thank you.

Your next question comes from Matthew Fassler with Goldman Sachs.

Thanks a lot, good morning. I want to follow-up on the inventory question. You talked about your markdowns being down a bit sequentially given that you've taken some medicine at the end of the second quarter. That said, with the inventories that you have and it looks like with the margins haven't been up as much as they were in Q3, you sort of bypassed the opportunity to mark down more aggressively. Is there kind of a point of reckoning over the next quarter or two when you have to take margins down somewhat further just to kind of clear out the product? It sounds like inventories are flat on a comp store basis, but if comps are down 4 to 6% and not really improving at this point, wouldn't you want to aim for tighter rather than sort of accept kind of a consistent deleveraging there?

Matt, it's Larry Stone, I'll start off on this quarter. In the second quarter we did accelerate some of our markdowns on seasonal goods and certainly as an example on patio furniture, we sold through the items that we did not want to carry over into '07. I guess if you look at an area that we possibly made, we wanted to have patio and grills and products like that in year-round markets and really test the water in terms of how much sales we could drive. So we erred on the high side in terms of putting inventory on those markets. This is the '07 products that we put out there, so certainly the risk is very limited because the product will sell in '07 and it's a '07 line that we put in here. But we erred on the high side of putting more inventory in those markets to see how much sales we could drive.

Our comps have been good in those year-round markets on these categories, but certainly, looking back the mistake that I think that I made was probably too much inventory on those certain categories. But in terms of overall quality of the inventory, we're very confident in our inventory, and certainly there's programs, if you look at programs everything's changing constantly. Give you a couple of examples right now, seasonal heat has not started off as strong. Because we've had a -- so far the weather's not been as cold. But certainly we know it's going to be cold. Snow throwers have not started off as strong. Haven't had the snows in the northeastern part of the country yet. We know those are coming, so we certainly have the inventory in place, and you have to have the inventory in place prior to some of these seasons breaking in order to capitalize on opportunity. I feel like our inventories are in much better shape than we were a year ago on our seasonal goods.

Our trim a tree program continues to do well and certainly we feel good about quality of that inventory and sell through of that as we get closer to the Christmas season. So overall we're confident of it and I don't see a need to take drastic markdowns from product that really would not gain anything because the products could sell with inventory and we're ready for the next season. And we've got to start thinking now a lot of our inventory for the '07 seasons as we get through the '06 final 10 or 11 weeks of this year.

Fair enough, and then as we look at your comp guidance, just by way of follow-up, the two-year run rate which you cited attracted about 2% for the quarter overall. And you intimated that you started off relatively light in November, but essentially and finished light in October and started off light in November, but essentially in line with that trend. Is there any reason to expect that you might actually bounce back to the high end of that negative 4 to negative 6 range? Given that you have a soft December but it's bookended by very good November and January a year ago?

This is Robert. Yes, I think a lot, I think there is opportunity to bounce back to that. A lot of it obviously will impact on what is, what does the weather do to us in January. We always talk about it every year, January is the month that it's -- you don't know how tough the winter's going to be and how much that's going to impact your sales. But so I think some of it will be subject to that. I think there is still a reasonable opportunity to be able to get to the tighter end of that range.

And just one final comment on the markdown, just want to make sure clear. We didn't delay, avoid, or decided not to do any markdowns during the third quarter from the margin standpoint. We look at that depending on where we're at with the season, with the seasonality, with merchandise, where we stand in the quarter, so on and so forth. Just like in the second quarter we accelerated some because we wanted to make sure in a slowing sales environment we were out of those seasonal categories early. We're not at that point yet. Obviously with the seasonal merchandise that is in and stuff that would have otherwise been marked down had already had a good sell-through. Once again we feel good about the overall inventory.

Thank you for the clarity.

I think we have time for one more question.

Okay, your final question comes from Chris Horvers with Bear Stearns.

Thank you very much. As we think about the bonus and retirement accruals, looking into the first half of next year, do you expect continued benefits because you were still accruing earlier this year? And would they be less on a run rate?

We did have some slight leverage in the first quarter from bonus and retirement. As we indicated at the analyst conference in September, those will be likely head winds in 2007. We would likely return to more normalized payouts in 2007 as our performance improves especially in the back half of the year. Our plan going into 2007 would be to have some level of deleverage for incentive compensation. Obviously the opportunity in 2007 is to offset that with payroll leverage.

Got you. And then on the -- similarly on the mix benefit that you get from the hurricane, the hurricanes related to sales, how long is that tail wind? And is that something that we could look forward to as well in the first half?

There could be some slight benefit in the first half. Really the lion's share of the hurricane -- the benefit we received it from a sales standpoint was Q3 and Q4 last year. So some benefit again in the fourth quarter from that starting to trail off to more modest impacts in the first half of next year.

This is Robert. Robert Niblock -- from the hurricane impact on mix, obviously immediately after hurricanes, generally you're selling a lot of those lower margin -- going into and immediately after the response to the hurricane -- lower margin items. Even those we've talked to can be a tail of maybe up to a year on a hurricane. As you get further and further away from the actual event, hurricane event, the consumer normally starts moving inside the home, which generally has some of the higher margin goods associated with it. As Bob said, more of that impact is the first quarter or two after the hurricane. It lessened somewhat after that.

Thank you. And finally as we -- you talked about a negative one on a rolling four quarter basis is where you saw the potential comp downside in this housing cycle. Do you have any updated thoughts on that?

Well, I think based on our performance in Q3 and the guidance in Q4, there's an opportunity for it to get little bit worse than that. Especially as we talked about a challenging environment in the first half of the year. But I would not -- you shouldn't get significantly worse than that.

Were you referring to some comments that were made at our analyst conference?

Yes.

Yes, I think that was historical, not forecasted information, obviously, and certainly we'll see how tough the first and second quarter is. I think from a negative comp standpoint because we've got tough comparisons we're going against. I think the fourth quarters hopefully where we'll kind of bottom out. Even though we'll probably likely still be negative in the first quarter, maybe second quarter, I think you start to see improving overall trends from a comp standpoint.

Thank you. I think that makes a lot of sense.

Okay. Well, thanks and as always, thank you for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter results in February. Good-bye.

This concludes today's conference call, you may now disconnect.