勞氏公司 (LOW) 2013 Q3 法說會逐字稿

Good morning, everyone, and welcome to Lowe's Company's third-quarter 2013 earnings conference call.

This call is being recorded.

(Operator Instructions).

Supplemental reference slides are available on Lowe's Investor Relations website within the investor packet.

While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the Company's results and to be used as a reference document following the call.

During this call, management will be using certain non-GAAP financial measures.

The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.

Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Management's expectations and opinions reflected in those statements are subject to risks and the Company can give no assurance that they will prove to be correct.

Those risks are described in the Company's earnings release and its filings with the Securities and Exchange Commission.

Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer; Mr. Greg Bridgeford, Chief Customer Officer; and Mr. Bob Hull, Chief Financial Officer.

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

Please go ahead, sir.

Good morning and thanks for your interest in Lowe's.

I am pleased that we have delivered another solid quarter driven by balanced performance.

Comparable sales for the quarter were 6.2% once again driven by balance of ticket and transaction growth.

We drove positive comps in 11 of our 12 product categories in the quarter.

In fact outdoor power equipment, the only outlier, was achieving solid positive comps until the last week of the quarter when faced with the substantial headwind from the sales generators, the result of Superstorm Sandy.

We also saw strength in all regions of the country with double-digit comp performance in Florida as well as particular strength in California and Arizona.

Markets where the housing recovery is well underway.

And our pro-services business continued to do well across the country.

Our balanced performance is a testament to our enhanced sales and operations planning process, the plot of the stronger base we've been building with value improvement, positive differentiation, and our store labor investment.

I am also pleased with our performance in Canada.

We have a new leadership team in place and for the second consecutive quarter they've delivered double-digit comps in local currency.

Gross margin expanded 26 basis points.

We effectively controlled expenses and we delivered earnings per share of $0.47 for the quarter, a 34.3% increase to last year's third quarter.

Delivering on our commitment to return excess cash to shareholders, in the third quarter we repurchased $761 million of stock and paid $191 million of dividends.

As I mentioned, we have enhanced our sales and operations planning effort, a process that is led by our customer experience design team within Greg's organization.

The intent is to better understand and anchor around the consumer mindset season to season and to change the way we go to market through coordinated planning across channels that binds together every function of our organization.

That cross functional effort has produced a comprehensive and coordinated view of the path ahead, allowing us to leverage resources to drive sales and margin.

Greg will provide more details in a few minutes, leveraging our All for Fall campaign as a tangible example of this effort.

Now looking at the consumer landscape going forward, our most recent consumer sentiment study suggests that consumers are adapting to a more resilient mindset and as a result embracing a broader perspective.

During the recession, consumers had a very focused perspective, the result of household budgetary constraints.

Their primary concern was how to adapt to what felt like a freefall.

That perspective is starting to broaden as consumers have gained a foothold and we are seeing it play out in strengthening home-improvement affinity metrics, an increasing number of installed sales leads, as well as in the strength of large project category performance.

So despite the recent government shutdown and fall off in home affordability, the home-improvement industry is poised for persisting growth in the fourth quarter.

Based on our year-to-date performance and outlook for the balance of the year, we have raised our fiscal year 2013 guidance.

We expect further acceleration of industry growth next year, stronger job and income growth, improving household financial conditions, and the lighting benefit of the recovery in home buying will be the key drivers.

In closing, our sales and operations planning process applied to the strong base we've been building with value improvement, core differentiation, and our store labor investment together with our associates' hard work and continued dedication to serving customers has improved our level of execution, allowing us to more fully capitalize on market demand in 2013.

Thanks again for your interest and with that, let me turn the call over to Greg.

Thanks, Robert.

Good morning, everyone.

Our third-quarter performance reflected our improving collaboration and execution within a strengthening home-improvement market.

We performed particularly well in large project categories such as flooring, kitchens, and appliances.

The strength of these large project categories reflects an emerging willingness among consumers to finally replace items that are worn or outdated or to make significant enhancements to their homes.

Large project discretionary spending is still far below pre-recession peaks but we are seeing steady improvement.

We also performed well in fashion, fixtures, and paint as we were well prepared the right products and advice to assist customers as they spruced up their interiors in advance of the holidays.

We are pleased that our improved performance is enabling us to take advantage of home-improvement market growth.

This is due in large part to our enhanced sales and operations planning process.

Through this process we have addressed an opportunity to improve seasonal planning, including the cadence of product introductions, promotions, and staffing.

We have always planned and executed these seasons in our stores.

Previous planning was completed function by function and reconciled to minimize conflicts.

Now the process starts earlier and is anchored on a customer mindset for the season.

The process more thoroughly considers detailed input from all functions to determine resource allocation and it enables Lowe's to provide a consistent message and experience across all selling channels -- stores, Lowe's.com, contact centers, and in-home selling.

Our recent All for Fall campaign which ran from late August through the end of October is a great example of how the enhanced process works.

Our planning began earlier than it would have under the legacy process and instead of each function separately developing its own plan to achieve our comp and margin targets; we started with two key customer mindsets for the fall.

First, customers want to complete fall maintenance projects such as prepping the lawn for next spring, planting, and ceiling windows and doors to save energy during the winter.

And then they transition to make their home's interior more inviting to holiday guests.

We anchored on the mindsets to determine the projects customers would complete, the key products needed, which of those products should be promoted to drive traffic, what products should we merchandise nearby as project completers helping to build the basket, how much inventory will be needed, when it would need to be available, and what staffing and training was needed for each store department.

Then we staged the introduction of new product and sets based on climatic zone.

This planning process, while capturing input from many different teams, was centrally managed by Bob Gfeller's customer experienced design team.

Bob's team communicated the final plans both the underlying insights and the implementation steps.

This approach drove better understanding of each function's role and the plan's success and consistency of execution across channels.

This season's theme, All for Fall, was also clearly and consistently messaged across all media and was used in themed store displays built for cross merchandising.

We believe that our particularly strong performance in fall interior project categories like flooring, kitchens and appliances, fashion fixtures, and paint is evidence that our coordinated All for Fall campaign resonated well with customers.

Remember, this enhanced sales and operations planning process is made more effective by other elements of our transformation undertaken since 2011, including the organizational changes we made last year; our product differentiation initiative, which drives customer engagement through better display techniques and facilitate the smooth execution of seasonal themes and product introductions; and our value improvement initiative, which is providing the right product assortments and inventory depth by location.

All these elements work in concert to improve the customer experience.

Having just mentioned value improvement, I would like to take a moment to update you on the progress of this initiative.

At the end of the third quarter, we've completed resets representing approximately 80% of our business and we expect to substantially complete the initial round of resets in 2013.

As a reminder, the financial benefit of value improvement is greatest once we have reached stabilization.

That is when we are past clearance and selling only new assortments.

We estimate that roughly two-thirds of our business was at this stage at the end of the third quarter.

Value improvement is captured in our improved comp performance and we continue to obtain average gross margin rate improvement of roughly 100 basis points for product lines that have reached stabilization.

Beginning in 2014, value improvement will be fully operationalized and no longer separately tracked as an initiative.

Examples of resets completed in the third quarter include core products like thermostats and electoral tools; the core products such as wall sconces and decorative shelving and seasonal products such as leaf blowers and fireplace gas logs.

In addition to the value improvement resets, we are investing to improve the customer's in-store experience.

One example of our implementation -- is our implementation of mobile functionality that helps customers locate products in our stores.

Customers can create a shopping list and plan their route before arriving at the store.

While there, they can check items off the list as they shop, ensuring they get everything they need accurately and efficiently.

We will share further plans to improve our customer experience as we enter 2014.

Likewise, we continue to invest in inventory.

Using intelligence provided by value improvement together with our sales and operations planning process, we are leaning into increasing demand as we bolster job lot quantities to benefit pros, increase overall in-stock service levels, and present compelling end cap displays.

We expect that these incremental inventory investments will be completed this year and will be positioned to achieve greater inventory productivity.

We have also invested in additional weekday labor hours to improve close rates.

As a reminder, we added an average of approximately 150 hours per week to the staffing model for nearly two-thirds of our stores.

These hours were allocated to interior areas of the store supporting key fall projects identified within the sales and operations planning process.

While we realized improving benefits from this program in the third quarter, this incremental investment caused payroll deleverage as expected at this point in the program.

We continue to monitor this initiative's performance and will make adjustments as necessary.

Finally, I am pleased to share that through the first three quarters approximately 87% of our US stores have qualified for a service and sales employee initiative or SSEI payment.

As a reminder, SSEI is our profit-sharing program for hourly associates.

Thank you for your interest in Lowe's and I will now turn it over to Bob.

Thanks, Greg.

Good morning, everyone.

Sales for the third quarter were $13 billion, which was an increase of 7.3%.

Total customer transactions increased 5.7% and total average ticket increased 1.5% to $64.07.

As you know, we acquired 72 Orchard Supply Hardware stores on August 30.

Orchard's smaller format neighborhood hardware stores are located in densely populated markets and offer a product selection focused on paint, repair, and backyard categories.

As a result, Orchard stores has more transactions per square foot but fewer per store and a lower average ticket than a traditional Lowe's store.

So while Orchard aided total sales by approximately 75 basis points and added roughly 175 basis points toward transaction growth, it negatively impacted average ticket growth by almost 100 basis points.

The Orchard stores are considered non-comp and will be included in our comp sales calculation after the anniversary of the acquisition in Q3 2014.

Comp sales were 6.2% for the quarter.

Looking at monthly trends, comps were 7.3% in August, 5.6% in September, and 5.8% in October.

For the quarter, comp transactions increased 3.6% and comp average ticket increased 2.5%.

As Robert noted, our sales and operations planning process applied to a stronger base, we have been building the value improvement, product differentiation, and our store labor investment allowed us to more fully capitalize on market demand.

Additionally, inflation added roughly 25 basis points to [cuffs] while last year's hurricanes, Sandy and Isaac, were a headwind of approximately 45 basis points.

Year-to-date sales of $41.8 billion were up 5.8% versus the first three quarters of 2012, driven by a 5.1% increase in comp sales, new stores, and the acquisition of Orchard Supply Hardware.

Gross margin for the third quarter was 34.58% of sales, which increased 26 basis points over Q3 last year.

The biggest driver of the increase was value improvement, which helped gross margin by 52 basis points.

Our estimate of the improvement net the clearance impact of the resets against the benefit of the stabilized lines.

This improvement was offset somewhat by the following items.

First, our proprietary credit value proposition negatively impacted gross margin by 14 basis points.

This is driven by higher penetration of our proprietary credit program, which reached 26.6% of sales, an increase of 145 basis points over Q3 2012.

The negative margin impact was more than offset by expenses leverage associated with the program, which I will comment on in a moment.

Also, competitive pressures in the market impacted the level of appliance promotions, which reduced gross margin by an estimated 10 basis points.

Lastly, the mix of products sold modestly hurt gross margin in the quarter.

Year-to-date gross margin of 34.57% of sales is an increase of 27 basis points over the same period last year.

SG&A for Q3 was 24.56% of sales, which leveraged 47 basis points.

In the quarter, we incurred long-lived asset impairment and discontinued project expenses of $10 million.

This compares to $52 million in similar charges last year, resulting in 35 basis points of SG&A leveraged in this year's third quarter.

Risk insurance leveraged 35 basis points in the quarter.

We are self-insured for certain claims related to workers' comp and general liabilities.

Due to the duration of the claims, we discount our liability.

As discussed Q3 last year, we reduced the discount rate applied to occurred but not reported claims, which increased Q3 2012's insurance expense by $33 million and was the primary driver of expense leverage this year.

Also we experienced 31 basis points of leverage associated with our proprietary credit program.

The leverage was driven primarily by lower operating costs including costs associated with promotional financing.

Contract labor leveraged 20 basis points as we cycled against an elevated level of spending for information technology [projects] in Q3 last year.

These items were somewhat offset by incentive compensation expense, which deleveraged 41 basis points as a result of higher expected detainment levels relative to last year.

During the quarter, store payrolls deleveraged 16 basis points.

Payroll dollars were up approximately 9% versus Q3 last year, which includes the additional weekday hours investment.

Reset of our merchandising expense deleveraged 16 basis points, driven by the efforts Greg described to improve customer experiences.

Year to date, SG&A was 23.52% in sales, which leveraged 39 basis points versus the same period last year.

Depreciation for the quarter was $373 million which was 2.88% of sales and leveraged 20 basis points compared with last year's third quarter as a result of the sales growth.

In Q3, earnings before interest and taxes or EBIT, increased 93 basis points to 7.14% of sales.

Year-to-date EBIT was 8.43% of sales which was 85 basis points higher than the same period last year.

For the quarter, interest expense was $125 million, deleveraged 2 basis points to last year as a percent of sales.

Total expenses for Q3 were 28.41% of sales and leveraged 65 basis points.

Year-to-date, total expenses were 26.97% of sales and leveraged 54 basis points versus last year.

Pretax earnings for the quarter were 6.17% of sales.

The effective tax rate was 37.6%, which was essentially flat to last year.

Net earnings were $499 million for the quarter, an increase of 26% over Q3 2012.

Earnings per share of $0.47 for the third quarter were up 34.3% to last year.

The $0.47 were roughly $0.05 per share higher than our expectations.

Year-to-date earnings per share of $1.84 represents a 29.6% increase over the same period last year.

Now to a few items on the balance sheet starting with assets.

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

Our third-quarter inventory balance of $9.6 billion increased $598 million or 6.7% versus Q3 last year.

The increase was driven by higher inventory levels to support demand and the addition of 72 Orchard Supply stores.

Inventory turnover calculated by taking a trailing four quarters cost of sales divided by average inventory for the last five quarters was 3.71, a decrease of 4 basis points versus last year.

Return on assets determined using a trailing four quarters earnings divided by average assets of the last five quarters increased 98 basis points to 6.72%.

Moving on to the liability section of the balance sheet, accounts payable of $5.8 billion represented a 6.6% increase over Q3 last year, which was consistent with an increase in inventory.

In the third quarter, we issued $1 billion of unsecured bonds.

The bonds were split between 10- and 30-year issuances with a weighted average interest rate of 4.44%.

At the end of the third quarter, our lease adjusted debt to EBITDAR was 2.17 times.

Return on invested capital [determined] by using the trailing four quarters earnings plus tax adjusted interest divided by average debt and equity over the last five quarters increased 187 basis points for the quarter to 11.26%.

Looking at the statement of cash flows.

Cash flow from operations was nearly $3.9 billion, an increase of $351 million over last year, largely due to the earnings growth.

Capital expenditures were $610 million, a 36% decrease from last year.

As a result, year-to-date free cash flow of nearly $3.3 billion was 27% higher than last year.

In August, we entered into a $500 million accelerated share repurchase agreement.

At this point we expect to receive 10.5 million shares but the [ultimate] number of shares will be determined upon completion of the program in the fourth quarter.

Also in the third quarter we repurchased 5.5 additional shares for $261 million through the open market.

For the quarter, we've repurchased a total of $761 million.

We have approximately $2.2 billion remaining on share repurchase authorization.

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

Based on our year-to-date performance and our outlook for the fourth quarter, we've raised our 2013 guidance for the second time this year.

We expect total sales to increase by approximately 6%, primarily driven by comp sales increase of approximately 5%.

We expect to open nine stores for the year.

We are anticipating an EBIT increase of approximately 75 basis points.

The effective tax rate is expected to be approximately 37.8%.

As a result of these inputs, we are expecting earnings per share of approximately $2.15, which represents an increase of 27% over 2012.

For the year, we are forecasting tax flow from operations to be approximately $3.8 billion.

Our forecast for capital expenditures is approximately $900 million.

This results in estimated free cash flow $2.9 billion for 2013.

Our guidance assumes approximately $3.7 billion in share repurchases for 2013.

For the year we expect -- we suggest that debt to EBITDAR will be at or below 2.25 times.

Regina, we are now ready for questions.

(Operator Instructions).

Scot Ciccarelli, RBC Capital Markets.

Morning, guys.

Bob, can you give us any more details on the impact that Orchard had on the quarter, specifically on gross margin and SG&A?

I know you listed out some items already on SG&A but particularly curious on that line item.

Scot, Orchard had a relatively modest impact.

I gave you the sales impact, which was 75 basis points.

Orchard's gross margin is modestly higher than the Company's, but remember we only had two months of activity in the three month's order.

From an SG&A perspective, not much impact other than we had roughly 5 basis points of (inaudible) related expenses included in the quarter.

That obviously was included in our guidance for the quarter but would not have been included in Q3 last year.

And then the compensation that you noted, the 41 basis points, that is executive compensation?

Is that separate from the incentive comp for the stores?

Can you just give us some more clarity on that and kind of the way to think about that part going forward?

Thanks.

Scot, that is all incentive compensation.

That would include the SSEI that Greg spoke of that is entirely store-based.

That would be the store manager program.

That would be DCs and that would be the corporate office.

By far the largest share of that expense is stores.

Also recognize that there's some timing involved in the accruals for incentive compensation.

So while it's up 41 basis points to last year in the third quarter, it's only expected to be up roughly 15 basis points to last year for the year.

So think about the rate of accrual this year versus last year.

It did have a pronounced impact on Q3 this year.

All right, very helpful.

Thanks, guys.

Dennis McGill, Zelman and Associates.

Good morning.

I was wondering if you could just talk about how you are thinking about the pace of growth transitioning from 3Q into 4Q, if you take the approximate 6% in comps this quarter and then the pace down to I guess 4-ish implied by the guidance.

Dennis, I will start.

Certainly there's a couple things that we spoke about.

Certainly cycling against Hurricane Superstorm Sandy last year and the sales associated with that, so that's obviously a headwind in the quarter.

As you know, most years, the fourth quarter is probably our most weather-susceptible quarter and so certainly not knowing what the weather is going to hold -- last year if you remember, the month of January had extremely favorable weather so we are cycling up against -- even if it's not unfavorable weather this year, we are cycling against very favorable weather last year.

So we took all of that into account and so as is just the case, we always want to be somewhat conservative because of the unknown that's out there.

So all of those would be implied into topline in the comp guidance was in our updated outlook.

Okay, just based on the last comment on the conservatism, is it fair to say that November so far is running above that guidance?

Yes, I don't think you would've seen us say our guidance up if we weren't comfortable with our outlook for the balance of the year.

Okay, just secondly, can you elaborate a little bit more on the appliance promotion headwind that you talked about in the quarter?

Dennis, this is Greg Bridgeford.

I will be happy to elaborate on that.

It is a -- relative to larger tickets categories and appliances is the key one.

It is more of a promotional environment out there and there's a lot of media out there.

We indicated early on in the year we are going to drive at -- what we believe to be an effective blend of traffic driving, promotional activities, and especially through the sales and operations planning process, make sure we are coordinated across the channels and across the messages we are sending and especially in store.

That's what we did in Q3.

It was as promotional as we expected it to be and there's a -- this is a peak period for appliance sales pre-Thanksgiving, so we did see -- we performed well and appliances.

One of our best-performing categories.

And we are excited.

The addition of LG this year has meant a lot to be a leader in innovation in appliances, with both LG and Samsung promoted and highlighted on our floors.

Okay, thank you.

Mike Baker, Deutsche Bank.

You talked about the large product discretionary of sales still being below past peak.

Can you talk about -- can you sort of quantify that where you are with past peak and also the trough after the recession?

And I didn't hear -- maybe I missed it, but I didn't hear you talk about growth in tickets less than $50 or greater than $500 as you sometime talk about.

Mike, we have those figures and we will come back to that, but let me start by giving you some context.

We have done that 2 by 2 that you've seen so often about small ticket, large ticket, nondiscretionary, discretionary.

And in the discretionary large ticket category, it really hasn't moved appreciably.

We are seeing in sales of some movement but we think it's from a -- it is a relatively small segment of the market right now that has the income that it feels confident to spend on some discretionary categories.

But overall, we still think it's a slow build because as we've tracked this through the last six years, we are still seeing that large discretionary spend inch up as opposed to make some significant leaps.

Bob, do you want to talk about ticket?

This is Robert.

On the slides that we provide for you, that detail is in those slides on ticket size but I will give it to you, less than $50, up 3%; $50 to $500, up 5.6%; greater than $500, up 8.6%.

Thanks, I haven't seen the slides yet.

One last question just (inaudible) this quarter there was some incentive comp and other things but can you remind us the kind of comp that you feel like you need to leverage your SG&A excluding all one-timers that show up?

Like we've talked about, generally speaking we need a 1 comp to get to a flattish and then beyond that, 1 point of comp drives roughly 20 basis points of EBIT growth.

Obviously my response to Scott's question, I mentioned there is some fluctuation quarter to quarter in how incentive compensations accrued relative to last year, so that had a pronounced impact this year.

Also in both Greg's and my comments, we talked about reset, reemerge activity.

Think about that as preparing for next year's sales.

We are creating value improvement resets and customer experiences that are going to invest Q4 and beyond, so that's not necessarily periodic expense, more of an investment for future sales.

Generally we can keep that rule of thumb for on an annual basis?

Generally speaking, yes.

All right.

Peter Benedict, Robert Baird.

All right, guys, thanks.

Just one thing on the third quarter.

You said that the earnings were $0.05 better than your plan.

I assume that the sales were favorable.

But can you break it down a little bit, how much of it was sales and then gross margins presumably were less than you had anticipated.

Just a little more color around that?

Thanks.

Sure, Pete.

This is Bob.

Our sales were roughly $300 million higher than our implied guidance for the third quarter.

The margin rate was modestly worse largely due to the impact of the credit value proposition.

The performance and the customer take on the program continues to be above our expectations, which is a good thing.

As I noted, we had more than offset by lower promotional financing costs within SG&A.

Then we only added roughly about $20 million of SG&A higher than our applied guidance, so that really drove the $0.05 beat.

Okay, that's helpful, Bob.

And then just a bigger picture question, just trying to understand your current store portfolio and how it compares to how the Company looked back in 2005 when you guys had your peak sales productivity and operating margins.

You've added about 500 stores since then.

Can you help us understand that bucket of stores and how they are performing right now relative to the rest of the business?

Are they in line?

Are they noticeably better?

Are they lagging?

What can you tell us about that?

So relative to 2005, our average sales in 2005 are roughly $37 million.

The traditional big-box stores this year will do just a hair below $30 million, so to a degree all boats have fallen based on what happened to housing in prior years.

As we think about store performance, age of store is less of a predictor.

It's more about location of the store, the local market performance and the state of housing.

Yes there were some stores that were opened in the 2006, 2007, 2008 timetable that underperformed.

Some of those closed in 2011, but as we culled the pipeline and reduced the number of new store openings, the productivity of those stores has been really, really positive over the last couple of years.

Okay, great.

Thank you very much.

Joe Feldman, Telsey Advisory Group.

Good morning.

I wanted to get a little more color on the pro-customer.

I know you mentioned the pro-services were solid.

But can you just give any more color on maybe how the trends were, percent of sales, any incremental changes that you are noticing and maybe what they are buying?

Are they making bigger purchases on the trips or not?

Thanks.

I will start and then I know Rick is going to add in.

We have seen, as we mentioned, we've seen that particular segment of our customer base outperform many other segments and that is intuitive given the strength of commercial sales and the market place today under -- as you look at any third party or any research.

We have a number of pro-initiatives going on.

I will start in merchandising.

We have actually restructured our merchandising group to make sure that we are providing relevant commercial assortments, project-based assortments that both have the breadth of product and the depth of product that we needed, thus the inventory investment we made earlier this year.

It was targeted to what we call the center of our store, which is rough plumbing, rough electrical, hardware, power tools, accessories, some of those categories that are key to commercial customer supply.

Rick may want to add in some comments on pro.

Absolutely.

When you look at this, Joe, when you look at our pro-sales we had strong performance across all operating divisions.

And as Greg mentioned, the sales of pro continue to outpace our DIY consumer and did so again in this quarter.

Our average ticket increased by $2.38 year-over-year driven primarily by ticket size and transaction.

But ticket was the primary grower -- driver of the performance growing at 8.9% when you look at it from that way.

We saw traffic increase in all ticket buckets with the greatest amount being driven in the medium-range ticket growth area.

Got it.

That's great.

Thanks, guys.

And then another kind of similar question, I know you mentioned that all regions were positive.

I was kind of curious again if you'd kind of look at what was selling in the various regions, are you seeing any big differences beyond the normal, like maybe when the housing markets that are recovering a little faster at the moment, is what they are spending on different than some of the slower recovering markets?

This is Robert, Joe.

We are seeing obviously as we said widespread strength across the country.

Certainly I have talked about California, Florida, Arizona, areas where you are seeing housing recover.

As we've said, one of the -- we feel good about how the recovery is taking place out there in housing.

We expect that to continue through the fourth quarter and obviously into 2014.

And one of the big drivers is where home values are increasing, consumers are feeling better about moving gradually into larger and larger projects.

So whether that's in some markets it may be windows when they are doing work there, other times it may be refreshing the inside of the home and the bath and those type of things.

Obviously we highlighted a lot of the categories you can think about flooring, kitchen appliances, paints, all of those being above average for the Company where you are seeing the consumer reinvest in the home.

So we saw a nice balanced strength across the country and we expect that to continue as the housing base continues to recover.

Joe, this is Greg.

To layer onto Robert's comments, where we have seen some particular category strengths in some of the areas where housing is on quite an upturn is in the fashion fixtures categories and kitchens and appliances.

It is really interesting because it's more of a refresh than a remodel activity, so you are seeing some delayed.

In some cases, it's projects that may have been delayed for years in particular parts of the country where housing values have been on a rise for the last 18 months, the last 12 months.

So our focus is on bath refresh and kitchens and appliances, where the opportunity is available.

And that did very well for us in Q3.

Perfect.

That's really helpful, guys.

Thanks.

If I could indulge one more question, the buyback trend seems a little bit slower than I think what we had initially thought.

Any color you can provide there?

No, I think, Joe, coming in the year, we said the buyback would be roughly pro rata across the four quarters.

It was modestly lower in the third quarter, but we are still targeting $3.7 billion for the year, which is up $100 million from our thinking 90 days ago.

Got it.

Okay.

Thanks, guys, for clarifying that.

Good luck with this quarter.

Budd Bugatch, Raymond James.

Good morning and thank you for taking my questions.

I guess I have two questions.

First on Orchard Supply, what is implied in the guidance for Q4 and will it be accretive or how do you think about that?

I will start just with overall just to remind you and then I will have Bob jump into the guidance.

As you know, we bought assets at 72 locations.

We didn't buy the entire company so coming out of bankruptcy, we bought the assets of 72 locations.

That's why they are not comped.

We won't have prior history built in the numbers so it's just from the performance of those 72 locations from the August 30 date going forward.

And so Bob, that sort of puts -- built into their guidance.

I think as we think about fourth quarter, Budd, should add about $125 million in sales or about 110 basis points to sales growth.

For the year, Orchard is going to be modestly dilutive about $0.01 per share, which does include the deal costs I mentioned previously.

On that, just make sure that -- what was it in this quarter?

Was it the $0.01 in this quarter or would the $0.01 be in the fourth quarter, or is it half and half?

Half and half.

Okay, and my second question really goes to appliances.

You talked about 10 basis points of margin degradation.

Appliances are about 10% of your overall business if it's still true as it was in 2012.

That implies that the overall appliance margin was down about 100 basis points on the appliance sales.

What's the outlook for Q4?

How does that impact overall gross margin?

Are you going to get any help from the vendors?

Maybe you can go into a little detail of what's implied in your guidance and how we should think about all of that.

Budd, I will start.

This is Greg.

The focus on our work in Q4 is that to make sure that we can continue the sales momentum and I think that we are always adjusting the balance of promotional activity from ticket to traffic driving and basket building and that's the work of that process I talked about today called sales and ops planning.

So as we move past Thanksgiving, we move into seasonal categories.

We move into gift-giving opportunities like tools and hardware.

We move into home fashions.

We move into cleaning and home organization.

So we have to drive against those occasions appropriately and we are watching that balance very, very carefully.

We are continuing to work on value improvement, which we are moving further down the cycle, virtually completing all the resets at the end of this quarter and moving to stabilization on a significant larger portion of the business.

We have resets going on and value improvement in Q4 because we have capacity to reset particularly in December.

So when you put that body of work together, we recognize that there is opportunity in the appliance category right now.

We're trying to manage it appropriately through sales and ops planning.

We also have lots of other opportunities on the occasion and we will carefully manage and lead the blend of that business.

Thanks.

Matthew Fassler, Goldman Sachs.

Thanks a lot and good morning.

I would like to start out by asking about the labor investment and just get a sense from you as to the return on that labor investment that you think you extracted this quarter and how that compares to your big picture expectations for that program?

Matt, I will start just a little bit and turn it over.

Obviously everything we are doing, we're talking about value improvement, product differentiation, labor, all those things I think come together to see -- some of which you are seeing in the comp performance that we have had out there.

We are starting to see improvement in our close rates, so I think the investments are resonating with the consumer.

Certainly as you know, our average customer doesn't shop every day so as we went into this, we knew the incremental labor investments that it is something that we ratchet from the customer and we build over time.

I think we talked about in prior calls that it took us a little while to get the jobs filled with the right people, ensure they are going to -- that they work permanent weekday positions are out there.

We feel really good about where we are at now and we are starting to see the benefits of that.

But no, we knew it would be a drag at this point because as we said, we're making an investment really to build that experience that will build over time.

Absolutely, Matt.

One of the things I think that we've learned as we moved from the first half of the year to the back half of the year is how we allocate those hours across the store.

We communicated in the initial roll out that they were used as flex moving across the store, interacting with the customers throughout.

As part of the sales and operation planning focus during the second half of the year, we have allocated those hours into the departments as Greg highlighted that we expect to drive incremental traffic to.

So we are redeploying them more specifically into areas therefore being able to provide greater depth of training into the areas they will focused on in this quarter.

As Robert highlighted, the hours of investment alone with value improvement and product differentiation go to allow us to capitalize on the market that is being driven in the marketplace.

We went into the second quarter, we talked about gaining momentum coming out of quarter.

I'm pleased to say that momentum continued throughout Q3 and drove approximately 200 basis points of closed rate improvement in Q3 compared to last year.

If I could just follow up I guess on expenses more broadly, the incremental operating margin that you drove this quarter clearly I think was a bit light of where the street was.

I guess many of us look at the numbers excluding the impairments last year.

I know those are real dollars but we don't really build them into our base.

And I guess the labor investment and the incentive comp are probably the two outliers I would guess to street numbers.

So, Bob, if you think about whether you view this quarter as sort of an outlier from an expense growth perspective or whether this is sort of the run rate that you think we should consider, it would be very helpful color for the go forward.

Sure, Matt.

You mentioned potential outliers from where the street were and the two items you mentioned were incentive comp and labor investments.

The third item I would give you is the reset and remerchandising expense.

So as we think about our business, they are not all periodic expenses.

As Robert mentioned with the labor hour investment, just because you add somebody in the department today doesn't mean the customer shows up the same day and they are able to interact with that associate.

So some things do take time.

As I mentioned with the incentive comp, it's lumpy based on the rate of accrual going forward.

I think, Matt, in prior conversations, a lot of discussion regarding Lowe's ability to capitalize on the market.

How well are we doing from a comp sales perspective?

How well are we doing from a market share perspective?

For the first three quarters of 2013, we are growing with the market something we couldn't have said in prior years.

We feel good about that.

As we think about investing in our business, we expect to generate returns on these investments, whether it's SG&A or inventory.

It just doesn't show up in the same quarter.

Consequently the dollar growth rate, would you expect to --?

Clearly incentive comp is lumpy but as you think about that impact of labor for the next couple of quarters, should that persist and just sort of wait for the business to build?

Labor will be persistent until we cycle the investment last year.

As was described previously, as we think about the training and classification and positioning of those employees to better match up with the seasons and the sales and ops planning process to ensure that they are positioned for high likelihood to (inaudible) with customers and generate a return.

Thank you so much, guys.

Eric Bosshard, Cleveland Research.

Good morning.

Two questions.

First of all, I think within the numbers if I remember right, the October improved a little bit from September and I know October is when the Sandy compare began.

I'm just wondering if you could give a little bit more color on the month of October.

In light of that, were there other areas that improved in October that might be sustainable or was more of your Sandy influence showing up later into November?

Eric, relative to last year, we did have some Sandy improvement -- sales associated with Sandy towards the tail end of Q3 last year, obviously all hitting in October.

Not a substantial amount of money.

As I think about the rate of growth, I think we saw some improvement in some of the bigger ticket categories in October relative to September -- and Greg can probably --

We did, Eric, and that was -- one of the keys was sort of the big ticket categories related to prepping home for the holidays began to kick in in October, real strength in flooring, strength in kitchens, strength in appliances, strength in fashion fixtures and most specifically fashion bath.

So those were -- that was some of the impact that you saw sequentially from September to October.

Great, and then secondly, if you could give us a bit of an update of as you are working through the line review process and wrapping that up here shortly what the next phase of that might look like, how that is continuing or evolving from the first effort even the pace of what you are doing in those areas as we move into 2014 and beyond relative to what you have experienced over the last 12 or 18 months?

Absolutely, Eric.

What you are seeing in the fourth quarter now is a completion of the resets of what we would call the first round of accelerated product line reviews or value improvement category programs.

In some categories, we are actually in round three, so this is an ongoing process but we have taken a step back and we did this beginning nine months ago and we reset kind of the cadence of the process about six months ago and said here's the categories that were going to go through full line reviews on at least an annual basis.

And as you know in some categories, appliances for example, because of new product introductions and staying on top of innovations, we actually have to review categories in some cases more than annually on a cadence.

In other categories, we said we're going to review those on a mini basis in excess of more than -- in excess of a year in an 18 months or a 24 months basis and in some categories we are going to go in and do some tweaks, some business reviews in those categories on kind of a constant basis.

We probably would be on a three-year rotation.

So we have really stratified the 400 categories into what's appropriate for those categories and where -- but again, it is an ongoing process.

The key is that -- and we all tend to forget the focus of why we are doing it.

We are doing it to create values from using the insights and the information that customers give us about the buying occasions that these categories are represented in and to drive better line design and therefore drive better productivity out of that.

So that has helped us quantify what's the timing of each of these.

Does that make sense?

Yes, and what is there -- the timing, I appreciate that.

Within the strategy and implementing or executing these, is it fair to say that similar to sort of the earlier part of today's discussion that it's a little bit more balanced on achieving market share progress in concert with margin and inventory progress?

How is the balance of that different in the second or third version of this relative to the first?

I think it is.

We're actually trying to drive through the ongoing improvements to this category that Mike Jones is leading in merchandising is to go back and make sure we have utilized the consumer insights and research.

Because line design as the primary focus we think we -- we have hit the marks in a fairly large percentage of the reviews, but we still have some improvements to make there.

If we do that, we get that better balance.

We get better productivity out of the lines.

We do achieve share but we achieve better what I would call operating margin flow through.

Perfect, thank you.

This is Bob.

Just two points back to your first question on monthly comp progression.

Looking back at Q3 last year, we did 3.4% in September and 1.3% in October so a little bit easier comparisons in October as relates to storm activity.

In Q3 last year, we saw sales associated with Isaac and Sandy in Q3 2012 roughly offset by Irene sales in Q3 2011, so storm activity was relatively flat for Q3 last year.

Regina, we've got time for one more question.

Christopher Horvers, JPMorgan.

Thanks, two questions.

So big picture, you mentioned the 20 basis points of EBIT margin expansion for point of comp above 1. But to your point, Bob, as you think about next year, you get the major reset expenses behind you, you're going to lap the incremental labor that you put into the stores and there should still be a lag benefit from -- to the gross margin line from the reset activity.

So shouldn't that 20 bp rule look a bit better as we get this stuff behind us?

As we think about 2014 and we'll certainly provide a lot more color on 2014 on our Q4 call, as we think about what's next beyond valued improvement and the works of Bob Gfeller's organization and the sales of ops planning process, there will be some other investments in customer experience design.

Some of that is taking place in Q4 this year.

And then the second thing as we think about 2014, Chris, it's our prior outlook regarding 2013, 2014, and 2015 did not have any expenses associated with the Affordable Care Act.

We have open enrollment at this point in time as we think about the individual mandate and the number of employees that are on our insurance plans in 2014 relative to 2013 is still unknown.

So we will certainly provide more color on that and other initiatives on the Q4 call.

Then more as it relates to the fourth quarter, just to check my math based on what you said about the incentive comp pressure the year about 15 basis points, it looks like -- does that imply about 5 basis points or so of incentive comp accrual pressure year-to-year in the fourth quarter?

And should the reset benefit the gross margin, improve sequentially given the number of categories through stabilization?

So yes, as we think about the reset benefit, that should be greater because greater lines stabilizing Q4 relative to Q3.

Having said that, Greg noted this is peak time for appliances.

As we think about Black Friday morphing into Black November, there's some risk on the margin line there that we are proceeding with caution.

As it relates to expenses, Chris, I will give you some color on pushes and pulls for expenses for Q4 but the biggest delever is reset and remerchandising.

I will call that 40 basis points.

Risk insurance about 20 basis points largely because we had huge favorability in Q4 last year, credit about 20 basis points, again huge favorability Q4 2012.

And then a similar deleverage in operating salaries because of labor hour investment offset by incentive comp leverage of roughly 10, some contract labor impairment, and legal benefits in the 5 to 10 basis point range.

Thanks very much.

Thanks again for your continued interest in Lowe's.

We look forward to speaking with you again when we report our fourth-quarter 2013 results on Wednesday, February 26.

Have a great day.

Ladies and gentlemen, this concludes today's call.

Thank you all for joining and you may now disconnect.