Good morning, everyone, and welcome to the Lowe's Companies Third Quarter 2012 Earnings Conference Call. This call is being recorded. [Operator Instructions] 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 in its filings with the Securities and Exchange Commission. Also during this call, management will be using certain non-GAAP financial measures. You can find a reconciliation to the mostly directly comparable GAAP financial measures and other information about them posted on Lowe's Investor Relations website under Investor Documents. Hosting today's conference will be Mr. Robert Niblock, Chairman, President and CEO; Mr. Greg Bridgeford, Chief Customer Officer; and Mr. Bob Hull, Chief Financial Officer. I would now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.

Good morning, and thanks for your interest in Lowe's. Following my remarks, Greg Bridgeford will review our operational performance and Bob Hull will review our financial results in detail. But first, let me express our sympathy for all those impacted by the devastating effects of Superstorm Sandy. I also want to express my sincere appreciation for the Lowe's team members who have worked so diligently to get supplies to the affected area, both before and after the storm, and for those who are working diligently to staff and support our stores as we help communities recover from the damage. While roughly 200 of our stores were in the affected area, we only had 1 store that remained closed for an extended period of time due to severe water damage. That store, in Rosedale, New York reopened last Wednesday and stands ready to assist the community. As we've done in the past when national disaster strikes, Lowe's stores around the country, as well as Lowes.com, become official donation sites for the American Red Cross Disaster Relief Fund. Lowe's is contributing $1 million to the relief efforts through the American Red Cross and other partner organizations. Turning now to our operating performance. We are keenly focused on improving our core business. In the U.S., we're focused on 2 large bodies of work this year: value improvement and product differentiation. Together, they will enable us to compete more effectively in the current macroeconomic environment. These focus areas build on Lowe's core strengths and are expected to deliver comp transaction growth and better gross margins by localizing assortments, driving excitement in our stores through better display techniques and managing an appropriate balance of product cost and retail pricing. We continue to make progress and are encouraged by early results. By mid-2013, we will have…

Thanks, Robert, and good morning, everyone. I'd like to dive a little deeper into our quarterly results and update you in the progress of our 2 focus areas: value improvement and product differentiation. During our second quarter call, I emphasized our focus on driving improved results over the short and mid-term. So I'm pleased that in the third quarter, we showed sequential improvement from our second quarter comp and margin performance as we enhance our promotional planning and execution and begin to benefit from value improvement resets. As Robert noted, 12 of our 14 product categories had positive comps. I'd like to highlight a few. Within lawn and garden, we were prepared with ample inventory to help customers rebound from the second quarter heat and drought, and we drove improved attachment rates with strong sales in lot goods, fertilizers, soil, rocks and mulch. Paint continued to benefit from its value improvement line review and reset in which we developed 4 new color collections, 1 for each season and introduced premixed samples in clear sample jars. We also simplified our offering of paint applicators, creating a bay that is much easier for the customers to choose from, providing national brands where they are valued and offering a clear progression of features and brand relevance at increasing price points. In big-ticket categories such as cabinets and countertops and appliances, we drove positive comps and higher gross margin rate by more effectively managing promotions. While lumber had the highest comp in the quarter, it was mostly driven by inflation. On the other hand, building materials finished the quarter with double-digit negative comps as it continued to face headwinds from last year's substantial tornado and hurricane repairs. Tools and outdoor power equipment and hardware showed solid performance throughout the quarter but particularly benefited from…

Thanks, Greg, and good morning, everyone. As noted in our earnings release, there is a week shift in fiscal 2012 as a result of 2011's 53rd week. Sales for the third quarter were $12.1 billion, which represents a 1.9% increase over last year's third quarter. The increase was driven by a comp sales increase of 1.8% and new stores, offset slightly by the impact of prior year store closings and the calendar week shift impact, which we estimate to be $62 million or 0.5%. In Q3, total average ticket increased 2.1% to $63.11 while total customer transaction decreased 0.2%. The decline in total transactions was due to the impact of the week shift. Looking at monthly trends. Comps were 0.4% in August, 3.4% in September and 1.3% in October. For the quarter, comp average ticket increased 1.6% and comp transactions were up 0.2%. Transitioning to the comp drivers for Q3, lumber inflation aided comps by 65 basis points. We estimate that our focus areas, value improvement and product differentiation, drove 50 basis points of comp in the quarter. Additionally, we estimate that our proprietary credit value proposition, which offers customers a choice of 5% off every day or promotional financing, positively impacted Q3 comps by 40 basis points. We estimate that sales related to Hurricanes Isaac and Sandy this year were essentially offset by comparisons to the sales related to Hurricane Irene last year. With regard to product categories, the categories that performed above average in the third quarter include lumber, tools and outdoor power equipment, lawn and garden, cabinets and countertops, paint, home fashion, storage and cleaning, appliances and hardware. In addition, fashion electrical, flooring and plumbing performed essentially in line with the company average. Year-to-date sales of $39.5 billion represent a 2.3% increase over 2011. The increase was…

[Operator Instructions] Our first question will come from the line of Scot Ciccarelli with RBC Capital Markets.

Can you give us a little bit more detail regarding the comments about once you're past the reset and clearance stages, that the mid-single-digit comp, how much of your SKU mix is that? And how much did we actually see during the quarter? And what kind of timeframe are we talking about? Is this just over like the initial 2 or 3 months? Or do we have a longer track record than that?

Yes, Scot. That's the track record since the categories that we've had to go through a reset have actually stabilized from an inventory standpoint. In other words, I don't have inventory flowing in to fill in the new set. I don't have inventory clearance that would be creating noise on the numbers. So that is the continuing comp performance of the summation of that through what now is about 2.5 months of stabilization of categories. And as I mentioned last quarter, we only had a handful of categories that had reached that, if you want to call it, normalization stage. In this quarter, we're seeing the results -- we're seeing those results about between 3 and 4 dozen categories have reached that normalization stage now and more coming every week.

So what -- Greg, what is that on a percentage of mix basis, I guess? 3 to 4 dozen categories out of -- I guess, I honestly don't know what that's out of.

Sure. It's still in the range. We're still under 20% at this point of categories that have normalized.

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

My first question, I know it's a little hard with the extra week, but can you give us a feel for the fourth quarter gross margin and SG&A? I know year-over-year would be a tougher comparison. So sequentially, how will that look, Bob?

So Budd, yes, there are a lot of moving pieces associated with the week shift impact. As you know, we had a significant drop in gross margin for the fourth quarter last year. So we do anticipate an increase in gross margin in Q4 this year. The expected increase will be a bit larger than the 26 basis points that we saw in Q3, so we're making continued progress on the line reviews. As Greg described, we're early in the process of resetting stores. We're seeing good benefit, but there's still a very small percentage that's been fed to date. As we continue to reset additional lines, we'll continue to see greater improvement in both sales, the comp impact from those new sets, as well as gross margin.

Okay. And just as a follow-up if you could, the rate of share repurchase has a bit slowed. And obviously, I think your guidance also gives an additional slowing. With the improvement in stock price, how do you think now about share repurchase going forward? And can you maybe give us a little color on that?

Sure. So our stock price certainly has improved today relative to the $28.68 average share repurchase price in Q3. And as we take a look at a long-term financial performance, we still feel that the stock is attractive at the current price. The modest decline in share repurchases for the year really relates to the decline in cash flow from operations. As I mentioned, we've got a bit of a working capital drag relative to 90 days, but nothing substantial. So that's contributing to the decline in net working capital as relates to APU is just timing.

Your next question will come from the line of Dave Gober with Morgan Stanley.

I just wanted to touch on SG&A a little bit. It seemed like excluding the charges, you saw some nice improvement there and actually a little bit of a decline year-over-year. Anything that you could point to there? And is that -- did you foresee that being sustainable over the next few quarters?

So as we talked about, we're working on a number of things to kind of right-size our cost structure. As you know, we took some assets last year including store closings and realigning the field structure. We implemented the voluntary separation program early this year. We continue to realign our corporate office. The store teams continue to evaluate opportunities to serve customers in a more efficient fashion. So there's not any one thing I could point to, Dave. There's a number of things that are kind of in flight that we've referenced in our progression to 10% operating profit in 2015 at the analyst conference last year.

Okay. And my follow-up is on Canada. Just wondering if you could comment at all. Obviously, there's been a bit of a saga there with the interest in RONA, and then retracting the interest in RONA, now some movement in management at RONA. Could you just give us any kind of updated thoughts on how you're thinking about Canada and maybe in particular RONA, given some of the changes there?

Yes, Dave. It's Robert. Certainly, any comments with regard to any specific company would not be appropriate. Or anything about the change in management as to why that took place, it's not appropriate for us to comment on that. I think as we've said before, we like Canada from a market standpoint. It's – but we're pleased with the performance of our 32 stores. I think we've got a couple of more opening before the end of the year. We're continuing to make improvements in the operations of those stores, but we need more scale. And so the scales we've talked about is going to come from opening additional big-box stores, looking at other formats. We just launched in October our e-commerce site in Canada. So that's a big plus, where now our consumers can buy online, have a product either shipped to their home or pick it up in store. And I think we've got over 30,000 items available on the website. So we think that was a competitive disadvantage previously in the market. And we'll also continue to look at acquisitions as a potential way for expansion. So we're going to evaluate all options. But as far as any comments with regard to where we stand with a particular company, it would not be appropriate for me to address.

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

First question on value improvement. It sounds like you said you were doing better than expected on the inventory reductions and making progress on value improvement. Can you give us an update on where you are, how those discussions have gone with vendors, whether you still think the endpoint is the same? And just a little bit of additional color on the progress you're making there.

Sure, Colin. This is Greg. Be happy to. We are making good progress on the inventory reduction efforts through the line review process. And then as we reset the lines, as you know, reinvesting a portion of that reduction back into the higher velocity categories. On the cost side, we have made good progress since we've begun the accelerated product line review rotation. And to be honest with you, the way we're looking at this is that this is an ongoing commitment to disciplined line review process. So while we are focused on -- we've talked about goals of inventory reduction in the 10% range and cost reduction in the 5% range, we recognize this is a long-term process to basically to improve, continually improve our entire operating model from the product sales standpoint. And it's not going to happen over a quarter, it's not going to happen -- this is a commitment to something that we're going to do within our merchandising, logistics and operating ranks longer term. So that's -- we're seeing continual progress as we continue to cycle through the first rotation of the accelerated product line review processes. And we're actually will come into 2013 and begin second cycles of some product categories.

Okay. So of the resets, the category department resets that are done, something a little under 20% of the product categories, are you achieving that endpoint in those categories, the 5% out of COGS? Or is that kind of you didn't expect to get there in the first wave and you'll kind of get there over time?

We're making progress. We've exceeded our inventory goals, Colin. We are work -- making progress towards our cost-reduction goals. And obviously, there's about a half dozen product line reviews going on right now. So it's good progress. I like the trends that we're seeing. And it's a continual commitment to do this.

Okay, fair enough. And then just a quick follow-up. Obviously, we're all focused on how the performance of the reset categories is going. Of that 20% in 2, 3 months, Greg, what kind of a standard deviation are you seeing there? Are you seeing pretty consistent results? Or is this still kind of all over, where some category resets are fantastic and others hardly see any lift?

No, I would categorize this into 2 buckets, Colin. I said we're below 20% right now. I wasn't giving 20% as a pinpoint. But I'd categorized it into 2 buckets of product. One is the in-line, interior or exterior steady-state demand type product. And I would say that the paint example, the flooring example that we've been pretty public with are good examples of that, hardware, rough plumbing, rough electrical. Then there are some seasonal categories and some commodity categories, where we have seen more variability. That's expected. And that's where we have seen the variability within the numbers. The steady-state, more predictable demand categories are performing within a much tighter band and they're performing above expectations.

Your next question will come from the line of Greg Melich with ISI Group.

2 questions. One is a housekeeping. Could you give us the breakdown of the bigger tickets versus smaller ticket and how they did? Then I have a cash flow question.

Sure, Greg. So as we take a look at the ticket buckets, the below $50 were approximately positive 1.3%. The above $500 were up approximately 2.5% with everything in the middle being up roughly 1.6%.

Got it. And then on cash flow. Earlier in the year, we started, I believe, with a $4.0 billion cash from operations estimate. And I think it was $3.5 billion and now $3.4 billion. Is there something going on with working capital that sort of made that one-off $600 million switch because it actually looks like working capital has been pretty good, especially this quarter. So help us understand how the cash from operations actually progressed this year.

Sure. So if you go back to the beginning of the year, I think our initial estimate was that at year end, inventory would be roughly $400 million below year-end 2011. The current estimate is about $200 million lower end of '12 relative to end of '11. Second, AP was a bit higher relative to inventory up 3% end of Q3 against a flat inventory. But as we forecasted timing of purchases for the year, it's still expected to be a modest drag relative to initial expectations. And then the third item, Colin -- I mean, Greg, excuse me, relates to deferred taxes as we evaluated the impact of bonus depreciation last year. So if you think about the large CapEx spend principally in IT, the opportunity to fully appreciate that in 2011 gave us a nice benefit, cash flow benefit in 2011. We're now cycling against that in 2012, where booked depreciation is, in fact, higher than tax depreciation. So those are really 3 big drivers of the reduction in cash flow from operations relative to our initial expectations on the Q4 2011 call.

Would it be fair to characterize the first 2 as sort of a normal on the inventory and the AP is that this year, you'll be at a normal state, given the line reviews and where you want the business to be?

What do you define as normal set? I'm not sure...

Well, I mean, because with working capital, things can put and take and it can be timed into a given year, right or week. So I guess, is that $200 million down in inventory, do you think that's now the right run rate for inventory, whereas before you thought it was $400 million? Has there something changed, I guess, through the line reviews that would have made that change?

So generally speaking, yes, it's a normal course of business, it's the pushes and pulls of running a business. However, we talked about on the Q1 call the cadence of the line reviews were going to take a little bit longer than expected, so there's a small impact from that. But generally speaking, it is just the normal puts and takes.

Your next question will come from the line of Chris Horvers with JPMorgan.

On the gross margin side, you mentioned that the benefit, the categories that you reset, you saw 100 basis point improvement on the gross margin side. Can you talk about what components are in there? How much of that is big buckets, lower volume costs, lower markdowns? And is there any lapping of markdowns as you put those categories under initial line review in the prior year?

Chris, this is Greg. It is a combination of lower first cost through the accelerated product line review process. And we're experiencing above-expectation performance in gross margin of our nonproductive inventory, a.k.a. clearance items. And I credit that to a joint effort on the part of the merchants, the logisticians and a tremendous commitment by the operators to make sure that we sell through this clearance inventory at as much full margin as possible. And the way it's been handled, it's been -- we've been selling a lot of product in line and a lot of product off of a couple of promotional space or drops in spaces we've devoted to clearance inventory, and now a couple of endcaps that we're devoting to clearance inventory. So good success there, and combined with a good positive first cost reduction on key categories that we're seeing the benefit of through the accelerated product line review process.

So I mean, as you cycle over time that you would expect 100 basis points of gross margin expansion over the next, however, 12-, 24-month timeframe?

Well, it depends on the categories that are being reviewed at that time, Chris. So you'll see some variation in that number. But our expectations of, obviously, first cost reduction through the product line review process. And I don't really -- I mean, I think we've said set some very good standards and excellent processes to drive the nonproductive inventory gross margin productivity. I expect that to continue. But you'll see some variation as different categories get reviewed through the oncoming months before we begin to cycle our first series of this product line reviews, which was late, late last year.

Understood. And then as a follow-up, just on Sandy. You mentioned that Sandy and Isaac were neutral versus Irene a year ago. I'm not sure if you cut it this finely, but did October's 1.2% comp, did you actually see any lift there from Sandy? And do you expect Sandy to become a net positive in the coming quarters?

So Chris, as we take a look at the impacts fourth quarter, Sandy helped about 30 basis points. Isaac helped about 30 basis points. Irene hurt about 65 basis points, so a modest drag from the aggregate of the 3. We didn't go specifically determine the impact of Sandy on Q3. But if you take -- what would be hard to do the math on 4 weeks out of 13 weeks, given the 30 basis points. Looking forward, we believe there is some upside related to Hurricane Sandy. We certainly want to be there for folks as communities rebuild. It's very difficult for us to estimate what the potential impact is going forward. But as we have later quarters, we'll tell you what the estimated impact was for that quarter.

Your next question will come from the line of Gary Balter with Credit Suisse.

Could you talk about the endcaps, kind of some of the programs that are working and some that you feel need to be changed and how that rollout has gone?

Sure, I will, Gary. This is Greg. Couple of key categories within the endcap and drop zone programs that are all part of product differentiation that -- or have been highlights in the program is the innovation endcaps, where we're focusing effort to bring new products to the market and in some cases, new categories such as connected home through our launch of our high-risk connected home platform for customers. The key to that is being able to demystify some of these innovations and bring them -- bring customers' interaction with them. So the way that we've been able to communicate through running videos on the endcaps have driven sales of those products actually in excess of expectations. The other category of endcaps that have done very well are the value endcaps. And what previously I mentioned that I think we can make there are aligning them closer to the categories that they are home to and make them pull-in to the categories. Whether it's rough plumbing, whether it's lighting, whether it's a seasonal category, make sure that the adjacency is correct for that. We've not done the greatest job of that since we started the program. We're making improvements for that every month, and as we cycle in new products, making sure that the adjacencies are stronger and that the items that we pick are more impactful. So we've seen sequential improvement in the productivity, particularly in the innovation endcaps, particularly in the value endcaps and in specific drop zones. And we're working, we're taking that information and improving it every month as it goes along. And it's run by a cross-functional team, lots of input from operations about what's working and what's not working and a lot of the effort from logistics to make sure that we're backing those endcaps with the proper amount of inventory.

What's not working in that area?

I think again I'd say that adjacencies haven't been our strong spot, so we have a heavy focus on that. We've made improvements in those in the last 3 months. And as we cycle through the placement of new product, I would say that we've done -- made big steps to correct that problem area. The other category that I would say that did not work very well were some of the theme endcaps such as creative ideas. It's a great concept. It's bringing together aspects of an entire project for the customer. But in some cases, the effort to try to get a customer to connect with the 6 different components of a product really rail against our mantra of keep it simple.

And just following up on that, just the -- and where are you on the rollout of these endcaps?

Of creative endcaps, ideas endcaps?

Yes.

They're done, they're done. We took them out. So we're making running changes to make improvements in this particular program.

Your next question will come from the line of Dan Binder with Jefferies.

It's Dan Binder. My question revolved around your question -- your comment about the gross margin performance of the reset items. I think you said they were up about 100 basis points. So if we look back last year, I think your gross margin was down about 55 basis points and first half of this year, down about 60 basis points. So what I'm curious about is are we essentially going to get back to where we were before the process began such that the end result is really a comp driver more so than a gross margin driver?

Dan, I think the number was down 99 basis points Q3 last year of margin. The short answer is yes. If you think about the gross margin outlook that we shared at the analyst conference last fall, we still think those targets are appropriate. So as Greg and the team take a look at the line design, yes, there are certainly margin opportunity like reconstructing the line design to be better market-assorted should also drive top line improvement, which is what we're looking for. This never wasn't intended to be solely on margins, it was having line design that was more reflective of the local market opportunity that we thought we were missing.

Dan, another -- this is Greg. Another positive impact on gross margins for the quarter was we stated at the end of the second quarter that we knew we could manage our promotional activities better. And the [indiscernible] on driving anchor items, which would improve attachment rates and balancing that with traffic-driving items, that was a keen focus in Q3. And it's paid off. So I think our promotional efforts are much more accretive from a gross margin standpoint.

Right. Yes, Bob, I was referring to all of last year on the 55 bps. But just as a follow-on, sometimes I think you guys will comment on kind of how the beginning of the quarter is going. Any thoughts now that we're sort of well into the cleanup and hopefully some of the recovery on Sandy?

So as we talked about, the estimated impact of Sandy is very difficult to estimate. We're watching [indiscernible] of what's taking place with the fiscal cliff. We're also mindful of comparisons relative to last year, specifically a very difficult January. So we're off to the start we expected to be, and we're comfortable with the outlook we just provided.

Our next question will come from the line of Michael Lasser with UBS.

Can you talk about the puts and takes on your traffic during the third quarter? Are you starting to see the housing recovery benefit your traffic? It seemed to be up just slightly during the period.

So Michael, it was up 0.2% in the quarter, comp traffic was; a variety of items. Greg talked about the lawn and garden performance with the attachment rates. Our commercial business was up actually a little better than the company average. I think it's a little early to suggest that housing has a material impact on our business. We certainly think as we get into 2013 and the housing recovery continues to gain traction, we'll start to see more of that benefit as we move forward. But I think it's a little premature to see that show up in our numbers at this point.

Were there vast geographic differences on your overall comp performance?

Not too wide. A very narrow band relative to what we've seen a number of years ago.

Okay. And then my last question is on the guidance. I believe you lowered your EBIT margin expectation for the quarter -- for the year. Can you talk about what made that change?

Yes. So we guide off GAAP. We had some nonoperating charges in Q3. Those impacted our EBITDA outlook for the year.

And nothing changed about the fourth quarter, correct?

Correct.

Your final question will come from the line of Matthew Fassler with Goldman Sachs.

Two questions. First of all, maybe cutting it a bit finely here. But your quarter ended a week than it perhaps otherwise might have, given the shift in the 53rd week last year. And so you had, I guess, Sandy prep sales that fell into, I guess, the traditional retail fiscal quarter. And then you had 4 or 5 days that encompassed the storm and its immediate aftermath. Of the 60 basis points -- or sort of the 30 basis points or so associated with Sandy, was most of that before or after, if you have a way of cutting it that finely?

This is Robert, Matt. I would say most of that would be before because if you think about the storm hit on a Monday night, okay, Monday night and that our quarter ended on that Friday, so 4 days after the storm. So you've got to consider that starting on Monday, you start having store closures. So you had, as Greg said in his comments, over 140 stores that had their operating hours impacted to some extent. By the end of that week, we'd gotten all the stores back open except for the Rosedale, New York store that I spoke about that opened last Wednesday. So it was closed for a couple of weeks. So yes, more of it would have been preparatory because you had a lot of stores' operating hours closed, and then of course, by Friday, it was the end of the quarter.

Got it. And then my follow-up. We haven't talked about the MyLowe's portal. Today, obviously, a lot seems to be going right on the merchandising side. But if you think about that online effort, can you talk about signups? And can you talk about whether you're seeing commercial impact to M&A from the connections you're making with customers through that portal?

Yes, I'll start, and then I'll turn it over to Greg. But our activations now, unique swipes are up, it's about 14.5 million. We've got over 4 million registered users, so continuing to see a great response to MyLowe's. One of the key items that is used, which is a tremendous benefit for customers, is the purchase history. So whether they're buying in-store, online, no matter what channel, if they've got everything out and registered, all of those sales, they have the history of that out there. So it's a convenient way for them to be able to manage everything about their home. So we're seeing great response. Greg, did you have...

Yes, Rob, I just would mention that now we're up to about 300,000 -- almost 400,000 items on Lowes.com. The acquisition of ATG has really helped us accelerate the addition of critical relevant items to that experience. And we're finding that 1 out of 4 customers in some way through their shopping purchase process is in contact with dot-com. It's in one of those phases. So the addition of flexible fulfillment has helped quite a bit. And we're seeing the dot-com revenue, the penetration is exceeding expectations right now. And I would say that there's – in large part helped by the MyLowe's, which really is a loyalty program in a sense from that point and Flexible Fulfillment, which is giving customers what I think are relevant options to make sure that they can get a product where they want and how they want it.

And gentlemen, if you profile the customers who swipe MyLowe's and their behavior before they hooked up with the program, if you're able to track it versus after that or perhaps just a general characteristic of the customers who's availed themselves of the program, any change in their behavior during the time that they've adopted or hooked up with the program?

Yes. Matt, they spend more overall. And they continue to transact more often and they spend more transactions than those customers that aren't in the program. So those trends continue.

As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter 2012 results on February 25. Have a great day.

Ladies and gentlemen, this does conclude today's call. Thank you, all, for joining, and you may now disconnect.