Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2016 Earnings Conference Call. This call is being recorded. [Operator Instructions] Also, 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 in its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Robert Niblock, Chairman, President and Chief Executive Officer; Mr. Mike Jones, Chief Customer Officer; and Mr. Bob Hull, Chief Financial Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.

Good morning, and thanks for your interest in Lowe's. We delivered a solid first half of the year and made continued progress against our key strategic priorities, providing better omni-channel experiences to more closely connect with customers, deepening our relationship with the Pro customer and driving productivity and profitability. We continue to generate strong cash flows, enabling us to strategically invest in the business while returning capital to our shareholders. In the first six months of 2016, we delivered comparable sales growth of 4.4%, in line with our plan. In the second quarter, comparable sales grew 2,%, driven primarily by a 1.7% increase in average ticket. As we've mentioned before, the timing of spring impacts the first half of the year. This year, the season began with robust demand for outdoor projects. Customers took advantage of favorable weather conditions in the first quarter to complete those projects. In the second quarter, we saw more strength in indoor project demand, leading to strong performance in lumber building materials, kitchens, tools and hardware and fashion fixtures. Our seasonal living business also performed well in the second quarter, driven predominantly by air conditioner and patio furniture sales. Healthy macro fundamentals, our project inspiration expertise and targeted promotions continue to drive demand, resulting in positive comps in 10 of 13 product categories. We were also pleased with the work we've done to further advance our product and service offerings to the Pro customer. The strategic investments we've made to build deeper relationships with the Pro are allowing us to capitalize on strong Pro demand driven by a favorable macro backdrop, as our Pro business continued to perform well above the company average. Today, we have a strong foundation for the Pro customer including dedicated service in store, solid inventory depth, field-based Pro account executives…

Thanks, Robert. Good morning, everyone. In the second quarter, we achieved positive comps in 10 of 14 regions, with all regions in the south and west comping positively. This strength was offset by weakness in our northern regions. We also posted positive comps in 10 of 13 product categories. While comps were below expectation for the second quarter, we delivered a solid first half of the year, in line with our plan. As Robert mentioned, the season kicked off with stronger-than-expected outdoor project demand as customers took advantage of favorable weather, bolstered by a strong macroeconomic backdrop. We drove traffic in Q1 through compelling offers designed to take advantage of the early spring project demand, leveraging enhanced digital capabilities to reach the spring customer earlier in the season. As we moved into Q2, we saw softer comps in May stemming both from Q1 project pull-forward and unfavorable weather. Temperatures below normal in our northern regions prevented customers from enjoying outdoor projects. As we moved into June and July, traffic rebounded and we capitalized on stronger demand for indoor projects and customers' continued desire to invest in their homes with our project inspiration and expertise and targeted promotions. This contributed to stronger performance in interior categories, such as kitchens and fashion fixtures. We also drove solid comps in appliances. And for the eighth time in the last 9 years, J.D. Power and Associates ranked Lowe's highest in customer satisfaction among appliance retailers based on the knowledge of sales specialists, breadth of assortment, competitive pricing and delivery. To take advantage of increasing demand for kitchen projects and to ensure we provide a more holistic solution to a simple kitchen refresh or a full remodel, we display our kitchen solutions, including cabinets and countertops, immediately adjacent to our appliance offering so customers can…

Thanks, Mike, and good morning, everyone. This is the first quarter that we're including RONA in our financial results. While we closed the acquisition May 20, our second quarter includes only 5 weeks of RONA results, as they are consolidated on a 1-month lag. In conjunction with the transaction, RONA's operating results are adjusted to reflect purchase accounting as well as to align their accounting policies with U.S. generally accepted accounting principles. Also regarding RONA, they will be included in our comp sales calculation after we anniversary the transaction in the second quarter of 2017. Now on to our Q2 results. Sales for the second quarter were $18.3 billion, an increase of 5.3%. Total customer transactions grew 3.7%, with RONA accounting for about 75% of the increase, and total average ticket increased 1.6% to $68.91. The sales increase was driven by the addition of RONA and increasing comp sales and new stores. For Q2, $461 million or 2.7% of the sales growth came from RONA. New stores contributed approximately 60 basis points of the sales growth. Comp sales were 2%, driven by comp average ticket increase of 1.7% and comp transaction growth of 0.3%. Looking at monthly trends, comps were negative 2.8% in May, positive 5% in June and positive 3.8% in July. The timing of Memorial Day and July 4th versus last year had fairly significant impacts on the monthly comps. We estimate that normalizing for these -- for the timing of the holidays, comps would have been positive all 3 months, with comps of 1.7% in May; 2% in June; and 2.3% in July. We estimate that weather negatively impacted comps sales in the quarter by 110 basis points. Year-to-date sales of $33.5 billion were up 6.4% versus the first half of 2015, driven by: a 4.4% increase…

[Operator Instructions] Our first question comes from the line of Michael Lasser with UBS.

Robert, are you surprised that the business didn't sequentially improve more than it did, adjusting for some of the calendar shift over the course of the quarter, given the demand pull-forward that you saw earlier in the year? And then based on that, what's still inspiring your confidence that business can accelerate to 3% to 4% comp in the back half of the year?

Yes, well, Michael, if you look at the adjusted calendar numbers that Bob gave you, we certainly saw the sequential improvement in comps over the quarter. And then if you also look, 40% of our business in the second quarter is outdoor seasonal products. We think about the impact that the weather had, the rain impact that we had in May, and then obviously, the late spring, which impacted the north and the extreme heat that we ran into later in the quarter. We still saw sequential improvement when we look at everything from talking to our Consumer Sentiment Survey, everything we heard from the consumer, they're still highly engaged in discretionary spending around the home driven by how they build out the overall housing market and the value of their home continuing to increase. So when we look at the macroeconomic environment and look at the impacts that weather had on our particular business in the quarter, it still sets us up incredibly well. Now I'll get Mike to jump in on some of the things that he thinks is going to drive the excitement for us on our outlook for the back half of the year and what we're focused on.

Absolutely. Macro backdrop certainly is constructive. The consumers want us to do projects. Feels good. As you get into the back half, you start to lean more towards interior projects. Certainly less weather impact on interior projects. We're positioned to take advantage on some of the strong demand in the back half with expected interior projects. We've spoken about our project specialist program being expanded to all stores. I spoke earlier about the investment that we've made in digital. I like how we're positioned from a product perspective with our strength in appliances. Our full vignettes, our delivery, all brands and installation. I like how we're positioned in fashion lighting. With our 3-brand strategy around Kichler, Progress and Quoizel, our foreign lineup is second to none, with Pergo laminate, Cali Bamboo and our STAINMASTER brand. We like our position in paint. We've talked a lot about Sherwin-Williams, Valspar and PPG/Olympic, the exclusives that we have there. We've done a lot of work around stain, bringing back Cabot and expanding our Minwax. And if you think about the Pro business, we continue to be more relevant with Pro with return of brands like Marshalltown on top of those other brands that we took back and spoke to earlier in the year. So we think we're well positioned going into the second quarter -- excuse me, the second half. And we think the macro is going to play to avail a lot of investments, in particular on the interior strength and some of that demand.

That's helpful. And my follow-up question is, over the last few quarters, you've engaged in targeted promotions. What have you learned from that? And how is that going to inform your promotional posture moving into the second half of the year and beyond?

Sure. Absolutely. First, we continue to learn. It's -- both the promotional landscape as well as marketing -- Digital Marketing, continue to evolve. We continue to utilize media mix modeling so that we can optimize every dollar spent against the best return. We continue to migrate from print advertising and analog into digital. We're not seeing a fundamental shift in promotional cadence or promotional depth. So the market remains very rational in terms of promotions. But what we are seeing are new and enhanced techniques on getting our promotions in front of our customers. So as an example, we have a very strong social media footprint on Snapchat, Facebook and Instagram. In the second quarter, we drove 27 million impressions on social media alone, and that's on top of 32 million impressions in the first quarter. So with our digital capabilities and our ability to continue to flex promotions, we're finally getting the right promotion from the customer at the right time. So we're learning a lot. We continue to evolve it, and it's an evolving space.

Your next question comes from the line of Simeon Gutman with Morgan Stanley.

Can you share with us the spread between some of the weather impacted markets and the non? And I think you mentioned, just to clarify, 110 basis point shortfall from weather. And I don't know if you can share maybe the percentage of markets where there was weather, but I don't know if it gets us something like a 400 to 500 basis point impact -- negative impact on weather markets?

Sure, Simeon. I'll start. So Robert talked about the 40% of outdoor/seasonal business. That's certainly a strength of ours. While we experienced the same weather as everybody else, we were disproportionately impacted by the strength in those categories. As we talked about Q1, with weather favorability of 150 basis points that came back in the second quarter. In Mike's comments, he talked about the strength we saw in the west as well as positive comps in the south. Certainly, we had pressure up in the northeast, which contributed most of the pressure associated with weather.

Yes. Simeon, this is Robert. If you look at -- to part of your question kind of the spread. The west was our best performing area of the country, best performing division. We said the north was our weakest-performing division. There was almost a 500 basis points spread in comps between those 2 divisions. So hopefully that highlight or addresses the spread questions you were talking about from what we saw from market-to-market.

Yes. Okay. And then I guess a follow-on to that. You said that, I guess, if it was 110 basis points, then I presume you're expecting to do a 3 and a 3 on top of, I guess, next to the 7. So the first half, you're looking more at a 5 compared to the guidance of 4. Is that fair? And then do you think about the back half in a similar way where you set up, and if things go well, there could be some upside to that?

Yes. So regarding the first half, Simeon, we delivered a 4-4 comp, which was essentially on plan for the first half. Q1 came in a little better based on the weather benefits. Second quarter came in a little bit worse based on the weather drag. But we are on plan for the first half of the year. So if you think about the second half, we essentially are looking at a 3.5 comp in Q3 and Q4 to achieve the 4% comp for the year. So we feel comfortable and confident of our ability to achieve that.

Your next question comes from the line of Matt Fassler with Goldman Sachs.

I'd like to follow-up on sales, if we could. I guess, my question is to the extent that the impact of weather peaked in May and abated gradually through the quarter and you had the heat driving air-conditioner sales, why do you think the recovery on a calendar adjusted basis was more rapid? And also within that, did you see -- was all of the recovery -- the sequential recovery on an adjusted basis a function of traffic? And if traffic recovered more, did ticket subside during that period of time?

So from a traffic and ticket perspective, the performance was relatively flat across the months of the fiscal period similar to the comp performance. So the adjusted figure is 7, 2 and 2, 3, fairly narrow band. We saw ticket and traffic perform largely consistent with the 3 months of the period.

And then just by way of follow-up, I understand the macros are where they are and lots of tailwinds pointing in your direction. Given that none of the 3 months of Q2 on an adjusted basis were at parity with the second half comp guidance, is there anything you're seeing today here at the outset of Q3 that's reinforcing your confidence in that 3.5 for the second half of the year?

So with the start to Q3, we are confident in our ability to achieve the 2016 targets. Certainly, there's much less potential for weather impact in Q3. And based on the sales volume in Q4, there's always potential for weather, but it's less of an impact. We talked about some modest disruption associated with the .com platform in Q2. That's behind us. We're seeing really strong performance subsequent to that. The other thing I would suggest, Matt, is we've had some modest deflation pressure on sales in the first half of the year, more so in Q1, less so in Q2. That should flip with strength in lumber prices to modest inflation in the second half of the year.

Your next question comes from the line of Christopher Horvers with JPMorgan.

Also following up on sales. So just looking at the category performance, you had weakness in millwork, rough plumbing and electrical, paint, really core repair and remodel project categories. So how should we think about that? And think about the favorability of weather, was that a pull-forward into 1Q? But also, did you actually see some pull-forward into 4Q '15 last year? And this is just normalization and we're going to get back to stronger trend. And then on that, it sounds like you're expecting 3.5% in both the third quarter and the fourth quarter. Do you think that, that fourth quarter could be a hidden tough weather comparison considering that category performance?

Let me take the first part of that on the category performance. Where we saw pressure with the categories below average, in most cases, it's because of outdoor sales. So in outdoor power equipment, as example, we had very soft mower sales. In millwork, we had soft doors and windows sales. However, with some of our interior lower categories, we actually saw very robust sales. And in paint, we had soft sales in exterior coatings, but positive comps in interior coatings. So another way to think about it, right, if I think about big-ticket strength, as an example, in the second quarter, kitchen cabinets actually showed strength. Chandeliers and vanity lightings were up double digit. Wooden vinyl flooring was up double-digit. Bath vanities were up double digit. We had some exterior projects that were up quite strong as well. Shingles were up double digits. Warding's [ph] up double digits. Fencing was up high single digits. But where we did we see a little softness was in exterior projects, and we tipped and typed that DIY customers would take on. So the macroeconomics feel pretty good. In rough plumbing and rough electric, we had deflation, in particular, around copper that impacted the category.

The potential pressure from weather, in looking at the second half, our comparisons in Q3 are 4.6%; and Q4, 5.2%. So not much of a difference in our comparisons we're going up against in the second half of '15. And based on the factors that Mike described, the efforts with the Pro, replatforming our comp site and progress we're making on LowesForPros, enhancing our PSI offering and the resets he described, we feel confident in the second half of the year.

Okay. And then as a follow-up, could you -- I'm not sure if you said this, but could you quantify what you thought the .com disruption was? And then on the other side, perhaps what you thought air-conditioners lifted comps in the second quarter.

So, Chris, the estimated impact of the .com disruption in Q was roughly 25 basis points. As part of the DCs, I don't have the -- actually, I do have that impact. That's roughly 20 basis points of impact to the second quarter.

Your next question comes from the line of Greg Melich with Evercore ISI.

I wanted to just another sales follow-up and then understand RONA a little bit better. Were .com sales down in the quarter when you said that 25 bps disruption or was it just less growth than you expected? And also, just to be clear, are we currently, this quarter, running in that sort of 3 to 4 plan that you have for the second half?

Greg, this is Rick. On the Lowes.com performance, we still had solid double-digit comp performance on the platform at 14%. So we expected roughly a 5-week disruption period from the relaunch of the platform. Historically, that's what we've always seen. And that held through again. We ran back to the normal run rates after that 5-week period when the customers became adjusted to the new site and how the new site functions.

We're also seeing good .com performance to start Q3. As I mentioned a moment ago, with the Q3 start, we're confident in our ability to hit the targets for the year as well as the 3.5% for the second half.

Got it. And then -- that's helpful. And on RONA, just to make sure I got these right. In this quarter, the hit I get was about $35 million of purchase accounting hitting the COGS, right?

That's about right.

For the full year, it's a 35 bps hit to the plan. It implies it's about a $200 million hit. Could you help us walk through how much of that $200 million hit is fees to lawyers and bankers? How much of it's purchase accounting? How much of it is integration costs? And I thought you said accretion of RONA was next year, not this year. I just wanted to clarify that.

Yes. So what we're seeing, so if you exclude the net gain on the hedge, as we bring in the operating performance of RONA, that more than offsets transaction and integration costs. So from an EPS perspective and from an EBIT dollar perspective, it's accretive. What's happening is there's 2 items. So if you pull in RONA's results, which have a lower EBIT percentage, has effective mixing of the total companies EBIT down. Second are the purchase price accounting adjustments. So by the impacts I gave you for the year and then specifically for Q3 and Q4, the 60, 50 basis points impact on EBIT, you should be able to take RONA's 2015 reported financials to be able to discern the mix and the purchase price accounting impact for the second half of the year. So it is accretive from an EBIT dollar and EPS standpoint, but it does have a negative impact as a percent of sales.

And just that -- so that $35 million that we saw in the second quarter, we're not done with the purchase accounting. There's more of that in the next 2 quarters.

There's more of that. That's why there's a $60 million...

That's the $50 million to $60 million. Okay.

That's the purchase accounting and the EBIT mix.

That's great. And I apologize if I sneak the third one in, but on the categories, which were the -- I think there were 3 categories that were actually down in the quarter. Could you mention which ones those were?

Yes, I just spoke to them. It's outdoor power equipment, millwork and paint.

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

With regard to the changes in promotion, some of that we saw in credit promotion, with some of the broader percentage off promotions that you ran. I was just curious, as you look back, how would you grade the level of promotional effectiveness? And how should we think about those programs going forward in Q3 and Q4? Would we continue to see them?

So Dan, we talked a lot about promotions in the first quarter. Certainly, margin down 43 basis points. We talked about some specific things we did in Q1. We take advantage of the spring season again, it's a strong proportion of our business and with favorable weather. We indicated that, that pressure was largely contained to Q1. As we think about our gross margin performance, absent the RONA impact, up 17 basis points in the second quarter. Bob can take you through the array of options we have for promotions. But we do think about the tools and capabilities we have to align the promotional tactics around the categories and the timing to stimulate the demand and build baskets.

And I guess, I would probably describe the promotional environment, again, I think it's rational. I don't know that you're going to see any substantial increases in promotional depth. I think, you see us leverage our consumer insights analytical capability to tweak promotions to make them more efficient, and I think you see us use some of our marketing digital capabilities to ensure that we're getting better utilization on how we extend our promotions. But again, I would define the promotional environment as rational with much better tools to help us optimize how we bring promotions in front of our customers. And I think that the learnings, I think, are inherent in some of the digital tools that are being deployed and how we better utilize promotions to get a return on every dollar spent.

Now, I was wondering separately if you could just talk to us a little bit about what happens next with the RONA integration? How long that will take? What do you tackle first? What changes should we see to that organization first, whether it's in stores or back of the house?

Dan, Richard Maltsbarger's in the room. And he -- Robert reports up through him, Head of International. So I'll get him to address your questions.

Yes, Dan. Thank you for the question. The integration is going quite well so far. We've made great progress on our initial plans. Our initial focus has been very much on placing the right leaders and the right structure in order to be able to manage the integration and to be able to manage the joint planning of the 2 organizations that we shape a new culture to compete in Canada. As we said when we're putting the deal together, we have 3 core fundamental tenets of what we're doing with our integration and our plan. This is about revenue and cost synergies as we go about competing in the Canadian market with better customer relevance by leveraging our strengths and omni-channel and our approach to be able to bring all of our channels together to serve customers; our expanded customer reach through our strengths and expertise in key product categories, including introducing appliances into the RONA stores across the country; and then increased profitability. We do believe that the combined scale of our 2 organizations, both in our direct purchasing and our indirect purchasing as well as eliminating key things like public company cost will allow us the opportunity to possibly double profitability within the first 5 years. All indications to date are that we're well on track for that and we're quite encouraged by what we see.

Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.

So I have a question on the 110 basis point impact you highlighted from weather. Wouldn't all the weather impact really been in the month of May, because it seems like that'd be a really sizable hit if it was just in that 1 month. Or did you see disruptions throughout the quarter that maybe we're not thinking about properly?

So, Scot, as we think about weather impact, we compare actual temperature and precipitation to historical norms to determine the weather impact. The majority of the weather impact certainly was in May. There were some minor impact as well in July because of the extreme heat.

Okay. So if we were to try and kind of eyeball or back of the envelope some of those impacts, the June numbers should have been relatively clean in terms of the monthly comp that you provided with July just a slight change versus what you disclosed?

Yes. So what we did was we've given you the weather impacts based on the methodology I just described. What I can't quantify is the exact amount of pull-forward and the impacts to each of the first 6 months of the fiscal year. I can't tell you how that changed consumer behavior and the timing of the purchases.

Okay, understood. And then can you provide any more color or magnitude in terms of the difference that you saw regarding that comp growth between the DIY and Pro, because it seems like you guys highlighted a couple of times the strength of the Pro this quarter?

There was almost a 400 basis point gap in the Pro comp relative to the DIY comp.

Your next question comes from the line of Peter Benedict with Robert Baird.

Sticking with the Pro a bit. Just curious how the MRO business has been trending for you guys? Maybe you got a comment there.

Sure. We still -- we continue to be pleased with what we're seeing from the MRO customer segment, especially when you look at the Pro in general, we continue to make and leverage our investments. As Mike highlighted earlier, to continue to drive relevance and build relationships with those customers. You look at our LowesForPros launch, it's really something that we continue to see the MRO customer gravitate to as they -- it becomes easier for them to shop our stores and make it easier for them to purchase and build segmented profit list. And then you look at the investments in our inventory depth as well as our AEP networks. International sales teams, I think, all combined to help us continue to drive that performance. As we've talked about, Pro is now approximately 30% of our total volume, continues to grow at a faster rate than our DIY business as the Pro continues to leverage our strengths in the categories, the brands that we're bringing in and continue to introduce as well as our 5 Ways to Save value proposition. So we think, holistically, those aspects drive greater relationships and synergies across all Pro customers, not just one segment.

Okay, perfect. And my follow-up is just back to RONA. As we think longer term, Bob, does RONA impact the EBIT margin flow-through profile benchmarks that you guys have spoken to in the past at all?

Peter, thanks for the question. As you know, we've got analyst conference in December. We'll update you on our long-term financial targets at that time.

Our final question will come from the line of Mike Baker with Deutsche Bank.

I wanted to ask about some of the bigger ticket items because the big-ticket growth was as well as it's been in a couple of years. So appliances, I think, in line this quarter and below average last quarter. Can you describe -- discuss what's going on there? It seems like you're not doing as well as some competitors. There's been some new entrants in this space. Is that having an impact at all?

No, we're not seeing any impact from new entrants. I guess, I would think about appliances as we had comps in line on top of very strong comps last year. So our 2-year stack appliances is very, very strong. We like how we positioned appliances. We like that. We can -- we have the largest dedicated showroom floors on appliances. We like where we are with respect to our J.D. Powers and Associates ranking. We like the fact that we do our deliveries. We really do appreciate the way we do our display techniques with appliances with full vignettes to allow the customer to envision more appliances in their home. The way I would think about appliances is that it's a critical category for us. We hope to make -- we will work to maintain our #1 position and it's a great way for us to sell the entire kitchen and leverage the cabinets and countertop space that we have right next to the category. So we continue to be very bullish about it. And we think that we'll gain share in the second quarter -- excuse me, in 2016 just as we did in the second quarter.

Okay. You think you gained share in the second quarter?

When we look at our performance in appliances versus the industry, we actually believe we gained share in the second quarter.

Okay, interesting. I wanted to follow up on paint as well. With some of the moves you guys made earlier in the year with some vendors, are you surprised -- I guess you explained it, but -- that outdoor was weak. But are you surprised that the paint business isn't doing better at this point? Or is it really just because of the weather?

We felt good in the -- certainly in the fourth quarter and the first quarter on paint, with both quarters being above the company average. We can clearly see that we're gaining share for it in first quarter. As we look at the second quarter, we can see this clear split, this clear line of demarcation between indoor and outdoor. We think there's some opportunities for us to continue to enhance our line design, but outside of that, we feel we're good about our brands. When you have Sherwin-Williams, Valspar and PPG/Olympic, those exclusive brands are very powerful. We think it positions us well.

Okay. Lastly, just one more bigger ticket. Pro, can you repeat the gap? Did you say 100 basis points gap? And how does that compare with the previous quarters?

So the number is 400 basis points.

400. Okay.

Right, which was slightly higher than what we saw in the first quarter. Also, as you think about the big-ticket categories and the comp performance above 500, our worst-performing category in the quarter was outdoor power equipment. I think, riding mowers, we've get #1 share as the big-ticket category had a disproportionate negative impact on that segment of our business.

And why was that weak again? Just the weather, you think?

Yes.

Thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our third quarter results on Wednesday, November 16. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you all for joining and you may now disconnect.