Good morning, everyone, and welcome to Lowe's Companies Third 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. Rick Damron, Chief Operating Officer; and Mr. Bob Hull, Chief Financial Officer. Joining during the Q&A session will be Mr. Mike McDermott, Chief Customer Officer; and Mr. Richard Maltsbarger, Chief Development Officer and President, International. .

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. Our third quarter operating results were below our expectations due to slower sales in the first 2 months of the quarter. .

While we expected moderation in the second half of the year, as reflected in our guidance, traffic slowed more than we anticipated in August and September before improving in October, which put pressure on our profitability.

Our third quarter comparable sales grew 2.7%, which was driven by a 0.5% increase in transactions and a 2.2% increase in average ticket. Our U.S. home improvement comp was 2.6%. The comps for our South and West divisions were in line with our expectations. In contrast, we experienced continued softness in our North division throughout the quarter.

We posted positive comps in 11 of our 15 regions. Overall, we drove positive comps in 10 of our 13 product categories, while one category was also flat..

We saw relative strength in big-ticket purchases driven by outdoor power equipment and appliances. Continued strong demand from Pro customers was evident in lumber building materials as well as tools and hardware. And lawn guard also performed well as we helped customers tackle exterior maintenance and prepare their lawns for winter. .

We continue to be pleased with the performance of our Pro business as the strong foundation we built with this important customer drove comps well above the company average. And we remain focused on providing best-in-class omnichannel customer experiences that will make Lowe's the project authority.

We continue to see strength in our Project Specialist Interiors program, with strong growth in both leads and comps again this quarter. And we posted 20% comp growth on Lowes.com, driven by robust growth in both transactions and ticket following our website redesign in Q2..

Our Orchard Supply Hardware business drove mid-single-digit comps for the quarter. And internationally, we continued our strong performance, including double-digit comps in Mexico and mid-single-digit comps in Canada in local currency. We also made continued progress on the integration of RONA, which remains on track.

With RONA, we have fortified our Canadian market position, particularly in Québec. We are now well positioned to capitalize on the market's strong long-term fundamentals..

We reported earnings per share of $0.43 for the quarter, which included several noncash charges. First, we recorded further impairment on our investment in the Masters joint venture.

Second, we wrote off projects that were canceled as part of an ongoing review of our strategic initiatives in an effort to focus on critical projects that will drive our desired outcomes.

And finally, we recorded goodwill and long-lived asset impairments associated with our Orchard Supply Hardware operations as part of our strategic reassessment of the business during the quarter. Bob will discuss these items in greater detail in his comments. .

Adjusted earnings per share was $0.88, an increase of 10% over the prior year. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $550 million of stock under our share repurchase program and paid $309 million in dividends.

As we look ahead, we are laser-focused on improving productivity across the organization. Our immediate focus is continuing to optimize associate hours to better match customer demand.

And while we've made progress in driving productivity in recent years, we are in the process of evaluating meaningful incremental opportunities to drive shareholder value while continuing to meet customers' needs in an omnichannel environment.

We look forward to discussing these opportunities with you at our upcoming Analyst and Investor Conference on December 7..

Turning to the economic landscape. We have a continued opportunity to benefit from a fundamentally solid but moderating home improvement market. Home improvement growth has continued to outpace overall retail sales thus far in the second half of the year.

The industry will continue to benefit from several factors, including a solid consumer backdrop, lighting benefits from existing home sales and rising home prices that encourage the customer to engage in discretionary remodels and upgrades on top of routine maintenance.

We believe that strengthening demand for revolving credit will also continue to support big-ticket spending, while moderating gains in the job market and incremental income growth should contribute to solid growth and overall consumer spending..

We expect that housing will continue to be a bright spot in the economy. Home sales started out quite strong in 2016 and are now moderating to a sustainable pace. Home price appreciation should persist, which, along with stronger incomes, should motivate more homeowners to spend on home improvements.

We are also encouraged by growth in first-time homebuyer activity, which is expected to continue through 2017..

Our third quarter Consumer Sentiment Survey shows a similar trend, with consumers' favorable views around their personal finances holding steady. We continue to see supportive trends for the home improvement industry. Specifically, we found that over half of homeowners believe the value of their home is increasing.

And home improvement spending intentions held steady, continuing to outpace overall spending intentions. .

While this was no doubt a challenging quarter, we will continue to better match leverage to demand and drive productivity. Importantly, our fundamental strategy remains intact.

We will continue to focus on providing customers with the best omnichannel experiences to assist with their home improvement projects, whether they choose to connect in the store, online, in their home or through most contact centers.

At the same time, Pro continues to outperform, and we will remain focused on deepening our relationship with this important customer. .

Before I close, I'd like to thank our employees for their incredible commitment to serving customers. Their dedication was certainly evident during times of need, including Hurricane Matthew and the extreme flooding in Louisiana. As true members of the community, the team helped customers prepare for and rebuild after these disasters..

Thank you again for your interest in Lowe's. And with that, I would like to turn the call over to Rick. .

Thanks, Robert, and good morning, everyone. As Robert mentioned, traffic slowed more than expected in the first 2 months of the quarter before improving in October.

Our Labor Day and Columbus Day events drove sequential comp improvement in the South and the West, resulting in third quarter comps for those divisions that were in line with our expectations. However, we saw continued softness in our North division throughout the quarter. .

We posted positive comps in 10 of 13 product categories, while one category was flat. Both outdoor power equipment and lawn and garden performed well, given the focus on exterior maintenance and winter lawn preparation as well as opportunities from an extended planting and lawn cutting season.

Once again, we drove above-average comps in appliances by leveraging our leading brands and service advantages as well as our investments in the customer experience, both in-store and online..

Within seasonal living, grills posted double-digit comps, bolstered by our Weber and Char-Broil brand partnerships. Additionally, our customer experience design capabilities continued to pay dividends.

Leveraging our largest store format in a space that was initially planned for outdoor living experience, we created a seasonal stage to anticipate customers' needs for the season, showcasing an experience that helped drive a 65% comp in Halloween products and addressing power preparation needs like lawn care and seasonal maintenance. .

We have now transitioned this space to our holiday decor experience in preparation for the upcoming selling season. Once again, leveraging the seasonal stage, we intend to help customers refresh their homes for guests, decorate and organize their homes after the holidays..

We saw continued strong demand from the Pro customer with comps well above the company average. Pro activity drove solid comps in lumber and build materials and tools and hardware.

We were able to capitalize on this demand by improving our total assortment with destination brands like Marshalltown, a trusted Pro brand and the leading supplier of cement masonry tools, which rolled out to stores this quarter.

This adds to our impressive portfolio of Pro-focused tool brands, including exclusives like Hitachi and Bostitch, the #1 and #2 brands in pneumatics; Vaughan, a leader in the hammer category; and our extensive private-label line of Kobalt tools. .

first, preparation in advance of the storm; second, impact, when the storm actually causes damage; third, cleanup; and fourth, recovery, when customers begin to make repairs and replace damaged items.

In the third quarter, we experienced preparation, impact and some initial cleanup from Hurricane Matthew, and we're into the recovery phase from the Louisiana floods. We expect hurricane recovery to begin in the fourth quarter and extend into 2017. Bob will share further details about the impacts of these events in his comments. .

We continue to focus on our strategic priorities, one of which is leveraging our omnichannel capabilities to help customers achieve great project results.

Customers can engage with our associates in-store for expert advice; our content on Lowes.com for inspiration; our contact centers for ongoing support; and our project specialists, who work with them in their homes to design, plan and manage their home improvement projects..

In the second quarter, we relaunched our Lowes.com site, providing an upgraded online shopping experience with optimized functionality and display for touch screen devices; improved product and content recommendations; refined search algorithms; larger product images; and expanded product views, including video content.

We've seen a great response to the new website this quarter, which, along with our flexible fulfillment options of buy online, pickup in-store and buy online, deliver from store, combine to drive Lowes.com comp growth up 20%. .

Furthering our omnichannel capabilities, this quarter, we completed the national rollout of our interior project specialists. Both interior and exterior project specialists are now available across all U.S. home improvement stores to meet with customers and their homes to design, plan and complete their home improvement projects.

This in-home selling program represents another critical element of our omnichannel strategy with a differentiated capability in capturing and servicing project demand. Our in-home sales program continues to outperform, with double-digit sales growth again this quarter. .

Our Pro business continues to thrive with comps well above the company average, driven by a favorable macro backdrop as well as our continued efforts to optimize our product and service offering to better serve the Pro customer.

Beyond improvements in our tools offering, we have also strengthened our overall portfolio of Pro-focused brands and make necessary investments into our inventory depth to optimally serve the Pro customer.

And we continue to incorporate feedback from Pro customers and store employees into a better offering and experience while working to identify local market opportunities and introduce products optimized to local preferences to further increase our relevance with Pros. .

Our ProServices team continues to advance a multilevel customer engagement strategy across the country through LowesForPros.com and our national sales team at the market level, with our account executive ProServices, or AEPs, and at the store level with our dedicated in-store ProServices teams.

Last year's relaunch of LowesForPros.com made it easy for Pros to manage multiple properties and quickly purchase items nationwide. This full omnichannel experience allows Pros to easily order online and choose their preferred fulfillment option of parcel, store pickup or store delivery, saving them both time and money.

Our AEPs work with larger regional customers to help them order and replenish products across multiple geographies and locations. Our AEPs have been very effective in growing our business with larger Pro customers, especially maintenance, repair and operations, or MRO, customers.

We currently have over 200 Pro outside sales representatives in the field that continue to be very pleased with the program's results. And once again, we saw double-digit growth in AEP sales this quarter, which contributed to the strong Pro comp growth.

Our focus on further strengthening our portfolio of brands, improving our inventory depth and continuing to build upon our omnichannel offering through our relaunch of LowesForPros.com and our growing ProServices team are all part of a broader commitment to build on a strong foundation with the Pro..

In addition to our efforts to drive top line growth, we continue to focus on driving productivity and profitability. As Robert said, we are focused on optimizing associate hours to better match labor to customer demand. When we experienced softer sales in the early part of the quarter, we worked to adjust labor accordingly.

In fact, payroll leverage improved substantially from August to September following our staffing adjustments. In order to maximize our profitability, we will continue to optimize our mix of customer-facing to noncustomer-facing hours..

While this was a challenging quarter, we continue to focus on executing our strategic priorities and making progress on our initiatives to drive top line growth and improve productivity and profitability..

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

Thanks, Rick, and good morning, everyone. First, let me remind you that Q3 includes a full quarter of RONA's financial results. In conjunction with the transaction, RONA's operating results were adjusted to reflect purchase accounting as well as to align their accounting policies with U.S. generally accepted accounting principles.

They will be included in our comp sales calculation after we anniversary the transaction in the second quarter of 2017..

Now on to our Q3 results. Sales for the third quarter were $15.7 billion, an increase of 9.6%. Total customer transactions grew 7.5%, with RONA accounting for about 85% of the increase, and total average ticket increased 2% to $68.68. The sales increase was driven by the addition of RONA and increasing comp sales and new stores.

For Q3, approximately $900 million or 6.3% of the sales growth came from RONA. New stores contributed approximately 60 basis points of the sales growth. Comp sales were 2.7%, driven by an average ticket increase of 2.2% and transaction growth of 0.5%. .

Looking at monthly trends. Comps were 1% in August, 2.1% in September and 5.1% in October. We estimate that the net impact of weather positively impacted comp sales in the quarter by approximately 60 basis points.

The benefits of serving customers in storm-impacted areas was somewhat offset by heavy rain in the middle of the country in August as well as extreme heat early in the quarter. .

Gross margin for the quarter was 34.35% of sales, which decreased 40 basis points from Q3 last year. Gross margin was negatively impacted by RONA due to both purchase accounting adjustment and the mix of business. In the quarter, these items negatively impacted gross margin by 46 basis points. .

SG&A for the quarter was 25.98% of sales, which deleveraged 309 basis points. As Robert noted, there were several noncash charges negatively impacting our results. Our 1/3 interest in the Australian joint venture is classified as a long-term investment on our balance sheet.

For the terms of the joint venture agreement, our investment should be valued as a going concern as of January 18, 2016, the date we exercised our put option. However, Woolworth's [indiscernible], the majority partner, has commenced the wind-down process.

Given this unilateral action, accounting rules require us to recognize an incremental $290 million charge has contributed 184 basis points to the deleverage. Our claim related to the going concern value as of January 18, which is above and beyond the amounts expected to be received through the wind-down process, will be recognized as realized.

This matter is currently in arbitration..

Also, as part of an ongoing review of our strategic initiatives in an effort to focus on critical projects that will drive our desired outcomes, we made the decision to cancel and rescope a number of projects, resulting in a write-off of $96 million, which caused 60 basis points of deleverage.

A number of these projects were technology-enabled, and we were trying to customize a solution. With technology advancing so rapidly, off-the-shelf products became less costly in a faster deployment alternative..

Lastly, we recorded $76 million of goodwill and long-lived asset impairments related to our Orchard Supply Hardware operations, resulting in 48 basis points of deleverage. We invested in Orchard in 2013 to capitalize on opportunities to significantly increase our market share in California.

Post-acquisition, we made critical investments to improve the infrastructure and remodel retail facilities that, prior to bankruptcy, had been neglected..

In addition, we launched several initiatives as we worked to reinvigorate the Orchard business model. Specifically, we tested a variety of things, including new store opening density, new market penetration approaches and atypical prototypes to allow for more metro market penetration.

Over the past 2 years, our combination of some tests proved more difficult to achieve, and pressures from the historic drought conditions on the gardening and nursery business have caused the business to perform below our expectations. Learnings from these tests have shaped how we take the brand and market opportunity forward.

In fact, we begun to see these learnings reflected in our results. As Robert noted, Orchard grew mid-single-digit comps in the quarter. .

risk insurance, which is driven by a favorable adjustment last year that didn't repeat this year; private-label credit cost due to an increase in loan losses; and store payroll as a result of slow sales trends early in the quarter. These items were partially offset by 27 basis points of leverage in bonus. .

Depreciation for the quarter was $378 million, which was 2.4% of sales and leveraged 21 basis points. Earnings before interest and taxes or EBIT decreased 328 basis points to 5.97% of sales. Adjusted EBIT decreased 35 basis points to 8.9% of sales..

RONA impacts associated with purchase accounting adjustments, the mix of business and integration costs negatively impacted EBIT by 55 basis points in the quarter..

For the quarter, interest expense was $163 million. The effective tax rate for the quarter was 51.2%. The higher rate was driven by the joint venture noncash charge, which was a long-term capital loss. Future recoveries related to our claim will be capital gain and result in a reduction in the effective tax rate in the quarter they are realized. .

Earnings per share were $0.43 for the quarter. Adjusted earnings per share were $0.88. Earnings from RONA's operating results offset purchase accounting adjustments and integration costs. .

Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $960 million. Inventory at nearly $11 billion increased $556 million or 5.3% versus Q3 last year. The increase relates to the addition of RONA..

Inventory turnover was 3.89, up 4 basis points to last year. Asset turnover increased 4 basis points to 1.79. .

Moving on to the liabilities section of the balance sheet. Accounts payable of $7.8 billion represented a 6.8% increase over Q3 last year due to the timing of purchases year-over-year, terms improvement as well as the addition of RONA. At the end of the third quarter, lease-adjusted debt to EBITDAR was 2.36x..

Return on invested capital was 13.6%. The net impact of last year's noncash impairment charge related to our Australian joint venture and this year's foreign currency hedge gain and noncash charges hurt ROIC by 318 basis points..

Now looking at the statement of cash flows. Year-to-date operating cash flow was $5.3 billion. Capital expenditures were $820 million, resulting in free cash flow of over $4.4 billion, which was up 20% to last year..

In August, we entered into a $250 million accelerated share repurchase agreement, which settled in the quarter for 3.4 million shares. Also, we repurchased approximately 3.9 million shares for $300 million through the open market.

In total, we repurchased $550 million of stock in the quarter, with approximately $630 million remaining on our share repurchase authorization. .

First, a reminder that fiscal 2016 will include an extra week in the fourth quarter for a total of 14 weeks and 53 weeks for the year. Also, based on our year-to-date operating performance and updated expectations for the fourth quarter, we revised our fiscal 2016 business outlook. .

first, we're forecasting a comp sales increase of 3% to 4%; second, we expect RONA to contribute 4% to sales growth; next, we anticipate the 53rd week will aid total sales by 1.5%; lastly, we plan to open 40 stores, which adds 0.5%. On a GAAP basis, we're anticipating an EBIT increase of approximately 65 basis points.

While the acquisition of RONA adds EBIT dollars, there's a negative impact to the percent of sales due to both RONA's lower EBIT rate and the impacts of purchase accounting I noted a moment ago. Combining these items pressure EBIT by 35 basis points for the year. Negative impacts to Q4 are estimated to be 40 basis points..

For Q4, on a GAAP basis, we expect EBIT improvement of approximately 490 basis points. The impact of last year's joint venture charge is 400 basis points. The remaining 90 basis points of expected EBIT growth comes from primarily expense leverage, notably bonus and depreciation..

The effective tax rate is expected to be 40.1%. The higher-than-expected rate is driven by the joint venture noncash charge..

For the year, on a GAAP basis, we expect earnings per share of approximately $3.52. We're forecasting cash flows from operations to be approximately $5.6 billion. Our forecast for capital expenditures is approximately $1.5 billion, which results in estimated free cash flow of $4.1 billion for 2016. .

Our guidance assumes approximately $3.5 billion of share repurchase for 2016. .

Regina, we're now ready for questions. .

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

So the growth you put up in the second quarter was a little less than half of the growth in the industry with -- from announced underperformance in traffic.

Do you think that was more due to draw or conversion? And how do you improve each of those factors while improving your cost structure?.

Michael, we've -- as we've talked about in the past, we've put in place systems to monitor the inflow of customer traffic. As a result, we've been able to monitor that relative to our transaction activity to have a perspective on conversion rate.

For the third quarter, we actually saw a modest improvement in conversion rate, which means the problem is more related to draw. .

And how do you expect to -- how do you anticipate improving that with cost under pressure?.

Michael, this is Mike McDermott. As Bob and Robert stated, our traffic slowed more than we anticipated in August and September before improving in October. We saw a particular weakness in the North. Additionally, we found that we've got opportunities to improve our customer engagement, promotional targeting and marketing reach across the country.

Throughout the quarter, we made some necessary adjustments to our consumer messaging, further refined our media mix and tweaked our promotional activity in the quarter, which supported that improvement that we saw in October. We anticipate improved traffic in the fourth quarter as we continue to work those actions. .

Okay.

My follow-up question is, as you look across your store base, has the slowdown that you experienced throughout the last couple of quarters been consistent across the entire population of stores? Or has it been more pronounced in certain types of areas, more rural areas have underperformed, more suburban -- or urban areas, adjusting for the weather?.

Michael, this is Rick. As we look at the store base, we continue, as we said, to see softness in the North. As we communicated in Q2, the North was, from an overall performance expectation, our lower-performing division at that time. So we saw that trend continue in Q3.

As Mike said, we have some opportunity to continue to improve our mix to this customer as it relates to how we're going to market from a media perspective and how they consume marketing advertising. So we know we have some opportunity to do that.

When we look at the overall store base, we see our largest opportunities to be in the most urban markets where we have more significant competitive pressure either out-stored in -- by multiple locations to the competition and/or in most of our 3-way markets.

So I would say, from a geographical standpoint and a store base standpoint, we still see most of the pressure coming from the heavy dense metro and urban market. .

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

So first question for Robert Niblock. Today, you mentioned in your comments moderating home improvement market. I don't know if I interpreted or heard it right. I know last quarter we talked about not seeing a lot of change in wholesale trends. You mentioned the survey that you run for sentiment. So it sounded like things were okay.

Again, I don't know if I'm taking that moderating comment out of context, but curious what's changed from second to third quarter, especially if there were some maybe weather issues that maybe explain some of the early quarter weakness. .

Yes, Simeon. I'll be-- glad to clarify that for you. Overall, from the consumer standpoint, their desire -- their feelings around the home, the value of their home increasing, their intentions to invest in the home have all continued to be strong during the year.

From the beginning of the year, based on what we saw in the data, we said that we thought home improvement would -- the overall factors would moderate some as we went through the year. So for example, total housing turnover is expected to be annualized at 4.8% versus 7.3% last year.

Home price depreciation this year forecast is 4.9% versus 5.5% last year. So still strong numbers, but moderating disposable income at 2.3 -- 2.6% annualized this year versus 3.5% last year. And part of that was driven by the decreased turnover that we saw a year ago. We knew that, that would moderate some.

So we still expect to be in a very healthy environment. We still think the #1 driver that's out there is continued appreciation in homes, but it has moderated some. So still a very healthy industry, but not to the extent that we would have seen the numbers supporting a year ago. .

Okay, that's helpful. My follow-up, in the press release, is this quote, that you're evaluating meaningful incremental opportunities to drive shareholder value.

Can you talk about the timing, the size, the magnitude? And then what's prompting you to make that comment now? What's causing that?.

Yes. We've obviously been, for a while, looking at ways to improve productivity, and so we've been undertaking initiatives throughout the past couple of months looking at our productivity and opportunities to improve that, rationalized our cost structure. A couple of things.

We talked about the project -- portfolio rationalization that we mentioned, as Bob mentioned, some technology-enabled projects to get us to focus on the critical few, which led to the noncash write-off that you saw in our press release today. Rick talked about continued work to optimize our labor hours in the store against our customer demand.

And we have a number of other work streams underway as well as we're looking across the entire organization to say, "How do we better rationalize what we're doing?" If you think about as we're moving to an omnichannel, we're continuing to build that way in an accelerating pace.

We're making sure we're investing in the right areas to make sure that we support where the customer wants us to be. So as I said, we've got some other work streams in place, and we'll be able to give you additional detail, we believe, at the Analyst and Investor Conference. But we're not ready today to get into those details with you.

But it is a comprehensive review. .

Okay. I guess, just to clarify. And I guess some of these will be teed up at the Investor Day, but is it more SG&A streamlining? Because I know you took this Orchard write-off, but you mentioned Orchard comps -- it sounded like they were pretty healthy. So I'm just trying to connect those 2. .

Yes, a couple things. One is -- I think we have 2 things.

One is, as you heard, we'll go from both Rick and from Mike McDermott, is that we have an opportunity to continue to drive sales and traffic into our stores by continuing to look at our marketing message, the promotional cadence we use, the move that we've been making -- that we've made to digital over the past few months that has been -- we've seen great response to as we continue to remix the -- I think with our media mix model; and two, we've been able to remix the message.

So it is driving additional traffic to drive additional sales on the one hand. On the other hand, it is rationalizing our cost across the organization. So it really is a two-pronged approach. Specifically, with regard to Orchard that you mentioned, as Bob talked a little bit about in his comments, we bought it out of bankruptcy.

The impact on the customer franchise from bankruptcy, the remodeling of the stores, the fact that we had to change the technology and platform out there and bring it up to speed, all of those things.

The lifting was just a little heavier than we thought, but we're at a great point now as we're starting to see our great performance in the fundamental stores that are out, and we've kind of rationalized how we're going to use Orchard going forward. So we're still very optimistic about what we can -- what Orchard can do for us.

Just getting to this point was a little bit more difficult than we had anticipated so... .

Your next question comes from the line of Seth Sigman with Crédit Suisse. .

I was just wondering if you could give us a sense of how much weather impacted each of the months of the quarter. You saw a nice improvement in October. Just trying to understand how much of that would have been weather.

And then just wondering, did you see an improvement in the nonweather-impacted markets in October as well?.

So Seth, as we think about the weather impact, the heavy rains in the middle of the country, which, in fact, led to the flooding in Louisiana as well as extreme heat, had a pretty significant negative impact on the month of August. So the net impact was probably 80 basis points unfavorable in August.

As we think about the recovery efforts, mostly, as Rick said, given the stage for Louisiana flooding, which is about 2/3 of the benefit we're seeing from the recovery efforts, that would have helped September about 90 basis points and would have helped the October by roughly 150 basis points.

If you exclude the benefit from serving customers in those impacted markets, we did see improving underlying trends in the month of October. .

Got it. Okay, that's helpful. And then just as you look at the Pro side of the business, it's nice to hear it's outperforming.

Can you give us a sense of the magnitude of that outperformance? Maybe how that compares to prior quarters? And I know there's been a big focus on effective promotions to try to get that customer reengaged here as you've improved the assortment and the offering. Just give us a sense of how that's played out. .

Sure. The performance in Pro has continued to be strongest. As we've talked about over the past several quarters, the Pro consumer continues to outpace our DIY consumer across the business portfolio. And I think a lot of that still continues to focus on really a few things that we've done, Seth, to continue to drive that customer.

The merchants, first, have done an outstanding job in working with the operators to bring in the brands that really drive relevance with the Pro. We've talked a lot about that. But we don't want to underestimate the impact that having the right brands in our stores that these customers really value does help us drive that business.

Second thing that I would highlight is the fact that we continue to leverage our organization from that multilevel design approach to really be able to service these customers in a different and unique way, leveraging our national accounts teams to really help them from that perspective, diving deep at the market level and really working with our larger MRO customers and the larger accounts to drive incremental share and be more relevant from that perspective; leveraging our 5 Ways to Save programs, where I think our Pro see significant value in the -- our initiatives to drive incremental value for them; the relaunch of LowesForPros.com from -- in Q2 of last year, which is really an informational site into a commerce site, and the transactional site has continued to help us drive significant growth; and then, fourth, the investments we'd made into inventory to continue to improve our breadth and our depth of products that are really critical for this customer.

So we see this as a continued evolution of our Pro initiative. We are extremely pleased with the receptivity of the Pro to the actions that we're taking. And I think that shows in the numbers, especially this quarter and over last several quarters, as we continue to drive greater relevance with the customer. .

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

So Mike McDermott, in his remarks today, talked about some of the actions that you took through the quarter to enhance sales performance, including tweaking the promotional cadence and some other things. Can you talk about what impact that had on profitability over the course of the quarter? Clearly, you had a much better month in October.

Was there some cost to operating margin or operating margin trend associated with some of the changes that you made?.

So Matt, I'll start with the profitability and let Mike add some color. As we think about the comp progression, as we talked about, payroll was a little heavy start to quarter, given the sales trends. Rick described the significant improvement in payroll productivity from August to September. So we feel really good where we are exiting the quarter.

From a promotional standpoint, the reported margin was down 40 basis points. Absent the RONA impact of 46, margin's actually up 6 basis points. So we feel good about the ability to refine the promotional mix without having a disproportionate drag on gross margin. .

Yes. I would only add to that by saying working closely with our vendor partners, the merchants have done a great job working on cost of goods in a consistent way and making sure that we remix our promotional strategy consistent with where the consumers' mind is.

Promotional environment in the third quarter was in line with previous periods, with the exception of only a couple of categories.

We saw a little bit of elevated activity in the appliance business really related to additional competitors in the space; some elevated activity in flooring as the carpet industry, in general, is in decline; and grills really related to specific close out activity associated with Weber's relaunch of their Genesis line.

Behavior's fairly typical across competitors as everybody's shifting promotional focus to engage the customer. And early indications in the fourth quarter, our promotional activity seems comparable from an intensity perspective versus prior year. .

That's very helpful detail. One quick follow-up. So your earnings guidance was quite precise, which, I guess, is most important. You have still for the year a 1 percentage point range of comp outcomes between 3% and 4%, which, when we put all that variability to the fourth quarter, suggests a much wider range.

Do you care to weigh in at all on what kind of sales thought process underlies that earnings number for the quarter?.

So Matt, coming out of a tough third quarter, we did, as you might imagine, spend quite a bit of time thinking about our outlook for the fourth quarter and in fact, put forth both sales and earnings figures that we felt confident in our ability to achieve. So as we think about the implied comp for the fourth quarter, it's a 2% comp.

So certainly coming off the 2.7% in the third quarter with strengthening trends at the end of the quarter, we felt -- feel like it's certainly achievable. And in fact, we're off to a good start in the fourth quarter running ahead of the 2% comp expectations. From a profitability perspective, we take a look at the levers we have.

I mentioned in my comments, for Q4, absent the JV charge last year, 90 basis points of EBIT expansion coming from bonus and depreciation. We feel pretty confident about the ability to, based on the forecast, to achieve those.

So we feel good about where we are coming out of Q3, feel good about the start to Q4 and confident in our ability to achieve the implied Q4 results. .

[indiscernible] As you know, as we've talked in the past, Q4 can be a very weather-sensitive quarter. We had great weather last year, so we are cycling some pretty strong comps that we had kind of decent for January time frame. So we took all that into account when we built our guidance. We're very pleased with the way the quarter started.

We took all that in account as we looked at putting the implied guidance out there for you. .

Your next question comes from the line of Eric Bosshard with Cleveland Research Company. .

Strategically curious how you're thinking about balancing the investment in SG&A relative to your sales or market share performance.

A lot on productivity that you've identified opportunities with productivity that it sounds like you're going to talk more about, but curious as you think about investing to perform better on the top line relative to saving to improve leverage and productivity. Just curious strategically how you're thinking about how you're balancing those 2. .

Yes, Eric, I'll start. But certainly, what we're focused on is where do we need to be investing that is going to resonate with the consumer, particularly in an omnichannel environment today, and give us the payback that we need.

So some great example, as we've talked about, it's how we're looking at our media mix modeling and the amount we're investing in digital and how it's going to resonate with the consumer, social media, all else, everything.

I think Rick's going to look at how we're allocating labor hours across the store when we think about how we're engaging with the customer today online, in-home, by in-store, how we're allocating those hours to ensure that we're there at the right time so we're getting -- we're investing where it makes sense for the consumer.

We've talked about our rationalization of projects, technology-enabled, so which are the ones that will really resonate to the consumer, where we can add the best value and focusing on those.

And then separately, looking across the organization, whether it's from looking at anything like enterprise strategic sourcing, how we're allocating all of our -- aggregating all of our spend together so that we're getting better value associated with that.

We're in other areas where in today's environment that we had invested in the past, we don't need to invest in the future that we can rationalize that spending that helps drive the ability to invest in areas that resonate to the consumer and also helps drive better productivity across the organization.

So it is a comprehensive review that we're undertaking with a number of work streams, with the executives on point and in charge of those various work streams as they're working together to really look at how we're going to deliver greater value for shareholders in the future as well as drive the ongoing relationship consumers require in an omnichannel environment.

.

And I guess as a follow-up, a bit curious if you think about -- and you stated earlier that you underperformed the market growth this quarter as you move forward, and maybe this is something for Mike McDermott in his new role.

Is there a commitment? And what is the strategy or course down the strategy to get back to growing at least in light not ahead of the market? Or is that not as relevant of a metric for you as you think about the business moving forward?.

Well, it's certainly relevant to grow in excess of the market. We're going to spend a lot of our time initially focusing our marketing spend as it relates to our digital platforms, allowing us to be more nimble in shifting our messaging and adjusting to weather or traffic dynamics as we see them unfold throughout the quarter.

We've worked to reduce our print advertising and expand our presence on social media and increase digital advertising, including digital display, online video and search. So I think there's an opportunity for us to take a look at the investment -- the overall investment that we've got in marketing.

Really, that analog-to-digital transformation is where we'll focus initially to make sure that we're driving traffic to any of the contact points for our customer. .

Your next question comes from the line of Alan Rifkin with BTIG. .

As we move into the recovery phase from both the flooding and the hurricane, can you maybe shed some color on what you think the benefit will be both to the fourth quarter as well as to 2017 and how long that tail may, in fact, last?.

So Alan, as Rick talked about in his comments, there's stages to each event and recovery efforts. Each store event is difficult to predict. It depends on the type of damage. It depends upon the amount of recovery required. It depends upon the population density in which the storm activity occurs.

So we do expect a further benefit into Q4 and 2017, but that's tough to estimate going forward. .

Okay. And my follow-up if, I may, can you maybe just provide, Robert, an update on how the assimilation of RONA is going, what you're seeing with respect to systems conversions and potential main play changes? If you can give us an update there, that would be great. .

Yes, Alan. As I said in my comments, we're today very pleased with what's going on with the RONA assimilation. I was just -- met with the team here last month. Very pleased about the activities, the work streams they have in place to do the assimilation integration. Actually, Richard Maltsbarger set up reports up through him.

Eyes in the room, I'll get him to talk a little bit more detail about the -- how the integration is going.

Rich?.

Sure. Alan, thank you for the question. As you know, when we set out on the RONA journey, we specifically focused on key areas of top line and bottom line synergy, and both are very well on track.

We've been quite confident and encouraged by the first 6 months of working together as a team, specifically seeing great progress towards what we announced as a critical element of this in terms of rolling out appliances across all of Canada and seeing great share uptake in the markets in which we're testing that.

We're also seeing great combinations of the 2 teams identifying new areas of synergy and joint operations that we may not have even planned on prior to the deal. .

Okay.

If I may, I mean, relative to where your original expectations are, do you believe, Robert, that the benefits may be greater, the same or not as great as what you originally thought when you completed the deal?.

Al, I'd say, we're 6 months into it. We feel good about what has taken place today before wrap from an integration standpoint. As Richard indicated, we still -- we're seeing incremental opportunity that we believe that's out there. But as you know, as you get through this, there could still be some unknown.

So you get here to say that we think it's dramatically better than what we thought 6 months ago, no. But to sit here and say that -- basically, what we're seeing, we're even more confident in at least the business case, if not greater at this point in the integration journey.

I'd say that we're confident in the business case and see upside to it, but not ready to quantify that at this point. .

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

Wanted to follow up on some of the category growth in the third quarter.

Which core categories were actually negative in the quarter? And as you think about core repair and remodel categories like millwork, rough plumbing, rough electrical and paint, did you see improvement in those categories as the quarter progressed? And then, Robert, you mentioned that you expected more moderate growth, but still solid growth in the home improvement industry going forward.

How should we think about that growth? Why do you think 2015 grew? And how do you think about the growth rate going forward?.

I'll start off, Chris, and I'll get Mike McDermott talk a bit more about it in detail. Just to your hell of a question, paint and kitchens were the 2 categories that were negative during the quarter. Mike will give you some more details on how they progressed and our thoughts there.

Yes, as I said, we -- the overall environment, from a macro standpoint, moderated somewhat from housing turnover, home value appreciation, but it's still a very healthy environment.

When you combine that with the fact that we performed below our expectations, we know we have opportunity to improve our performance and marry that efforts to the great opportunity for our outlook, our performance going forward as we continue to improve our execution in an environment that may be just slightly less robust than what it was a year ago.

So that's kind of the way I would sum up kind of the headline store. With that, I'll get Mike McDermott talk a little bit more about the detail product categories. .

Sure. Paint had soft performance early in the quarter that we were unable to overcome as the business improved throughout. Softness was primarily due to weakness in exterior paint projects within the North region specifically. We also saw the kitchen category deliver negative comp for the quarter.

While we drove a positive comp in cabinets and countertops, the aggregate kitchen comp was reduced by weaker performance in closet organization and shelving. The other category that was flat was millwork, and we did see improvement throughout the quarter in that product category. .

And then, Mike, you're new to the role. Mike Jones, I think, to the surprise a lot of investors, left the company earlier. Actually, not too long ago.

Can you talk about how your views on the business were -- are going to be different from the way that Mike Jones approached it? And how do you think about this transition opportunity going forward?.

Well, I'm very excited about the opportunity to serve our customers and our team members. I can tell you we're going to be laser-focused on delivering the best omnichannel experience possible and supporting our customers through their home improvement project needs.

So different or the same, our focus is on the customer and evolving to serve their needs. .

Okay. And then one quick last one.

Bob, with some of the changes, the write-offs, does -- how should we think about the impact of depreciation going forward? And then related to that, how are you thinking about the impact to, actually, the flow-through model? I know you typically talk about 20 basis points of EBIT above previous point[indiscernible] comp above 1.

Does the -- do any of these write-offs change that algorithm?.

So Chris, as we think about, I guess, both for 2016, both the GAAP as well as the adjusted EBIT outlook, we're at about 24 basis points of flow-through, so a touch below the 25 to 30 range. We'll talk more about the future when we see you next month for our Analyst Conference regarding specific expectations for 2017 through 2019.

As it relates to depreciation, depreciation is down modestly this year, even including the depreciation associated with RONA. This will reduce that depreciation trajectory somewhat for 2017, but nothing material. .

Your final question will come from the line of Greg Melich with Evercore ISI. .

Great. Got a couple questions. One question, two-part. Bob, you mentioned RONA was 55 bps hit to EBIT in the third quarter because of a mix of purchase accounting and then the actual business mix. And I think you said it was 40 bps in your guidance for the fourth quarter.

Is it fair to assume that the fourth quarter is now just the clean mix impact of RONA? Or is there still some other one-offs in purchase accounting there? And then I have a follow-up. .

So the -- when I talk about the purchase accounting impacts last quarter, they were more pronounced early and dissipated over time to the extent they're essentially immaterial as we get into 2017. So yes, as we get further away from the transaction, a large proportion of the EBIT impact is from the mix of business, yes. .

So it's -- it'll -- if you took the 55 bps, it might have been 20, 25 bps purchase accounting in the third quarter. It might be 10 in the fourth quarter and then fade just... .

That's a good way to think about it. .

Conceptually. And then second, I think it ties into -- and Mike, it was great to hear your thoughts about the new role and things to focus on.

As we look at the quarter and how the traffic improved, is it fair to say that the improvement in the comp, if you back out the weather, was more traffic or ticket-driven? And Mike, if you think about the Chief Customer role, and you mentioned omnichannel, how do you view that in terms of a way that to drive traffic and transaction accounts as you think into not just the fourth quarter but next year?.

Well, I think we'll continue to focus on a balance between traffic and ticket, utilizing all of our omnichannel resources. So when I think about the role of Chief Customer Officer, it really is to balance those 2 things, leveraging all the tools at our disposal. .

And on the traffic improvement that you have seen since the summer, is it fair to say that the comp improvement was all traffic? Or was there ticket and traffic in that?.

There was both ticket and traffic in that improvement. .

Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again or report our fourth quarter results on Wednesday, March 1. Have a great day. .

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