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Lowe's Companies, Inc. logo
Lowe's Companies, Inc.
LOW · US · NYSE
235.83
USD
-0.5
(0.21%)
Executives
Name Title Pay
Ms. Jennifer Wilson Senior Vice President & Chief Marketing Officer --
Mr. Joseph Michael McFarland III Executive Vice President of Stores 1.41M
Ms. Kate Pearlman Vice President, Investor Relations & Treasurer --
Ms. Juliette Williams Pryor Executive Vice President, Chief Legal Officer & Corporate Secretary 4.26M
Mr. Marvin R. Ellison President, Chief Executive Officer & Chairman 3.38M
Mr. Dan Clayton Griggs Jr. Senior Vice President of Tax & Chief Accounting Officer --
Ms. Janice M. Dupre Executive Vice President of Human Resources --
Ms. Seemantini Godbole Executive Vice President and Chief Information & Digital Officer 1.8M
Mr. Brandon J. Sink Executive Vice President & Chief Financial Officer 1.24M
Mr. William P. Boltz Executive Vice President of Merchandising 1.44M
Insider Transactions
Date Name Title Acquisition Or Disposition Stock / Options # of Shares Price
2024-06-28 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 68.04 0
2024-06-28 Taylor Colleen director A - A-Award Phantom Stock 56.7 0
2024-06-28 Simkins Lawrence director A - A-Award Phantom Stock 113.399 0
2024-06-28 ROGERS BRIAN C director A - A-Award Phantom Stock 136.079 0
2024-06-28 BATCHELDER DAVID H director A - A-Award Phantom Stock 113.399 0
2024-06-28 DREILING RICHARD W director A - A-Award Phantom Stock 249.478 0
2024-06-15 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. D - F-InKind Common Stock 2297 223.35
2024-05-31 Stone West Mary E director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Taylor Colleen director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Simkins Lawrence director A - A-Award Deferred Stock Units 1000 0
2024-05-31 SCOTT BERTRAM L director A - A-Award Deferred Stock Units 1000 0
2024-05-31 ROGERS BRIAN C director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Gupta Navdeep director A - A-Award Deferred Stock Units 1000 0
2024-05-31 DREILING RICHARD W director A - A-Award Deferred Stock Units 1000 0
2024-05-31 DOUGLAS LAURIE Z director A - A-Award Deferred Stock Units 1000 0
2024-05-31 COCHRAN SANDRA B director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Baxter Scott H director A - A-Award Deferred Stock Units 1000 0
2024-05-31 BATCHELDER DAVID H director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Alvarez Ralph director A - A-Award Deferred Stock Units 1000 0
2024-05-31 Simkins Lawrence - 0 0
2024-05-31 Gupta Navdeep - 0 0
2024-04-01 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. A - A-Award Common Stock 2294 0
2024-04-01 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 6746 249.28
2024-04-01 McFarland Joseph Michael EVP, Stores A - M-Exempt Common Stock 15525 0
2024-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Common Stock 4402 0
2024-04-01 McFarland Joseph Michael EVP, Stores D - F-InKind Common Stock 8422 249.28
2024-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Non-Qualified Stock Option (right to buy) 12947 249.28
2024-04-01 McFarland Joseph Michael EVP, Stores D - M-Exempt Performance Share Units 15525 0
2024-04-01 Sink Brandon J EVP, Chief Financial Officer A - A-Award Common Stock 3449 0
2024-04-01 Sink Brandon J EVP, Chief Financial Officer A - M-Exempt Common Stock 1674 0
2024-04-01 Sink Brandon J EVP, Chief Financial Officer D - F-InKind Common Stock 938 249.28
2024-04-01 Sink Brandon J EVP, Chief Financial Officer A - A-Award Non-Qualified Stock Option (right to buy) 10144 249.28
2024-04-01 Sink Brandon J EVP, Chief Financial Officer D - M-Exempt Performance Share Units 1674 0
2024-04-01 Dupre Janice EVP, Human Resources A - M-Exempt Common Stock 8957 0
2024-04-01 Dupre Janice EVP, Human Resources A - A-Award Common Stock 2270 0
2024-04-01 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 4620 249.28
2024-04-01 Dupre Janice EVP, Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 6676 249.28
2024-04-01 Dupre Janice EVP, Human Resources D - M-Exempt Performance Share Units 8957 0
2024-04-01 Vance Quonta D EVP, Pro & Home Services A - A-Award Common Stock 2139 0
2024-04-01 Vance Quonta D EVP, Pro & Home Services A - M-Exempt Common Stock 2546 0
2024-04-01 Vance Quonta D EVP, Pro & Home Services D - F-InKind Common Stock 1096 249.28
2024-04-01 Vance Quonta D EVP, Pro & Home Services A - A-Award Non-Qualified Stock Option (right to buy) 6289 249.28
2024-04-01 Vance Quonta D EVP, Pro & Home Services D - M-Exempt Performance Share Units 2546 0
2024-04-01 Vagell Margrethe R EVP, Supply Chain A - A-Award Common Stock 2076 0
2024-04-01 Vagell Margrethe R EVP, Supply Chain A - M-Exempt Common Stock 2546 0
2024-04-01 Vagell Margrethe R EVP, Supply Chain D - F-InKind Common Stock 958 249.28
2024-04-01 Vagell Margrethe R EVP, Supply Chain A - A-Award Non-Qualified Stock Option (right to buy) 6106 249.28
2024-04-01 Vagell Margrethe R EVP, Supply Chain D - M-Exempt Performance Share Units 2546 0
2024-04-01 Ellison Marvin R Chairman, President & CEO A - M-Exempt Common Stock 49601 0
2024-04-01 Ellison Marvin R Chairman, President & CEO A - A-Award Common Stock 15044 0
2024-04-01 Ellison Marvin R Chairman, President & CEO D - F-InKind Common Stock 27755 249.28
2024-04-01 Ellison Marvin R Chairman, President & CEO A - A-Award Non-Qualified Stock Option (right to buy) 44246 249.28
2024-04-01 Ellison Marvin R Chairman, President & CEO D - M-Exempt Performance Share Units 49601 0
2024-04-01 Godbole Seemantini EVP, Chief Information Officer A - M-Exempt Common Stock 11774 0
2024-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Common Stock 3672 0
2024-04-01 Godbole Seemantini EVP, Chief Information Officer D - F-InKind Common Stock 6589 249.28
2024-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Non-Qualified Stock Option (right to buy) 10799 249.28
2024-04-01 Godbole Seemantini EVP, Chief Information Officer D - M-Exempt Performance Share Units 11774 0
2024-04-01 Boltz William P EVP, Merchandising A - M-Exempt Common Stock 14798 0
2024-04-01 Boltz William P EVP, Merchandising A - A-Award Common Stock 4362 0
2024-04-01 Boltz William P EVP, Merchandising D - F-InKind Common Stock 7987 249.28
2024-04-01 Boltz William P EVP, Merchandising A - A-Award Non-Qualified Stock Option (right to buy) 12829 249.28
2024-04-01 Boltz William P EVP, Merchandising D - M-Exempt Performance Share Units 14798 0
2024-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Common Stock 1204 0
2024-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - M-Exempt Common Stock 2487 0
2024-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO D - F-InKind Common Stock 925 249.28
2024-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO D - M-Exempt Performance Share Units 2487 0
2024-03-29 Taylor Colleen director A - A-Award Phantom Stock 49.072 0
2024-03-29 DREILING RICHARD W director A - A-Award Phantom Stock 196.286 0
2024-03-29 ROGERS BRIAN C director A - A-Award Phantom Stock 117.772 0
2024-03-29 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 58.886 0
2024-03-29 BATCHELDER DAVID H director A - A-Award Phantom Stock 98.143 0
2024-03-21 Vagell Margrethe R EVP, Supply Chain A - A-Award Performance Share Units 2546 0
2024-03-21 Godbole Seemantini EVP, Chief Information Officer A - A-Award Performance Share Units 11774 0
2024-03-21 McFarland Joseph Michael EVP, Stores A - A-Award Performance Share Units 15525 0
2024-03-21 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Performance Share Units 2487 0
2024-03-21 Ellison Marvin R Chairman, President & CEO A - A-Award Performance Share Units 49601 0
2024-03-21 Sink Brandon J EVP, Chief Financial Officer A - A-Award Performance Share Units 1674 0
2024-03-21 Vance Quonta D EVP, Pro & Home Services A - A-Award Performance Share Units 2546 0
2024-03-21 Boltz William P EVP, Merchandising A - A-Award Performance Share Units 14798 0
2024-03-21 Dupre Janice EVP, Human Resources A - A-Award Performance Share Units 8957 0
2024-03-15 Vance Quonta D EVP, Pro & Home Services D - F-InKind Common Stock 93 244.73
2024-03-07 Sink Brandon J EVP, Chief Financial Officer A - M-Exempt Common Stock 4153 80.42
2024-03-07 Sink Brandon J EVP, Chief Financial Officer D - S-Sale Common Stock 6227 242.01
2024-03-07 Sink Brandon J EVP, Chief Financial Officer D - G-Gift Common Stock 829 0
2024-03-07 Sink Brandon J EVP, Chief Financial Officer D - M-Exempt Non-Qualified Stock Option (right to buy) 4153 80.42
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Common Stock 0 0
2024-03-01 Vagell Margrethe R EVP, Supply Chain I - Common Stock 0 0
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Non-Qualified Stock Option (right to buy) 1970 114.07
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Non-Qualified Stock Option (right to buy) 5730 108.93
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Non-Qualified Stock Option (right to buy) 2733 191.32
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Non-Qualified Stock Option (right to buy) 2609 202.4
2024-03-01 Vagell Margrethe R EVP, Supply Chain D - Non-Qualified Stock Option (right to buy) 2349 199.97
2024-03-01 Godbole Seemantini EVP, Chief Information Officer A - M-Exempt Common Stock 27292 80.42
2024-03-01 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 23844 240.2627
2024-03-01 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 3448 240.866
2024-03-01 Godbole Seemantini EVP, Chief Information Officer D - M-Exempt Non-Qualified Stock Option (right to buy) 27292 80.42
2023-12-29 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 67.401 0
2023-12-29 DREILING RICHARD W director A - A-Award Phantom Stock 224.669 0
2023-12-29 ROGERS BRIAN C director A - A-Award Phantom Stock 134.801 0
2023-12-29 Taylor Colleen director A - A-Award Phantom Stock 56.167 0
2023-12-29 BATCHELDER DAVID H director A - A-Award Phantom Stock 112.334 0
2023-09-30 Taylor Colleen director A - A-Award Phantom Stock 60.142 0
2023-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 144.342 0
2023-09-30 DREILING RICHARD W director A - A-Award Phantom Stock 240.57 0
2023-09-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 72.171 0
2023-09-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 120.285 0
2023-10-01 Vance Quonta D EVP, Pro & Home Services D - F-InKind Common Stock 265 207.84
2023-09-15 Vance Quonta D EVP, Pro & Home Services A - A-Award Common Stock 1950 0
2023-09-15 Vance Quonta D EVP, Pro & Home Services A - A-Award Non-Qualified Stock Option (right to buy) 5730 220.02
2023-08-31 Dupre Janice EVP, Human Resources A - M-Exempt Common Stock 5380 91.62
2023-08-31 Dupre Janice EVP, Human Resources D - S-Sale Common Stock 5380 231.281
2023-08-31 Dupre Janice EVP, Human Resources D - M-Exempt Non-Qualified Stock Option (right to buy) 5380 91.62
2023-08-28 McFarland Joseph Michael EVP, Stores D - S-Sale Common Stock 4500 222.53
2023-07-01 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 916 225.7
2023-06-30 Taylor Colleen director A - A-Award Phantom Stock 55.383 0
2023-06-30 ROGERS BRIAN C director A - A-Award Phantom Stock 132.92 0
2023-06-30 DREILING RICHARD W director A - A-Award Phantom Stock 221.533 0
2023-06-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 66.46 0
2023-06-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 110.767 0
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Common Stock 0 0
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Non-Qualified Stock Option (right to buy) 2733 191.32
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Non-Qualified Stock Option (right to buy) 10369 102.2
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Non-Qualified Stock Option (right to buy) 7198 80.42
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Non-Qualified Stock Option (right to buy) 2609 202.4
2023-06-19 Vance Quonta D EVP, Pro & Home Services D - Non-Qualified Stock Option (right to buy) 2349 199.97
2023-06-15 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. A - A-Award Common Stock 2536 0
2023-06-15 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. A - A-Award Common Stock 25462 0
2023-06-15 PRYOR JULIETTE WILLIAMS EVP, CLO & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 7632 218.93
2023-05-26 Taylor Colleen director A - A-Award Deferred Stock Units 1000 0
2023-05-26 Stone West Mary E director A - A-Award Deferred Stock Units 1000 0
2023-05-26 SCOTT BERTRAM L director A - A-Award Deferred Stock Units 1000 0
2023-05-26 ROGERS BRIAN C director A - A-Award Deferred Stock Units 1000 0
2023-05-26 HEINRICH DANIEL J director A - A-Award Deferred Stock Units 1000 0
2023-05-26 DREILING RICHARD W director A - A-Award Deferred Stock Units 1000 0
2023-05-26 DOUGLAS LAURIE Z director A - A-Award Deferred Stock Units 1000 0
2023-05-26 Baxter Scott H director A - A-Award Deferred Stock Units 1000 0
2023-05-26 COCHRAN SANDRA B director A - A-Award Deferred Stock Units 1000 0
2023-05-26 BATCHELDER DAVID H director A - A-Award Deferred Stock Units 1000 0
2023-05-26 Alvarez Ralph director A - A-Award Deferred Stock Units 1000 0
2023-05-26 Frieson Donald EVP, Supply Chain D - S-Sale Common Stock 13114 203.4479
2023-05-25 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 17634 202.0532
2023-05-25 Boltz William P EVP, Merchandising A - M-Exempt Common Stock 13341 80.42
2023-05-25 Boltz William P EVP, Merchandising D - S-Sale Common Stock 36341 203
2023-05-25 Boltz William P EVP, Merchandising D - M-Exempt Non-Qualified Stock Option (right to buy) 13341 80.42
2023-05-03 PRYOR JULIETTE WILLIAMS officer - 0 0
2023-04-01 Sink Brandon J EVP, Chief Financial Officer A - A-Award Common Stock 4057 0
2023-04-01 Sink Brandon J EVP, Chief Financial Officer A - M-Exempt Common Stock 3732 0
2023-04-01 Sink Brandon J EVP, Chief Financial Officer D - F-InKind Common Stock 1823 199.97
2023-04-01 Sink Brandon J EVP, Chief Financial Officer A - A-Award Non-Qualified Stock Option (right to buy) 12418 199.97
2023-04-01 Sink Brandon J EVP, Chief Financial Officer D - M-Exempt Performance Share Units 3732 0
2023-04-01 McFarland Joseph Michael EVP, Stores A - M-Exempt Common Stock 38798 0
2023-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Common Stock 5380 0
2023-04-01 McFarland Joseph Michael EVP, Stores D - F-InKind Common Stock 21437 199.97
2023-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Non-Qualified Stock Option (right to buy) 16467 199.97
2023-04-01 McFarland Joseph Michael EVP, Stores D - M-Exempt Performance Share Units 38798 0
2023-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - M-Exempt Common Stock 2488 0
2023-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Common Stock 751 0
2023-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO D - F-InKind Common Stock 975 199.97
2023-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Non-Qualified Stock Option (right to buy) 2349 199.97
2023-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO D - M-Exempt Performance Share Units 2488 0
2023-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - M-Exempt Common Stock 24062 0
2023-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Common Stock 2772 0
2023-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - F-InKind Common Stock 13296 199.97
2023-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 8484 199.97
2023-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Performance Share Units 24062 0
2023-04-01 Godbole Seemantini EVP, Chief Information Officer A - M-Exempt Common Stock 25218 0
2023-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Common Stock 4401 0
2023-04-01 Godbole Seemantini EVP, Chief Information Officer D - F-InKind Common Stock 13438 199.97
2023-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Non-Qualified Stock Option (right to buy) 13471 199.97
2023-04-01 Godbole Seemantini EVP, Chief Information Officer D - M-Exempt Performance Share Units 25218 0
2023-04-01 Frieson Donald EVP, Supply Chain A - M-Exempt Common Stock 23502 0
2023-04-01 Frieson Donald EVP, Supply Chain A - A-Award Common Stock 2582 0
2023-04-01 Frieson Donald EVP, Supply Chain D - F-InKind Common Stock 12838 199.97
2023-04-01 Frieson Donald EVP, Supply Chain A - A-Award Non-Qualified Stock Option (right to buy) 7903 199.97
2023-04-01 Frieson Donald EVP, Supply Chain D - M-Exempt Performance Share Units 23502 0
2023-04-01 Ellison Marvin R Chairman, President & CEO A - M-Exempt Common Stock 110894 0
2023-04-01 Ellison Marvin R Chairman, President & CEO A - A-Award Common Stock 18128 0
2023-04-01 Ellison Marvin R Chairman, President & CEO D - F-InKind Common Stock 61271 199.97
2023-04-01 Ellison Marvin R Chairman, President & CEO A - A-Award Non-Qualified Stock Option (right to buy) 55488 199.97
2023-04-01 Ellison Marvin R Chairman, President & CEO D - M-Exempt Performance Share Units 110894 0
2023-04-01 Dupre Janice EVP, Human Resources A - M-Exempt Common Stock 18332 0
2023-04-01 Dupre Janice EVP, Human Resources A - A-Award Common Stock 2747 0
2023-04-01 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 8401 199.97
2023-04-01 Dupre Janice EVP, Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 8408 199.97
2023-04-01 Dupre Janice EVP, Human Resources D - M-Exempt Performance Share Units 18332 0
2023-04-01 Boltz William P EVP, Merchandising A - M-Exempt Common Stock 36982 0
2023-04-01 Boltz William P EVP, Merchandising A - A-Award Common Stock 5279 0
2023-04-01 Boltz William P EVP, Merchandising D - F-InKind Common Stock 20424 199.97
2023-04-01 Boltz William P EVP, Merchandising A - A-Award Non-Qualified Stock Option (right to buy) 16157 199.97
2023-04-01 Boltz William P EVP, Merchandising D - M-Exempt Performance Share Units 36982 0
2023-03-31 Taylor Colleen director A - A-Award Phantom Stock 62.509 0
2023-03-31 ROGERS BRIAN C director A - A-Award Phantom Stock 150.023 0
2023-03-31 DREILING RICHARD W director A - A-Award Phantom Stock 250.038 0
2023-03-31 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 75.011 0
2023-03-31 BATCHELDER DAVID H director A - A-Award Phantom Stock 125.019 0
2023-03-23 Sink Brandon J EVP, Chief Financial Officer A - A-Award Performance Share Units 3732 0
2023-03-23 McFarland Joseph Michael EVP, Stores A - A-Award Performance Share Units 38798 0
2023-03-23 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Performance Share Units 24062 0
2023-03-23 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Performance Share Units 2488 0
2023-03-23 Godbole Seemantini EVP, Chief Information Officer A - A-Award Performance Share Units 25218 0
2023-03-23 Frieson Donald EVP, Supply Chain A - A-Award Performance Share Units 23502 0
2023-03-23 Ellison Marvin R Chairman, President & CEO A - A-Award Performance Share Units 110894 0
2023-03-23 Dupre Janice EVP, Human Resources A - A-Award Performance Share Units 18332 0
2023-03-23 Boltz William P EVP, Merchandising A - A-Award Performance Share Units 36982 0
2023-03-15 Frieson Donald EVP, Supply Chain D - S-Sale Common Stock 9411 197
2023-03-09 Sink Brandon J EVP, Chief Financial Officer D - F-InKind Common Stock 275 199.05
2023-03-09 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 159 199.05
2023-01-28 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - F-InKind Common Stock 774 202.49
2023-01-30 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - F-InKind Common Stock 1272 201.91
2022-12-30 Taylor Colleen director A - A-Award Phantom Stock 125.477 199.24
2022-12-30 Taylor Colleen director A - A-Award Phantom Stock 125.477 0
2022-12-30 ROGERS BRIAN C director A - A-Award Phantom Stock 150.572 199.24
2022-12-30 ROGERS BRIAN C director A - A-Award Phantom Stock 150.572 0
2022-12-30 DREILING RICHARD W director A - A-Award Phantom Stock 250.954 0
2022-12-30 DREILING RICHARD W director A - A-Award Phantom Stock 250.954 199.24
2022-12-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 75.286 199.24
2022-12-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 75.286 0
2022-12-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 125.477 199.24
2022-12-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 125.477 0
2022-12-30 Alvarez Ralph director A - A-Award Phantom Stock 150.572 199.24
2022-12-30 Alvarez Ralph director A - A-Award Phantom Stock 150.572 0
2022-12-19 McFarland Joseph Michael EVP, Stores D - S-Sale Common Stock 15301 203.8218
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - M-Exempt Common Stock 22600 84.59
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 11811 209.5241
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - M-Exempt Common Stock 10860 82.21
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 16318 210.994
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 18877 212.0562
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 10623 212.6497
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Non-Qualified Stock Option (right to buy) 22600 0
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Non-Qualified Stock Option (right to buy) 10860 82.21
2022-12-13 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Non-Qualified Stock Option (right to buy) 22600 84.59
2022-11-11 Baxter Scott H director A - A-Award Deferred Stock Units 800 0
2022-10-01 Sink Brandon J EVP, Chief Financial Officer D - F-InKind Common Stock 204 187.81
2022-10-01 Godbole Seemantini EVP, Chief Information Officer D - F-InKind Common Stock 4058 187.81
2022-10-01 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 204 187.81
2022-09-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 133.113 187.81
2022-09-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 133.113 0
2022-09-30 Alvarez Ralph director A - A-Award Phantom Stock 159.736 187.81
2022-09-30 Alvarez Ralph director A - A-Award Phantom Stock 159.736 0
2022-09-30 Taylor Colleen director A - A-Award Phantom Stock 133.113 187.81
2022-09-30 Taylor Colleen director A - A-Award Phantom Stock 133.113 0
2022-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 159.736 187.81
2022-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 159.736 0
2022-09-30 DREILING RICHARD W director A - A-Award Phantom Stock 266.227 187.81
2022-09-30 DREILING RICHARD W director A - A-Award Phantom Stock 266.227 0
2022-09-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 79.868 187.81
2022-09-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 79.868 0
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2022-08-19 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 3475 214.0167
2022-08-19 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 5576 215.111
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2022-08-19 Boltz William P EVP, Merchandising D - S-Sale Common Stock 7329 211.2696
2022-08-19 Boltz William P EVP, Merchandising D - S-Sale Common Stock 15373 211.6429
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2022-08-19 Boltz William P EVP, Merchandising D - S-Sale Common Stock 17072 214.9412
2022-08-19 Boltz William P EVP, Merchandising D - S-Sale Common Stock 7666 215.5098
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2022-08-19 Boltz William P EVP, Merchandising D - M-Exempt Non-Qualified Stock Option (right to buy) 28170 0
2022-08-19 Boltz William P EVP, Merchandising D - M-Exempt Non-Qualified Stock Option (right to buy) 28170 114.07
2022-08-19 Boltz William P EVP, Merchandising D - M-Exempt Non-Qualified Stock Option (right to buy) 28780 108.93
2022-08-04 Baxter Scott H - 0 0
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2022-07-01 Griggs Dan Clayton Jr SVP, Tax & CAO D - F-InKind Common Stock 241 177.36
2022-07-01 Dupre Janice EVP, Human Resources D - F-InKind Common Stock 164 177.36
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2022-06-30 ROGERS BRIAN C A - A-Award Phantom Stock 171.752 174.67
2022-06-30 ROGERS BRIAN C director A - A-Award Phantom Stock 171.752 0
2022-06-30 DREILING RICHARD W A - A-Award Phantom Stock 286.254 174.67
2022-06-30 DREILING RICHARD W director A - A-Award Phantom Stock 286.254 0
2022-06-30 DOUGLAS LAURIE Z A - A-Award Phantom Stock 85.876 174.67
2022-06-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 85.876 0
2022-06-30 BATCHELDER DAVID H A - A-Award Phantom Stock 143.127 174.67
2022-06-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 143.127 0
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2022-06-30 Alvarez Ralph director A - A-Award Phantom Stock 171.752 0
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2022-06-15 Sink Brandon J EVP, Chief Financial Officer A - A-Award Common Stock 5761 0
2022-05-27 Taylor Colleen A - A-Award Deferred Stock Units 1100 0
2022-05-27 Stone West Mary E A - A-Award Deferred Stock Units 1100 0
2022-05-27 SCOTT BERTRAM L A - A-Award Deferred Stock Units 1100 0
2022-05-27 ROGERS BRIAN C A - A-Award Deferred Stock Units 1100 0
2022-05-27 HEINRICH DANIEL J A - A-Award Deferred Stock Units 1100 0
2022-05-27 DREILING RICHARD W A - A-Award Deferred Stock Units 1100 0
2022-05-27 DOUGLAS LAURIE Z A - A-Award Deferred Stock Units 1100 0
2022-05-27 COCHRAN SANDRA B A - A-Award Deferred Stock Units 1100 0
2022-05-27 BATCHELDER DAVID H A - A-Award Deferred Stock Units 1100 0
2022-05-27 Alvarez Ralph A - A-Award Deferred Stock Units 1100 0
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2022-04-30 Sink Brandon J EVP, Chief Financial Officer D - Non-Qualified Stock Option (right to buy) 2395 102.2
2022-04-30 Sink Brandon J EVP, Chief Financial Officer D - Non-Qualified Stock Option (right to buy) 4153 80.42
2022-04-30 Sink Brandon J EVP, Chief Financial Officer D - Non-Qualified Stock Option (right to buy) 1798 191.32
2022-04-30 Sink Brandon J EVP, Chief Financial Officer D - Non-Qualified Stock Option (right to buy) 1740 202.4
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2022-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Non-Qualified Stock Option (right to buy) 8991 202.4
2022-04-01 McFarland Joseph Michael EVP, Stores A - M-Exempt Common Stock 27540 0
2022-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Common Stock 4645 0
2022-04-01 McFarland Joseph Michael EVP, Stores D - F-InKind Common Stock 15301 202.4
2022-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Non-Qualified Stock Option (right to buy) 15857 202.4
2022-04-01 McFarland Joseph Michael EVP, Stores D - M-Exempt Performance Share Units 27540 0
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2022-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Common Stock 2660 0
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2022-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 9080 202.4
2022-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 9080 0
2022-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Performance Share Units 17260 0
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2022-04-01 Godbole Seemantini EVP, Chief Information Officer D - M-Exempt Performance Share Units 16940 0
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2022-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Non-Qualified Stock Option (right to buy) 2609 202.4
2022-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Non-Qualified Stock Option (right to buy) 2609 0
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2022-04-01 Frieson Donald EVP, Supply Chain A - A-Award Common Stock 2454 0
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2022-04-01 Frieson Donald EVP, Supply Chain A - A-Award Non-Qualified Stock Option (right to buy) 8376 202.4
2022-04-01 Frieson Donald EVP, Supply Chain A - A-Award Non-Qualified Stock Option (right to buy) 8376 0
2022-04-01 Frieson Donald EVP, Supply Chain D - M-Exempt Performance Share Units 16940 0
2022-04-01 Ellison Marvin R Chairman, President & CEO A - M-Exempt Common Stock 75220 0
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2022-04-01 Ellison Marvin R Chairman, President & CEO A - A-Award Non-Qualified Stock Option (right to buy) 51976 202.4
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2022-04-01 Dupre Janice EVP, Human Resources A - M-Exempt Common Stock 1840 0
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2022-04-01 Dupre Janice EVP, Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 8658 0
2022-04-01 Dupre Janice EVP, Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 8658 202.4
2022-04-01 Dupre Janice EVP, Human Resources D - M-Exempt Performance Share Units 1840 0
2022-04-01 Denton David M EVP, Chief Financial Officer A - M-Exempt Common Stock 38220 0
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2022-04-01 Denton David M EVP, Chief Financial Officer D - F-InKind Common Stock 21230 202.4
2022-04-01 Denton David M EVP, Chief Financial Officer A - A-Award Non-Qualified Stock Option (right to buy) 18265 0
2022-04-01 Denton David M EVP, Chief Financial Officer A - A-Award Non-Qualified Stock Option (right to buy) 18265 202.4
2022-04-01 Denton David M EVP, Chief Financial Officer D - M-Exempt Performance Share Units 38220 0
2022-04-01 Boltz William P EVP, Merchandising A - M-Exempt Common Stock 26260 0
2022-04-01 Boltz William P EVP, Merchandising A - A-Award Common Stock 4514 0
2022-04-01 Boltz William P EVP, Merchandising D - F-InKind Common Stock 14586 202.4
2022-04-01 Boltz William P EVP, Merchandising A - A-Award Non-Qualified Stock Option (right to buy) 15410 0
2022-04-01 Boltz William P EVP, Merchandising A - A-Award Non-Qualified Stock Option (right to buy) 15410 202.4
2022-04-01 Boltz William P EVP, Merchandising D - M-Exempt Performance Share Units 26260 0
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2022-03-31 ROGERS BRIAN C director A - A-Award Phantom Stock 148.375 0
2022-03-31 DREILING RICHARD W A - A-Award Phantom Stock 247.292 202.19
2022-03-31 DREILING RICHARD W director A - A-Award Phantom Stock 247.292 0
2022-03-31 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 74.188 0
2022-03-31 DOUGLAS LAURIE Z A - A-Award Phantom Stock 74.188 202.19
2022-03-31 BATCHELDER DAVID H A - A-Award Phantom Stock 123.646 202.19
2022-03-31 BATCHELDER DAVID H director A - A-Award Phantom Stock 123.646 0
2022-03-31 Alvarez Ralph A - A-Award Phantom Stock 148.375 202.19
2022-03-31 Alvarez Ralph director A - A-Award Phantom Stock 148.375 0
2022-03-17 McFarland Joseph Michael EVP, Stores A - A-Award Performance Share Units 27540 0
2022-03-17 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Performance Share Units 17260 0
2022-03-17 Frieson Donald EVP, Supply Chain A - A-Award Performance Share Units 16940 0
2022-03-17 Godbole Seemantini EVP, Chief Information Officer A - A-Award Performance Share Units 16940 0
2022-03-17 Ellison Marvin R Chairman, President & CEO A - A-Award Performance Share Units 75220 0
2022-03-17 Dupre Janice EVP Human Resources A - A-Award Performance Share Units 1840 0
2022-03-17 Denton David M EVP, Chief Financial Officer A - A-Award Performance Share Units 38220 0
2022-03-17 Boltz William P EVP, Merchandising A - A-Award Performance Share Units 26260 0
2022-03-09 Dupre Janice EVP Human Resources D - F-InKind Common Stock 160 225.88
2022-01-30 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - F-InKind Common Stock 1105 234.99
2022-01-02 Godbole Seemantini EVP, Chief Information Officer D - F-InKind Common Stock 1857 258.48
2022-01-02 Denton David M EVP, Chief Financial Officer D - F-InKind Common Stock 3737 258.48
2021-12-31 ROGERS BRIAN C director A - A-Award Phantom Stock 101.555 0
2021-12-31 DREILING RICHARD W director A - A-Award Phantom Stock 154.751 0
2021-12-31 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 50.778 0
2021-12-31 BATCHELDER DAVID H director A - A-Award Phantom Stock 87.047 0
2021-10-01 McFarland Joseph Michael EVP, Stores D - F-InKind Common Stock 4801 203.7
2021-10-01 Frieson Donald EVP, Supply Chain D - F-InKind Common Stock 2110 203.7
2021-10-01 Boltz William P EVP, Merchandising D - F-InKind Common Stock 3085 203.7
2021-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 129.4 202.86
2021-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 129.4 0
2021-09-30 DREILING RICHARD W director A - A-Award Phantom Stock 197.18 0
2021-09-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 64.7 0
2021-09-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 110.914 0
2021-07-02 Ellison Marvin R Chairman, President & CEO D - F-InKind Common Stock 22927 195.71
2021-07-01 Dupre Janice EVP Human Resources D - F-InKind Common Stock 165 195.82
2021-06-30 ROGERS BRIAN C director A - A-Award Phantom Stock 135.33 0
2021-06-30 DREILING RICHARD W director A - A-Award Phantom Stock 206.217 0
2021-06-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 67.665 0
2021-06-30 Braly Angela F director A - A-Award Phantom Stock 141.775 193.97
2021-06-30 Braly Angela F director A - A-Award Phantom Stock 141.775 0
2021-06-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 115.997 0
2021-06-02 Godbole Seemantini EVP, Chief Information Officer A - M-Exempt Common Stock 15234 92.27
2021-06-02 Godbole Seemantini EVP, Chief Information Officer D - S-Sale Common Stock 15234 190.7654
2021-06-02 Godbole Seemantini EVP, Chief Information Officer D - M-Exempt Non-Qualified Stock Option (right to buy) 15234 92.27
2021-05-28 Stone West Mary E director A - A-Award Deferred Stock Units 900 0
2021-05-28 SCOTT BERTRAM L director A - A-Award Deferred Stock Units 900 0
2021-05-28 ROGERS BRIAN C director A - A-Award Deferred Stock Units 900 0
2021-05-28 DREILING RICHARD W director A - A-Award Deferred Stock Units 1700 0
2021-05-28 HEINRICH DANIEL J director A - A-Award Deferred Stock Units 900 0
2021-05-28 DOUGLAS LAURIE Z director A - A-Award Deferred Stock Units 900 0
2021-05-28 COCHRAN SANDRA B director A - A-Award Deferred Stock Units 900 0
2021-05-28 Braly Angela F director A - A-Award Deferred Stock Units 900 0
2021-05-28 BATCHELDER DAVID H director A - A-Award Deferred Stock Units 900 0
2021-05-28 Alvarez Ralph director A - A-Award Deferred Stock Units 900 0
2021-05-28 Stone West Mary E - 0 0
2021-05-28 HEINRICH DANIEL J director I - Common Stock 0 0
2021-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Common Stock 2705 0
2021-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Non-Qualified Stock Option (right to buy) 10321 191.32
2021-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer D - F-InKind Common Stock 695 191.32
2021-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Common Stock 4241 0
2021-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Non-Qualified Stock Option (right to buy) 16179 191.32
2021-04-01 Little Janice Dupre EVP Human Resources A - A-Award Common Stock 2447 0
2021-04-02 Little Janice Dupre EVP Human Resources D - F-InKind Common Stock 264 191.32
2021-04-01 Little Janice Dupre EVP Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 9333 191.32
2021-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Common Stock 2605 0
2021-04-02 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - F-InKind Common Stock 2437 191.32
2021-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Non-Qualified Stock Option (right to buy) 9937 191.32
2021-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Common Stock 680 0
2021-04-01 Griggs Dan Clayton Jr SVP, Tax & CAO A - A-Award Non-Qualified Stock Option (right to buy) 2671 191.32
2021-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Common Stock 3216 0
2021-04-01 Godbole Seemantini EVP, Chief Information Officer A - A-Award Non-Qualified Stock Option (right to buy) 12270 191.32
2021-04-01 Frieson Donald EVP, Supply Chain A - A-Award Common Stock 2520 0
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2021-04-01 Frieson Donald EVP, Supply Chain A - A-Award Non-Qualified Stock Option (right to buy) 9613 191.32
2021-04-01 Ellison Marvin R President and CEO A - A-Award Common Stock 13548 0
2021-04-01 Ellison Marvin R President and CEO A - A-Award Non-Qualified Stock Option (right to buy) 51691 191.32
2021-04-01 Denton David M EVP, Chief Financial Officer A - A-Award Common Stock 5660 0
2021-04-01 Denton David M EVP, Chief Financial Officer A - A-Award Non-Qualified Stock Option (right to buy) 21593 191.32
2021-04-01 Boltz William P EVP, Merchandising A - A-Award Common Stock 4042 0
2021-04-01 Boltz William P EVP, Merchandising A - A-Award Non-Qualified Stock Option (right to buy) 15421 191.32
2021-03-31 WISEMAN ERIC C director A - A-Award Phantom Stock 138.027 0
2021-03-31 WARDELL LISA W director A - A-Award Phantom Stock 118.309 0
2021-03-31 ROGERS BRIAN C director A - A-Award Phantom Stock 138.027 0
2021-03-31 DREILING RICHARD W director A - A-Award Phantom Stock 210.327 0
2021-03-31 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 69.014 0
2021-03-31 Braly Angela F director A - A-Award Phantom Stock 144.6 0
2021-03-31 BATCHELDER DAVID H director A - A-Award Phantom Stock 118.309 0
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2021-02-26 BATCHELDER DAVID H director A - P-Purchase Common Stock 4688 159.4893
2021-01-28 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Common Stock 5121 0
2021-01-02 Little Janice Dupre EVP Human Resources D - F-InKind Common Stock 410 160.51
2020-12-31 WISEMAN ERIC C director A - A-Award Phantom Stock 163.541 0
2020-12-31 WARDELL LISA W director A - A-Award Phantom Stock 140.178 0
2020-12-31 ROGERS BRIAN C director A - A-Award Phantom Stock 163.541 0
2020-12-31 DREILING RICHARD W director A - A-Award Phantom Stock 249.206 0
2020-12-31 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 81.771 0
2020-12-31 Braly Angela F director A - A-Award Phantom Stock 171.329 0
2020-12-31 BATCHELDER DAVID H director A - A-Award Phantom Stock 140.178 0
2020-10-03 Griggs Dan Clayton Jr Vice President, CAO D - Common Stock 0 0
2020-10-03 Griggs Dan Clayton Jr Vice President, CAO I - Common Stock 0 0
2020-10-03 Griggs Dan Clayton Jr Vice President, CAO D - Non-Qualified Stock Option (right to buy) 2769 80.42
2020-10-03 Griggs Dan Clayton Jr Vice President, CAO D - Non-Qualified Stock Option (right to buy) 4000 102.2
2020-09-30 WISEMAN ERIC C director A - A-Award Phantom Stock 158.266 0
2020-09-30 WARDELL LISA W director A - A-Award Phantom Stock 135.657 0
2020-09-30 ROGERS BRIAN C director A - A-Award Phantom Stock 158.266 0
2020-09-30 DREILING RICHARD W director A - A-Award Phantom Stock 241.167 0
2020-09-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 79.133 0
2020-09-30 Braly Angela F director A - A-Award Phantom Stock 165.802 0
2020-09-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 135.657 0
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - M-Exempt Common Stock 26450 71.31
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - M-Exempt Common Stock 25760 69.44
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 32467 168.1724
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 19743 168.5961
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 4646 168.1164
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - S-Sale Common Stock 5982 168.4952
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Non-Qualified Stock Option (right to buy) 25760 69.44
2020-08-26 MCCANLESS ROSS W EVP, GC & Corp. Sec. D - M-Exempt Non-Qualified Stock Option (right to buy) 26450 71.31
2020-07-01 Little Janice Dupre EVP Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 8824 135.63
2020-07-01 Little Janice Dupre EVP Human Resources A - A-Award Common Stock 2072 0
2020-06-30 WISEMAN ERIC C director A - A-Award Phantom Stock 203.523 0
2020-06-30 WARDELL LISA W director A - A-Award Phantom Stock 166.519 0
2020-06-30 DREILING RICHARD W director A - A-Award Phantom Stock 296.033 0
2020-06-30 ROGERS BRIAN C director A - A-Award Phantom Stock 194.272 0
2020-06-30 DOUGLAS LAURIE Z director A - A-Award Phantom Stock 97.136 0
2020-06-30 Braly Angela F director A - A-Award Phantom Stock 203.523 0
2020-06-30 Braly Angela F director A - A-Award Phantom Stock 203.523 135.12
2020-06-30 BATCHELDER DAVID H director A - A-Award Phantom Stock 166.519 0
2020-06-22 Little Janice Dupre EVP Human Resources D - Common Stock 0 0
2020-06-22 Little Janice Dupre EVP Human Resources D - Non-Qualified Stock Option (right to buy) 5380 91.62
2020-06-22 Little Janice Dupre EVP Human Resources D - Non-Qualified Stock Option (right to buy) 2450 84.59
2020-06-22 Little Janice Dupre EVP Human Resources D - Non-Qualified Stock Option (right to buy) 2200 108.93
2020-06-22 Little Janice Dupre EVP Human Resources D - Non-Qualified Stock Option (right to buy) 4845 80.42
2020-05-29 WISEMAN ERIC C director A - A-Award Deferred Stock Units 1400 0
2020-05-29 WARDELL LISA W director A - A-Award Deferred Stock Units 1400 0
2020-05-29 SCOTT BERTRAM L director A - A-Award Deferred Stock Units 1400 0
2020-05-29 ROGERS BRIAN C director A - A-Award Deferred Stock Units 1400 0
2020-05-29 DREILING RICHARD W director A - A-Award Deferred Stock Units 2500 0
2020-05-29 DOUGLAS LAURIE Z director A - A-Award Deferred Stock Units 1400 0
2020-05-29 COCHRAN SANDRA B director A - A-Award Deferred Stock Units 1400 0
2020-05-29 Braly Angela F director A - A-Award Deferred Stock Units 1400 0
2020-05-29 BATCHELDER DAVID H director A - A-Award Deferred Stock Units 1400 0
2020-05-29 Alvarez Ralph director A - A-Award Deferred Stock Units 1400 0
2020-04-01 Weber Jennifer L EVP, Human Resources A - A-Award Common Stock 5848 0
2020-04-01 Weber Jennifer L EVP, Human Resources A - A-Award Non-Qualified Stock Option (right to buy) 25314 80.42
2020-04-01 Weber Jennifer L EVP, Human Resources D - F-InKind Common Stock 2279 80.42
2020-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Non-Qualified Stock Option (right to buy) 26243 80.42
2020-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Non-Qualified Stock Option (right to buy) 20187 80.42
2020-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Common Stock 4664 0
2020-04-01 THALBERG MARISA F EVP Chief Brand & Mktg Officer A - A-Award Common Stock 6062 0
2020-04-01 McFarland Joseph Michael EVP, Stores A - A-Award Non-Qualified Stock Option (right to buy) 41988 80.42
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2020-04-01 MCCANLESS ROSS W EVP, GC & Corp. Sec. A - A-Award Common Stock 6016 0
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Transcripts
Operator:
Good morning, everyone. Welcome to Lowe's Companies Fourth Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.
I'll now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2024. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. In the fourth quarter, comparable sales declined 6.2% as DIY customers continue to remain cautious with their home improvement spend and harsh weather impacted large parts of the U.S. in January. In spite of these challenges, I'm very pleased with the excellent customer service in our stores and strong operating profit performance for the quarter, driven by a disciplined focus on our perpetual productivity improvement initiatives or PPI.
Looking at the full fiscal year 2023, we delivered sales of $86.4 billion, adjusted operating margin of 13.3% and adjusted earnings per share of $13.09. Beginning with our DIY sales results. November and December trends improved from the third quarter, followed by a sharp drop in traffic during periods of extreme weather in January. Macroeconomic factors like persistent inflation and a stagnant housing market continue to make DIY customers and consumers hesitant to spend on big ticket purchases for their homes. And those who did engage in home improvement activities took on smaller, nondiscretionary projects with a heightened focus on value. This impacted demand for bigger ticket interior categories like kitchen and bath, flooring and appliances. In last quarter, we shifted our strategy to adapt to these changing consumer behaviors resulting in a record Black Friday and Cyber Monday online sales and improved holiday sell-through and margins. While we're pleased to see these results, we're now focused on winning spring and we're excited to see how the customer responds to our more targeted traffic-driving marketing strategy and our lineup of great spring products at an outstanding value. Bill will provide more detail on our compelling product assortment for spring later in the call. Amongst the most exciting changes for this spring is our new DIY loyalty program that we announced in January. This first-of-its-kind rewards program designed for DIY customers gives these value-focused homeowners more reasons to choose Lowe's. In a marketplace where nearly all DIY home improvement customers shop multiple retailers, MyLowe's Rewards loyalty program is designed to get these DIY customers to choose Lowe's over other retail competitors for the home improvement needs. We expect this to drive traffic and return visits while also enabling us to personalize offers and experiences for our loyalty members, creating a flywheel effect that increases DIY loyalty and demand over time, both in-store and online. MyLowe's Rewards will be available nationwide in March just in time for spring making Lowe's the only national home improvement retailer with a distinct loyalty offering for both Pro and DIY customers. Now moving to Pro. Despite a challenging macro environment and difficult weather in January, our comparable Pro sales were flat for the quarter. As a reminder, our core Pro customer is a small- to medium-sized business owner. And in our recent Pro survey, these customers told us their backlogs are in line with last year, and they are cautiously optimistic about their ability to generate and close leads in 2024. We remain focused on executing our holistic Pro strategy with more convenient fulfillment options and enhanced product assortment, creating a best-in-class digital experience and a rewards program that incentivizes long-term loyalty. As these investments scale and mature, they will increasingly save Pros time and money, enabling us to earn more of their business as we aim to grow Pro at 2x the market rate. Now turning to online. Comparable sales were flat for the quarter, and we're pleased to see higher conversion rates and lower returns, a positive indicator that customers are responding to our faster fulfillment and improved digital experience. Our talented technology team remains focused on developing a best-in-class omnichannel experience to seamlessly serve our multigenerational customer base, including co-creating innovative customer solutions with world-class technology companies like our immersive kitchen design app for Apple's new Vision Pro headset and using generative AI to improve how we sell, shop and work like our home improvement ChatGPT plug-in. Now let's transition to our view to macro. As we look forward, many of you are asking when we expect home improvement demand to inflect? Although it's a very fair question, unfortunately, it's still very difficult to predict. And while there is increased confidence of a soft landing, there's still a lot of speculation on the timing of anticipated interest rate cuts in the pace of slowing inflation. It's also unclear how quickly the consumer will react to these changes and how quickly their spending habits will change. Overall, the consumer is financially healthy. But in this post-pandemic time frame, customers are still showing a preference of spending on services with elevated demand for travel, restaurants and other experiences. And while we anticipate these trends will normalize, the timing is uncertain. Also, existing home sales are at levels we've not seen in almost 30 years. And even as mortgage rates decline, 2/3 of homeowners remain locked in at rates below 4%, which may keep many on the sidelines. Due to these factors, we expect DIY demand to remain under pressure, and Brandon will provide more detail on our 2024 expectations later in the call. However, we're very confident in our strategic plan and in our ability to execute at a high level in a multitude of economic environments. Despite near-term uncertainty, let me remind you why we remain bullish on the medium- and long-term outlook for home improvement. The 3 core demand drivers of our business, disposable personal income, home price appreciation and the age of housing stock remain supportive. When you pair these factors with trends like chronic undersupply of homes, millennial household formation, baby boomers aging in place and a sustained number of people working from home, you can see why we are confident that home improvement demand will trend upwards over time across both homeowners and Pros. And in the meantime, we're focused on controlling what we control, and making the right investments in our Total Home Strategy to modernize our supply chain and IT infrastructure, localize and improve our merchandising assortments, rolling out a Pro and DIY loyalty program, continuing to elevate our store environment and developing a best-in-class digital and omnichannel experience. All of these investments in our Total Home Strategy will position Lowe's to win in the short run and set us up for strong sales and profit growth when the home improvement market recovers. Before I close, I'd like to extend my appreciation to our hard-working associates for their commitment to serving customers. In recognition of their dedication, we awarded our frontline associates with an end-of-year discretionary bonus of $140 million. This is our way of saying thank you to hourly associates and assistant managers who serve our customers and make our communities better. As I travel across the country visiting stores and conducting town halls to hear directly from our frontline associates, I'm consistently humbled by their passion, commitment and their expertise. Now I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. While softer DIY demand trends continued this quarter, we remain focused on highlighting value and convenience, both in our stores and online to a price-conscious consumer, all while maintaining a balanced focus on profitability. We are also staying committed to serving a resilient Pro, which resulted in flat Pro comps as we continue to enhance our Pro product and service offering.
Beginning with building products. This was our best performing area with positive comps in Building Materials. This strength was fueled by an increased demand for roofing and drywall, combined with improved fulfillment capabilities and in-stock positions to better serve our Pro customers. Throughout the quarter, we continued to launch additional Klein products across our stores, bringing the #1 tool brand for electrical and HVAC professionals back to Lowe's. We now have the largest assortment of Klein tools in the home improvement retail channel with initial sales exceeding our expectations across electrical, hand tools and stackable tool storage. Throughout the store, we continue to introduce new and innovative products to Lowe's, like Pella's hidden screen windows. This new window includes a built-in screen that appears when the window is open, but hides away when it's closed. Turning to home decor. This division was significantly impacted by softer DIY demand in bigger ticket interior categories like kitchens and bath, flooring and appliances. This past quarter, we pivoted our go-to-market strategy to be more responsive to a shift in shopping trends, like the appliance consumers' increasing preference for a single unit purchase and their search for the best deal. While these actions pressured our average selling price as expected, this approach was a major contributor to our successful Black Friday and Cyber Monday events. And while some consumers remain budget conscious, we are seeing others trade up for innovation, which we continue to offer across all major appliance categories. A great example is our exclusive LG smart refrigerator, which has a double freezer and also makes the popular slow melting craft ice. This product is consistently a top seller despite retailing for over $2,500. This type of innovation adds to our already industry-leading assortment in appliances, including high-quality brands like Bosch, Miele, LG, Samsung and KitchenAid, and we are continuing to help our customers see the value and attainability of trading up for affordable premium features. Paint is another category where we've seen product innovation resonate like our exclusive line of Spec Right paint designed for Pros who paint. Beyond gaining traction with Pros, we saw strong exterior paint demand before the weather turned colder in January, which gives us confidence we have the right offering in place as spring arrives. We also recently completed the rollout of our upgraded paint department, which converted our color wall to trusted Sherwood-William Colors and improve the shopping experience to make it easier for our customers to grab the higher-margin attachment items they need to complete their paint projects. Turning to our results and hardlines. This is another area where we quickly adjusted to the changing consumer buying patterns, which was reflected in our improved holiday sell-through and profitability. We are also encouraged that our new rural assortments continue to resonate across the country with strength in apparel, pet and automotive as consumers respond to the products and brands. We also recently launched a new partnership with Sunrun, the market leader in home solar and battery installation. This partnership now enhances our services offering for consumers looking to power their homes with renewable energy. Lowe's is the go-to destination for homeowners in spring. And as we enter our biggest season of the year, we are positioning ourselves to capitalize on this demand. As Marvin mentioned, we are excited about our product lineup. The launch of Toro builds on our industry-leading outdoor power equipment lineup alongside John Deere, Aaron's, EGO, CRAFTSMAN, Husqvarna, Kobalt and SKIL, our outdoor power equipment assortment is unmatched in home improvement, which is reflected in our continued market leadership in this space. I'm also excited about our new patio sets from our private brands, allen + roth and Origin 21, which enables homeowners to update their outdoor spaces for spring with trending styles across multiple price points. And if consumers don't see the color they're looking for on our sales floor, they can easily shop the extended aisle with associates now able to tender the purchase directly on their mobile smart devices. The merchants in our seasonal businesses are also bringing customers innovation and functionality at more competitive prices like our new exclusive Char-Broil grill lineup, which lets grillers switch from a traditional grill to a griddle in seconds or the fast-growing Blackstone brand of grills that continues to bring new features and value to the market. Beyond our compelling seasonal assortment and strong in-stock position, I'm also looking forward to launching our enhanced marketing strategy for spring. This season, we are taking a more sophisticated tech-enabled advertising approach and we will be featuring traffic-driving events that will motivate homeowners to get started on their spring projects at Lowe's. We are also leaning into live sports with an expanded NFL relationship and leveraging our popular commercials featuring Lowe's home team players trying their hands at DIY projects. We are extremely pleased with the success of this season's home team players with 2 members of the Lowe's team, Travis Kelce and Christian McCaffrey, both participating in Super Bowl 58 while being featured in our commercials. Shifting gears to merchandising productivity. Our team is making tremendous progress on our perpetual productivity improvement or PPI initiatives, which, as we planned, are offsetting the cost of our supply chain and Pro investments. As a reminder, the PPI initiatives that I outlined at our analyst and investor conference include expanding our private brand penetration, improving inventory productivity, maintaining a disciplined approach to pricing and promotions, scaling our retail media network and closely managing product costs. Over the past year, we have been working closely with our vendor partners to claw back some of the cost increases we absorbed during periods of exceptionally high inflation. And now that raw material and transportation costs are normalizing. Our best-in-class cost optimization tool gives us robust data down to the item level that allows us to take a calculated surgical approach, helping guide us to reducing costs across our portfolio. As we work to recoup these costs with our suppliers, we are reinvesting those savings into our marketing and merchandising strategies to drive traffic and sales. As I close, I'd like to thank our vendors and merchants for their unwavering focus on delivering value to our shared customers and for putting us in a strong position to win spring. I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone. I would like to start by thanking our frontline team for their relentless focus and execution this quarter. Their efforts to serve our customers while tightly managing controllable expenses once again resulted in improved customer service scores and strong operating profit performance despite slower sales. Customer satisfaction scores were up 200 basis points this quarter versus last year with improvements in both Pro and DIY, reflecting the hard work of our frontline associates combined with improved omnichannel fulfillment capabilities. In fact, this year, omni score has improved almost 25% since 2020. Customers have new functionality like two-way texting, where they can be notified in advance to confirm their delivery date as well as same-day delivery options through our gig network. They can also use our new self-service functionality to track their order status and resolve issues directly, all without needing to call a store.
In addition to expanding our fulfillment options and improving how we communicate with our customers, we're also enhancing the BOPIS or buy online, pickup in store experience through our new front-end configuration. We completed over 450 front-end rollouts this year with over 500 planned for 2024. Customers are embracing the new front-end experience, telling us they appreciate the faster and easier checkout process. This new front-end configuration also keeps sales associates in the aisles helping customers instead of needing to assist with checkout process when lines get long. While we are improving the front end of our stores, we are also making strides on the back end with our ongoing freight flow transformation. We are further improving our freight flow process with distribution centers now adding new labels that are linked to each store's layout. These labels provide our store teams a direction of exactly where to place the product on the sales floor once the freight is removed from receiving. These enhancements will make it quicker and easier for associates to get products onto the floor and cross merchandise attachments and will drive better in-stocks for our customers and improve payroll productivity for our stores. These new capabilities and improved processes are all part of our ongoing perpetual productivity improvement or PPI initiatives, which both improve the customer experience and drive profitability. Turning to our efforts to become the employer of choice in retail. I am really pleased with the progress we've made. Last quarter, we saw a record response rate to our annual associate engagement survey with 90%-plus participation. And even more importantly, scores improved significantly across 3 areas that we measure; engagement, leadership effectiveness and inclusion. It's clear that better associate engagement leads to lower turnover and directly translates into better business results with a workforce more focused on serving our customers and driving productivity in our operations. As Marvin mentioned, we announced $140 million in discretionary bonuses this quarter. This includes an incremental $5,000 for our assistant store managers and other frontline supervisors as well as our special discretionary bonus of $400 for full-time hourly associates and $200 for part-time hourly associates. Additionally, since 2018, we have invested over $3.5 billion in incremental wage and share-based compensation for our frontline associates. In fact, we are one of the few retailers to award stock grants to our store managers and assistant store managers so they share in our long-term success. These programs for our store leaders are not new. In fact, store managers have been receiving share-based compensation for decades and assistant store managers since 2019. We are also creating opportunities for advancement for our associates to encourage them to build their careers with Lowe's. Since 2018, we have added over 10,000 new department supervisors and over 2,500 new assistant store managers. And through Lowe's University, we are training and developing our associates for their next role. This year, we're extending our advanced leadership training to our assistant store managers to equip them with the tools they need to succeed as they move up in their career. With these enhancements, we've worked to increase the number of store managers promoted from ASM to over 80% over the past 3 years. In fact, more than 80% of our leadership roles are now built from within. All of these investments have led to one of the best spring staffing levels in many years, and the stores are ready to serve our customers this spring. We are very excited about the new MyLowe's Rewards DIY loyalty program and the great spring merchandise lineup Bill outlined. As I close, I would like to once again thank all of our store associates for their hard work and dedication. Now I'll turn it over to Brandon.
Brandon Sink:
Thank you, Joe. Let me begin with our Q4 results. We generated diluted earnings per share of $1.77. As a reminder, in the prior year, we recognized $441 million of pretax transaction costs associated with the sale of the Canadian retail business. My comments from this point forward will include comparisons to certain non-GAAP measures from last year where applicable. Q4 sales were $18.6 billion.
Of note, prior year sales included $958 million generated in our Canadian retail business and approximately $1.4 billion related to the additional 53rd week. Also, Q4 results reflect approximately $200 million in sales headwind due to the related shift in our fiscal calendar. Comp sales were down 6.2%, driven by continued pressure in DIY bigger ticket spending and unfavorable January winter weather. Lumber deflation did not have a material impact on comp sales. Although the calendar shift pressured total sales growth in Q4, it had no impact on comparable sales as comps are calculated based on weeks 41 to 53 in fiscal 2022. Comparable average ticket was down 0.1% to prior year. Continued ticket growth in many Pro-heavy categories offset appliance pricing pressure and lower DIY bigger ticket sales. Comp transactions declined 6.1%, driven by the DIY slowdown in unfavorable January winter weather impacting traffic. Our monthly comps were down 4.8% in November and 6.6% in December. January comps declined 7.4% as we experienced significant pressure during weeks of unfavorable winter weather. Gross margin was 32.4% of sales in the fourth quarter, up 7 basis points from last year. Gross margin benefited from multiple PPI initiatives as well as favorable product mix and lower transportation costs. These benefits were somewhat offset by supply chain expansion costs. SG&A of 20.9% of sales delevered 5 basis points versus prior year adjusted SG&A as the momentum we continue to build with our PPI initiatives across all functional areas of the company largely offset sales volume deleverage. Operating margin rate of 9.1% declined 48 basis points versus prior year adjusted operating margin. The effective tax rate was 23.8%, in line with prior year adjusted effective tax rate. Inventory ended the quarter at $16.9 billion, $1.6 billion lower than the prior year quarter as we invest in high-velocity Pro SKUs while managing replenishment in line with sales trends and improving the flow of spring product builds through our supply chain. As a reminder, prior year inventory excluded Canadian operations as the sale was complete before year-end. Now turning to capital allocation. In 2023, we generated $6.2 billion in free cash flow and returned $8.9 billion to our shareholders through a combination of share repurchases and dividends. During the fourth quarter, we paid $632 million in dividends at $1.10 per share and repurchased 1.9 million shares for $404 million returning over $1 billion to our shareholders. Capital expenditures totaled $620 million in Q4 as we continue to invest in strategic initiatives to drive growth and profitability. Adjusted debt-to-EBITDAR finished the year at 2.81x. And lastly, we delivered a return on invested capital above 36% for the year. Now I would like to discuss our 2024 outlook. As Marvin mentioned, we are bullish on the medium- to long-term outlook for the home improvement industry, but the near-term macro backdrop remains uncertain. There is optimism around potential interest rate cuts and improved consumer sentiment. However, the timing of Fed actions remains unclear, and there can be a lag before monetary policy impacts the consumer. Also housing turnover remains depressed and the consumer is still showing a greater preference for spending on services rather than goods. We are expecting these factors to continue to pressure home improvement spending in 2024, especially for the DIY. And with that in mind, we are expecting sales ranging from $84 billion to $85 billion and comparable sales declines in a range of 2% to 3%. Pro sales should continue to outpace DIY as we leverage our multiyear strategy to improve product offerings, fulfillment options in the in-store and digital shopping experience to drive Pro growth at 2x the market rate. We expect operating margin in the range of 12.6% to 12.7%. When we bridge our 2023 operating margin to our 2024 expectations, there are a couple of points to keep in mind. First, the impact of sales volume deleverage and second, the cycling of a favorable legal settlement in each of the first 2 quarters. These pressures are partly offset by the expected positive impact of our ongoing enterprise-wide PPI initiatives. We have made significant progress in realizing our productivity goals over the past few years, and we remain laser-focused on driving these PPI efforts and closely managing expenses through this tough sales environment. These expectations result in full year earnings per share of approximately $12 to $12.30. Now to assist you with your modeling, I'd like to take a moment and provide some color on the cadence of our expected results for the year. As a reminder, the steep pullback in DIY demand, which intensified in the third quarter of 2023 sets us up for different compares in the first and second half of this year. Given this, we expect first half comp sales to remain under pressure as the current DIY demand trends continue. But as we move into the second half, we expect comp sales to improve as we begin to cycle over the pullback in the third quarter. To be clear, we are not forecasting an improvement in demand trends this year. Rather, the compares are easier in the second half. And while we are planning for a normal spring season, the timing of spring is unpredictable and always brings some variability to our first half performance. Given our customer mix, these DIY drivers disproportionately impact our business. Now more specific to our first quarter, we expect comp sales to be consistent with our fourth quarter results approximately 300 basis points below the bottom of our full year guide. The combination of lower sales volumes as well as cycling a sizable legal settlement is expected to result in a Q1 operating margin rate approximately 200 basis points below the prior year adjusted rate. Before I close, let me remind you of our capital allocation strategy, which remains unchanged. Our first priority is to reinvest in the business with capital expenditures of approximately $2 billion. Next, we continue to target a 35% dividend payout ratio. We also plan to use our free cash flow to repay a $450 million bond maturity and then return excess cash to shareholders through share repurchases. In closing, we are confident in our ability to execute through the near-term market uncertainty and remain focused on realizing the benefits of our total home strategy while continuing to drive sustainable shareholder value. And with that, we'll open it up for questions.
Operator:
[Operator Instructions] Our first question today comes from the line of Peter Benedict with Baird.
Peter Benedict:
First one would be just around the sensitivity of your margin forecast, if comps end up trending below that 2% to 3% range for the year, and then alternatively, as you think perhaps longer term, as comps swing positive, just what types of incrementals do you think you could achieve on that, given that you've been pretty lean on the expense front here given the current environment. That's my first question.
Brandon Sink:
Peter, sure, this is Brandon. In terms of incremental, decremental, we've established essentially a flow-through rule of thumb. If our sales do exceed the top end of our guide, we do expect about 10 basis points for every 1% of incremental comp sales on the high side. And then on the low side, sales fall below the bottom end. We're looking at about 15 basis points of margin contraction for every point of comp decline. So high level, that's more of a rule of thumb on an annual basis. It doesn't necessarily work in terms of quarterly performance.
And the other thing I'll stress is the plus 10 and minus 15, not necessarily natural output. So I would tell you that the model and the algorithm very contingent on us continuing to drive PPI across all functions, and that's what's contemplated on both the upside and the downside.
Peter Benedict:
Okay. That's helpful. And then secondly, just around -- I mean, you've had success with your cost optimization efforts. Just kind of your view on where you stand with those, how much more is left to go? And how that kind of plays into maybe your view of average ticket versus traffic in '24. Do you think you can hold on to the ticket in '24, given all the dynamics out there and you're clawing back some costs? Do you think you'll reinvest and maybe tickets down. Just curious how you see that interplaying in '24?
Brandon Sink:
Yes. Peter, I think to your first question on just our ability to manage costs. We're really pleased with our ability to manage expenses here in the last couple of years through this downturn. We have a robust and evolving road map of PPI initiatives. We were down comps 4.7% this year, expecting down at the midpoint, 2.5%. So our ability to manage the sales deleverage there with that robust pipeline. Again, really pleased there. And as we look out, a number of initiatives you heard from Joe and Bill that we continue to be excited about. We believe in '24 in particular, that PPI is going to enable us to offset over $400 million of wage pressure, inflationary pressure and strategic investments.
I think the second part of your question, just as we think about ticket into 2024, we are expecting that to hold up, and that's largely what we saw in 2023. The pullback is expected again in transactions. And really, the drivers of that Pro growth positively impacting average ticket more from a mix standpoint. And then on the pressure point side, we're continuing to see the DIY bigger ticket pressure, and that's going to continue to be a drag. We don't expect any significant improvement off of that second half 2023 run rate. And then on appliances, specifically, ASP pressure is expected to continue as we return to more of a pre-pandemic environment. But overall, as we cycle into the second half of the year, we are expecting a more normal historical relationship between average ticket and transactions.
Operator:
Our next question is from the line of Zack Fadem with Wells Fargo.
Zachary Fadem:
I know there's a lot of moving pieces on the SG&A line as you lap the legal settlement and some of the incentive comp dynamics. So is there any way you could bridge all the puts and takes in a little bit more detail from the 13.3% operating margin in '23 to your 12.6%, 12.7% in '24? And also, any color on gross margin versus SG&A?
Brandon Sink:
Zack, this is Brandon. I would say on SG&A, it's really 2 themes and it's the cycling of the settlements and its deleverage on lower sales. And when you look at the midpoint of the range, a step back about 65 basis points, it breaks down about half and half there. So those are really as we look at managing SG&A in '24. Those are the pressure points.
You mentioned incentive compensation. We paid a discretionary bonus in Q4 of $140 million, which offset any previously expected Q4 benefit that we had from lower management incentive comp, and we're pleased that we were able to reward our frontline associates. But what that resulted in for the full year '23, we had the benefit from lower management incentive comp based on performance. That was offset by the discretionary frontline bonuses that we paid in Q2 and Q4. So that really does not create a headwind for us as we bridge '23 to '24. So back to the 2 themes, it's mainly the cycling of the legal settlements and the deleverage on lower sales.
Zachary Fadem:
Got you. And then two more quick ones. Just any color on gross margin. And then second, your Pro comps were slightly positive in '23 by my math and outcomping DIY for a few years now. So curious if you could just talk about DIY versus Pro mix today and if it's still in that 75%, 25% range?
Brandon Sink:
Yes, Zack. Sorry, I forgot your gross margin question. So I'll take that one. I'll toss it to Marvin for Pro. So we're expecting gross margins for '24 to be roughly flat. And the gross margin themes are really similar to what we saw here in 2023. Ongoing supply chain investment pressure as we wrap the rollout of market delivery. We're continuing to make investments in Pro fulfillment, but those pressures are being offset by ongoing PPI initiatives that Bill discussed as we manage product costs, lower transportation, continue to expect private brands. So those are the puts and takes from a gross margin standpoint. And on Pro, I'll toss it to you, Marvin.
Marvin Ellison:
Yes. So on the mix, that's directionally correct on the percentages. And look, we feel good about the resilience of our Pro customer. And as a reminder, our customers are small to medium sized business owner, and we're actually pleased with the survey results where they feel confident that they can build, the backlog is consistent with what they saw last year and that they can continue to drive their business.
And again, they're cautiously optimistic based on what they know, but that gives us confidence that the things we're doing around loyalty, around product assortment expansion, around service levels, our digital platform and how we've dramatically improved that. And we think we have a best-in-class experience is resonating. And relative to the DIY, I mean we equally feel good about the level of execution in that business. I mean we view it as probably as a macro issue versus a strategic issue or any type of an execution issue. As Brandon I both said in our prepared comments, when we think about the medium to long term, we're very bullish because we've made tremendous investments in this business across supply chain, IT infrastructure, omnichannel, localization, assortment planning, space productivity, store environment and service levels that we know are going to pay dividends, not only in the short run while we deal with this macroeconomic headwind, but when the market recovers, we think we're perfectly positioned to grow and take market share.
Operator:
Our next question is from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Marvin, your answer just now touched on this a bit. I wanted to put it out here. There's this perception or even misperception that the way that Lowe's expenses have been so well managed could either impact how much sales can grow and the cycle resumes or how much EPS grows if you have to put more SG&A back into the business. So I'm curious if you can comment on that.
Marvin Ellison:
No, look, it's a fair question. I think the best way for me to answer would be our customer service results. And when you look at the fact that we have improvements in both Pro and DIY, 200 basis points for both. That gives you an indication that our service levels remain extremely high and also gives you an understanding of the power of our PPI initiatives because a lot of our expense takeout is not the traditional cut payroll, it is more about the investments of technology that drives productivity that allows us to add more hours to driving service and selling and taking hours out of tasking.
And Joe has talked about this for 5 years. We're trying to build a model where we invest technology and we drive productivity that allows us to have more customer-facing associates and less tasking. So we believe that our activity-based staffing model puts us in a great position that when sales go up, we invest a payroll based on the activity driven to create the sales. And when sales come down, we have an activity-based system that we think is best-in-class that we can take hours out based on department level day and hour that we think will drive the business from a productivity standpoint, but without hindering service. So we feel good about the whole model, and we don't think there's any negative implications of sales going up and SG&A not being able to be managed as tightly and as efficiently as we've managed in the last couple of years.
Joseph McFarland:
And Simeon, let me give you a quick example. If you think about 5 years ago, we had less than 50% of the stores that actually had self-checkout. And so over the last 5 years, we've mentioned we've developed our own internal self-checkout built with the home improvement customer in mind. We now have that complete across the entire chain. And now we have started our front-end transformation in adding incremental assisted self-checkouts, and we have 400 stores complete. This has also allowed us to roll out a best-in-class loyalty program for the DIY customer that is tied right in with our mobile technology. And so as we look to complete the incremental 500 in 2024. And then I mentioned in the prepared remarks, our back-end initiatives, too. So very confident in the activity-based labor model and the PPI initiatives we continue to focus on.
Marvin Ellison:
One last point. I mean that's just one example of many initiatives that Brandon and I both have on our time line that we've yet to develop and yet to implement. So this is an ongoing process that is alive and well in every function, including merchandising, as Bill outlined in his prepared comments.
Simeon Gutman:
The follow-up is on the cycle. I think in some models, the weakest part of the cycle would have been the second half of '23 and even the first half of '24. And maybe the market was kind of looking for light a little bit sooner. I can't tell if that was your base case as well. It seems like the market is more dependent on existing home sales. And then Marvin, you mentioned in the prepared comments that it is a big question of whether or not we get back to something normal. And I'm curious when things start up again, do we get back to normal? Or is it something that's less than normal?
Marvin Ellison:
I'll give you my perspective, Simeon, and I'll let Brandon provide any additional comments. When you think about the cadence of our comp sales for this year, as Brandon mentioned, is more indicative of year-over-year comparison versus our forecast that the market is going to improve at some point this year. We hope that it improves and we are positioning ourselves that when that happens, we think that we will have outsized top and bottom line growth. But our perspective of 2024 is that we're going to feel this DIY pressure throughout the year and we're going to perform at a high level irrespective of kind of what type of macro environment that we're dealing with. I'll let Brandon add any additional comments.
Brandon Sink:
Yes, I would just say, Simeon, you mentioned the base case. I mean our base case guide assumes no change in macro conditions versus what we've experienced here the last couple of quarters. It's unclear is the timing of the rate cuts, the improvements in home improvement share of wallet. Marvin mentioned housing turnover, consumer sentiment. So sort of more of the same philosophy there. And even when we start to see some green shoots there, it's going to be -- the trends are going to improve. There is an expected lag before the macro drivers we believe are going to translate into spending. So those have been the underpinnings, the assumptions that we've made here for 2024. And again, the improvement is just a function of what we're cycling in the second half versus our views on the macro and the timing of any improvement.
Operator:
Our next question is from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
So two related questions, a follow-up on the demand environment. First, did you see a -- do you think weather was a net headwind in the fourth quarter? Obviously, December was warmer year-over-year and that probably helped areas like outdoor paint. But then January is much colder, and you have a much more southern geography and it seemed to impact that part of the country more. So do you think weather was actually a net headwind over the quarter? Or was it more neutral when you think about the December side?
And then, Brandon, you mentioned green shoots on share of wallet. Did you see anything in the holiday period that would suggest that, that share of wallet pull forward is at least starting to move past due but maybe not moving towards the more positive side?
Brandon Sink:
Chris, let me -- I'll hit the weather things first, and it really was just a January winter -- extreme winter weather story impacted January as we sized at about 200 basis points of impact on the month. It had an outsized impact on our Pro business over those weeks. The other weather theme also just to mention is we've cycled 2 straight years of hurricane recovery with Ian and Ida, it's about 150 basis point comp impact to Q4, just cycling that. But again, that was all baked into our expectations. And in terms of just what we saw through the holiday season, I'll actually toss it over to Bill, and he can give a view on what we saw in terms of consumer behavior there.
William Boltz:
Yes. Chris, I think for the holiday, we saw -- as I mentioned in my prepared remarks, we saw record holiday sales. We saw the consumer respond very favorably to our trim and tree program and saw a nice performance there. We also saw, as you mentioned, December was warmer. And so we saw those outdoor businesses perform both on the Pro side as well as on the DIY side as the consumer continued to take on outdoor projects. As we've rolled into February and get started with 2024, as we begin to start our spring program for the South and Deep South, we're starting to see some of those early signs of spring where the weather is warmer, we're starting to get started with some of those spring-related businesses. So where we've got some warm weather, we're starting to see some of those early signs of spring. So we're excited about that.
Christopher Horvers:
And then my follow-up is on the appliance category. It did track below, I think, your overall comp, you mentioned ASP pressures as you're leaning to the assortment more to the value side. Do you think -- how are you looking at your performance relative to the market? I don't know if you track line or something gives you sort of unit demand performance relative to the market. But it's your largest category. And obviously, you have a leading assortment and footprint in the store. So how do you think you're performing on the share side?
William Boltz:
Yes. So for the year, we saw share growth in appliances. For the quarter, we saw unit growth across all the major categories. We did see average selling price pressure as we called out. For the key major events, both Black Friday and Cyber Monday, we saw a nice performance across those holiday weeks, and we're pleased with that. We did see the consumer pivot. And we met them where they wanted to go, and that was a shift from multiunit purchases to a single unit purchase as the consumer was looking for that.
We also see the consumer moving to kind of two spectrums. We're seeing them look for value, so looking for products in that value conscious, and we're also seeing them trade up and finding innovation, and I'll share two examples. They'll look for entry-level laundry, for example, and then they're not afraid to invest in, for example, the GE Profile all-in-one washer dryer combination that retails for over $2,500 of which we could sell every single one that we can get our hands on. So those are just 2 spectrums of what's going on in that business. And it's happening across really all categories of the appliance business. So it's really 2 spectrums of what's going on. We're continuing to see our online appliance business perform very well as that business continues to evolve, and we're continuing to build out our capabilities there to make sure that we're meeting the customer where they want to be met and those fulfillment capabilities and delivery. And as Joe talked about, with two-way text and market delivery and getting all those capabilities rolled out so that we can fulfill the way we want to fulfill.
Marvin Ellison:
And Chris, this is Marvin. Just one last point on appliances. The work of our market delivery supply chain infrastructure is going to be significant, not only in 2024, but for years to come. I mean, we're virtually the only national player that can deliver major appliances next day and two-day in virtually every zip code in the country. And that's significant in addition to having same-day capacity for customers to have emergency purchases we still have take-with inventory in virtually every store where a customer can come in and literally leave with an appliance within the hour. And so our model is difficult, if not impossible, to replicate in the brands that Bill and his team have brought to our assortment is something that we think will continue to work for us. And look, we'll work and manage through the macro environment. And I think Bill and his team have done a really nice job, and we'll continue to listen to the consumer and pivot based on where they want us to go.
Operator:
Our question comes from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
You mentioned big ticket still stays under pressure in DIY. And we wondered if we could try and get our arms around that a little bit more in terms of how it compares the mix of what you were seeing prepandemic in terms of smaller versus larger projects. And that also -- that question goes to the Pro as well within the backlog. It sounds like you're seeing a stable backlog. But what are you seeing in terms of percentage of mix when it comes to those big ticket versus smaller ticket?
Marvin Ellison:
Yes. Kate, this is Marvin. I'll take the first part, and I'll let Bill or Joe jump in on the second part. But if you think about the DIY consumer for a second, the consumer is healthy and we feel good about the financial wherewithal of that consumer. They're simply choosing to leverage their spend in different places. As we've discussed and is not just us, but in all the different companies that talk about consumer spending, customers are just spending more of their wallet on experiences, on travel, on concerts, on restaurants because of this whole post-COVID relationship of getting back out and getting back to normal.
And also, I don't think is a surprise for us to say that customers purchased quite a few home-related goods during the pandemic. So we're still working through that cycle. Having said that, we believe that we will work our way out of this macro environment at some point. We're not trying to call the timing on it. Our objective is to continue to invest in our business and execute at a high level. So whenever that consumer spend reverts back to normal, we're going to be in a perfect position to take advantage of it. One of the reasons why we launched our DIY loyalty program is specifically for the DIY consumer to give them some level of rationale to choose us over someone else and to create a level of differentiation in the marketplace, both in-store and online, so that we can be a preference for the DIY consumer. And so as we think about what they're buying and where we think that big ticket is going, I think it remains to be seen, but we feel good about what we're positioning for those consumers, and we'll wait on whatever time frame occurs with them to change their spending habits.
William Boltz:
Yes. Kate, I would just add that it really varies by product category. And so as I said, with appliances, you've got really two spectrums going. You've got the value-conscious consumer looking at low-end pricing all the way to innovation, and we meet the customer across a variety of price points. And then you have the Pro looking at their jobs, and we can meet them wherever they want to be met, whether that's on stock cabinets and having those products in our stores again across a multitude of price points that we offer in our stores and the different levels of product quality of product that we offer both online and in-store.
And as we get ready for spring, we have a lot of new product that we're excited about. And so you think about bigger ticket product like riding lawn mowers, walk-behind mowers, the launch of Toro, it's bigger ticket product. We're excited about that. And those are all new. And so same thing with patio furnitures, we introduced Origin 21. We introduced the allen + roth program. Those are bigger ticket products as she's looking to address and upgrade their outdoor spaces. So again, we want to meet her wherever she wants to be met. We want to be able to offer a variety of pricing to her based on how she wants to be met as she takes on these projects. And that's what we're trying to do, both online and in-store. And we're excited about the readiness. We've worked really hard with our assortments that we offer both online and in-store. We've worked really hard to make sure that we've got these variations across the country so that we're localized to address those needs across the different areas and geographies of our stores, and we're ready. We're ready for mother nature to cooperate and we're ready to get going. So with that, Rob, we have time for one more question.
Operator:
The final question will be from the line of Steven Zaccone with Citi.
Steven Zaccone:
Brandon, I wanted to just circle back to the same-store sales guidance. And I was curious if you could talk a little bit more about that second half outlook in particular because it does embed a pretty big improvement on a 1-year basis and then also on a multiyear basis, from stacks perspective. So maybe just flesh out a bit what's really driving the improvement? Because you could arguably say that's not conservative in one view.
Brandon Sink:
Yes, Steve. Really, just when we look at the cadence of comps, I'm going to reaffirm my earlier comment, we expect the macro pressures, inflation, higher interest rates, low housing turnover to persist. When we looked specifically at the second half, we're cycling the easier compares as we comp over the DIY weakness that intensified in particular in Q3 of last year. And to be clear, our comp improvement in the second half is not a result of any views on the improving macro, but purely are reflective of easier year-over-year comparison. So we looked at the cadence. We looked at it a lot of different ways. I would tell you on a 2-year basis, which we leaned into pretty hard 2-year ex lumber, there's a pretty consistent trajectory as we moved across the year. So we feel really comfortable with the full year, the breakdown, the comps and the operating margin and wanted to provide the right level of transparency and visibility to that.
Steven Zaccone:
Okay. That's helpful. And then the follow-up I had is just on the rural framework. Is there anything that's new this year as you think about the opportunity? And then when you think about the store portfolio more broadly, one of your peers has shifted to opening stores, would you consider being a net opener of stores at some point in the future?
Marvin Ellison:
This is Marvin. I'll take that final part of your question. So on the new store openings, it's -- we're going to always look for what we describe as real estate voids around different parts of the country where we believe that we can get the right return on our capital for new store investment. But candidly, I mean, our focus is on space productivity. We have such incredible upside opportunities in our stores to just invest capital in our existing infrastructure and create space productivity. We think the return on invested capital is significantly greater in using our dollars for that versus opening new stores with expensive real estate, where we're struggling to get those investments to pencil. And again, we'll open a handful of stores for voids where you're going to see us spend a ton of time on driving space productivity and creating greater value from the assets that we already own. And that's going to be our key focus.
Relative to rural, we're extremely pleased with the performance of those 300-plus stores when you think about categories like pet, things like clothing and automotive, they're positive performing, outperformed the company and most other merchandising categories. And you're going to see us start to expand some of those rural categories in nonrural locations around the country. We wanted to make sure that we learned enough about the consumer demand, enough about how we serve customers well and Bill and Joe and their teams have done an exceptional job. And so you're going to hear us continue to talk about this, but it's something that we're very pleased with. And you'll start to see it show up in more places around the portfolio of our stores.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our first quarter earnings call in May.
Operator:
This concludes Lowe's Fourth Quarter 2023 Earnings Call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. For the third quarter comparable sales decline at 7.4%. Our results were driven by a greater-than-expected pullback and DIY discretionary spending, especially in bigger ticket categories. While we've seen a more cautious consumer for some time now, this quarter, we saw some of these consumers increasingly prioritizing experiences over goods spending on travel and entertainment.
As a reminder, at Lowe's, 75% of our revenue is driven by DIY customers and 25% by Pros, while the broader market mix is roughly 50% DIY and 50% Pro. As a result, whenever the DIY customer becomes cautious, it disproportionately affects us. And while we face a softer DIY demand in the third quarter, I'm pleased that at the same time, we once again delivered positive sales comp in Pro. Now I'd like to take a moment to dig a bit deeper into our DIY performance for the third quarter. In categories like appliances, decor, flooring and kitchen and bath, where we have strong DIY penetration, we saw increased pressure on sales of bigger ticket purchases like appliances where consumers are postponing purchases if they can. For example, customers may have previously bought an entire kitchen suite may now just buy a refrigerator. Keep in mind that the industry-wide pullback in appliance sales has a larger impact on Lowe's since we are the market leader in appliances in the U.S. with 14% of our sales coming from this category. Later in the call, Bill will discuss some of the initiatives we're implementing in Q4 to improve DIY performance with a more targeted effort to reach value-conscious customers including our most competitive offers on single unit appliance purchases ahead of the holiday season and the launch of our Lowe's lowest price guarantee, so our customers can shop with confidence knowing that they'll always find the best price at Lowe's. Despite the pullback in DIY, our Pros are still working and many of their projects are a result of increased wear and tear on aging homes, which lead to unavoidable repairs. This continues to create project backlogs for small- to medium-sized Pro, who is our core customer. In our most recent survey, nearly 70% of PROs reported healthy project backlogs, but given the uncertain macro environment, they're feeling a little less confident. Although Pros may be a bit cautious in this environment, our ability to deliver a positive pro sales comp in the third quarter is a reflection that our strategy is working. We're making progress with the investments we've made over the last several years to improve our service offering, including increasing loyalty through our MVP Pro rewards, developing a world-class CRM platform, improving job site delivery, enhancing service levels in our stores, creating a more seamless online experience and a number of merchandising initiatives that Bill will discuss later in the call. Overall, we built a competitive pro sales and service model, which is creating a flywheel effect that will enable us to grow Pro sales at 2x the pace of the market. Let's now turn to online sales, which declined 4% in the quarter as the same pressures in DIY bigger ticket categories impacted digital sales. Now let's talk about what we're doing to manage this unique environment. In store operations, we've made foundational improvements to associate productivity that enable us to effectively align labor to demand while continuing to serve our customers. During the quarter, we leveraged these new capabilities to reduce operating expenses while enhancing the customer experience for both Pro and DIY customers at the same time. Joe will provide more detail on these initiatives and our improved customer service scores later in the call. I'm pleased that our disciplined focus on expense management across the organization contributed to a 46 basis point increase in operating margin rate compared to adjusted operating margin in the prior year despite the sales decline, which led to diluted earnings per share of $3.06. As we pull ways to drive improved sales with our DIY customers, I'd like to provide you with an update on two initiatives, our new Lowe's outlet stores and our rural strategy. Let me start with our Lowe's Outlet stores. We opened our 15th Lowe's outlet location in Q3. With these smaller format stores, we can leverage lower cost real estate in trade areas closest to our core customer without cannibalizing a nearby Lowe's store. In an environment where DIY consumers are seeking value, we're pleased with the customer response and the overall performance of our outlet locations. These stores complement our market delivery network, allowing us to offer savings between 25% to 70% off on big and bulky scratch and dent items like appliances, patio furniture, grills, all while maximizing profitability and offering our customers enhanced value. We look forward to discussing the potential growth opportunities of this strategy on an upcoming call. Turning to our rule strategy. This one-stop shop concept is designed to give customers located in rural areas across the country, everything they need for their home and farm, including a wide offering of farm, ranch and outdoor products. During the summer, we launched this rural assortment to over 300 stores where we're selling products like livestock feed, pet food, utility vehicles and apparel from brands like Cohort and Wrangler. These programs include a Petco store within a store, which enhances the total home solution we offer by bringing together home improvement and pet care services, products and expertise under one roof. We're pleased to see this new initiative already gaining traction with strong performance in pet, apparel and automotive. In fact, these rural customers are our best-performing DIY segment and these stores are performing significantly above the company average. Given this initial success, we're now exploring expanding this rule assortment beyond the original 300 designated rule stores. In addition, we're planning to add incremental merchandising initiatives within these original 300 stores because the customer is responding favorably to these new assortments and product lines. Looking ahead, we remain focused on our merchandising and marketing efforts that highlight the everyday value at Lowe's for our price-sensitive customers. And we will continue to invest in our strategic growth initiatives within our Total Home strategy as we strive to become a world-class omnichannel retailer. And as I wrap up, let me say that we remain bullish on the medium- to long-term outlook for the home improvement industry, supported by favorable housing and demographic trends. We expect home prices to be supported by a persistent supply/demand imbalance of housing, while at the same time, 250,000 millennial household formations are expected per year through 2025, and their parents and grandparents, the baby boomers increasingly prefer to age in place in their own homes. And we cannot overlook the fact that we now have the oldest housing stock in U.S. history with the medium age of homes now 41 years old, which will need ongoing investments in repair and remodel projects. These factors continue to reinforce our optimism about the mid- to long-term outlook for our industry. In closing, I'd like to thank our frontline associates with our continued hard work and dedication to serving customers and our communities. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone.
Despite a pullback in DIY discretionary demand, we are pleased that we delivered positive Pro comps this quarter as our enhanced product and brand offerings continue to resonate with the Pro. Over the past several years, we've added the brands that Pros want, and we have invested in the inventory quantities pros need, and we continue to tailor our product assortments to local building codes and preferences. These investments continue to pay off even in a more challenging macro environment, where we remain laser-focused on highlighting everyday value and convenience, both in our stores and online to a price-conscious consumer. Turning to our results in Building Products. We continue to serve our Resilient Pro customer who remains active, especially on repair and maintenance projects. We delivered positive comps in building materials, partly driven by strong performance in Pro-heavy categories like roofing and drywall. We also delivered comps above the company average in rough plumbing, largely driven by positive comps in water heaters demonstrating that Lowe's is the go-to solution for critical repair needs. This quarter, Klein Tools returned home to Lowe's. This trusted brand is the #1 tool brand for electrical and HVAC professionals, and we are thrilled to now offer the largest assortment of Klein Tools in the home improvement retail channel. Our Pro customers' response to our relaunch of Klein tools has exceeded our expectations, and we're excited about our plans to expand this iconic brand to support the unique needs of these trade professionals. Now let's shift gears to home decor, which was most heavily impacted by lower DIY project-related demand. And as you heard from Marvin, this had a greater impact in categories like appliances, flooring and kitchens and back. Within appliances, we are seeing lower industry unit volumes as well as the reintroduction of pre-pandemic levels of vendor-funded promotion, which puts pressure on average selling price. And while our results in kitchens and bath were also impacted by softer DIY demand. We are seeing our private brand products gaining traction as the consumer continues to look for value, like with our new allen + roth butcher block countertops. These are made of solid FSC-certified wood and this stylish product is a cost-effective way to refresh your kitchen, bar or studio. This item has been so popular that we are now doubling our sales expectations. Turning to paint. We delivered comps above company average in the quarter, largely driven by the Pro paint, who relies on Lowe's as a one-stop shop for their project needs. We continue to look for opportunities to expand our product offering, including a recent launch of an exclusive line of Sherwin-Williams primers from HGTV Home. These new primers designed for the Pro who paints, gives them a versatile multi-surface application that makes it easier to work on both interior and exterior projects. Shifting gears to hardlines. In addition to a broad-based DIY pullback, we also saw pressure in categories impacted by storm-related activity. such as generators, gas cans, fuel and chain saws as we cycled Hurricane Ian from last year. We delivered comps above company average in lawn and garden as our customers engaged in smaller fall cleanup projects. And we also drove comps above company average in hardware led by key Pro categories like fasteners, safety equipment and cleaning products. Lastly, we continue to build out our brand portfolio like with our new strategic partnership with the Toro Company. Their exciting product lineup further complements what is now the strongest brand offering in outdoor power equipment, one that resonates with both the Pro and DIY customer who relies on Lowe's to offer the best selection. We're looking forward to launching Toro ahead of our upcoming spring season and building on our momentum as the leading retailer of outdoor power equipment. In response to the customers' increased focus on value, I'd like to talk about how we are highlighting some of the ways that customers can save time and money during this holiday season. For starters, we recently kicked off our holiday campaign with a commitment to supporting shoppers in new ways, all season long, which includes a wave of exciting offers and new deals every week, on great gift ideas, including power tools from some of the best brands like DEWALT, Craftsman and Cobalt and pre-lit Christmas trees, trimmed with the innovative energy-saving LED lighting. Our customers can also look forward to same-day delivery on key holiday and home improvement items as well as services like holiday light hanging for the home through A&G. And as Marvin mentioned, we recently launched our new Lowe's Lowest Price Guarantee to remind customers that not only can they expect a great shopping experience, but they will also receive the lowest price on items for their home. In fact, Customers can now find our lowest prices of the year on select major appliances. And in an effort to simplify the offer and make it easier to understand, we're offering $100 off for every $800 a customer spends. For our Pros, we have tailored exclusive bulk saving offers on appliances as well and to drive even greater excitement and traffic on Black Friday, we will feature more than 10 major appliance doorbusters. We are excited to deliver what we think will be the most compelling offers in the market. In addition to these great deals, Lowe's is now offering Carhartt apparel online and in select stores. This iconic workwear brand makes a perfect gift for the Pro this holiday.
Before I close, I'd like to highlight just a few of the perpetual productivity improvements or PPI work streams that are underway in merchandising. Our teams continue to make progress in our three main focus areas:
product cost management, inventory productivity and pricing and promotional strategies.
We continue to partner with our suppliers to take cost out, especially now that transportation and commodity costs have come down. And we are expanding our private brand portfolio, which delivers great quality and value at a lower price to our customers, while also driving better margin rate productivity. Our teams are working hard to ensure that customers have the best value every day at Lowe's, while also delivering productivity for the organization. And as I close, I'd like to extend my appreciation once again to our vendors and our merchants for their hard work, dedication and ongoing partnership. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone. I'd like to begin by thanking our frontline associates for their ongoing efforts to deliver excellent customer service. As Marvin mentioned, we were able to reduce operating expenses this quarter, while at the same time delivering a 200 basis point improvement in DIY customer satisfaction scores and a 300 basis point improvement for the Pro. This represents the ongoing benefit of our foundational technology investments, designed to modernize our stores operational process and simplify our associates' jobs while also creating a great shopping environment for our customers.
Let me highlight just a few of these changes. For starters, we created an industry-leading customer-centric scheduling system, which allows us to predict customer demand and align staffing around peak customer traffic for each store and each department. This system creates enhanced operational agility so we can rapidly adjust as demand patterns shift. Second, we've enabled greater productivity by putting mobile smart devices in all of our associates' hands to make them more efficient, reducing manual tasking and enabling faster customer service. For example, by integrating smart devices with our new store inventory management system, or SIMS, our associates can find products 40% faster. And through Project Simple, we've eliminated duplicative tasks and reduced nonproductive hours, so we can re-purpose associate time from tasking to selling and service. A third foundational improvement is the expansion of our merchandising services team or MST. This team keeps our shelves stocked, and they recently assumed responsibilities for price changes across the store and watering in the garden center. MST is now leveraging a new app that directs them to serve a specific base based on the rate of sales, making their hard work even more productive and freeing up more time for our Red Best associates to spend with customers. Another important aspect of delivering excellent customer experience is convenience. That's why we're making a number of enhancements to create a more convenient shopping experience ahead of the holiday season. For example, we're extending our same-day delivery to in-store purchases through our gig network to both Pro and DIY customers. And in certain locations, we'll even be delivering live Christmas trees to our customers' doors saving them the hassle of getting it home themselves. This new gig delivery capability, which we first rolled out on lowes.com, enables us to tap into the One Rail network of 12 million drivers to deliver directly to Pro job sites and customer homes in just a matter of hours. Our store operations team is also focused on unlocking even more productivity through our perpetual productivity improvement initiatives or PPI. This past quarter, we fully retired the old self-checkout systems and have shifted to the proprietary self-checkout systems that we've built for the home improvement shopper. We've seen greater customer adoption of these new systems since they're so much easier to use. In fact, our front-end transformation is well underway, with approximately 450 stores planned by the end of this year. Over a 3-year time line, we're revamping the checkout experience across all of our stores and increasing the selling space at the front where we're adding more merchandise right of checkout with a new design that makes it easy to showcase grab-and-go items. And with this front-end transformation, we're shifting to an easy-to-use assisted self-checkout with cashiers who will be right there to answer questions and help customers when they need it. Finally, we're tripling the staging area for buy online, pick up in store orders to support increased online sales and create a much faster, easier customer experience building on our momentum when it comes to driving improved customer service scores for these orders. At the same time, we're excited to launch omni selling in our stores, a critical milestone in our journey to become a world-class omnichannel retailer, enabled by our new store operating system, we can now easily sell our endless aisle on Lowes.com within the aisles of our stores. For example, let's say, a customer is shopping for new faucets and browsing our selection of the most popular finishes in the store. While talking with an associate, they decide to go with the unique finish from Lowes.com that the associate highlights on their mobile device. The associate then saves the faucet in the customer's digital cart with their phone number and the customer can continue shopping in the store. When the customer is ready to check out, all the cashier needs to do to combine the digital and physical purchases is pull up the digital cart using the customer's phone number. We're still in the early innings here, but we know this is a great opportunity to drive our omni sales and make sure our customers get everything they need to complete their project in one shopping trip. As I close, I would like to thank all of our store leaders and associates once again for their hard work serving customers and delivering results each and every day. Thank you. And now I'll turn it over to Brandon.
Brandon Sink:
Thank you, Joe, and good morning, everyone. Starting with our Q3 results. We generated diluted earnings per share of $3.06. Please note, in the prior year, we recorded an asset impairment charge of $2.1 billion associated with our Canadian retail business. Now my comments from this point will reference comparisons to certain non-GAAP measures from last year were applicable. Q3 sales were $20.5 billion. For reference, prior year sales included $1.2 billion generated in our Canadian retail business.
Additionally, Q3 results include a $115 million sales headwind due to the shift in our fiscal calendar as we cycle over a 53-week year. Comp sales were down 7.4% as a slowdown in DIY bigger ticket spending offset growth in Pro. Q3 comps were negatively impacted by approximately 50 basis points due to lumber deflation. As a reminder, the calendar shift impacted total sales growth, but had no impact on comparable sales as comps are calculated based on weeks 28 through 40 in fiscal 2022. Comparable average ticket was down 0.5%, driven by lumber deflation, more normalized appliance promotions and a decline in big-ticket DIY transactions. However, average ticket still increased in the majority of our merchandise categories. Comp transactions declined 6.9%, driven by softer demand in DIY discretionary projects partly offset by positive comp transactions in Pro. Our monthly comps were down 6.3% in August, 8.3% in September and 7.3% in October as DIY traffic slowed as we exited our peak seasonal weeks. Gross margin was 33.7% of sales in the third quarter, up 36 basis points from last year. Gross margin benefited from our ongoing merchandising PPI initiatives as well as favorable product mix and lower transportation costs. This was partially offset by costs associated with the expansion of our supply chain network and consistent with our year-to-date performance, [ shrink ] was in line with prior year. SG&A of 18.4% levered 30 basis points versus prior year adjusted SG&A demonstrating our enterprise-wide agility to manage expenses and drive productivity in a lower sales environment. These results would not have been possible without the exceptional efforts of our store leadership teams to rapidly respond to the sales pressure as well as the ongoing benefits that we are harvesting from our technology-led PPI initiatives. Operating margin rate of 13.2% improved by 46 basis points versus prior year adjusted operating margin. The effective tax rate was 24.6%, in line with prior year adjusted effective tax rate. Inventory ended the quarter at $17.5 billion, down $2.3 billion compared to Q3 of last year. U.S. inventory dollars and units were both down compared to last year as we align inventory purchases with sales. Turning now to our capital allocation. During the quarter, we generated $485 million in free cash flow. We repurchased 7.3 million shares for $1.6 billion and paid $642 million in dividends at $1.10 per share, returning $2.2 billion to our shareholders. Capital expenditures totaled $579 million as we continue to invest in our strategic priorities within our Total Home strategy. Adjusted debt to EBITDA finished the quarter at 2.72x in line with our stated 2.75x leverage target. Finally, we delivered return on invested capital of 35%, inclusive of an unfavorable 125 basis point impact related to transaction costs associated with the sale of our Canadian retail business and the gain we reported in Q1. Now turning to our 2023 financial outlook. Given the recent pullback in DIY, bigger ticket discretionary spending and the uncertainty surrounding the macro factors that impact our business, we are updating our full year 2023 financial outlook. With this in mind, we are now forecasting Q4 comp sales to be fairly consistent with Q3 results. Also, the fourth quarter of 2022 included approximately $1.4 billion in sales from the additional 53rd week. We are now expecting 2023 sales of approximately $86 billion with a comparable sales decline of approximately 5%. We also now expect adjusted operating margin of approximately 13.3% and as our ongoing PPI initiatives and disciplined expense management helped to offset volume deleverage pressure from lower sales. Additionally, we expect full year interest expense of approximately $1.4 billion, capital expenditures of up to $2 billion and an adjusted effective income tax rate of approximately 25%. This results in an updated outlook for adjusted diluted earnings per share of approximately $13. Please note that our outlook for operating margin and diluted earnings per share are adjusted to exclude the gain associated with the sale of our Canadian business that we recorded in Q1. Finally, we are reconfirming our capital allocation priorities. We will continue to invest in the business to take market share, target a 35% dividend payout ratio and then return excess cash to shareholders through share repurchase, which will be funded in the near term through free cash flow. And in closing, I'm confident that our continued investments in our Total Home strategy, our strong balance sheet and our ability to effectively manage our business in any environment will allow navigate the near-term challenges while continuing to deliver sustainable shareholder. And with that, we will open it up for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Steven Forbes with Guggenheim Securities.
Steven Forbes:
Marvin, you mentioned in your prepared remarks the 300 rural stores comping above average and some of those categories being the best performing ones. So curious, if you can maybe help reframe how you guys are thinking through the more medium-term and longer-term opportunity there. How many stores do you think can accommodate such an assortment? And any contextualization of the spread in the DIY comp in the 300 stores versus the company average?
Marvin Ellison:
Steven, thanks for the question. We're not going to get into that level of specificity for competitive reasons, but what I will tell you is that the rural stores have exceeded expectations. And as we noted, we started out with roughly 300. But candidly, the performance and the customer response has been such that we're now looking at a couple of different options. One option is we're going into those original 300, and we're add incremental investments initiatives, categories based on feedback from customers. We're also looking at categories that are working really well in those rural stores and asking the question, can we now take some of these categories and put them in nonrural format locations because we believe we could get the same response from customers in nonrural environments.
And then thirdly, we're just looking at expanding our profile and definition of rule because some of these characteristics, we think can fit other locations. And because of the response and because of the DIY customer being such a critical component of our company strategy, we think this makes a really good strategic rationale and it's something that we're pursuing. But again, we'll speak more about this on future calls, but I don't want to get into more specifics for obvious competitive reasons.
Steven Forbes:
And then maybe sticking with some initiatives here and maybe a follow-up for Bill. The front-end transformation, we're probably far enough right into it where it'd be helpful if you maybe frame the ROI of such transformations. I don't know if you can sort of maybe go through what you're seeing in terms of comp lift and/or just what is the outlook right for next year as we think through the maturation benefit of such an agenda.
William Boltz:
Yes. So as Joe said, we've got roughly 450 stores that we'll complete by the end of the year. We continue to test and learn in these stores. As you can imagine, there's opportunities for us to try some additional merchandising opportunities up front of the store. It's all about getting another item in the basket, and there's opportunities in the obvious areas like snacks and drinks, but we're also looking at other categories as well that can complement what we're doing and also that shopper, both a Pro and a do-it-yourselfer that's making that transaction in our store that could pick that kind of stuff up and you think about like aspirin, band-aid, stuff like that, that could complement what they're doing and could be used on a job site or in a glove box of a car at your home.
Marvin Ellison:
And Steve, the other thing that I'll add is this also complements the ongoing omni expansion that Joe talked about. As we extend the capabilities of connecting digital and physical stores, we need more productive space, and we need to just optimize all the things that the associates are going to accommodate and fulfill those orders. And as Joe mentioned, part of this is to create more designated space in a more productive fashion for that process, but also it's creating a much better customer experience, and it's also driving a lot of productivity for Joe's taming the store.
Operator:
Our next question is from the line of Peter Benedict with Baird.
Peter Benedict:
Just kind of curious as you talked a lot about the PPI initiatives and your ability to kind of be agile with expenses. If we think kind of longer term, think maybe out to next year, if there's another environment where comp store sales are maybe down in the mid-single-digit range. How do we think about your ability to manage margins in that environment? I know some of the benefit this year is cycling Canada, but just maybe some benchmarks to think about as we move to next year on how the P&L could act in different top line environments.
Brandon Sink:
Yes. Peter, this is Brandon. Just in terms of as we're looking at 2024, we're in the later stages of our planning process at the moment across the organization. So we're going to hold off on providing any in-depth guidance until our Q4 call. But what I will tell you just in terms of top line macro home improvement, there's continued uncertainty on interest rates, when we're going to see relief when existing home sales are going to turn the corner and begin to improve. And obviously, the ongoing impact of inflation, higher rates on consumer wallet. So we're watching all that. I think to your specific question on margins, we're managing several puts and takes as we look at next year. We're cycling onetime legal settlements, normalization of incentive comp, wage growth, the pacing of our PPI initiative. So we're looking at all that. We're going to take all those factors under consideration as we develop our guide and hold off on providing that until we get to February.
Marvin Ellison:
Peter, this is Marvin. And the only thing I'll add is you heard in some of your prepared comments, was talking about an old operating system. And we talked a lot about this 30-year-old operating system. There's really been a significant impediment to some of the technology advancements, and we're going to be sunsetting that system at the end of this year, and it's going to just unlock a little bit of acceleration in some of the technology advancements that we have on the project list. We just candidly, we couldn't get to because of this system. And so the good news is we're going to continue to work to Brandon's point on all the elements of running an improved business from a merchandising to operations, supply chain, but also the technology project list over the next 3 to 5 years is robust, and it's going to allow us to continue to find ways to drive profitability, irrespective of the macro environment that we're in. We're hoping the macro environment gets better with the brand at this point. We're going to wait until our Q4 call to talk about '24 and give a much more educated perspective at that time.
Peter Benedict:
All right. Fair enough. Appreciate that perspective. I guess my follow-up would be just around maybe the cost environment that you're seeing out there, a lot of talk of -- obviously, disinflation and some outright deflation in certain areas. What are you seeing right now in terms of the cost you're receiving from your suppliers? And how do you kind of view that as we look out over the next few quarter.
Brandon Sink:
Yes, Peter, this is Brandon. I would say just in terms of costs coming into the organization at this point, just from an inflation price action response to that. It's leveled off pretty dramatically here as we move through the year. We've had targets in terms of clawback for this year. We laid those expectations out back in December, I would say, very much pacing in line with those targets. We laid out about $500 million over the course of 3 years. We're leveraging cost management teams, working closely with the merchants, the tech-enabled tools that we've invested in. We have very detailed product cost breakdowns that are informing those negotiations with our suppliers. So we're continuing to be balanced. We're taking a portfolio approach. We're investing in price strategically where needed, but also looking through the lens of protecting our margins.
Operator:
Our next question is from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
I want to try to take another stab at this margin question for next year. I know there's not a whole lot you can provide. If you think about the levers that you have do you lose any for next year? I realize you're going to lap the legal settlement in the first part of the year. And then connected to it, as you manage your selling expenses, do you think that's having an impact on sales at all? Meaning, is that not something you press on is hard for next year?
Brandon Sink:
Yes. Simeon, this is Brandon. I wouldn't say when we look at next year, we're losing the benefit of any of those levers. In fact, I think we're looking at where we have opportunities to accelerate. We've talked about PPI, I talked about where we were in that journey in terms of middle innings. Marvin mentioned the conversion of the store technology to a modern omnichannel platform. We got a lot of initiatives stacked up where we expect to see those benefits as that gets delivered next year. Earlier question on transforming the front end really expanding assisted checkout, expanding the BOPIS experience, and then Bill talked in his prepared comments about multiple other kind of merchandising PPI initiatives, whether it's cost clawback, inventory productivity, pricing, promotional strategies, expansion of private brands. So we're really confident in that portfolio of initiatives. We feel like it's in our control. We're managing the road map and the pacing of that and have a lot of confidence as we look at the longer-term margins that we can deliver against our stated targets there.
Marvin Ellison:
So Simeon, this is Marvin. I'll add this perspective. The reason why we call this a perpetual productivity improvement initiatives because we're trying to stay away from onetime events. We think that good companies create an ongoing sustained process of improvement and productivity gains. And so we have a road map of initiatives. And it's important that it's not just about store operations. You heard Bill talk about the PPI initiative, specifically for merchandising. If Don Frieson was here, he could speak specifically to supply chain and Seemantini could speak specifically for IT.
And so this is a culture that we've created here that candidly did not exist, but the key word is perpetual. And that means that it's ongoing, it's consistent and it's sustainable. And so as we look at '24, we know we're not going to get into the details. What Brandon is reinforcing is that we have a list of things that we're going to do. We're well aware of what we're overlapping. We understand some of the onetime factors we're going to face. And we built processes, initiatives in place to address that. And we'll be more transparent and more detail in our Q4 call because we think it's really important to lay out to you all exactly how we see it and the steps we're going to take.
Simeon Gutman:
So my gentle follow-up to that, Marvin, is you have OpEx productivity and PPI. Those are the two biggest unlocks. I -- Just to clarify or an assumption, it doesn't sound like what the business comps has anything to do on what those two buckets produce. And then is there a situation in which those two buckets actually produce more in terms of sequencing in '24 than what it was yielding in '23.
Marvin Ellison:
So I'll give you the perspective of a long-term operator. If we get the top line, PPI works a whole lot better. So irrespective we're going to intensify the focus. Obviously, if we have a softer top line perspective, we're going to be a lot more aggressive in the PPI side. But irrespective of our comp outlook, PPI is going to be in existence, and we're going to work really hard to make sure that we hit some of the key targets that we lay out. And again, you have our commitment that as we lay out 2024 as best we can, we'll be as transparent as possible about all of these things in our February call.
Operator:
Our next questions are from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
I want to focus a bit on the top line. You've seen increased big-ticket sensitivity, others are talking about, you mentioned flooring. People are doing smaller projects, you're not buying the suite of appliances, you're doing the bathroom, not the entire [first floor] and flooring. I guess -- so my question is, why isn't the Pro and the remodel business or maybe the remodel business and the answer is different from you on the Pro because of share, but why isn't the remodel business and the Pro business that the next should a drop? And given the changes that you've seen over the past 3 or 4 months, how are you thinking about the bottom of the comp cycle and sort of when does it start to refer back to positive?
Marvin Ellison:
So Chris, I'll take the first part of that, and I'm going to just let Bill Boltz talk about some of the initiatives relative to addressing some of the top line concerns. So specific on sales for us, when we look at the quarter, we look at it from a penetration from a DIY perspective and a product mix. So as a reminder, 14% of our revenue comes from appliances. So when you have pull back on some of these big-ticket categories like appliances, is going to be disproportionately impactful for us.
Having said that, we look at the Pro and to your point, we had a positive comp, and we're really pleased with that, and I went through some of the investments we've made over the course of the last 4 years that we believe are paying dividends relative to that specific small or medium Pro. And the reason we think that, that specific segment of Pro will remain healthy, although cautious, as we've noted from our survey is because of the age of homes. I mean it is a foregone conclusion that if you have a house over 40 years old, things are going to break. And when those things break and those repairs are required that smaller-to-medium contractor is typically the one that's going to get that call. And these pros are incredibly transparent with us and 70% say they feel really good about their backlog. But they also said that when they watch the news and they read the headlines, they're a little cautious because they just don't know what's lurking around the corner, but they're busy because these homes are old. These homes are not turning, so people are living in these homes. And so that's really the driver of that customer segment remaining healthy and busy. And look, we can't predict the bottom. But what we can say is that we're incredibly disciplined. Anytime you can deliver a 46 basis point improvement in operating margin on a negative [ 7.4% ] comp. It tells you that there are a lot of really things working from a productivity standpoint that drives margin rate improvement and basis point improvement in customer service that we're really proud of. So we feel good about the execution of the team, and we can't predict kind of what's going to happen when, but we can say whenever it happens, we're well positioned to take advantage of it. And I'll pivot to Bill just to talk about kind of what we're trying to do to remain agile and to try to make sure that we are driving a business environment that's attracting DIY customers and keeping these products coming back also.
William Boltz:
Yes. Thanks, Marvin. And Chris, just some of the things that we've talked about really over the last few quarters that I'm pleased with the work that the team has done is the continued acquiring of brands and making sure that we've got relevant assortments inside of our stores and online. And so we announced today Toro as part of our outdoor power equipment. We talked about Klein last quarter, and we're just starting to get that brand now into the electrical and the tool category. So that's excitement for us. We talked about localized assortments and Marvin touched briefly on the rural strategy. That's just one element of a localized opportunity.
And then we continue to try to pivot to where the customer is. So as -- we've seen some of the softening in appliances from an industry-wide standpoint, because we're the industry leader here, we want to make sure that we can meet the customer where they want us to meet them, and that's adjusting. And so we feel like the adjustments the teams have made to make sure that we can go after the 100,000-plus appliances that break in the United States every single week that we're there when the consumer needs us both online and in-store. We continue to enhance our fundamentals and our foundation online. And so offering Apple Pay as a way to make it easier for the customer to transact online. This is just one element, same-day delivery and then obviously being seasonally relevant. As we go into this Friday with Black Friday, it's about making sure that we've got strong offers out there that gets the customer to the door into the website. And that's the stuff that we'll continue to do. And at the same time, we have to be competitively priced. We've got to be relevant every single day. And so that's the kind of work that the team continues to stay focused on. And it takes time, obviously, to get that customer to know that these changes have happened inside of our store and online, and we're just going to just stay focused on what we can control.
Christopher Horvers:
And then my follow-up is, again, on the Pro side. As you think about the momentum in that business over this year or what you're seeing in the basket in terms of the projects that they're doing. Whether it's size or price point -- price spectrum, is there any change in momentum on the Pro side of the business?
Joseph McFarland:
Chris, thanks for the question. And listen, we can tell you that with the firm loyalty and CRM that we launched, we continue to view the basket. We continue to view the mix. We are very encouraged and continue to exceed expectation in the core metrics. And we continue to launch new capabilities, things like online quotes for the bulk pricing that Bill talked about. In my prepared remarks, I mentioned the integrated same-day gig delivery, streamlined order tracking. And so there's a lot going into that pro from an effort standpoint. And so we continue to be pleased at the progress.
Operator:
Next question is from the line of Seth Sigman with Barclays.
Seth Sigman:
So I wanted to follow up on pricing and promotional activity. Obviously, you talked about elevated promotions and appliances, and how that's being funded by vendors. I realize that category is a little bit unique, but how would you categorize discounting activity across other categories? And maybe you could also just elaborate on what you have seen and what you've been doing with that low price guarantee?
William Boltz:
Yes, Seth, it's Bill. And so just a couple of things here. As I said, we are seeing probably more of a move on pre-pandemic levels of promotion, specifically in the appliance area. These are largely vendor supported, but we want to make sure that we're there, obviously, and we're part of all that. As it relates to the overall, the industry remains pretty rational and pretty stable. You want to make sure that at certain times of the year, you're out there with the relevant offers and that you're doing the things that you need to do. So whether that's in the spring or this Black Friday, we're excited about having some of those offers out there and working within the guardrails and the profitability targets that we've established.
But all in all, it remains, I think, relatively rational. I think the consumer is looking for value, and so we've got to find different ways to highlight value, and those are the things that this team is doing and value can come a lot of ways outside of just a reduction in price. You can highlight it through new and innovative products. You can highlight it through a special offer if that's what comes out, or we can do it through a vendor-funded promotion. So those are things that we're trying to take advantage of.
Brandon Sink:
And Seth, this is Brandon. I would just add the adjustments that Bill is talking about that we're making as the consumers changing as we're moving through the year, our go-to-market strategy, all of that's fully embedded and reflected in our updated outlook and confidence that we're able to achieve our flat gross margins for the year.
Marvin Ellison:
And Seth on a low price guarantee, our research just indicated that we needed a more simplistic straightforward message to the customers about our value. We had something that was a little too cute, call it, a price promise that I think was way too ambiguous, and we just decided just to keep it simple and stand by the fact that we will support the lowest price in the industry on the products that we sell. We just launched it. We think the timing is perfect going into a holiday season where you have a slightly cautious consumer looking for a value. And so you take everything that Bill said about the definition of value and the fact that we're going to put media behind this lowest price guarantee. We hope that sends a message to the consumer that they could always expect a lowest price at Lowe's.
Seth Sigman:
Okay. That's very helpful. I did have one follow-up on capital allocation, specifically share repurchases. Just based on what you've done year-to-date, where leverage sits today, how do you think about the pace of buybacks from here? Should we be thinking about that starting to slow into the fourth quarter and even over the next couple of quarters based on the demand backdrop. How do we think about that?
Brandon Sink:
Seth, this is Brandon. So our capital allocation priorities unchanged. We're going to continue to invest in the business in high-return projects, targeting a 35% dividend payout ratio and funneling the remainder to share repurchases. As I mentioned in my prepared remarks, we do expect funding and share repurchases through operating cash flow here in the near term and expect modest if any share repo in Q4 also expect to be in line with our stated leverage target at the end of the year. So we're also looking at our debt towers, paying those off as they mature. We have $500 million this past Q3. We have $450 million coming due in 2024, and we remain committed to our BBB+ credit rating and expect to manage our leverage accordingly.
Operator:
Next question is from the line of Michael Lasser with UBS.
Michael Lasser:
Given the importance of sales to the PPI initiative, if you're looking at, call it, another down 5% comp next year, do you start to become more aggressive with promotions or other actions in order to start to drive sales because you'll get a return on it in other ways?
Marvin Ellison:
Michael, we're not going to get into 2024 at this time. We'll speak more specifically about that on the Q4 call. What I'll just repeat is PPI is perpetual for a reason. We're going to keep doing it. It's sustainable, it's ongoing, and we're going to be agile. We'll take the necessary steps to make sure we're running a really sound business thinking first about driving service for the customers and giving our associates a great place to work. But other than that, PPI will be in place irrespective of top line, and we'll adjust it accordingly.
Michael Lasser:
Okay. My follow-up question is, Morgan, as you look at your sales by market, by region, and tie to the underlying housing characteristics and dynamics in those markets, where are you seeing better trends? And where are you seeing worse trends such that it informs how you think about how the rest of this cycle is going to unfold from here. It's likely at some point, hopefully, housing turnover is going to pick up. That could bode well for home improvement demand. But if it comes with a corresponding tick down in home prices, that could be not so good for home improvement demand.
Marvin Ellison:
Michael, it's a fair question. If you strip out storm overlaps, geographically, our performance is relatively balanced. So there are really no outliers. When you look at markets that had a dramatic run-up in housing costs and some level of moderation, there's really no material impact to our business based on that. Obviously, it's something that we stay very close to. We're paying attention to it. But as of right now, it's not material, and we don't see it as something that's going to affect our business in the near term.
Operator:
Next question comes from the line of Brian Nagel with Oppenheimer & Company.
Brian Nagel:
So a couple of questions on top line. I just going to merge them together. But first off, a big follow-up just on appliances. So Morgan, you talked about maybe some normalization in overall promotion vendor way. I guess the question I have on appliances, are you seeing anything shift in the market? I mean obviously, we're against the demand backdrop. But are you seeing anything shift from a competitive standpoint? And then my second question, just with respect to the underlying cadence of the business. We saw, it would appear to be a weakening trends through the fiscal third quarter and then presumably here into the fourth quarter. Anything that you can -- clearly, there's seasonal factors there, but is there anything else you could really call out that they have -- you guys identified as kind of a driver of that we can trend the overall business?
Marvin Ellison:
Michael, I'll take both and just allow Brandon and Bill to jump in if they have any additional comments. On the appliance shift, I mean we're not seeing anything other than what Bill talked about, where you have vendor-funded promotions kind of driving average ticket down. And also, as we mentioned in the prepared comments, we're seeing customers being just a little more specific on their purchases going from an entire suite to just a refrigerator as an example.
And I think this is just the cautious nature of the DIY discretionary spending on some of these bigger ticket cargos we talked about. We already market leader in the U.S. and appliances. And as I mentioned earlier, 14% of our annual revenue is predicated to appliances. And so when the market is soft, we have a disproportionate impact. Having said that, we feel great about our market-leading position. And as Bill outlined, we have some competitive offers on single unit purchases for the holiday season, that's the best in the industry. And so we feel like we're in a good place relative to the marketplace. On weakening trends, there's not anything we can put our finger on it. I mean you know all the macro indicators with the resumption of student loan debt and sustained inflation, interest rates. And I just think that those things combined with the fact that people are just choosing to take discretionary dollars and have more experiences with those dollars is really leading into some of the things that we're seeing. And when those discretionary categories are impacted, those are typically DIY-related purchases. And again, at 75% penetration in DIY, we just have a disproportionate impact to that. So I'll let Brandon or Bill add anything else if they have it in addition to what I just said.
William Boltz:
The only thing that I would add, Brian, is that just, as I said earlier, just a reminder that over 100,000 units of appliances break in the marketplace every week. And we've got to be there for that consumer as the market leader, and that's what we're trying to do and do that in a responsible manner to make sure that we can hit all the financial targets that we need to hit. But also make sure that we can meet the customer where they want to be met, both online and in-store.
Brandon Sink:
Yes. And Brian, this is Brandon. Just to wrap it out in terms of how we are looking at Q4. I think our outlook largely a continuation of the macro and the traffic trends that we've experienced in Q3. We do expect a light or a slight impact from lumber deflation as we transition into Q4. All of the offers that Bill has talked about with appliance holiday offers are reflected in there. We do expect some light pressure from cycling Hurricane Ian. So we've triangulated all that. We've looked at 1-, 2-, 4-year trends all of that sort of baked into the expectations that we set, and we believe it's very achievable for us here for Q4.
Kate Pearlman:
Thank you all for joining us today. We'd like to wish everyone a Happy Thanksgiving and a wonderful holiday season, and we look forward to speaking with you on our fourth quarter earnings call in February.
Operator:
Thank you. This concludes the Lowe's third quarter 2023 earnings call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.
I'll now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. For the second quarter, comparable sales declined 1.6%. Our results were driven by a strong spring recovery, combined with continued growth in Pro and online, which helped to offset softer DIY discretionary spending and 160 basis points of pressure from lumber deflation.
Q2 also reflected the importance of our ongoing investments in our Total Home strategy. And despite an uncertain macro, these investments are paying off with positive comps in Pro and 6.9% comparable sales growth online as we continue to improve our omnichannel experience. We're pleased that our core Pro customer to small and midsized Pro remains resilient and continues to respond to our expanded national brands, MVP's Pro Rewards program and enhanced online tools. In our most recent survey, nearly 75% of polls reported healthy project backlogs and lead volumes remain consistent with recent quarters. This quarter, we launched a new same-day delivery option on lowes.com and our mobile app powered by 1 rail, enabling us to tap into their network of 12 million drivers to deliver directly to Pro job site and consumer homes in a matter of hours. This new capability allows us to leverage our 1,700-plus store footprint to make those much needed last-minute deliveries to Pro job sites, saving them both time and money. Our expanded same-day delivery capability is the latest of many examples of how we are meeting our customers where they are in making home improvement shopping faster and more convenient for both Pro and DIY customers. We're also making strides in the rollout of our market delivery model for big and bulky products with 13 geographic regions now supporting more than 1,200 stores, and we are on track to complete the initial rollout by the end of the year. As we invest in what will drive our future growth, we remain disciplined in improving productivity through our perpetual productivity improvement initiatives or PPI. In the second quarter, operating margin expanded 18 basis points, leading to diluted earnings per share of $4.56. A common misperception we hear is that our productivity journey must be close to us in as we've driven significant operating margin leverage since beginning our transformation 5 years ago. But the reality is we still have a lot of opportunity ahead. We're in the final phases of sunsetting our 30-year operating system, in addition to the productivity benefits of using intuitive touchscreens instead of hard to navigate green screens. This conversion gives us the modern foundation needed to quickly build and scale new omnichannel capabilities for the future. And we also continue to leverage our penetration of rural stores to drive sales productivity. We run these stores with a lower expense base than the rest of our portfolio and our ability to generate outsized operating margin leverage on sales growth is unique. Specifically, the expansion of our rural product assortment, combined with the implementation of our PPI initiatives, make our rural and remote stores a competitive advantage for our company. Beyond the productivity initiatives underway in stores, our leaders across all functional areas are executing against dozens of PPI work streams to deliver sustained operating margin improvement. One example of this is in our supply chain where we are driving greater throughput with new mobile applications combined with automation and robotics to improve productivity, maximize speed and minimize damages. And we're piloting a new break pack process, which leverages automation to break down cases 5x faster, making it far more efficient to replenish stores. And as we drive productivity, we also continue to focus on sustainability as the 2 often go hand in hand. And we recently published our 20th corporate responsibility report, spotlighting our path to net zero emissions along with our investments in our associates and communities. As we speak with investors, many of your questions have centered on the macro environment. And as a reminder, the 2 strongest demand drivers of our business are real disposable personal income and home price appreciation, and they are most supportive of demand when they pull in tandem. Home price appreciation has slowed, but it's still up 35% versus pre-pandemic while rural disposable income has been pressured by persistent inflation and elevated interest rates. But on a positive note, over the past quarter, growth in real disposable income started to improve and realign with long-term trends with growing wages surpassing inflation for the first time in 2 years. Consumer cinema has also improved slightly but remains below pre-pandemic baselines, and inflation concerns linger. However, improvements in sentiment typically must be sustained for a period of time before that translates to consumer spending. As a result, home improvement shoppers remain cautious with their spend, especially big-ticket discretionary purchases and are more focused on smaller repair and maintenance projects. These trends are consistent with our expectations and reinforced our outlook for our relevant market to be down mid-single digits in the second half of the year with our sales continuing to outpace the market by 100 to 200 basis points. Looking ahead, it's encouraging to consider that home improvement projects are typically postponed rather than canceled. And home improvement span as a percentage of home equity is below the historical average, a positive indicator for medium-term demand as consumer sentiment improves. The aging housing stock will also drive remodel and repairs, combined with other favorable trends like millennial household formation aging in place and persistent remote work. All of these factors continue to make us bullish on the mid- to long-term outlook for our industry. In closing, we remain a customer-centric company focused on our daily execution while also ensuring we continue to make the right investments to take share in any macro environment. Our total home strategy is resonating with our Pro and DIY customers alike, and we are confident in our ability to deliver in the short and long term. As an out visiting stores, each week continue to be impressed by our hard-working frontline associates, and I'd like to thank each of them for their commitment to Lowe's and their communities. And with that, I will turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. Our second quarter comparable sales were down 1.6%, slightly above expectations. We successfully recovered $300 million of delayed seasonal sales from Q1 due to the late start to spring, $50 million more than anticipated. We saw growth in rough plumbing, building materials, paint, seasonal and outdoor living, lawn and garden and hardware as we capture these spring sales and continue to see solid broad-based pro demand. These factors partly offset 160 basis points of lumber deflation as well as continued pressure on big-ticket DIY discretionary demand that Marvin mentioned earlier. In Hardlines, we drove broad-based sales growth driven by our stronger-than-expected spring recovery.
Lawn and garden was a standout category achieved in partnership with our live good vendors who helped us effectively respond to changing weather patterns and stretch spring into the summer months. We saw an increase in smaller instant gratification projects that improve outdoor spaces at an affordable price, like landscaping projects and pre-plotted plants. Seasonal and outdoor living also benefited from the weather recovery where we saw momentum in outdoor power equipment, specifically in riders with the strength of our exciting products from John Deere and Aaron's, along with the battery-powered equipment from the strength of EGO, Cobalt and Craftsman. And we are pleased with our strong seasonal sell-through putting us in a better inventory position than last year as we move into the second half. Hardware was another top-performing category this quarter as our associates drove attachments alongside the higher lumber units and leaned into fastening with key brands like SPACs, GRK, Power Pro One and Facet master. In tools, we started the rollout of Klein Tools, the #1 tool brand for electricians and HVAC professionals. We are excited about the launch of this brand, which is returning to Lowe's after nearly 15 years. As part of this launch, we will offer the largest assortment of Klein Tools anywhere in the home improvement retail channel, featuring hand tools, storage, safety and electrical products in-store and online, positioning us as the go-to retailer for these brand loyal customers. Within home decor, paint delivered the strongest comp performance this quarter as we gained traction with the pros who paint. These pros are increasingly taking advantage of our MVP's paint rewards program, paint job site delivery and our new spec right paint designed specifically for Pros. Turning to appliances. We continue to outperform the market. We've seen a return to pre-pandemic levels of vendor-funded promotions that are pressuring average tickets across the industry. But I'm excited about the traction that we're gaining as the leading appliance retailer in the U.S. reflected in our unit sales growth, market share gains and the momentum with our Pro customers once again this quarter. One encouraging trend was the increase in bundled appliance purchases. This was fueled by focused Red Vest associate selling, auto applied supplier rebates, faster fulfillment through our market delivery model and our improved online customer experience. Now shifting gears to building products. We continue to see strength in key Pro categories, helping offset the pressure from year-over-year lumber deflation. While lumber deflation pressured our top line by 160 basis points and our Pro comps by 315 basis points, the category once again delivered the highest unit comp in the company this quarter, reflecting strong Pro demand. Our continued growth in building materials and rough plumbing is another positive indicator of the resilience of the small to midsized Pros supported by the healthy backlogs Marvin mentioned earlier. In rough plumbing, we expanded our assortment of PEX products and added our first battery-powered cobalt drain auger. This is one of several new cobalt launches this year as we celebrate this private brand's 25th anniversary. Our private brands are spec-ed out and quality tested to ensure that they are equal to or better quality than comparable national brands and we continue to see our customers respond to their great quality and value. Our increasing private brand penetration is nicely balanced with a strong lineup of trusted national brands like Bosch, DEWALT, Rubbermaid and Scotts. Shifting to localization. We completed our rural expansion to roughly 300 stores ahead of schedule this quarter. This includes scaling our store within a store concept with Petco designed to provide a dedicated space for all things pet. While it's still early, we're encouraged to see an increasing basket size in these stores and customers are saying that they appreciate the convenience and the ability to reduce the number of stops they need to make. As Marvin mentioned, our work to optimize our rural stores is one piece of our broader localization strategy, designed to drive market share gains, increased productivity and margins. Another highlight this quarter is the growth we've driven online as we continue to improve the digital shopping experience and increase conversion or launch of same-day delivery nationwide on lowes.com, and our mobile app is resonating well with our customers. We also introduced a new digital [indiscernible] fit capability that helps customers determine if a refrigerator will fit into their space and a refined search experience with better recommendations, filters and featured categories. And our Halloween and holiday sets are already available online, positioning us nicely for customers who want to get a jump start on decorating. We are also encouraged to see better-than-expected performance for our Lowe's One Roof media network, which is driving increased traffic to Lowes.com and generating results that are exceeding the industry average for our suppliers. Our media network is one of many merchandising PPI initiatives underway at Lowe's. The team is constantly working with our suppliers to find ways to take cost out as commodity prices and transportation costs have come down, and we continue to enhance our technology and processes to optimize pricing. We have also expanded our merchandising services team, or MST, to over 30,000 associates across our stores and garden centers, which frees up our Red Vest associates to spend more time serving customers. New this year, we are adding MST assistant store managers. This role will be focused on providing dedicated store leadership for the critical work that this team does. Through their improved service, the team is squarely centered on driving sales per square foot productivity in our stores while creating a better shopping experience for our customers. As I close, I'd like to once again extend my appreciation to our vendors and merchants for their hard work and partnership. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
All right. Thank you, Bill, and good morning, everyone. I'm really pleased to begin by announcing that we are awarding over $100 million in bonuses for our frontline hourly associates in recognition of their hard work and dedication during the second quarter. Our investments in our associates are paying off as we continue to elevate the customer experience with a 200 basis point improvement in both our DIY and Pro customer service scores this quarter as compared to last year, and we are seeing strong staffing levels and improved associate engagement as we continue to invest in associate wages and ongoing development through Lowe's University.
As Marvin mentioned, our online comp sales grew 6.9% in the quarter, and roughly half of those orders are picked up in a store. We continue to unlock productivity through one of our many PPI initiatives by reducing the time to pick these orders by approximately 70% as our associates leverage our omni-channel investments, which include mobile devices and order picking carts with mobile printers to streamline the process. And we've enhanced our workforce management tools to better align staffing levels with customer demand. These enhancements are allowing our customers to get in, get what they need and get back to their projects faster. Looking ahead, we are further enhancing our BOPIS experience as we transform the front end of our stores. This includes an expanded staging area, a dedicated pickup desk with improved signage and new technology that expedites the process. Now shifting to Pro. We continue to deliver positive comps this quarter despite lumber deflation. And under the leadership of our new Executive Vice President, Quonta Vance, we will continue to expand our online business tools for Pros that allow them to easily generate quotes and track orders as part of the MVP Pro Rewards program. As we continue to find ways to save Pros time, this month, we launched our newest online tool purchase authorization. Until now, when Pro sent a crew member to the store to pick up an order, the designated buyer would need to call their team from the checkout line to confirm the order and have it authorized by the store. This could be a time-consuming process, taking the Pros time away from their job site and the associate's time away from serving other customers. Now runners can simply scan a QR code that's pre-authorized up to a specified amount and check out without having to wait in line at the Pro desk. This solution addresses a pain point for many Pro customers and our Pro desk associates and leapfrogs the competition. And we're encouraged to see that our suite of online tools is resonated with Pros and adoption is already exceeding our expectations. Now I'd like to spend a moment discussing how we are managing shrink, which is a big responsibility for any retailer, especially in this environment. As expected, shrink was in line with last year's results despite industry-wide challenges, driven by our proactive customer service, tech-driven solutions, industry-leading asset protection program and our penetration of rural stores. We're developing radio frequency identification or RFID technology embedded in power tools to prevent theft. This solution will be largely invisible to customers, but it makes a tool inoperable until it is scanned and purchased. Turning to PPI or perpetual productivity improvement in store operations, we have a series of exciting initiatives on our road map that will continue to deliver productivity for the company. In addition to the omni-channel enhancements that I mentioned earlier, we also upgraded freight flow process for shipments from our distribution centers into our stores and on to the selling floor. Through improved technology, we now have better visibility into how freight is flowing into our stores. This enables us to better match staffing levels with the type of inbound freight, getting the product onto the shelves faster. These PPI initiatives, combined with our continued investments in our associates have helped us to control our expenses and improve our customer service scores in a down sales environment. Before I close, I'd like to extend my appreciation to our frontline associates in Kentucky, New York and Vermont, who supported flood relief in their communities and to our teams in Hawaii, who are responding to the devastating wildfires. To support the recovery efforts in Maui, we are donating $1 million to provide food, emergency shelter and release supplies to those affected and are grateful for our frontline associates for going above and beyond to help those on the island with recovery and cleanup. With that, I'll turn it over to Brandon.
Brandon Sink:
Thank you, Joe. Let me begin with our Q2 results. We generated diluted earnings per share of $4.56. Q2 sales were $25 billion. As a reminder, prior year sales included $1.7 billion generated in our Canadian retail business. Results also reflect a $335 million sales headwind and due to the shift in our fiscal calendar as we cycle over a 53-week year. As Marvin mentioned, comparable sales were down 1.6%, which includes approximately 160 basis points of lumber deflation. This pressure was partly offset by a 125 basis point benefit or $300 million of seasonal sales delayed from Q1 due to a late start to spring. Although the calendar shift pressured total sales growth in Q2, it had no impact on comparable sales as comps are calculated based on weeks 15 to 27 in fiscal 2022. Comparable average ticket was up 0.3% to prior year. Ticket increases in the majority of our merchandise categories were offset by lumber deflation and more normalized appliance promotions. Comp transactions declined 1.9% driven by continued pressure in DIY discretionary purchases, partly offset by our seasonal recovery. Our monthly comps were down 1.2% in May, 1.6% in June and 2% in July as the seasonal recovery was concentrated in the first half of the quarter. Gross margin was 33.7% of sales in the second quarter, up 42 basis points from last year. Gross margin benefited from our ongoing PPI initiatives, favorable product mix and lower transportation costs. These benefits were somewhat offset by costs associated with the expansion of our supply chain network and as expected, shrink was in line with prior year.
SG&A of 16.4% of sales delevered 16 basis points, largely due to lower sales related to the shift in our fiscal calendar. Please note that it also includes the benefit of a onetime legal settlement. We continue to tightly manage expenses, adjusting spend appropriately to align with demand, all while still improving our customer service. Also, as you heard from Marvin, Bill and Joe, we are pleased with the ongoing momentum we are experiencing across our portfolio of PPI initiatives, which continue to create significant value for the organization and helped offset the impact from lower sales. Operating margin rate of 15.6% of sales levered 18 basis points, consistent with the expectations we outlined on our last call. The effective tax rate was 24.6%, in line with the prior year. Inventory ended the quarter at $17.4 billion, $1.9 billion lower than the prior year quarter. U.S. inventory units were down 3% compared to last year as we continue to manage replenishment in line with sales trends. Now let me turn to capital allocation. In Q2, we generated $3.5 billion in free cash flow and returned $2.8 billion to our shareholders through a combination of dividends and share repurchases. During the quarter, we repurchased 10.1 million shares for $2.2 billion. In addition, we paid $624 million in dividends at $1.05 per share, and we announced a 5% increase to $1.10 per share for the dividend paid on August 9. Capital expenditures totaled $385 million as we continue to focus on high-return projects that support our growth objectives. Our balance sheet remains healthy, adjusted debt-to-EBITDAR stands at 2.69x as we move towards our stated target of 2.75x in line with our BBB+ credit rating. Additionally, we delivered return on invested capital of 27.8%, inclusive of a 750 basis point impact related to transaction costs associated with the sale of our Canadian retail business and the discrete gain we reported in Q1. Now turning to our 2023 financial outlook. As Marvin mentioned, we continue to expect our relevant market to decline mid-single digits this year and to outperform the market by 100 to 200 basis points. As such, this morning, we reaffirmed our full year 2023 financial outlook. We continue to expect 2023 sales in a range of $87 million to $89 billion for the year, representing comparable sales of down 2% to down 4%. This includes a 150 basis point impact from lumber deflation for the full year. This outlook reflects continued strength in Pro and online, offset by ongoing pressure from DIY discretionary purchases. Specific to our Q3 expectations, we will be cycling over the toughest comparison of the year as we delivered plus 3% comparable sales in the U.S. last year. Given these difficult comps, we are expecting Q3 sales towards the lower end of our full year guide. We continue to expect full year adjusted operating margin in a range of 13.4% to 13.6%, with disciplined expense management and ongoing PPI initiatives, partly offsetting the impact of lower sales volumes. And we are reaffirming our outlook for adjusted diluted earnings per share of $13.20 to $13.60. As a reminder, our full year outlook for operating margin and diluted EPS excludes adjustments associated with the sale of our Canadian retail business. And finally, we continue to expect capital expenditures of up to $2 billion this year. In closing, I remain confident that the investments we are making in our Total Home strategy are positioning us to grow our market share regardless of the macro environment while continuing to deliver meaningful long-term shareholder value. And with that, we will open it up for questions.
Operator:
[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
So first question is on the top line. What drove the difficult comparisons in the third quarter that you're not expecting this year? And then as you think about those bigger ticket DIY discretionary categories, how do you see the rate of change in those businesses? Are we starting to get to a baseline level that we can grow from? Or is that spending pattern still deteriorating?
Marvin Ellison:
Chris, this is Marvin. And I'll take the first part, and I'll let Brandon take the second part. Look, when you look at last year, it's 2 different years, 2 different macro environments, 2 different sets of consumer sentiments. 2 different sets of expectations for DIY and Pro customers. I think the key point is that we feel good about the steps we're taking to grow market share regardless of the macro environment, we have a plan to outperform the home recruitment mark by 100 to 200 basis points, and that's what we're focused on. So I'll let Brandon answer the second part of your question.
Brandon Sink:
Yes. Chris, this is Brandon. Let me get into a little detail on Q3 and second half. First, before I do that, let me take care of one quick housekeeping item as it relates to Q2 exit rate. There's some noise that we saw in the comp spreads across Q2 given the calendar shift that we experienced. And after adjusting those spreads to compare to last year Q2, comps are down roughly 1% in July. Also, when we look at July and August, they're traditionally lighter volume weeks until we hit the Labor Day fall seasonal period. So looking ahead at Q3 specifically, we are cycling our toughest comparable of the quarter, plus 3% last year in August, the toughest across that quarter, plus 4. And then your question on sort of puts and takes different from Q2. As we get into Q3, we won't see the same level of seasonal benefit. Going forward, we called out $300 million there that we experienced in Q2. More modest lumber deflationary pressure in Q3, which sized at about 75 basis points and then continuing to expect pressure in the DIY discretionary spend. And then on the flip side, continued growth and momentum from the Pro business as we expect to outpace DIY. So those are -- just to give you some insights as we look at Q2, and how we transition in Q3.
Christopher Horvers:
Got it. Makes sense. And then on the gross margin line, I know you had some price cost issues in the first half of this year. As you look ahead, given -- is that behind you? And as you think about how freight is going to start to roll through the inventory? Should gross margin performance improve in the back half relative to the first half?
Brandon Sink:
Yes, sure, Chris. So gross margin bounced back as we expected. From Q1, we had easier product margin comparables due to prior year timing. The benefits, as you mentioned, the transportation cost relief is now flowing through margin as expected. We also benefited from product mix, and we continue to see great momentum with our PPI benefits across the merchandising portfolio. Those benefits are offset by continued investment in supply chain and the expansion specifically on market delivery. We called out shrink being neutral, as Joe mentioned, continuing to drive tech solutions to manage some of the industry-wide challenges there. And all in, as we look at the full year, we still expect roughly gross margins flat across the year. So puts and takes there, just like Q2, supply chain expansion continued pressure from some of the Pro growth initiatives. And then we expect continued benefits across the back half of the year from private brand penetration, supplier clawbacks, lower transportation costs and initiatives that we're seeing across the pricing portfolio.
Operator:
The next question is from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
We're at the halfway point of the year. I was hoping to take stock or diagnose the macro housing, Marvin, you mentioned that, and then also the consumer. Curious how it's playing out versus your expectation? It feels status quo, but wanted to hear the puts and takes on both sides.
Marvin Ellison:
Yes, Simeon. Look, I think you summed it up well. For us, when we look at consumer cinema, I mean, we know that we're seeing a pullback in DIY discretionary span. And that's really for us the kind of the overall theme of how we see the second half of the year. I think the good news for us is we remain really bullish on the mid- to long-term view of the home improvement market, and we think it's still very healthy. I mean I can just give you the traditional data points that really matter, and we think that they're going to matter not only for home improvement in the mid- to long term, but we think this is one of the best retail sectors to be in. You look at home demand, you had 2 million fewer homes than what's available for sale, the age of homes, 90% of homeowners have fixed mortgage rates in an environment where rates, as you know, are going up, and when we look at all the things that we're doing relative to Pro to DIY, we feel really, really comfortable that irrespective of the macro environment for home improvement that we're going to outperform the marketplace by 100 to 200 basis points. And key examples of why we believe that is when we take a brand like client tools that we have had absent from Lowe's for almost 15 years, and we can bring back the #1 brand for electrical and HVAC Pros and be the largest home improvement retail outlet for that brand, that gives us a lot of confidence that our strategy is working, and we're going to continue to grow market share across Pro and DIY. But the DIY discretionary pullback on big ticket drives our overall modest concerns about the back half. But even with that, we think we can outperform about 100 to 200 basis points.
Simeon Gutman:
That's helpful. The second question is more on margin, and this is maybe irrespective of what happens to sales, so both on SG&A per foot and even GM, you have the PPI as a good guy and then just in general spending levels. Can you talk about where PPI is? Is it performing better than you thought, and then is there any areas where you in hindsight should be spending more in or less for that matter just as we think about the margin progression going forward?
Marvin Ellison:
So, I'll take the first part, and I'll let Brandon add any additional context. What's interesting is that PPI started in store operations. I mean typically, you think about expense, it always begins in the store because of the amount of payroll we spend how we execute in our 1,700-plus store environment, but then the philosophy started to permeate around the entire company, merchandising, supply chain and across all those functional areas. And so because of that, we built a road map that Brandon and I could look at over a multiyear time frame, and we can understand the tech investments we're making and the expense reduction and the productivity that will be driven based on those investments. In addition to that, I don't want to understate the importance of our role in remote stores, as I mentioned in my prepared comments and Bill mentioned in his we simply believe as we continue to identify ways to localize this little bit in addition to putting in technology and implementing PPI, we think it's going to give us a disproportionate benefit over the long term in driving operating margin improvement. And again, PPI is a big part of that. Brandon.
Brandon Sink:
Yes, sure. Simeon, the good news too, when we look more in the short term around the back half of '23, we actually are expecting PPI to get more momentum in the second half than what we saw in the first half. A couple of really good efforts that are going on with new store tech architecture as we continue to build the modern foundation, enabling new capabilities in the store like omnichannel selling. We're transforming the front end of the stores with improved self-checkout, revamped BOPIS experience.
And then across the other areas, within merchandising. I mentioned earlier, pricing, private brand expansion and clawback and then also within the supply chain efforts as we continue to improve process and implement automation there. So all in, really pleased with the progress. We have those benefits factored in. They're going to continue to accelerate as we move across the second half of the year, and those are captured in our expectations.
Operator:
Our next question is from the line of Elizabeth Suzuki with Bank of America.
Elizabeth Lane:
Just a couple of questions about the assumptions of the guidance. So for the second half, you're assuming at the high end down about 1%, but on the low end, down about 5%. So I'm just curious what economic scenarios you're contemplating for both the high end and the low end. And then if trends you're seeing today continue, do you think you would end up on the higher end or on the lower end?
Brandon Sink:
Yes, Liz, this is Brandon. I think as we think about our range for the full year, we believe the range is practical and it reflects a measured approach given the various potential scenarios and outcomes, we still -- as we look at the back half, still significant macro uncertainty, inflation, interest rates, a more cautious consumer especially on the discretionary side. There's also variables such as the student loans and the uncertainty there with the moratorium. So the team continues to be focused on executing the Total Home strategy. We believe Home improvement is going to be down mid-single digits, and we'll outpace that 100 to 200 basis points. We expect second half the softness with DIY discretionary to continue, and we expect to continue to see momentum from Pro and .com. So those -- that's what's reflected overall in our second half.
Marvin Ellison:
So Liz, this is Marvin. And this is a point I want to continue to reinforce. I mean, obviously, we're looking at the data that we have available, and we're looking at historical trends and how that data correlates to historical trends. But what we're saying is we're going to outperform the market by 100 to 200 basis points. So if we're being too pessimistic in the second half, that's great. because we're going to outperform that 100 to 200 basis points. And so for us, we're really focused on controlling what we control, executing our Total Home strategy and just maintaining our organizational alignment and agility around whatever the macro throws our way. But we're just really confident as a team and the company that we have the agility to make sure that we continue to take market share irrespective of what the home improvement environment will be in the second half of the year.
Operator:
Our next question is from the line of Zach Fadem with Wells Fargo.
Zachary Fadem:
So your average ticket slipped back slightly positive. We know lumber played a role, but considering this line is still 30% above 2019. Can you talk us through the moving parts here in a little more detail, and if you think it's fair to say that the average ticket has normalized or if there's still risk that you revert back closer to those '19 levels?
Brandon Sink:
Zach, this is Brandon. Let me take sort of the ticket transaction narrative here. So on the ticket side, as we look at inflation, the benefits we expect to continue to normalize as we cycle a number of the price increases from 2022. As we look at new cost increases that are currently in our pipeline or inbound from our suppliers, that's effectively minimal at this point. There is some positive improvement in the average ticket and the expansion there that's not necessarily inflation driven as we continue to see healthy growth from our Pro customers and Pro penetration.
But punchline as we look across the second half, we're not anticipating meaningful deflationary pressure. We're going to see year-over-year lumber pricing is going to be much more normal across the second half, Bill mentioned, we're going to begin to cycle more normal appliance pricing, specifically as we get into and then the ongoing expectation with DIY discretionary is going to continue to put some pressure on ticket. So taking all that into account, our outlook assumes more pressure overall on transactions, and we look at ticket and expect that to really hold over the back half of the year.
Scot Ciccarelli:
Got it. And just over the past 2 years, your cost controls and operating margins have been able to show really nice progress even on a negative comp. And considering all the PPI commentary and host of structural changes, can you talk through what kind of margin progression we should anticipate as comps slip back to positive eventually? And if you think the expansion today could, in any way, preclude more meaningful expansion and recovery.
Brandon Sink:
Yes. Zach, this is Brandon. I think, look, right now, we're really focused on delivering our expectations for '23. We've laid that out in the guidance. I'll reference back just as we your question around slipping positive comp. We laid out various scenarios back in December. We still, as we sit here today, confident in our path to continue to expand comps, top line through deployment of our total home strategy. We feel like we have a nice path going forward to expand operating margins. We've talked already at length around where we are from a perpetual productivity initiative standpoint, we're going to continue to make progress there. I'm confident, again, that we have the road map in front of us and all those building blocks are in place when we look beyond.
Operator:
Our next question is from the line of Scott Ciccarelli with Truist Securities.
Scot Ciccarelli:
Can you please talk about any regional different things you're seeing both in different parts of the country but also differentiation here between, call it, the rural locations you guys continue to reference as well as heavier urban locations?
Marvin Ellison:
Yes. So Scott, I'll take the first part. Look, I'd say regional differences, there's nothing material to speak to. I mean we know that housing and home prices ramped up pretty aggressively during the pandemic time frame in a couple of markets. But when we look at the overall geographic spread. I mean there are no real material differences between locals that had dramatically increase in housing costs and some of those costs are starting to moderate because you still have markets around the company country rather where home price is still going up. So we look at it, obviously, because it's one of those key internal macro indicators that we factor into our assessments, but there's nothing material to speak to.
Relative to urban and rural. We spent a lot of time talking about the importance of localization. And to say that Lowe's was a company that was not very localized 5 years ago would be an understatement. And as much progress as we have made, I think Bill will tell you that we still are excited because there's still lots of opportunity for us to be even more specific in how we localize from a rule and from an urban standpoint. I'm going to let Bill talk a little bit about our rule initiative and kind of what we're seeing. It's early days, but the early signs are positive. And I'll let him share just some general thoughts around those initiatives and kind of what we hope we'll continue to see.
William Boltz:
Yes. Thanks, Marvin. And Scott, as I said in my prepared remarks, we got roughly 300 stores completed in the second quarter. Excited about what we're hearing from our consumers as they're giving us credit for the products that we're putting in there. We've been able to do some stuff around pet with our partnership with Petco, which we're excited about. We've also continued to learn and continue to listen to our customers. And so there's opportunities with different things related to that rural customer, whether that's utility vehicles, livestock feed, apparel, different types of products that they'll use every single day in and around their home. And so we're going to continue to learn. We're going to continue to adjust as we go, as Marvin said, kind of in the early innings of our localization opportunities. And on the urban side, we continue to adjust there as well, making sure that we're right for those urban markets, whether that's the types of products that they need for security and safety, whether that's areas in and around building codes and making sure that we can meet the Pro's needs in those markets, we're going to continue to tweak and adjust as we go forward. So excited about what we're doing on the localization front and what we're doing with rural.
Scot Ciccarelli:
Bill, just a clarification, if I can. On the rural side, like is it outperforming the urban areas now? Or that's the expectation as you wind up localizing more?
William Boltz:
It's performing at what we expected it to perform.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
It's not the fairest metric, and there's a lot of noise in it. But if we simply look at Lowe's performance relative to its largest competitor over the last couple of quarters, Lowe's has been outcomping that player. Presumably, this quarter, it's in part due to pro doing a little bit better online sales doing well, and maybe more seasonal catch-up as a result of leading higher -- harder into that category. So a, is that the right interpretation. And then b, how sustainable do you think that this measure of Lowe's performance is?
Marvin Ellison:
So Michael, I'll take that. This is Marvin. And I'll just be really honest with you. We spent a lot of time talking about the importance of being customer-centric. We don't pay a ton of attention to what's happening at our competitor because we believe if we take care of the customer, the customer takes care of everything else. So we're going to continue to stay focused on our total home strategy. We think if we do that well, then our results will be sustainable. And that means that we're going to be very localized. It means that we're going to be intentional around the small- to medium-sized Pro that we're going to make our 1,700 stores connected to our customers via omni-channel, and we're going to continue to be intentional around what we do to give our associates a great place to work. Those things are most important.
And I think our results this quarter, although in a difficult market, reflect that our Total Home strategy is working, and we're continuing to invest the appropriate amount of capital to ensure that irrespective of the macro environment, we're not going to slow down on our investments in supply chain IT infrastructure, omni-channel and our Pro initiative. So for us, it's all about taking care of the customer, and that allows us to outperform our close competitor, then that's just a benefit that we'll be more than willing to accept.
Michael Lasser:
Understood. My follow-up question is on your view of the sales environment for the back half, understanding that you're still taking a prudently cautious stance given what's happening with macroeconomic indicators. Now with that being said, are you seeing any signs that those discretionary big-ticket purchases that had been weak, such as patio furniture, grills, other big ticket purchases are starting to stabilize? Or do you have line of sight that they might start to stabilize as you move into next year?
Brandon Sink:
Yes, Michael, this is Brandon. Just a reminder, again, as we look out at the second half, we're cycling up plus 3% in Q3 of last year and a positive 0.7% in Q4. So that's been factored into our expectations. To your question specifically on DIY discretionary, we definitely saw the smaller ticket discretionary projects that were fueled by lawn and garden. We saw that benefit in Q2 as we get into second half, that seasonal benefit is going to subside. So some of the bigger, I'll call it, interior discretionary areas, I would say, we're seeing very much performance here early on through August, similar performance with what we've seen over the first half. And that baseline performance is essentially what's reflected in our expectations for second half.
Operator:
The next question is from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things, if I could. First of all, I guess probably for Bill, as you think about managing inventory and mix and promotions in this environment, how are you trying to position the business? Are you leaning in to try to drive traffic? Are you responding and perhaps a little bit more defensively, -- just how are you trying to position inventory mix and promotions?
William Boltz:
Yes, Eric, first of all, thanks for the question. We're focused on trying to provide value to the customer every single day. And so that comes through lots of different things, making sure that from the pro side that we continue to do things like we're doing right now as we roll out client tools in our stores, excited about that launch. We think that offers a nice opportunity for us is we'll have the largest assortment of client in the home improvement channel. So right now, we've got roughly 150 SKUs in the stores today. We'll have all of our stores set by the end of this week.
So that's just one way of being able to provide value to that Pro customer. And then from an inventory side, we came out of Q2 in better position with our seasonal inventories than we did a year ago. So that helps us. It allows us to invest as we go into Labor Day and fall planning and fall harvest, Halloween holiday, those types of things so that we can continue to provide value that way to the consumer with those holiday sets and Halloween sets provide a transition in the stores, as you know, and it gives the customer some excitement. And then we've got a lot of new stuff that we've talked about. We've got Coca-Cola that will finish rolling out in our stores being able to have access to that entire portfolio of product we're excited about. We'll roll out Carhart to 250 stores in Q3. So we're excited about getting that out there for both the DIY and the Pro. And then we'll have some new stuff in that spooky area for Halloween for the Halloween enthusiasts. So all of that try to provide value to our customers in lots of different ways. And then offer them those promotional offers and appliances like you have to provide because over 100,000 appliances break every single day, and we want to make sure that we're relevant out there, and try to manage all of it in a portfolio approach. So we've got a lot of stuff going. We're excited about it, and we think will give us a nice way to position ourselves to drive value for our customers through the back half of the year and into next year.
Eric Bosshard:
Okay. And then second question, if I could. As you -- Brandon did a good job of explaining that you've kind of cycled through the price increases, and there's minimal from here. The math of the past couple of years has been price up more than volume has been down. I'm just curious how you all think about as price no longer goes up, the path for volume turning from a negative to a positive. I'm just curious how you think about that, and what makes that happen and perhaps when?
Brandon Sink:
Yes, Eric, this is Brandon. I think again, focus right now on '23, as I mentioned earlier, we kind of breaking down transactions in ticket. We do expect pressure on transactions as we move across the balance of the year ticket to hold. I do think when we get on the backside of this, I'm not going to put a time frame on it, obviously, as there's a bunch of variables, a lot of uncertainty. It's too early for us to call what 2024 is going to look like. But I do think we are expecting a convergence in a better balance of transactions and ticket probably similar to pre-COVID levels as we start to look ahead across the long term.
Marvin Ellison:
This is Marvin. The only thing I'll add to that is we still are in the early innings of making what I would call best-in-class business operations in our omni-channel area, in localization and in just the overall technology infrastructure. I've mentioned that we're retiring a 30-year-old operating system. And not only will that make our stores a lot easier to operate from a technology standpoint, and what it does, it gives us incredible agility to build on top of that modern platform for more omni-channel capabilities. There's a lot of things we're doing today, the hard way.
And so I get excited because I can get out of bed every day, and I can see a long list of initiatives that we have yet to get to that's going to drive operating margin improvement drive space productivity and hopefully will drive top line as consumer sentiment continues to improve. So we're confident that we've not even reached a point of peak performance relative to the investment cycle that we have because we've been other places we know what world class looks like, and we know that we're on a journey to get there, but there are still areas of our business:
Pro, online, fulfillment capabilities, space productivity that we know that we're still in the early innings. And so that's exciting, and we just have to do the work to make sure that we can achieve the expectations we have.
And Rob, we have time for one more question.
Operator:
Final question will be from Steven Zaccone with Citi.
Steven Zaccone:
I wanted to circle back to your commentary about the appliance promotions, could you elaborate on that a bit more? It sounds new? What are your expectations for that side of the business in the second half of the year? And then just a follow-up on the promotions question earlier. It seems like the industry has not needed to be promotional. How long do you think this can last if big-ticket discretionary weakness continues?
William Boltz:
Yes. So Steve, this is Bill. So just on the appliance side, specifically, what we've seen with appliances is that really, the industry has returned to kind of a more normalized go-to-market promotional offering, similar to what you saw prior to the pandemic. And so this normalization, as I said in my remarks, has put pressure on average ticket and average selling price across the industry. Everybody, I think, is feeling that impact. But essentially, we cycle this as we get into Q4, and we come -- we get into more of an apples-to-apples comparison when we get to Q4, but we're excited about the strength that we've seen with our appliance business. First quarter track line data would indicate that we took share in the first quarter. So we're driving units and trying to make sure that we can meet the needs of our consumers is, like I said, in Eric's question, 100,000 appliances break every single day, we've got to be there for our consumer. But it's not a radical shift to heavy promotions. It's more of a normalized promotion.
Steven Zaccone:
Got it. And then just question on the back half margins for you, Brandon. Given the commentary about same-store sales in the third quarter, is there anything to be mindful of in terms of gross margin or SG&A cadence in the third quarter versus the fourth quarter?
Brandon Sink:
No. I would say, Steven, still expect 40 to 60 basis points of expansion. The one thing that I would call out. I mentioned we expect the PPI benefits to build over the second half. And then the second thing I'll mention is we are cycling over $400 million of associate discretionary bonuses that were paid out last year that we're not expecting to recur. So those are the big items that I would call out as we move through the second half.
Marvin Ellison:
And Steve, I would be remiss if I didn't just talk a little bit about our performance and shrink and the most difficult retail environment for shrink in my 35 years in this space. I want to let Joe just talk a little bit about the successes that we're seeing and how we hope that continues to support our gross margin forecast for the back half of the year.
Joseph McFarland:
Thanks, Marvin. And let me give you just a quick shout out to the store operations team and really our asset protection team. I believe they are best in class. And as you look across the actions that we've taken, whether it's in supply chain, whether it's on the front end with our new proprietary self-checkouts, replacing the MCRs, we have a best-in-class awareness platform. That's got a 92% voluntary participation rate. And that we have a line of sight for front-end transformations as we move into next year. The 100% execution of our high-strength program, where we've identified the stores. And so I feel really confident and just a great job by the team.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our third quarter earnings call in November.
Operator:
Thank you. This concludes the Lowe's Second Quarter 2023 earnings call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies First Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. In the first quarter, our comparable sales declined 4.3%, driven by approximately 350 basis points of lumber deflation, unfavorable weather and lower DIY discretionary sales. We continue to build momentum with the Pro through our MVPs Pro Rewards program and our expanded assortment of Pro national brands. Lumber deflation disproportionately impacted Pro sales by approximately 800 basis points of comp pressure and despite this pressure, comparable Pro sales were slightly positive in Q1 with broad-based strength across multiple categories. This positive comp in Pro builds on top of a 22% U.S. Pro comp in the first quarter of last year.
DIY sales were pressured by delayed spring and lower-than-expected discretionary demand, although we are encouraged to see better trends in periods of favorable weather. A late start to spring disproportionately impacts do-it-yourself customers who represent 75% of our business, given many seasonal categories are heavily concentrated in DIY. As weather improves, we're optimistic that customers will reengage with spring projects, and we are ready to support the increased demand with our best in-stock position and staffing levels in 3 years, coupled with improved omnichannel and fulfillment capabilities. However, we are expecting a pullback in discretionary consumer spending over the near term. Given these trends, we're updating our full year outlook this morning. Despite market pressures, we are pleased to see market share gains this quarter, and we expect to continue to outpace the market as we execute against the growth initiatives of our Total Home strategy. We're also confident in our ability to drive continued productivity through our perpetual productivity improvement initiatives or PPI. This operational discipline and agility helped us to offset the impact of lower sales and higher wage costs in Q1. Adjusted operating margin expanded 47 basis points in the first quarter, leading to adjusted diluted earnings per share of $3.67, a 5% increase compared to last year. While we can't control commodity deflation, weather or macroeconomic uncertainty, we can control how effectively we operate our business and adapt to a changing environment. A key component of our transformation that is often overload is the culture of continuous improvement we've introduced at Lowe's, which is the foundation of our perpetual productivity improvement initiatives. And although our PPI initiatives originated operations, we're now focused on driving productivity across all areas of the company. And we see tremendous runway ahead for continued productivity across the business including dozens of PPI work streams in merchandising, store operations, supply chain and corporate support functions. As an example, we're replacing our 30-year-old operating system with a modern omnichannel architecture that will enable a seamless, intuitive customer experience while removing complexity for associates. This project has been underway for 4 years, and we are pleased that we are on track to retire all legacy green screens by the end of this year. This new modern operating system will allow us to unlock a significant amount of labor productivity and deploy new capabilities including enabling more seamless omnichannel selling for within our stores. In addition to our new operating system, our penetration of rural stores gives us an opportunity to drive sustainable profit growth due to the much lower expense base that's required to operate these stores. As an example, what we spend to operate our store in Philadelphia, Mississippi is significantly less than the cost to operate one of our stores in Philadelphia, Pennsylvania. While in years past, our penetration of rural and remote stores was viewed as a competitive disadvantage, we now expect that these stores will be a key component of our operating profit growth over the next 3 to 5 years. Given our confidence in this trajectory, we set long-term targets of $1.5 billion to $2 billion in incremental productivity gains at our December Analyst and Investor Conference and we are tracking our progress against those initiatives on a monthly, if not, a weekly basis. In addition to our disciplined focus on productivity, this quarter, we also continued to make strides with our Total Home strategy. And in Pro, our growth was fueled by continued acceleration of our MVPs Pro Rewards Program and CRM tool, coupled with our improved Pro assortment, inventory depth and omnichannel capabilities. These initiatives have enabled us to continue to gain traction with our core Pro customer, which is a small to medium-sized Pro. Joe will discuss some of the exciting new Pro initiatives later in the call. Our online sales also accelerated this quarter with 6% comparable sales growth, representing more than a 10% sales penetration. Online growth was supported by an increase in Pro sales as we continue to upgrade our Pro digital experience with new tools and personalization. We also continue to enhance our DIY online experience by making home improvement projects easier for consumers to visualize, estimate and shop. And these investments are paying off with higher online conversions and attachment rates. In supply chain, we continue to roll out our market delivery model, bringing us to 12 geographic regions across the country, supporting more than 1,100 stores. And we're pleased that this more efficient model of delivering big and bulky products is already enabling us to accelerate our market share gains and appliances and will enable future growth in other big and bulky product categories. And we remain on schedule to have market delivery rolled out by the end of 2023. And despite a macroeconomic environment with mixed signals creating near-term pressures, we remain optimistic about the future of home improvement. And once we navigate through this uncertainty, we remain bullish on the long-term outlook for our industry due to the unique convergence of structural drivers and demographic trends that are supportive of home improvement demand. And we feel fortunate to operate in such a favorable sector of retail, where 2/3 of our sales remain nondiscretionary. And as we navigate this near-term pressure, we will continue to monitor trends closely and we are confident that we have the agility needed to quickly adapt to any scenario. In closing, I'd like to thank our frontline associates for their continued hard work and dedication to supporting our customers and our communities. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. During the first quarter, 5 of our 14 merchandising categories were positive, building materials, rough plumbing, paint, hardware and appliances. We continue to see broad-based Pro strength across all 3 merchandising divisions. In home decor, paint and appliances delivered the strongest comps this quarter. Our momentum in appliances continues to build as we drove higher unit sales and work to continue to take market share by leveraging our improved omnichannel shopping experience, enhanced market delivery capabilities and expanded assortment.
Appliances are a great example of an omnichannel category, where customers often compare options online, then visit our showroom to see products in-person and then get their questions answered by one of our appliance specialists. And with our improved online capabilities like easy scheduling and order tracking, we continue to see more and more of our customers getting comfortable completing their purchases online. In the U.S., we estimate that roughly 100,000 appliances break every day. So our investments in fast appliance delivery and a seamless omnichannel shopping experience, positions us well as the go-to destination for these urgent and often nondiscretionary needs. We are also seeing increased demand in paint, especially from our Pros who paint as they take advantage of our paint job site delivery, our MVPs Paint Rewards Program and our improved product assortment. This quarter, we took the next step in catering to these important customers by launching Spec Right interior paint in partnership with Sherwin-Williams. This is our first exclusive line of tintable paint formulated specifically for Pros. Within decor, we recently launched new closet organization solutions across 4 private brands to meet a range of storage needs and budgets. This includes modular, easy-to-install wood or wire closet systems that are modern, customizable and a far better value than the competition. Our private brand strategy allows us to deliver value to DIY customers who are looking for high-quality, on-trend products at more affordable price points which enables us to provide differentiation, loyalty and profitability. Turning to building products. Building materials and rough plumbing led the way. In building materials, we saw broad-based strength, reflecting the investments we made to improve our Pro offering through an enhanced assortment. You may remember, last year, when we announced a new 10-foot fiberglass rebar known as PINKBAR by Owens Corning. This product exceeded our sales expectation given its strength, lightweight materials and corrosion resistance. This year, we're building on that success with the new 20-foot PINKBAR product, designed to help Pros reinforce bigger structures using fewer connections, ultimately saving them time and money on material costs. Rough plumbing was driven by strength in water heaters, HVAC, plumbing repair and pipe and fittings. As we continue to strengthen our offering for the Pro and the DIY consumer in these categories. And while lumber comps were pressured by steep year-over-year lumber deflation, the category had the highest unit comp in the company this quarter, reflecting strong Pro demand. We are pleased with our continued enhancements to our strong assortment of Pro products from trusted brands like Bosch, DEWALT, Eaton, Estwing, FastenMaster, FLEX, GRK, Hubbell, ITW, Klein Tools, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Matabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner. In hardlines, our performance was pressured by the delayed spring, some volatile weather in the West and softer discretionary spending. However, we did see higher demand during periods where weather improved. In lawn and garden, we proactively partnered with our live goods vendors to increase our agility in responding to changing weather patterns, which was critical in a season marked by erratic weather. Our live good vendors play a key role each spring as we continue to refine our local offerings in addition to the timing of when product arrives to our stores. This year, they help support our new Green Vest program, where our merchandising service team or MST associates, along with support from our vendors, now provides service to our garden centers, taking the tasks off the shoulders of our Red Vest associates to allow them to focus on serving the customer. We also continue to expand our private brand offering including a full lineup of new and innovative lawn fertilizers and grass seed products through our Sta-Green brand, which is already exceeding our expectations. And in hardware, in addition to delivering a positive comp, we also saw strong attachment rates alongside the higher lumber unit sales and strength in building materials, powered by the improved assortments of the key fastening brands like SPAX, GRK, FastenMaster, ITW and Power Pro One. As we continue to enhance our assortments at a national level, we also continue to advance our localization work. This is a key pillar of our Total Home strategy with the goal of expanding market share, increasing inventory productivity and protecting our margins. We have been piloting a localized framework for a few common market categories like rural and urban stores. Today, I'm excited to announce we are now scaling our rural framework to as many as 300 additional stores by year-end, with a wider offering of farm, ranch and outdoor products that positions Lowe's as a one-stop shop to make it convenient for rural customers to get what they need in one shopping trip. Our rural format includes broader product offerings in categories such as pet, livestock, trailers, fencing, utility vehicles, specialized hardware and our new Carhartt Apparel, all designed to meet the unique needs and preferences of rural homeowners who work and play outdoors. Given our rural store footprint, and long-standing relationships in these communities, we see this as a natural opportunity for our business and one that will simplify the shopping experience for these very valuable customers. And as Marvin mentioned, we see the productivity improvements in these stores as a key component to delivering sustainable growth in our operating profit. We also remain focused on our many merchandising PPI initiatives, including leveraging our modernized cost optimization tools to negotiate costs with vendors and we're getting more strategic and surgical in our inventory planning to focus on more high-velocity core inventory items with low markdown risk like Pro replenishment and fewer slow velocity SKUs. From a technology standpoint, in the first quarter, we completed the rollout of new dedicated Zebra smartphones for all MST associates ahead of schedule. These devices are equipped with the new MST app designed to optimize their time with technology that leapfrogs the competition. The system automatically prioritize planogram changes, pricing updates, base service and other projects to optimize associates' time on the most efficient, highest value next task. And it also gives associates step-by-step instructions to maximize productivity and minimize the learning curve for new associates. This app was built internally to seamlessly integrate with our other mobile apps. For example, each time an MST associate resets a bay, the product location automatically updates in our associate product app and our customer mobile app. So both associates and customers can quickly find what they're looking for. As I close, I'd like to again extend my appreciation to our vendors and our merchants for their partnership, hard work, innovation and continued support. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone. At Lowe's, we are committed to being the employer of choice in retail for associates to choose to build their careers. As a reflection of this commitment over the last 3 years, we have increased the hourly rate for our store associates by 20%. And since 2018, we have invested over $3 billion in incremental wage and share-based compensation for our frontline associates. As a result of our consistent and ongoing commitment to our hourly associates, we are seeing our best staffing levels in 3 years, improved retention and the highest customer satisfaction scores in our company's history.
In addition to compensation, we are also taking other steps to show appreciation to our associates, including simple initiatives like lowering the prices of the food in our store break rooms and closing our stores on Easter for the fourth consecutive year. These expressions of appreciation may not sound overly complex, but to our hourly associates, they matter. As a former hourly associate, one way I measure improved associate engagement is by tracking the number of people who transition their jobs into careers. More than 85% of leadership roles are now filled from within up nearly 700 basis points over the last 2 years. Our frontline associates deserve all the credit for the transformation of our company, and I would like to personally thank all of our associates for everything they do to support each other, our customers and our communities. Now let me transition to Pro, one of the highlights in the first quarter. I'm excited to announce that we've just launched new Pro online business tools, the latest enhancement to our MVPs Pro Rewards program, which is designed to make Pros of all sizes feel like MVPs at Lowe's. Through our surveys, we learned Pros would welcome time-saving tools that help them shop quickly and minimize time away from the job site. At the same time, we learned our Pro associates spend a lot of time building quotes and checking order status, tasked to take them away from serving customers in their stores. To solve for both needs, we launched a suite of tools on lowes.com and our mobile app that make it easy for Pros to manage their orders from anywhere, whether that's on-the-job site, at home or out of town. Rather than having to drive to our stores to get a quote, Pros can now build and update online quotes in minutes. It automatically applies to their volume savings pricing and discounts and lets them quickly download a PDF quote for their customers. They can also use order tracking to track the status of the order throughout the fulfillment process. Pros tell us they love how easy and simple these tools are. In one Pro's words, he appreciates the convenience of being able to get a price, get it ordered and get it done. While these tools just launched in April, we are already seeing better-than-expected adoption rate and sales growth and expect results to accelerate as more Pros discover the new features. Our traction with Pros online is just one example of the momentum we are seeing in our MVPs Pro Rewards Program and one of the reasons we delivered a positive sales comp in Pro for Q1. Pros enrolled in our loyalty program continue to shop more frequently and buy more per trip and spend more overall. As our CRM tool matures, we are using data insights to identify trends that can improve our marketing and sales strategy, including tailoring our offerings by trade and by tier. These improved Pro capabilities and offerings are reflected in our Pro customer satisfaction scores, which are up 200 basis points over last year. In our April survey, over 75% of Pros continue to say their backlogs are healthy. While the Pro backlogs remain consistent with recent quarters, Pros did report a shift to smaller project sizes. Moving on to productivity. We continue to scale a series of perpetual productivity improvement initiatives or PPI. First, we remain laser-focused on technology modernization across all areas of our stores including rapidly replacing legacy self-checkout systems with our proprietary self-checkout registers. We are encouraged to see higher customer adoption, throughput, labor productivity and customer satisfaction on these registers and will complete all remaining stores later this year. We've also matured our new store inventory management system, or SIMS, which continues to improve our inventory visibility and operational efficiency. It also fully integrates with the mobile apps Bill just mentioned, reducing the time both associates and customers spend searching for product. We also continue to enhance our pick up in store experience to streamline processes and enhanced technology. These improvements drove faster fulfillment and a 400-basis point increase in pickup in store customer satisfaction scores in the first quarter. As we approach Memorial Day, I'd like to thank any veterans listening in for their service. As a marine who served combat tours in the Gulf War and Desert Storm, I'm proud of Lowe's long-standing history of giving back to our military community including a 10% military discount. And we are proud to support these customers who have given so much to our country. As I close, I would like to thank all our store leaders and associates once again for their hard work to serve customers, drive results and improve this business each and every day. And with that, I'll turn the call over to Brandon.
Brandon Sink:
Thank you, Joe. Beginning with our Q1 results. We generated GAAP diluted earnings per share of $3.77 compared to $3.51 last year. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. Non-GAAP measures have been adjusted to exclude the gain associated with the sale of our Canadian retail business.
In the quarter, we recognized a net pretax gain of $63 million on deferred consideration associated with the sale of our Canadian retail business. Excluding this benefit, we delivered adjusted diluted earnings per share of $3.67, an increase of 5% compared to prior year. Q1 sales were $22.3 billion, which includes approximately $735 million related to a shift in our fiscal calendar as we cycle over a 53-week year. Also, as a reminder, prior year sales included $1.2 billion generated in our Canadian retail business. As Marvin mentioned, comparable sales were down 4.3%, partly driven by a later start to spring and a more cautious consumer. This also includes approximately 350 basis points of lumber deflation. Please note that comparable sales are calculated based on weeks 2 through 14 in fiscal 2022. Comparable average ticket was down 0.3%, largely driven by lumber deflation as ticket increased in the majority of our other merchandise divisions. Comp transactions declined 4% due to the delayed start of spring and lower-than-expected DIY discretionary sales. Our monthly comps were down 3% in February. With unfavorable weather patterns across the country in March and April, comps declined 5.4% and 3.9%, respectively. Lower sales in seasonal categories pressured sales by approximately $400 million in the quarter, or approximately 175 basis points. Gross margin was 33.7% of sales in the first quarter, down 35 basis points from last year. Gross margin benefited from a favorable product mix, offset by costs associated with the expansion of our supply chain network. There was no meaningful impact from shrink or credit revenue in the quarter. Also keep in mind that product margin in the prior year quarter reflected a timing benefit driven by product cost inflation. Adjusted SG&A of 17.4% of sales levered 79 basis points. As Marvin mentioned, this performance reflects an enterprise-wide disciplined focus on PPI that helped offset pressure from lower sales and wage investments. It also includes the benefit of a onetime legal settlement. Adjusted operating margin rate of 14.4% of sales levered 47 basis points. The adjusted effective tax rate was 23.6% in line with prior year. Inventory ended the quarter at $19.5 billion, down $0.7 billion compared to Q1 of last year. As a reminder, prior year inventory levels includes our Canadian retail business. U.S. inventory units finished the quarter slightly down to last year. Now turning to our 2023 financial outlook. Given the higher-than-expected pullback we've seen in home improvement spending, we are now expecting our relevant market, which reflects our 75% DIY, 25% Pro mix to be down mid-single digits this year. But while we are seeing lower-than-expected DIY discretionary demand, we are also driving better-than-expected results in Pro and continued strength in our online sales and core categories like appliances and paint. This reinforces our confidence that we will continue to take market share and outperform the broader market. We are now expecting 2023 sales of $87 million to $89 billion with comparable sales expected to range from down 2% to down 4%. Please note that the updated outlook also reflects the impact of lower-than-expected lumber prices. This creates an incremental 50 basis points of pressure on full year sales as compared to our original expectations. We continue to expect Pro to outpace DIY for the year as Pro backlogs are healthy, and demand for Pro services remain strong. We now expect adjusted operating margin in the range of 13.4% to 13.6% for the full year driven by PPI initiatives across the company, partly offset by planned wage investments and lower sales volumes. We expect capital expenditures of up to $2 billion this year and with our planned share repurchases, we expect to reach our 2.75x leverage target by the end of the year while maintaining our BBB+ credit rating. Finally, we are also updating our outlook for adjusted earnings per share in a range of $13.20 to $13.60. Keep in mind that our outlook for operating margin and diluted earnings per share are now adjusted to exclude the gain associated with the sale of our Canadian retail business that we recorded in the first quarter. To assist you with your modeling, I would like to spend a moment discussing our expectations for the second quarter. We are expecting an approximately $400 million headwind to sales due to the timing shift in our fiscal calendar. We also expect lumber deflation to pressure Q2 sales by approximately 150 basis points. Finally, we expect $250 million benefit to sales from the delayed spring. Taking all of this into account, we are expecting Q2 sales towards the higher end of our full year guide. We are also expecting adjusted operating margins slightly above prior year results, partly due to the impact of the shift in our fiscal calendar as well as the timing of several productivity initiatives that are already in flight. Turning to our capital allocation strategy. During the quarter, the company generated $1.7 billion in free cash flow. We repurchased 10.6 million shares for $2.1 billion and paid $633 million in dividends at $1.05 per share, returning $2.8 billion to our shareholders. Capital expenditures totaled $380 million in the quarter as we continue to invest in our strategic growth initiatives. We ended Q1 with $3 billion of cash and cash equivalents which includes proceeds from our $3 billion notes offering in March. We ended Q1 at 2.62x adjusted debt to EBITDA. Finally, we delivered return on invested capital of 28%, inclusive of a 725-basis point impact related to transaction costs associated with the sale of our Canadian retail business and the discrete gain in Q1. In closing, we are confident in our ability to execute our Total Home strategy while navigating near-term market uncertainty. And we remain committed to our best-in-class capital allocation strategy centered around delivering sustainable shareholder value. And with that, we will open it up for questions.
Operator:
[Operator Instructions] Our first question is from the line of Liz Suzuki with Bank of America.
Elizabeth Lane:
So I think previously, we had heard a lot of focus on higher sales per square foot as the main driver of operating margin improvement. Now I think you guys are talking more about the benefits of operating in lower-cost markets like the more rural stores. So presumably, those stores have lower sales per square foot in your stores in more densely populated markets. So how are you thinking about geographic mix and potential for stores benching going forward if those more rural areas are now looking more attractive?
Marvin Ellison:
Liz, this is Marvin. I think it's more in tune with what Bill talked about with some of the investments we're making in those rural stores. As we survey those customers, they give us a list of things they wish they could purchase in one shopping occasion and some of those types of things like Carhartt Apparel, farm and ranch types of items and categories as part of our expansion opportunity. And we think by doing those types of initiatives, we're going to see sales per square foot actually improve.
As a matter of fact, when we look at the pilot stores where we've been very diligent on going after those specific categories, we actually saw that within the pilot locations. And so that is leading us into this roughly 300 store expansion of these extended categories. And we just see this as a unique opportunity. I mentioned that the expense base is lower. But as you said, if you can have a lower expense base, then you can improve sales per square footage, that in a combination of all the other initiatives we're doing around the company, we think will continue to drive our profit growth. And I'll let Brandon add any additional comments.
Brandon Sink:
Liz, this is Brandon. Just as we think about the CapEx, as Marvin mentioned, we're not necessarily looking at opening stores over the long term is really part of our core strategy, but we love what we're seeing with these rural stores. We initially piloted on a smaller subset of locations. We love the profit profile of these stores within these rural markets, and we've been very thoughtful around the assortments and where we're rolling out and really excited to see this scale as we move through 2023 and what this can deliver from a top line perspective beyond that.
Elizabeth Lane:
Great. And in those stores, just as a follow-up, are you seeing online penetration that's similar to your overall company average? Or is it a little bit lower? Is it higher? Just curious if there's any difference in the online mix?
Marvin Ellison:
Liz, it's about the same, but I mentioned in my prepared comments that we're retiring this old legacy operating system and by retiring this system, it opens up the ability to have really true omnichannel selling in the store. So we see omnichannel and e-commerce growth only accelerating with the ability of our 300-plus thousand associates having the ability to more easily transact in the store, thus connecting physical and digital in a more seamless way.
Operator:
Our next question is from the line of Christopher Horvers with JPMorgan.
Mr. Hovers, perhaps you're muted. Okay. I'm going to move on to our next question, which is coming from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Can you hear me?
Marvin Ellison:
Yes, we can, Simeon.
Simeon Gutman:
My question is, first, I'm trying to sort out the guidance. If you take the Q2 through Q4, what's embedded, both for sales and margin, is that roughly the same as what it was, call it, when you guided a year? Or has anything changed.
Brandon Sink:
Simeon, thanks for the question. This is Brandon. Let me just kind of speak a little bit to the curve specifically. When we look at Q2 as I mentioned in the prepared remarks, expecting Q2 sales towards the higher end of the full year guide. That's inclusive of the $250 million delayed spring benefit, offset by the 150 basis points lumber deflation and then the $400 million, week shift drag. As we start to transition and look at the second half, we do expect the Pro business is going to continue to outperform and drive our growth. We mentioned that backlogs remained healthy and we expect that business to continue to outpace DIY.
The lumber inflation is -- or deflation is going to moderate as we start to look at second half and we cycle over more normal pricing over the balance of the year and then continued strength in what we're seeing with the online business and in core DIY businesses like appliances and paint. So taking all that into account when we look at the second half, we're looking at that in line with the full year guide.
Simeon Gutman:
That's helpful. And then maybe a follow-up, sticking with the guidance. If you looked at whether it was the weak or even the moderate cases beforehand, margins were going to hold up reasonably well for a couple of reasons, a lot of your internal initiatives. Those drivers that were holding up margin, are those the same? Are you on a faster trajectory? Are you pivoting? Are you prioritizing some over the other? If you could share some of that, please?
Brandon Sink:
Yes. Simeon, largely the same, roughly flat is what we've spoken to as it relates to gross margin over the course of the year. The puts and takes that we've talked through still relatively consistent. The headwinds from the supply chain expansion and investments in the Pro growth initiatives. The benefits and Bill covered this when he talked through merch productivity, higher private brands penetration, lower commodity transportation costs and then the pricing initiatives that we're working through. So those largely are going to drive the outputs. And then just from an SG&A standpoint, that's where we're going to see the bulk of the leverage, 40 to 60 basis points reflected in the new guide. That's going to offset the planned wage increases and the strategic investments. And then on the lower sales, just the change from the previous guide, it's mainly volume related.
Operator:
Our next question is from the line of Steven Zaccone with Citigroup.
Steven Zaccone:
I wanted to focus specifically on the second quarter guidance just since weather has been so volatile. Is there any more detail you can provide about how the business is trending thus far in May would be helpful.
Marvin Ellison:
Steve, this is Marvin. I'll take that. So Steve, we would basically describe it as in line with our current guidance. The good news is, is as we've seen periods of more sustained seasonal weather, we've seen those seasonal categories respond in line to that. And that's geographically specific around West, South, North and East. But May is performing basically at our current guidance.
Steven Zaccone:
Okay. Appreciate that color. Then Marvin, I'm curious for your perspective on the potential duration of this weakness we're seeing in discretionary spending. What's your take on how long this potentially could last? There's a lot of macro cost currents at play. So just curious for your opinion.
Marvin Ellison:
Yes. It's a really good question and really to be quite honest with you, as you can imagine, we spent a lot of time looking at it, but it's just hard to predict. What we can say is that the overall structural drivers for home improvement remain really strong. And so we are bullish to the medium and long-term health of this business, things like the savings rate of consumers and you're looking at pent-up demand in the housing shortage, the age of homes. I mean, all of these things are still incredibly relevant. And when you think about the highest correlating factors to our sales, historically, they remain disposable personal income, home price appreciation and the age of housing side. So although we can't predict the duration of what we think will be a more short-term turbulence, but we think the medium and long-term health of this segment is incredibly strong.
Operator:
Our next question is from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
So my first question, Marvin, just maybe a bit of a follow-up on the prior question. But just with respect to the commentary around discretionary, maybe can you give a little more color on what you're seeing? And how do you think about this weakness in discretionary relative to some of the weather disruptions. And then if you look here at Q1, is there anything really noticeably different than what we saw maybe in Q4 on the discretionary side?
Marvin Ellison:
So Brian, I'd give you some thoughts. I'll let Brandon jump in and provide any additional thoughts. But candidly, what we're seeing is pressure across big-ticket discretionary purchases primarily. We're seeing some pressure in small ticket, but it's more pronounced in big ticket and is almost exclusively discretionary in DIY. As you know, 75% of our business is penetrated in the DIY customer, and Q1 is our most discretionary quarter of the year because of all the seasonal purchases.
So when we run into timing of unseasonal weather, it has a disproportionate impact on our business. So we've been trying to pull apart the difference between discretionary pullback in weather-related non-spending. And so as we look at the month of May, as an example, we can start to see more clarity that when the sun comes out and the weather gets a more normalized kind of performance, as you would expect, the business in those discretionary categories have picked up. So that's why Brandon noted that we have an expectation we're going to get roughly $250 million back from delayed spring. So for us, we're seeing discretionary big-ticket pullback primarily in DIY. The other good news for us is because our Pro-consumer and our target consumer is that small to medium-sized customer, that customer's backlog remains healthy and that customer spend has been relatively consistent. That's why we're able -- the positive comp in Pro for the quarter with over 800 basis points of lumber deflation specifically for that consumer. Brandon, I don't know if you have anything else.
Brandon Sink:
Brian, this is Brandon. I think just looking out a little bit beyond the weather that Marvin just spoke to, when we look at this topic of normalization, home improvement share of wallet, definitely seeing normalization back to services in terms of where discretionary purchases are going from consumers, travel, restaurants and a shift back to some necessity-based spend, groceries, gas, taking up a larger share of wallet given the inflation that we're seeing. But just as we look at the business at a broad level, units transactions well documented back in below, in some cases, to 2019 levels. But as Marvin mentioned, really nuances within that.
We're seeing Pro categories, in particular, building materials, rough plumbing, lumber has been a great story with what we've been able to drive with units and then categories like appliances where we've continued to grow units and shares. So all that combined, we are very optimistic in the medium to longer term that the categories where we've seen reversion or normalization, we got a new baseline there to which -- to manage the business. And then in these other categories that are out running, we can continue -- confidence that we can continue to take share there.
Brian Nagel:
That's very helpful. I appreciate it. And maybe a follow-up separately, interesting comments about your rural stores, your strategy there. Anything you could say to help us better size this opportunity? Where are those -- the volumes are those units now versus maybe the chain average of some of your larger volumes? And then as you think about this re-merchandising effort, I mean, how much could that add and over what time frame to store volumes there?
Marvin Ellison:
Brian, what I'll do and I'll let Bill give you just some specifics on some of the categories that we're adding. And again, we piloted this for over a year to get the mix right, to get the assortment right. And we came away extremely pleased with the pilot results and thus, we identified roughly 300 stores that we're expanding this too, but I'll let Bill give you some specifics on those categories and what we believe that we can get from them.
William Boltz:
Yes. And Brian, this is Bill. And so in my opening remarks, I mentioned some of these key categories in areas like pet. And we think there's an opportunity in these rural markets to do more in that category. There's opportunities with apparel. And so the launch of our -- the Carhartt brand, Wrangler brands gives us an opportunity to do something there in those markets. And then you think around livestock and really livestock feed as the consumer is looking for options from us to be able to serve that consumer. And then you can get into areas like fencing and some of these small pents that folks will use. And we're finding some interesting things with water troughs that are being used, certainly to water livestock, but they're also being used as a decorative piece for consumer's home where they're planting flowers in it.
So just a lot of interesting stuff that we're starting to learn here that the customer has given us a lot of credit for and wants to see Lowe's carry in their community. And that was part of the early pilot in those few stores that has allowed us to accelerate to get it to 300.
Marvin Ellison:
And Brian, this is Marvin again. Just last point on that. Both Bill and I grew up in rural parts of the country. Bill in rural Montana, I grew up in rural Tennessee and I think rural Tennessee is actually more rural than rural Montana, but that's for another discussion. We're seeing things like ATVs, we pilot it, having no idea if customers will respond. And it's been an incredible growth category for us. And in these rural markets, they are responding really well.
So a lot of learning, but what's also interesting is we are finding categories in these rural stores that we think will be relevant in nonrural locations, and that's been the beauty of this entire pilot and the strategy, and we'll continue to learn. But I'll just repeat what I said in my prepared comments, many of us, including me, and many in the marketplace perceive these rural and remote stores as a true competitive disadvantage to Lowe's, but we've now determined that, that is the opposite. We think that these stores give us incredible opportunities to not only grow top line with more improved sales per square foot but also just the operational profit opportunity with improved technology, improved omnichannel capabilities, improved efficiency. I mean, this is something that we're very excited about over the next, call it, 3 to 5 years.
Operator:
Our next question is from the line of Seth Sigman with Barclays.
Seth Sigman:
I wanted to just follow up on the May comment. I think you said it was consistent with guidance. I just want to clarify, does that mean consistent with the comment that Q2 would be at the upper end of the range. And then I think if you step back for a second, your original guidance had assumed some sequential improvement in the second quarter. Can you just remind us what some of the drivers of that were going to be.
Marvin Ellison:
So I'll take the first part on May. We tend not to give specific detail on current trends for all the obvious reasons. And so I'll leave my comments at May is performing at guidance, and we feel good about what we've seen, areas of sustained weather and how our seasonal categories are responding in those geographic locations, and that's reflective of May's performance.
And with that, I'll let Brandon answer the second part of your question.
Brandon Sink:
Yes, sure, Seth. Just consistent with the upper end of guidance is what we referred to. And just the components again, the $250 million delayed spring benefit, the lumber deflation is going to step up. So a 350-basis point pressure in Q1, now expecting that to be 150 basis points in Q2. And just a reminder of the week shift benefit from Q1 is now flipping into Q2, and we expect that to be a $400 million drag. So those are just the components again, as it relates to Q2.
Seth Sigman:
Got you. Okay. And then just a follow-up question on average ticket and inflation. It sounds like you still have some of the wrapping of the price increases from last year. But I guess, in general, how are you thinking about pricing going forward? Is there an opportunity to maybe roll some prices back? And maybe if you could tie in commentary around the elasticity that you're seeing in lumber. And I realize that category is a little bit different, but your commentary around the unit volume increase that you saw seem to be quite strong. So maybe just tie those 2 together.
Brandon Sink:
Seth, I can take that as well. So when we look at the makeup in terms of ticket and transaction, as you mentioned, we're seeing the pace and cost increases. Those have slowed pretty dramatically here over the course of the last couple of quarters. We are still expecting a modest level of product inflation as we look out at '23. Most of that is wrapped from pricing actions that we've taken in the second half of last year. We are -- ex lumber average ticket is actually up in most categories when we look at Q1. The lumber deflationary pressure is expected to continue to impact average ticket in Q2, but not as significant as Q1. And then when we look outside of commodities, we're not anticipating any meaningful deflationary pressure as we move through the year.
Mainly the pressure is going to be coming from what Marvin mentioned, the pullback in DIY discretionary which is going to put pressure on ticket and that's especially true in the larger ticket bucket. So all in, the makeup of the comp and the outlook assumes more pressure overall on transactions, and we expect the average ticket number to hold up.
Operator:
Our next question is coming from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
Is there a view, just given that you do cater to the smaller and midsized Pro, just that you can hold up maybe a little bit better given the industry backdrop. And with regards to market share, it sounds like there were some wins there during the first quarter. Have your share assumptions changed at all based on that for the year?
Marvin Ellison:
Kate, this is Marvin. I'll take the first part of Pro with Joe, and then we'll let Bill and Brandon provide some market share input. I would first say we're really pleased with our Pro strategy. We spent a lot of time in the last 4-plus years trying to refine this strategy but also being very disciplined on not trying to overreach beyond our capabilities. And that's why the small to medium Pro has been our target Pro customer, and we feel like we're gaining traction. Anytime you can face over 800-basis points of lumber deflation and comping up against a 22% growth last year and still deliver a positive comp, I think it sends a signal that we're making progress.
I'll let Joe talk specifically about a couple of the key initiatives that we rolled out that's gaining the most traction and while we feel confident that we can continue to take market share in that segment.
Joseph McFarland:
Thanks, Kate, for the question. And as you look at the makeup of our Pro, it is on that smaller side. And as we rolled out our MVP Pro Rewards program, we're really seeing the Pros engage with us in our loyalty, our credit programs, of course, when they are engaged there, they spend 3x more than those not engaged. We've rolled out new CRM insights so we can better anticipate the Pro's needs. We can build those relationships. And with the loyalty program and the CRM system, they continue to improve as they mature. And so really excited about the unlock that is still ahead. Very pleased with the Pro LTR that we're seeing as a result. So we feel we're in a good place.
Marvin Ellison:
And Kate, before I hand it to Bill, I'll just add one additional thing. We did a recent survey in April of our Pro customers and then 75% of those customers came back and their backlogs were still healthy compared to Q4 and that gave us confidence that we still believe that we can grow market share and grow to extra market with this specific customer segment.
So Bill, you can talk about market share.
William Boltz:
Yes. So when you look at market share, obviously, it's hard to measure home improvement share specifically, but we try to triangulate using data from mix, track line, other data, relevant market and broader market data. And then we look at our performance, obviously, in key categories like we've mentioned in our prepared remarks in areas like appliances where we've had unit growth feel like we're picking up share there in addition to the Pro growth that we've had and the continued acceleration with our online business, gaining traction with private brands, all of that and those elements kind of give us confidence that we're gaining some share here in these key categories. And when you see a positive growth in areas like paint, we also feel like we're gaining share in those areas as well.
Brandon Sink:
Bill, the only thing I would add is just really pleased with the execution of Total Home strategy. You talked about Pro, positive comp with an 800-basis point drag on top of 11 consecutive quarters double-digit growth, really pleased with the online performance at plus 6%. So clearly, as we look at share gains, both for relevant market and broader home improvement, confident in what we're seeing. And it gives us confidence when we look at the broader market and our ability to grow 100 to 200 basis points above the market and growing Pro 2x when we look at 2023 and beyond.
Operator:
Our next question is from the line of Jonathan Matuszewski with Jefferies.
Jonathan Matuszewski:
First one was on the rural pilot, Marvin. You've talked about localization for a couple of years now. A lot of the commentary in the past has been removing lawn mowers in Brooklyn, patio sets in West Philadelphia, Dex Damon, Scottsdale, when we think about this initiative here, it feels like it's a bit more strategic, more poised to benefit the top line versus limiting markdowns from the prior localization efforts. So if we go a bit deeper, is the benefit going to manifest itself more in terms of new customer acquisition or greater wallet share from existing customers. Presumably, both but just trying to understand kind of maybe where it may be more weighted in those pilot stores? That's my first question.
Marvin Ellison:
Jonathan, it's a very good question. And I think it is a combination of both because in order to add these new categories, we're taking categories out. And the categories we're taking out are the ones that were most at risk of being marked down because of the lack of localization. We had a, what I describe as a peanut butter spread on our assortment planning because our tools was so inferior is almost impossible for the merchants to do any really specific localization.
So now we've improved our assortment planning tools, we now have the ability to execute the localization strategy as part of our Total Home strategy. And because of that, we now know what categories to pull out of these rural stores that were not productive and now we're adding in new categories, which will give us the ability to take the customer who's shopping us and shopping of the retailers because of the lack of broadness of our assortment, and we're getting a larger share of wallet of that customer, and we're also attracting a new customer that's now coming in because we're selling items, i.e., pet that we didn't sell before that they are now coming to us as a destination. And so we think this is something that has lots of potential, not to mention as we also implement the technology with the retiring of this old legacy system and we can then put in self-checkout and we can put it in mobile devices and all the other technology advancements that Joe and Seemantini and team have developed is going to also drive increased productivity and profitability in these stores. So we think it's a really clear example of our strategy working and it all hinges on getting the localization right. And Bill, I don't know if you have anything to add.
William Boltz:
Just going to add, Marvin, that the early read in the test stores would tell us that we're getting a new customer coming in categories like pet, like apparel. Those are 2 of the -- 2 categories that we had early read on that said we were drawing a new customer to the door. And so that's exciting to see.
Jonathan Matuszewski:
That's really helpful. And then just a quick follow-up on regional trends. Any trends you're seeing in markets where housing prices have cooled a little bit. I think they were down a bit in April. Any discernible trends in terms of where you're seeing pressure, specifically in markets with cooling home prices?
Marvin Ellison:
Jonathan, you can imagine, we're paying close attention to that and the short answer is no. I mean, we're not seeing any disproportionate sales impact in some of these markets, and we are tracking these markets very aggressively and paying very close attention to all.
Operator:
Just going to announce our final question, Kate, that's coming from the line of Steven Forbes with Guggenheim Partners.
Steven Forbes:
I'll ask my 2 together just in the interest of time. The first one, guys, can you just expand on how the first quarter Pro comp compared to your internal expectations? Ex lumber deflation seems like a big highlight during the quarter. And I wanted to know if you sort of identified what drove the outperformance, whether it's simply wallet share or accelerated new Pro growth and then a quick follow-up is just around the progress against the OpEx productivity initiatives. Any quantification of where you are versus those OpEx productivity goals as of the first quarter and/or what the guidance implies for a year-end goal?
Marvin Ellison:
So Steven, I'll take the Pro question. I'll give Brandon the productivity question. The short answer is Pro did outperform our expectations. We -- candidly, we didn't anticipate 800 basis points of impact to lumber deflation for that specific customer. So the fact that we were able to deliver a positive comp, it actually exceeded our expectations. And I think it comes down to what you heard Joe mentioned earlier, and that is the maturity of our MVP Pro rewards program and our CRM tool, the increased Pro related national brands that Bill and his team have worked to get added to the assortment and our improved fulfillment capabilities that Don Frieson, the supply chain team in partnership with operations that really work to create a more seamless ability for Pros to get product and not to mention the improved digital capabilities that help to deliver a 6% online comp during the quarter as well. We take all of those things combined. And we believe that we'll continue to lean into those initiatives to drive continued market share gain. Brandon?
Brandon Sink:
Yes, Steven, I'll speak to PPI. So very much in line with our expectations there. I mentioned earlier, 40 to 60 basis points of EBIT expansion plan this year. We have a really aggressive portfolio, a road map of initiatives across the business, across every function set to drive operational efficiencies. We've mentioned a few of those today. Store tech modernization, front-end transformation to name a few. So really aggressive plans, and we're very much seeing those come to fruition in line with how we've guided.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you at our Annual Shareholders Meeting this Friday and on our second quarter earnings call in August.
Operator:
Thank you. This concludes the Lowe's First Quarter 2023 Earnings Call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2022 Earnings Conference Call.
My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During the call, we will be making comments that are forward-looking, including our expectations for fiscal 2023. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found on the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. In the fourth quarter, our total company comparable sales declined 1.5%, while U.S. comps decreased 0.7%.
For the quarter, commodity deflation impacted U.S. comps by 75 basis points. Our investments in the Pro customers continue to pay dividends for the company reflected by our continued strong Pro sales in the fourth quarter. In fact, this is the 11th consecutive quarter that we've driven double-digit Pro growth in the U.S. despite stronger-than-expected commodity deflation. And while there was continued solid DIY demand in core home improvement categories, as expected, we saw a DIY pullback on holiday gift buying. Despite a modest decrease in sales, we once again improved our adjusted operating margin by maintaining our disciplined focus on productivity. During the quarter, adjusted operating margin expanded approximately 88 basis points leading to adjusted diluted earnings per share of $2.28, a 28% increase compared to last year. These results cap off solid financial performance for fiscal 2022 with sales of $97.1 billion, adjusted operating margin of 13%, and adjusted earnings per share of $13.81 up 15% over the prior year. With these results, we're awarding $220 million in discretionary and profit-sharing bonuses to our associates, which includes an incremental $70 million for our assistant store managers and supply chain supervisors who hold 2 of the most critical frontline leadership roles in the company. This builds on our recent $170 million investment in permanent wage increases for our frontline, hourly associates, which went into effect in December. Since 2018, we've invested over $3 billion in incremental wages and share-based compensation for our frontline associates, including increasing associate wages by over 20%. And as we mentioned at our December Analyst and Investor Conference, we are committed to additional frontline wage investments over the next several years, which are contemplated in our long-term targets. These compensation investments are just one reflection of our commitment to becoming the employer of choice in retail, which Joe will discuss in more detail. Throughout the quarter, we continued to gain traction with our Total Home Strategy as consumers remain engaged in home-related activities. In Pro, we delivered U.S. growth of 10% and 36% on a 2-year basis. We are capitalizing on our momentum with our Pro by growing our MVPs Pro Rewards and Partnership Program, building relationships through our CRM tool and continuing to enhance our product assortment to meet Pro needs. One example of enhancing our Pro product assortment is the exciting news that client tools will be coming back to Lowe's. We know that our Pros are officially loyal to certain national brands and Klein is the #1 hand tool brand among electrical and HVAC professionals. This creates immediate credibility across trades. Bill will share more detail on this exciting addition to our assortment later in the call. Now one question many of you have asked is about our Pro backlog and if they're still healthy. We're in constant communication with our Pros through formal surveys, our Pro counsel and countless day-to-day conversations. In our January survey, more than 70% of Pros stated that they were booked out the same or more compared to 2022, and they remain confident in their ability to find jobs and hold on to their backlog. We believe this dynamic is being fueled by all the things we talked about at our December Analyst and Investor Conference, which includes homeowners with strong balance sheets and record levels of equity. On Lowes.com, sales grew 5% on top of 11.5% growth in the fourth quarter of 2021, partly due to strong appliance sales. This represents a 2-year comp of 17% and more than 11% sales penetration. We continue to remove friction from the customers' online experience, which includes adding Apple Pay this quarter to improve conversion. We're also focused on removing friction from our customers' omnichannel shopping journeys, like for appliances where customers often shop our showrooms before making their purchase online. We also continue to make strides in the rollout of our market delivery model for appliances and other big and bulky products. We added 2 new geographic areas this quarter, bringing us to 10 geographic regions across the country supporting more than 1,000 stores. And as a reminder, in the market-based delivery model, big and bulky products flow from our supply chain directly to customers' homes replacing our inefficient store delivery model. This delivery model is enabling us to further consolidate our industry leadership position in appliances and it positions us for profitable growth and other big and bulky product categories like grills, riding lawnmowers and stock cabinets. Turning to Canada. We completed the sale of our Canadian retail business to Sycamore Partners this quarter. As a result, we are now solely focused on the transformation of our U.S. business, where we estimate we have a $1 trillion addressable home improvement market, enabling us to invest more into higher-return opportunities to grow our business and to take market share. I'd like to extend my appreciation to the entire Canadian team for their commitment to serving our customers, and I wish them the best as they move forward under new ownership. Before I close, I'd like to share my perspective on the home improvement market. And as you know, there is a wide range of conflicting opinions on what's going to happen in the macro environment in 2023. From our perspective, the core drivers of our business, disposable personal income, home price appreciation, and the age of housing stock, remain supportive. Consumer savings are still roughly $1.5 trillion higher than pre-pandemic with 85% concentrated in the top 40% of income earners who are more likely to be homeowners. Homeowners continue to enjoy record levels of equity in their homes, nearly $330,000 on average. Even if there is a modest decline in home prices, the level of equity built up during the pandemic would not be meaningfully eroded. And the housing stock continues to age with 50% of U.S. homes over 41 years old, the oldest since World War II. These factors, along with strong millennial household formation, baby boomers' increasing preference to age in place and more widespread remote work will continue to be tailwinds for our business. And given the slowdown in housing turnover is driven by higher rates and low supply rather than demand, we continue to see a nationwide trend of trading up in place with consumers opting to upgrade their existing home to meet their evolving needs. All of these dynamics give us confidence in the medium- and longer-term outlook for the industry. That being said, we also know that consumers are weary of a potential recession, which is reflected in some of the discretionary pullback we experienced during the holiday season. We're closely monitoring trends and we have a proven playbook to pivot quickly if the macro softens. Our results in the fourth quarter demonstrate our operational agility, which is reflected in our ability to leverage expenses and deliver productivity in a negative comp sales environment. This gives our experienced leadership team confidence in our ability to effectively manage the business in a wide variety of macro scenario. In closing, I'd like to thank our frontline associates for their commitment to serving customers day in and day out. As I travel to country every week visiting stores, I continue to be impressed by their passion for helping customers and their communities. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. In the fourth quarter, U.S. comparable sales decreased slightly by 0.7%, though sales were up 34.4% on a 3-year basis, reflecting continued momentum with the Pro and resilience in core DIY home improvement demand.
We delivered positive comps in home decor, fueled by key categories like appliances, paint, and kitchen and bath. And we delivered strong growth in our Building Products division, excluding the impacts of commodity deflation. We are particularly encouraged by the Pro strength we're seeing across categories, including rough plumbing, building materials, paint and millwork as we continue to expand our product and service offerings to meet their needs. And consistent with our Total Home Strategy, we continue to add brands relevant to Pros, including 4 new partnerships. First, we're adding a portfolio of drinks from Coca-Cola to reduce the number of stops Pros make before going to the job site, which is important since time is money for these customers. Second, we are adding Carhartt Apparel that's popular with both our Pro and our DIY consumer especially in our rural stores. Third, we have entered a new national partnership with Hubbell, giving us access to all of their Pro branded electrical boxes, including Bell, TayMac and RACO. And fourth, we are excited to be bringing back client tools. As Marvin mentioned, this is the #1 hand tool brand among electrical and HVAC professionals. So this is just a big deal for us and our Pros. We are also really excited to announce that Lowe's will offer the widest selection of client products anywhere in the home improvement retail channel, which will be available in the second half of 2023. Our initial selection of client tools will include hand tools and electrical test and measurement tools, followed by a multiyear rollout of new product innovations. Fine Tools, Hubble, Carhartt and Coca-Cola are strong additions to our Pro brand arsenal, which already includes other great brands like Bosch, DEWALT, Eaton, Estwing, FastenMaster, FLEX GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner. As we gain momentum with the Pro, we continue to see brands come to Lowe's and in many cases, come back to Lowe's because they recognize our newfound recommitment to the Pro and see the opportunity to grow with us. Shifting to our merchandising division performance for the quarter. In home decor, appliances, paint and kitchens and baths led the way. Appliances grew across both Pro and DIY as we continue to gain market share in this critical category. Growth was bolstered by our new instant savings capability that automatically applies supplier rebates to a customer's order, making it much easier and faster for them to take advantage of these offers, which are supported by the manufacturer. This replaces our cumbersome mail-in rebates with real-time savings, both in stores and online to remove friction for the customer and improve conversion. This innovation is another example of Lowe's leapfrogging the competition with technology that not only improves the customer experience, but also drives labor productivity. Paint was another standout category with solid pro-growth fueled by our MVPs Pro Paint Rewards and Pro JobSIGHT delivery. We're also seeing an uptick in paint attachments items like applicators, paint sundries and caulk as we upgrade our paint departments across our stores. This upgrade is strategically designed to make it easier for our customers to get everything they need in one trip. We also began the launch of STAINMASTER paint, a high-quality, high-value solution for busy families looking to protect their walls from fingerprints and other messes. This is Lowe's first-ever private brand paint and early results are already outperforming our expectations. Our focus on driving private brand penetration is well timed enabling us to capitalize on the nationwide trend of increasing customer preference for private brands. Another category that outperformed this quarter is kitchens and bath. We were particularly encouraged to see a strong increase in demand for custom cabinets driven by improved lead times as well as an expanded suite of digital tools, along with our team of talented virtual designers, all of which help our customers tailor the right solutions for their budgets and design preferences. Turning to the Building Products division. We delivered strong, broad-based growth, excluding the impacts of commodity deflation across copper and lumber. We delivered strong positive comps across rough plumbing, building materials and millwork driven by Pro demand and continued DIY investment in the home. Our performance in hard lines was consistent with broader consumer trends as we saw a decrease in holiday gift buying compared to the prior year. However, the team still delivered a solid holiday season with sell-throughs above 2019 levels. As expected, consumers reverted to more typical holiday buying patterns as compared to last year when we saw a widespread early buying due to supply chain concerns. As we look ahead, we continue to build on our customers' preference for new and innovative products with continued enhancements to our product assortments. We are expanding on our popular Kobalt 24-Volt platform with new tools and technology that customers have been asking for, including a cordless Kobalt nailer that can instantly fire 1,100 nails on a single charge, eliminated the need to drag an air compressor and a hose around the job site. We're also excited about our new EGO zero turn radius mower with the industry's first e-STEER technology. With the sleek, intuitive steering wheel that increases the driver's control and precision, powered by the EGO battery system that now allows this unit to mow 3 acres on a single charge. We are ready to capitalize on spring with the best in-stock positions that we've had in 3 years, right on time to support our biggest selling season of the year. In addition to an enhanced assortment and strong in-stock levels, we're also making strides in driving merchandising productivity as part of our enterprise-wide perpetual productivity improvement initiatives. As one of the larger importers in the U.S., we continue to leverage our scale and carrier relationships to secure capacity and reduce our import and domestic transportation costs. As the cost of transportation and raw materials come down, we are working with our suppliers to ensure that our prices are competitive to support sales and to protect our margins. We have sophisticated cost optimization tools that track prices of the underlying components of the products we sell. So the teams are well informed for these discussions. We are also holding our suppliers accountable to drive out costs through their productivity just as we are doing throughout our own organization. We are also partnering with our suppliers through our Lowe's One Roof Media Network. Some of our top suppliers have already locked in sizable contracts for 2023, and we are excited to partner with them to strategically target the home improvement shopper to drive traffic on Lowes.com and convert to sale. Before I close, I'd like to extend my appreciation to our merchants and our inventory and supply chain teams, along with our vendor partners for their hard work and continued support throughout 2022. I'm looking forward to what we will accomplish together in 2023 as we continue to find ways to provide value to our shared customers. Thank you. And I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone. I'd like to start by thanking our associates for their unwavering commitment to serving our customers and delivering another solid year of operating results. Associates are the heart of any retailer, but even more so in our industry where customers rely on our associates' product knowledge as they look for the right solutions to repair and upgrade their homes. That's why we are so focused on becoming the employer of choice in retail, where associates chose to stay to build their careers.
As Marvin mentioned, we've made substantial wage investments over the last 4 years, and we constantly review each market and monitor candidate flow to help us remain competitive and maintain a robust hiring pool in all geographic areas of the company. Beyond competitive compensation, we offer comprehensive benefits, flexible scheduling options and bonus opportunities. As we close out the year, we are excited to award $220 million in discretionary and profit sharing bonuses. This includes $70 million for our assistant store managers and supply chain supervisors with an incremental $7,500 bonus this quarter on top of their annual incentive bonus, and we are one of only a handful of retailers to offer share-based compensation for our ASMs and which incentivizes them to build their careers at Lowe's. These critical leaders are undoubtedly some of the hardest working leaders in our company, and they are at the forefront of creating a culture focused on exceptional customer service. In addition to recognizing these leaders, we are also awarding $150 million to eligible hourly associates in recognition of their efforts this year. Based on continuous associate listening we also added other improvements this quarter, including sick leave for part-time associates in revamping our store break rooms with higher quality, lower-cost, food options. Our investments in our people have helped us build more than 80% of leadership positions from within over the last year with more than 90% of our store leaders starting as hourly associates. As we enter spring, our busiest time of year, I'm pleased that we have the best staffing levels that we've had in 3 years. Our focus on associates also translates into how we're serving the Pro, which is our biggest opportunity for growth. This quarter, we launched a Know the Pro training, helping our associates understand how to better serve Pro customers across the entire store, not just at the Pro desk. This training supported storewide participation in key Q4 Pro events, including the most successful PROVember we've ever had as well as our MVPs bonus days, which exceeded expectations. I would like to thank our associates, especially our Pro team for delivering outstanding results, driving U.S. Pro comps of 10% for the quarter, 36% on a 2-year basis despite commodity deflation. We continue to leverage our MVPs Pro Rewards and Partnership Program to capitalize on this demand by engaging Pros, incentivizing purchases and building long-term loyalty. Our program is designed to make every Pro feel like an MVP regardless of their size, giving small to midsize Pros, access to bonus points, savings and exclusive offers that they can't get elsewhere. We're pleased to see the results continue to exceed expectations as reflected in our 200 basis points increase in Pro customer satisfaction scores in Q4. Shifting gears to our focus on productivity. We continue to make progress with our PPI or perpetual productivity improvement initiatives. One of the key objectives of PPI is simplifying our associates jobs while removing friction for our customers. This approach allows us to generate productivity and cost savings in the store while simultaneously improving customer service. One great example of this is the transition of our outdated legacy technology to our new modern omnichannel systems. We just completed the conversion at our returns desk with easy-to-use touchscreens that enable associates to quickly scan items and process to correct return value, with the system automatically accounting for return policies and promotions. This simplifies the return experience for customers, gives our suppliers more insights to improve product quality, while also making it easier for associates to enforce our policies and manage complex returns. We also continue to roll out new tools, including 90,000 additional Zebra smartphones by the end of June, to ensure all associates walking the sales floor have a device, including our MST associates. Our leadership team knows that when we make things easier for our associates, they make things easier for our customers. And our new returns process is just one example of the dozens of initiatives underway to do just that. And of course, none of this would be possible without our associates. For our associates tuning in, thank you for your ongoing focus on serving customers and driving productivity. We appreciate your hard work. And with that, I'll turn the call over to Brandon.
Brandon Sink:
Thank you, Joe, and good morning, everyone. Let me begin with our Q4 results. We generated GAAP diluted earnings per share of $1.58 compared to $1.78 last year. Now my comments from this point forward will include certain non-GAAP comparisons where applicable.
Excluding the $441 million of pretax transaction costs associated with the sale of our Canadian retail business, we generated adjusted diluted earnings per share of $2.28, an increase of 28% compared to the fourth quarter of 2021. This increase was driven by our continued focus on productivity as well as disciplined capital allocation. Q4 sales were $22.4 billion, which includes approximately $1.4 billion in sales generated in the 14th week. Comparable sales declined 1.5%. U.S. comp sales were down 0.7% in the quarter with comp average ticket up 4.8% driven by product inflation and higher Pro sales partly offset by 75 basis points of lumber deflation. This was offset by a comp transaction decline of 5.5%. Sales in Canada totaled $958 million, a decline of 18% in USD on a comparable basis, partly driven by exchange rate unfavorability due to a stronger dollar and lumber deflation. FX represented a 25 basis point headwind to consolidated comps. Of note, both the Canadian sales decline and lumber deflation pressured our Q4 comps more than expected. U.S. Pro sales were up 10% in the quarter despite lumber and copper deflation. On Lowes.com, sales increased 5% in the quarter, partly driven by continued strength in appliance. Our U.S. monthly comps improved as we moved through the quarter, with comps down 3.1% in November due to DIY pullback on discretionary holiday spending. In December, comps were down 0.2%, with comps turning positive in January, up 1.4%, reflecting continued DIY investment in the home. Gross margin was 32.3% of sales in the fourth quarter, down 60 basis points from last year. Product margin rate improved 15 basis points versus the prior year. Gross margins also benefited from 30 basis points of favorable product mix due to a lower percentage of lumber sales. Higher product margin rate was offset by 40 basis points related to the expansion of our supply chain network, 30 basis points of pressure from shrink and 35 basis points of pressure from our private label credit portfolio. Adjusted SG&A of 20.9% of sales levered 131 basis points relative to Q4 2021 despite a modest decline in sales as we executed on our PPI initiatives across the company. Adjusted operating margin rate of 9.6% of sales levered 88 basis points as adjusted SG&A leverage was partly offset by lower gross margin rate. The adjusted effective tax rate was 24% below prior year levels. Inventory ended the quarter at $18.5 billion, which now solely reflects the inventory for our U.S. business as we closed on the sale of the Canadian retail business on February 3. Inventory is up $0.9 billion from the same quarter last year, largely driven by product inflation with units down slightly to prior year. We continue to shift our inventory mix more towards Pro categories as we invest to drive future growth. Now let me turn to capital allocation. In 2022, we generated $6.8 billion in free cash flow driven by outstanding operating results, and we returned $16.5 billion to our shareholders through both share repurchases and dividends. During the fourth quarter, we paid $643 million in dividends at $1.05 per share and repurchased 10 million shares for $2 billion. This brought the total to $14.1 billion in share repurchases for the year, ahead of our expectations for approximately $13 billion. This reflected better-than-expected operating performance and our commitment to return excess cash to shareholders. We ended the quarter at 2.44x adjusted debt-to-EBITDA. And finally, we delivered return on invested capital of 30.4%, inclusive of an 800 basis point impact related to transaction cost associated with the sale of our Canadian retail business. Turning to our 2023 financial outlook, which we introduced this morning. As Marvin indicated, the long-term outlook for home improvement remains strong. However, in 2023, residential investment will be under some pressure. Given elevated levels of inflation, higher interest rates and a more cautious consumer, we are forecasting a slight decline in the home improvement market. We expect to continue to outperform the market in 2023 with sales ranging from $88 billion to $90 billion. Comparable sales are expected to be in a range of flat to down 2%. Keep in mind that 2023 comparable sales will be calculated based on weeks 2 through 53 in fiscal 2022. Pro sales growth is expected to exceed DIY again in 2023 as we expect to continue to outpace the broader Pro market growth by 2x. We will continue to build on our momentum with the Pro with our new MVPs Pro Loyalty Program, CRM tools, and our expanded Pro brand lineup. We are expecting operating margin in the range of 13.6% to 13.8% as we continue to drive productivity through our PPI initiatives across the organization in part to offset our planned wage investments. For 2023, we are expecting to invest $350 million in incremental wages for our frontline associates, which includes the 2023 portion of the $170 million permanent wage investment that went into effect in December. We expect capital expenditures of up to $2 billion this year and with our planned share repurchases -- we also expect to reach our 2.75x leverage target in 2023, while maintaining our BBB+ credit rating. Our strong operating performance and shareholder-focused capital allocation strategy is expected to deliver approximately $13.60 to $14 in earnings per share for the year. Keep in mind that there was an approximate $0.25 contribution to adjusted EPS from the 53rd week in our Canadian business in 2022. I would like to spend a moment discussing our expectations for first half performance, which is an easier comparison from a sales perspective. However, when we consider the impact of lower lumber prices, we are expecting a nearly 300 basis point headwind to sales in the first quarter and a 100 basis point headwind to sales in the second quarter. Given these impacts, we expect our first quarter sales comps to be below our full year guidance range and our second quarter sales comps to be above our full year guidance range. In closing, I'm confident that the combination of our strong operating results and our shareholder-focused capital allocation strategies will continue to deliver meaningful, long-term shareholder value. And with that, we will open it up for questions.
Operator:
[Operator Instructions]
And our first question is from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
First, I have a macro and then a micro question. So you just comped -- roughly minus -- minus 1 in the U.S. with some rounding and the midpoint of the guide is minus 1. I know the monthlies -- when Brandon gave the monthlies that kind of answered it.
But ignoring comparisons, I guess the guidance assumes that largely the backdrop holds up. And I wanted to re-question that, given some of the deceleration in some of the housing metrics. So -- and what drives that?
Marvin Ellison:
I'll take the first part, Simeon. I'll kind of go back to what I said in some of the prepared comments. When we take a look at what our demand drivers are for home improvement -- and just to be specific, these are historical demand drivers that have held up over time. They still remain supportive.
And things like disposable personal income, which I mentioned, is roughly $1.5 trillion in savings above pre-pandemic levels. The average equity in U.S. homes, roughly $330,000 on average, the age of homes, and a reminder, 2/3 of everything we sell is nondiscretionary. And there are other tailwinds, millennial household, formation trend, baby boomers, aging in place, and more widespread, sustainable remote work. So all of these things give us some confidence that the backdrop remains supportive. But as Brandon said, we still have some degree of caution when we think about discretionary buying, and that is factored into the guide. So I'll let Brandon add anything additional to that.
Brandon Sink:
Yes, Simeon, this is Brandon. I'll talk to your question specifically on Q4. As I said in the prepared remarks, inflation, interest rates, we are seeing a bit more of a cautious consumer, one that's anticipating and responding to value.
We saw this play out in November with discretionary holiday categories, but we did see a nice progression of performance across the quarter as we hit the January exit. And we continue to see solid DIY demand in core home improvement categories like appliances. So as we turn and look at the guide in the next year, we feel comfortable with what we're seeing in Q4, very much in line with what we shared back in December in terms of the moderate scenario. And it's consistent with the market being down, call it, low single digits 2% to 3%. So I think we got a lot of good consistency with what we're seeing again in Q4 with what we're anticipating for the full year next year.
Simeon Gutman:
Okay. And the follow-up is more micro. Within this, the long-term guidance that you gave in December, the 14.5% to 15%, there's about $150 million to $200 million or so from OpEx productivity and then I think the -- some of the PPI initiatives. And I guess that's the stuff you can control.
I forget, if we discussed, if that's ratable. Meaning even across the time frame or are there things that you can pull forward this year or any year, if you need it? And/or is the cost environment going up such that it makes the achievement of that bucket any different?
Brandon Sink:
Yes. Simeon, I would say ratable as we look at the 3-year period with what we shared in December. I mean, when we look at the algorithm for the guide for '23, we are expecting roughly flat gross margin. So the bulk of the 60 to 80 basis points of EBIT expansion that's reflected in the guide is coming from SG&A leverage, and it's being largely driven by our productivity initiatives.
So that's specifically just translating and transitioning from what we shared on the 3-year to what we're expecting from an SG&A standpoint in '23.
Marvin Ellison:
And Simeon, this is Marvin. The only thing I'll add is, if you take a look at Q4, just as an example, it just -- it shows that even in a flat to negative sales environment, we still have the ability to leverage productivity, whether that's expenses or operating margin. And I think that is consistent with the PPI initiatives not being solely focused in one functional area, but as you heard at our December Analyst and Investor Conference, it's across all functions, merchandising, supply chains, to operations.
And so although it's ratable, we're very confident in our ability to deliver upon that in a variety of macro scenarios.
Operator:
Next question is from the line of Kate McShane with Goldman Sachs.
Patrick Hollander:
This is Patrick Hollander on for Kate. We just wanted to ask about price elasticity. Another item discussed at the December Analyst Day was kind of the confidence in prices sticking but your competitor mentioned that they saw more price sensitivity in the fourth quarter than they had in the third quarter.
So first, are you guys seeing something similar? And then how do you address some of the price sensitivity, do prices need to come down? Will we see more markdown activity?
Brandon Sink:
Yes. Patrick, this is Brandon. As it relates to the question on elasticity, stepping back, we look at the last 3 years through the pandemic, we saw consumers who were very resilient with higher prices, not necessarily impacting demand that we were seeing for our business.
As I mentioned in the last response, we are seeing more normal consumer trends with consumers anticipating and responding to value. So as we look at '23, we are expecting a modest inflation lift across the portfolio. Most of that is going to be wrap of inflation that we're seeing in 2022 lapping into 2023. We're expecting that inflation to continue to slow, and we're seeing minimal activity in terms of new pipeline requests coming in from our supplier base. And that inflation is going to impact mostly first half as those benefits are expected to normalize as we move through the year, next year. And then on the transaction side, we expect that inflation to be offset by a modest decline in transactions, which we also expect to see that improve across the year. So we're looking back half of the year and then into 2024 a more traditional balance between ticket and transaction.
Operator:
Our next question comes from the line of Scott Ciccarelli with Truist.
Unknown Analyst:
This is Joe on for Scott. I was really impressed by the Pro commentary. I was just wondering, is there any sort of regional thing that you'd break out whether or not people are more or less bullish on their outlooks and backlogs in areas where there's been more housing price correction?
Marvin Ellison:
So Joe, good question. What I'll tell you, there are a couple of markets around the country that had a more accelerated, what I would call, appreciation of home prices during the pandemic. And let's call out markets like South Florida, Phoenix, as an example.
And as you can imagine, we pay really close attention to those markets. We've not seen any material difference in sales performance in those markets as those prices tend to come -- are coming down than in the broader U.S. And so when I cited the statistic that 70% of our Pros in our survey from January are very confident in their backlog being consistent to last year and being able to sustain it, that is pretty much a universal statement across all geographies. What I can tell you is that we're very pleased with the performance of our MVP Loyalty Program and how it's sustaining and giving us the ability to drive sales. And I'll let Joe just touch a little bit on that program and how we think that's going to allow us to build loyalty and continue to grow this very important business.
Joseph McFarland:
Yes. Thanks, Marvin. And Joe, thanks for the question. As it relates to the Pro and the market, Marvin made his prepared comments. But as you dig deeper, there's kind of 5 key areas that we look at, which is the jobs how far out the Pro is booked in the next 6 months. Materials, can they get what they need and is it the right cost? Can they get to Pro Credit? What does the labor market look like? And then just the balance of the type of work they do.
So remodel versus new construction. And as we track these and as we roll out our Pro loyalty program, we're pleased with the trajectory of the business and the health of this small Pro that we're servicing.
Operator:
Our next question is from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
I apologize. My question may sound like similar prior questions. Going back to the comments made by your competitor last week, they discussed what -- they termed kind of broadening, if you will, of consumer normalization, consumer weakness.
You called out weakness around the holiday, the gift giving, discretionary. But are you -- would you characterize also seeing that, what they discussed in this kind of this broadening, a weakness in normalization across your portfolio?
Marvin Ellison:
Brian, it's a fair question. And I'd start off by saying Q4 is typically our highest discretionary selling period of the year because of the holiday season. But when we look at core home improvement categories, we feel really good about the performance of the DIY customer.
And I think as Brandon gave that monthly comp cadence for the fourth quarter, you notice that every month, the business performed stronger with a positive comp in January, and that was almost directly correlated to the DIY customer being stronger each month of the quarter because we moved away from that discretionary period that was so heavily focused on the month of November because of holiday buy. So as we look at the overall customer, we look at the health of the DIY discretionary spending. We don't see any really red flags that we're concerned about because the core home improvement discretionary categories held up really well for us, case in point, appliances, case in point, paint. So those are areas that really performed well. And I'll let Brandon add any additional comments.
Brandon Sink:
Yes. Brian, I'll just connect that to the guide, Marvin highlighted with what we're seeing more with the DIY customer. But just looking at the Pro and expectations into '23, continuing to outpace DIY 11 quarters in a row, double-digit comp, we're continuing to see Pro across all ticket ranges, both comp and transaction growth.
And while we did see DIY lag in 2022 in the discretionary category, some of what Marvin was describing, we are seeing those overall transactions continue to improve across the year. So when we look at '23, still expecting outperformance with the Pro but expecting that gap between Pro and DIY to continue to close and tighten, and that's what's reflected in our guide for next year.
Brian Nagel:
That's very helpful. And then my follow-up question, just with regard to lumber prices. So you discussed here -- and we get it, this is kind of a pass-along dynamic when prices declined as a negative for sales.
But if we've gotten to the point where lumber prices have declined so much of -- that's actually becoming a potential stimulant to demand, I don't know if you're seeing this in your business or maybe in some of pooling of your professional customers?
Brandon Sink:
Yes, Brian, I'll take that and, again, kind of connect it to the guide. So our guide at the midpoint for lumber, in particular, assumes a normalized pricing environment, certainly considered to what we've seen for the last [ 30 ] years.
And within that lumber assumption, as you heard in my prepared remarks, expecting headwind in both Q1 and Q2. And I'll call out also if that -- when we look at lumber pricing currently, if that were to play out across the remainder of the year, it actually puts another 100 basis points of pressure on the midpoint of the guide. But to your point, within that, we are expecting an offset in units, and there's potential that, that could be a stimulant for our business. But again, right now, we're expecting and have considered at the midpoint of our guide, just more normalized pricing and a slight rebound in units in the next year.
Operator:
The next question comes from the line of Karen Short with Credit Suisse.
Karen Short:
So just on 2 questions. You guided to flat to down 2% comps. So that was kind of in between the robust and moderate scenarios that you offered. And then your margins, though, are only on the moderate range, not the robust range. So I'm wondering if you could give any color on that.
And then on the wage investments that you called out. Obviously, one of your competitors also announced very sizable wage investments. So wondering if you could just give a little color on your wage investment versus industry and/or one of your largest competitors.
Marvin Ellison:
So Karen, this is Marvin. I'll take the wage question, then I'll let Brandon take the first part of the question.
So 2 things. First, we feel great about the financial commitment we've made to our front line associates. And we're also very confident in our long-term financial plan. So since 2018, as we mentioned, we've invested over $3 billion in incremental wages and share-based compensation for front line associates, including $170 million wage investment we made last year. And over the past 4 years, we've increased our wage by more than 20%. And Brandon mentioned that we're going to be investing $350 million this year in frontline wages. And over the next 3 years, we're going to invest nearly $1 billion. So when you contemplate all this together, it's factored in our 2023 guidance and our long-term financial guidance. And as an investor community, sometimes we get challenged by our rural footprint of stores as a competitive disadvantage. When you discuss wage, it's actually an advantage because most of the small and rural markets where we operate, we're the highest paying retailer. And where we're not, the local operators have a very, very specific process to follow to get wage adjusted. So our approach to wage is our strategy, and we feel really good about it, and our associates have responded well. And what I'll do before I hand it to Brandon, I'm just going to let Joe McFarland talk a little bit about staffing levels and spring hiring, which, as you know, is a really big deal for us this time of the year.
Joseph McFarland:
Yes. Karen, thanks for the question. And as it relates to our frontline associates, I'm very pleased with our staffing right now. This is the best staffing we've had in 3 years. And our spring hiring as the markets come into season is ahead of expectations. So very pleased with the team's ability to staff and pivot wherever the challenges are.
Marvin Ellison:
And so Karen, in summation on that, we have a strategy, we feel great about it. We feel like it's working for us, and we believe that our investment cycle, our commitment to our associates is something that is leading us to being truly an employer of choice in retail. And I'll hand it over to Brandon to answer the other part of your question.
Brandon Sink:
Yes. Karen, your first question on operating margin. We look at what we shared in December, a midpoint of the guide down 1% and 13.7% in that moderate scenario. Our guidance is right in line, purely consistent with that with the range that we provided just bookending those midpoints. So very consistent there.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
So first, at the analyst meeting in December, you pointed to the most likely scenario being the robust market scenario or the moderate market scenario. The guidance now at the midpoint is squarely on the moderate market scenario, and at the low end could be closer to the weak market scenario.
So what's changed in the last 90 days or so to moderate your expectations for 2023? And then I have a follow-up.
Marvin Ellison:
Yes. So Michael, this is Marvin. At a high level, it's lumber deflation. That pretty much sums it up. As Brandon mentioned, we're going to have 300 basis points of headwind in Q1 and 100 basis points of headwind in Q2.
Going into 2023, we looked at the first half of the year as our easiest compares. That remains. But when you throw in that lumber deflation, that pretty much sums up what's different between what we discussed in December and what our guidance is.
Brandon Sink:
Yes. And Michael, I'll just add that the weak scenario that we called out still very much sort of off the table for us. I think we called out at that point, it would require significant economic shock, and we don't see that playing out.
So we're still very squarely in line with that moderate view. And just as a reminder, the downside, even in that weak scenario was a 13.3% operating margin, so still 30 basis points of expansion even in that scenario.
Michael Lasser:
Understood. My follow-up is on the gross margin outlook for this year. What's a realistic expectation, especially as the consumer environment gets a little tougher, the consumer may shop or want to shop a bit more on promotion. And how are you thinking about the private label credit card contribution to the overall P&L this year?
Brandon Sink:
Yes, Michael, I'll talk about the guide as it relates to margins. So very focused next year on delivering operating margin expansion, and that's on flat to slightly negative comps.
As you mentioned, the gross margin we are expecting that to be roughly flat in '23. And there's a few different puts and takes that we're managing on the headwind side, continued rollout and expansion of our supply chain, specifically market delivery. We're going to continue to see mix pressure from our Pro strategic initiative investments. The flip side a number of productivity efforts. You mentioned private brand penetration, also lower commodity and transportation costs and then continued benefit from our pricing initiatives. So the large part of the leverage is going to come from SG&A and continued PPI productivity efforts that you've heard called out from the team. So that's sort of the formula as we look at margins and flow through next year. And Bill, I don't know if there's anything else you want to add on private brands and some of the momentum that we're seeing there?
William Boltz:
Well, Brandon, and for Michael, what we talked about in December, private brands certainly gives us an opportunity in categories where a national brand isn't relevant. Private brands carry a better margin. They offer the consumer some additional choices.
As it relates to promotional activity, we want to continue to offer the customers value, but we're not adding new promotions for 2023.
Michael Lasser:
That's helpful. And just to clarify, referring to the private label credit card, that was a drag on the gross margin in the fourth quarter.
Brandon Sink:
Yes. Got it, Michael. So -- yes, drag in Q4 mainly given the interest rate environment that we're seeing. But as we turn into 2023, again, a number of puts and takes, but we feel like the bulk of that for the most part has been absorbed, and we have that factored into '23.
Operator:
Next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I'll start with a follow-up on that last question before I get to mine. On other gross margin puts and takes, shrink was also I think a headwind in the fourth quarter. Could you just quantify that and give us your expectations for that into '23?
Brandon Sink:
Yes. So sure, Greg. On shrink, in particular, it was a bit of a pressure point, a bit worse than expected. It's been approximately 30 basis point pressure. We saw that Q3 and Q4, largely driven by what we're seeing more broadly in retail with organized crime.
But again, as we turn and look at '23, that pressure largely absorbed in 2022. We feel like we got great efforts within the team and the organization in terms of what we're doing to protect against shrink, and I'll maybe let Joe call that out.
Joseph McFarland:
So thanks for the question. And listen, we're really pleased with the asset protection team. The entire industry has pressure from ORC. Our asset protection team has rolled out some new, innovative things for safety, for shrink, and so we see the outlook good.
Gregory Melich:
Great. And then I guess, my key question was on the traffic and inflation and how that sort of comes in through the year. So if you think about the cadence through the year, it sounds like first quarter is below the range, second quarter is above the range. Should we assume the second half is better than the first half or worse than the first half or in line?
Brandon Sink:
Yes. Second half, Greg, very much in line.
Gregory Melich:
Got it. And the difference would be better traffic in the second half, maybe still negative but less negative? And less...
Brandon Sink:
Correct. Correct.
Operator:
Our next question comes from the line of Peter Benedict with Baird.
Peter Benedict:
Just wanted to -- on the first quarter comp view that you laid out there. We understand the commodity impacts there. But just curious, any early season read? I know it is early, but some of your markets in the South, just curious how Spring seasonal demand is starting out here? That's my first question.
Brandon Sink:
Yes. Peter, as we look at February sales consistent with our guidance, we called out the Q1 being below the full year guidance range. And again, that's primarily due to the lumber pricing pressure that we're seeing. We are encouraged to see early signs of strength in discretionary seasonal categories, in particular, South and deep South as our customers begin to prepare for spring, and I'll let Bill talk to that in a little bit more detail.
William Boltz:
Yes. Thanks, Brandon. And Peter, we started setting our stores in the South, Deep South, early January. And I think what's nice to see is spring start to come in the way it's supposed to come. And you start to see sales of product in fertilizer, chemicals, landscape products start to occur the way they're supposed to occur. And so we're encouraged by that. February can always be a wildcard month. But certainly, in these months -- in these Deep south and South markets seeing it kind of progress the way it's supposed to.
Peter Benedict:
Got it. And then just back to the -- maybe the promotional plan that you have laid out for the year. I mean, you mentioned in your prepared remarks that the consumer is responding to value.
I'm just curious -- I mean, we've been through a period where there's been very limited promotion. So how do we think about the plan maybe for the first half of the year here in terms of your promotions? Things that you tend to do to drive traffic, how they compare to maybe what you've done in the last couple of years? That's my second question.
Marvin Ellison:
So Peter, I'll take the first part of that. At the highest level, you're not going to see any increased promotional activities by us. We're very fortunate to be in a very rational industry relative to promotions. And to be quite candid, a lot of the irrational activities came from old Lowe's.
And those practices and behaviors are along behind. Those are one of the first things that Bill Boltz and I discussed when we arrived 4.5 years ago was getting off the high-low promotional drug that we felt was not consistent with how you should run business in this industry. And it's taken us a while to get there, but we're very fortunate that we are there. So we anticipate and see no increased promotional activities. Obviously, as you get out of these pandemic-driven demand cycles, customers are looking for value, but we believe we can offer value without getting to a high promotional environment. Bill, I don't know if there's anything you want to add?
William Boltz:
No. I think the one area that the team may see different activity on is in appliances, and you guys have to remember that roughly 100,000 appliances break every day. And so there's always going to be an offer in the marketplace for appliances driven by the manufacturers, supported by the retailers.
So that's one area supply has improved. Those offers are out there for appliance products. But no additional promotions.
Operator:
We have time for 1 final question, which will come from the line of Steve Forbes with Guggenheim.
Steven Forbes:
Marvin, Brandon, I just wanted to follow up with a quick modeling question given the exit of Canada. And so I'm not sure if you could help us think about the mix impact on gross margin because I would think the Canadian business and the exit of it has a positive impact on gross.
And can you help us quantify that relative to 60 basis point net impact and whether this is partially sort of supportive of the 2023 outlook for a flattish gross margin '23?
Brandon Sink:
Yes, Steve, 60 basis points was a full year impact on operating margin. And when you think about the split there between gross margin and SG&A, it's roughly half and half.
Steven Forbes:
And then lastly, the ongoing compensation related investments that you noted during the prepared remarks, which is great to hear. I was curious, if we just take a step back and think about the dollar level of OpEx productivity initiatives you've highlighted at the Analyst Days in 2020 and 2022. Any contextualization about how much still remains in front of us in dollar terms?
And Marvin, I'm not sure, if you maybe talk about some specific PPI initiatives that you're most excited about this year?
Marvin Ellison:
Yes. Well, it's a really good question, Steve. A couple of things. Number one, as you can imagine, we have been working aggressively to update our IT infrastructure.
We still have a 30-year-old basically mainline system that we're getting ready to retire, and it's literally taken us 4.5 years to get to this point. The moment that system is officially retired, it gives us the ability to create so many technology advancements that will do 2 things, will simplify the associate's job and limit friction points for customers, which will reduce payroll and improve customer service. And that's what Joe cited in some of his prepared comments. And so holistically, a lot of our PPI initiatives on the store and merchandising side, and candidly, the supply chain side are tied and correlates to the retirement of this 30-year-old operating system that we are excited is going to be going away over the next few months. And as we look at that, you'll start to see more omnichannel type of systems available in the store. At point of sale, you'll start to see pricing initiatives and pricing systems advanced on the merchandising side. You'll start to see us have the ability to do more relative to integrating gig network deliveries online in a more seamless way in addition to all the supply chain and some of the advanced sourcing logic we'll be able to do that, will give us the ability to ship merchandise, aggregate merchandise, from different points of stores, distribution centers without having to go out and build these monolithic DCs that some retailers have had to do. So all of those things are tied together. But again, it's almost foundationally driven to a lot of the IT work that's been done the last 4-plus years.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our first quarter earnings call in May.
Operator:
Thank you. This concludes the Lowe's fourth quarter 2022 earnings call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2022 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President of Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. In the third quarter, our total company comparable sales increased 2.2%, while U.S. comps increased 3%. These better-than-expected sales were driven by improved DIY demand supported by fall nesting trends as travel slowdown and children return to school.
We also saw continued momentum in Pro, reflecting the success of our Pro initiatives and the resilience of home improvement demand. In addition to strong sales growth, our persistent focus on productivity once again drove improved operating performance with substantial improvement in adjusted operating margin of 54 basis points and adjusted diluted earnings per share of $3.27, an increase of 20% as compared to last year. These outstanding results enable us to make critical investments in our most important asset, our associates. In this quarter, we announced an incremental $170 million investment in permanent wage increases for our frontline hourly associates. These increases are designed to ensure that our more tenured associates continue to receive market-competitive wages. And in further recognition of the hard work and dedication, we are awarding $200 million in bonuses to our frontline hourly associates ahead of the holiday season. At Lowe's, we make every effort to ensure that our associates share in our financial success, and I am very pleased that we are once again able to award a discretionary bonus because our performance is tracking ahead of our expectations. This is a true win-win outcome for the company, for our shareholders and for our associates. All of these investments reflect our efforts and our commitment to become the employee of choice in retail, where we continually invest in our associates and help them support their families and grow their careers at Lowe's. Now turning to Pro. We delivered growth of 16% and 36% on a 2-year basis, the tenth consecutive quarter that we've driven double-digit Pro growth. We are building on our greatly improved Pro product and service offerings with our new MVP Pro Rewards and Partnership Program and our enhanced Pro CRM, which Joe will discuss later on the call. We recently completed our annual Pro Pulse Survey, which provides real-time insights into what's on the minds of our Pros and how they view their future business opportunities, and we're encouraged to hear that Pros remain optimistic with over 70% saying that they expect even more work in 2023 than they had in 2022. This is just another proof point of the resilience of home improvement demand even in this uncertain macro environment. On Lowes.com sales grew 12% this quarter over 4x our U.S. growth rate, representing a sales penetration of 10%. We continue to enhance the online user experience as well as our fulfillment capabilities as we focus on driving this critical growth initiative within our Total Home Strategy. Turning to our supply chain transformation. We've made significant strides in our rollout of our market delivery model for big and bulky products this quarter, spanning the country from Southern California to Southern Illinois to Atlanta, Georgia. We've now reached an important milestone with 8 geographic regions covering more than half our stores converted to the new model, and we're on track to complete the rollout by the end of next year. This is a centerpiece of our supply chain transformation as the market delivery model will enable us to further consolidate our industry leadership position in appliances and position us for profitable growth in other big and bulky products like grills, riding lawn mowers, stock cabinets and vanities. This also improves the customer experience through expanded fulfillment options and a seamless omnichannel shopping experience powered by technology. We also just announced that we will be opening a new coastal holding facility in the port city of Suffolk, Virginia. Our expanded coastal holding facility network is opening up capacity for us to hold product upstream from our distribution centers, which creates the flexibility we need to flow the products quickly and where and when is needed. This helps us to not only capture sales, but also mitigates markdown risk because we avoid stranding product unnecessarily in our stores. And now I'd like to discuss the macro environment and specifically address some misperceptions that I've heard about the home improvement market. You've heard me talk about this before, but demand drivers for home improvement are distinctly different from those that drive home building. So it's important not to confuse the two. And as a reminder, at Lowe's, the 3 highest correlating factors of home improvement demand are home price appreciation, age of housing stock and disposable personal income. So let's start with home price appreciation. Even if there is a broad-based decline in home prices, homeowners currently have a record amount of equity in their homes, nearly $330,000 on average, which remains supportive of home improvement investment. And even in the select U.S. markets where home prices have declined after a particularly steep run-up during the pandemic, we are not seeing any impact to sales; second, the average age of homes in the U.S. is over 40 years old and roughly 3 million more homes built during the housing boom in the mid-2000s, will be entering prime remodeling years by 2025, which is a key inflection point for big-ticket repairs. This is one of the key reasons why 2/3 of home improvement spend is nondiscretionary on repair or maintenance projects that cannot be delayed; third, consumer savings are near record highs, while disposable personal income remained strong. And more than 90% of homeowners either own their home or are locked into a low fixed mortgage insulating them from rising rates. On top of these 3 factors, there is a persistent 1.5 million to 2 million under supply of homes and 250,000 first-time millennial homebuyers are expected per year through 2025. This unique combination of factors is causing homeowners to trade up in place, preferring to invest in repairs and renovations to make their current homes meet their families evolving needs rather than buying a new home. And this is why we're so confident about the outlook for the home improvement industry even in a period of high inflation and rising interest rates because the key drivers of our business remain supportive. And with the investments that we've made to transform our business, we also have the operating agility needed to rapidly pivot if market conditions worsen. And we have a very experienced leadership team of home improvement veterans who have developed a proven playbook to respond to a slowdown. At the same time, we would not lose our focus on investing in long-term growth. Now before I close, I'd like to take a moment to discuss our recent announcement regarding our intention to sell our Canadian retail business to Sycamore Partners. Lowe's first entered Canada in 2007 and later expanded with the acquisition of RONA in 2016. Over the last few years, we focus on the retail fundamentals of our Canadian operations, which brought the Canadian business to profitability and improved its operating cash flows. However, for this business to achieve the profitability in line with the U.S. significant incremental capital investments would be required to streamline the banners and improve operating margins. By contrast, we have tremendous opportunity for continued market share and profitable growth in our U.S. home improvement business. This transaction will simplify our business model, improve our operating margins and return on invested capital while enabling us to deliver sustainable value to our shareholders. Brandon will provide details regarding the financial impact of the transaction later on the call. I would like to thank our entire Canadian team for their hard work and dedication to our customers, and we look forward to collaborating with Sycamore Partners and executing a seamless transition. I'd like to also extend my appreciation to our team in the U.S. for their ongoing commitment to serving customers and the communities. And with that, I'd like to turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. In the third quarter, U.S. comparable sales increase 3%, reflecting solid core home improvement demand across both Pro and DIY customers. This quarter, we drove positive comps in our building products and home decor divisions, fueled by momentum with the Pro and improve DIY demand. In hardlines, comps were down slightly as we cycled over significant storm prep activities in Louisiana from Hurricane Ida in 2021 and that did not repeat at the same scale when flu radiances prepared for Hurricane Ian in 2022.
Overall, growth was well balanced with 8 of our 15 merchandising departments above company average. Beginning with our home decor division, the fall nesting trends that Marvin mentioned led to standout performance across core interior categories, including appliances, paint, kitchens and bath and flooring. Appliance sales were bolstered by a strong Labor Day event and higher online sales as we continue to enhance our Lowes.com user experience. As an example, this quarter, we began displaying delivery dates earlier in the purchase process to highlight our improved next-day delivery options. If customer needed to quickly replace a refrigerator or washer that's just stopped working, this feature now helps them focus their attention to product that's immediately available. This is especially important for Lowe's as our appliance business is skewed toward replacement within existing homes versus new housing starts. As I mentioned last quarter, we also continue to see customers trading up for innovation, like with our new Maytag Pet Pro washer with technology that removes pet hair from clothes in the wash cycle, which is exclusive to Lowe's. This quarter, we also launched a new exclusive home center partnership with Miele, a global leader known for high-end premium appliances. This reflects our ongoing commitment to ensuring that we have new high-quality offerings across all price points with leading products from All-Star brands like Trex, DEWALT, Owens Corning, John Deere, EGO, Honda, KitchenAid, Samsung, LG, Kohler, Moen, Whirlpool, Husqvarna and Aaron's. Paint delivered strong positive comps this quarter across both Pro and DIY. Many of our Pros, especially those who focus on repair and remodel work, paint is part of their larger jobs. In other words, these are Pros who paint rather than professional painters. And these Pros are starting to see the value of our new MVPs Pro Paint Rewards Program paired with our expanded job site delivery for paint. These enhanced benefits and capabilities are making it more convenient and cost-effective for Pros to purchase their paint directly from Lowe's, earning us more of their business. In our continued partnership with Sherwin-Williams, we are also upgrading our paint departments across the U.S., including a new color wall that converts all HGTV colors to Sherwin-Williams colors, which resonates with both DIY and Pro customers. With our new color wall, we are bringing all the colors together so that customers can easily match their favorite Sherwin-Williams paint color at our paint desk. We are also resetting some categories to pull relevant, higher margin and more frequently purchased products closer to the front of the department, make it easier for customers to get everything they need for their paint project in one trip. We plan to have half of our stores converted to this new color wall by the end of this year and roll it out everywhere by the end of next year. We are very pleased with the progress we've made in this core category in just a few short years. We are gaining traction with both the Pro and DIY, and this recent update highlights just a few ways that we plan to continue to take market share in paint. We also had strong positive comps in kitchens and bath, largely driven by improved in-stocks for cabinets and customers opting to trade up for larger, higher quality in-stock cabinets versus waiting for custom orders. Within flooring, vinyl flooring once again led the way as busy homeowners returning to durable, low maintenance flooring options available in popular brands like Pergo and STAINMASTER. And we're gaining momentum across our private brand portfolio, especially in STAINMASTER, Origin 21, allen + roth and Cobalt as this is just another indication of the traction that we are gaining with our Total Home Strategy. Turning to our performance in building products division. We continue to see broad-based balanced growth across Pro and DIY in millwork, rough plumbing, electrical, lumber and building materials, driven by strong project-related demand. We are encouraged by the DIY strength that emerged in building products this quarter as lumber prices have come down DIY consumers are reengaging in home improvement projects, they had previously put on hold leading to double-digit lumber comps in the quarter. In our hardlines division, as lumber demand increased, so as demand for related attachments categories like fasteners, leading to our strong positive comps in hardware. We also continue to see a trend of customers investing in innovation. Our EGO battery now powers 75 different tools, everything from traditional outdoor power equipment like mowers, trimmers and leaf blowers to lifestyle products like camping generators and misting fans. And with the accelerated growth in battery-powered products that we're seeing, it's not surprising that EGO continues to lead the pack in battery-powered outdoor power equipment. Given the concerns in the marketplace, some of you have asked if we're seeing a shift away from discretionary purchases, which is what we typically expect to see in a softer macro environment. And the straightforward answer is no. We had a strong sell-through in Halloween this year with an early sell-out of our 12-foot Lighted Animated Mummy at a price point over $300. One could argue that this is one of the most discretionary items we sell. And with Halloween in total being a highly discretionary category, this continues to give us a positive indication of the strength of our consumer. We kicked off the holiday season with our trim and tree sets early in the quarter. We are seeing early sell-through on taller, higher-end artificial Christmas trees, which is another example of both discretionary purchasing and consumers trading up. Before I close, I'd like to thank our merchants, supply chain team and our vendor partners for their hard work and the continued partnership as they continue to provide our customers with the products that they need as we support our stores and communities in the recovery efforts from Hurricane Ian. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone. Let me begin with a heartfelt thank you to our associates. Our strong performance this quarter is a direct reflection of their hard work and dedication to providing excellent customer service. That's why we are so focused on becoming the employer of choice in retail where associates choose to stay to build their careers. At its core, that means providing good, stable jobs, comprehensive benefits, competitive wages and bonus opportunities.
As Marvin mentioned, this quarter, we announced $170 million in permanent wage increases and we are awarding $200 million in bonuses ahead of the holiday season for our frontline hourly associates. This translates to up to $1,000 for eligible full-time associates and up to $500 for eligible part-time associates. As someone who started my career as an hourly associate in home improvement, I understand how meaningful this type of financial recognition can be. Our executive leadership team is passionate about rewarding our associates and taking care of our customers, which is demonstrated in the investments we make in both our people and in the communities we serve. Another example of these investments in action is the transformation of our disaster response capabilities over the last few years, which dramatically improved our ability to support communities through devastating storms like Hurricane Ian. Year round, Lowe's now has a cross-functional command center dedicated to supporting our disaster response efforts. In fact, it was these enhanced capabilities that enabled us to respond so effectively to the pandemic. We also deploy our emergency response teams to the hardest hit areas. These associates volunteer to lead their home stores, giving their colleagues in the impacted areas, a chance to focus on their families, and we go a step further to help impacted associates by deploying refueling stations and our mobile disaster relief trailers with showers, washers, dryers and meals and offering financial assistance through our Lowe's employee relief fund. In addition to demonstrating the importance of our improved disaster response capabilities, Hurricane Ian also spotlighted the value of our expanded omnichannel fulfillment options. Earlier in the quarter, Lowe's rolled out same-day delivery nationwide with more than 1,700 stores now supported by Instacart. This partnership allows us to deliver over 30,000 items stocked in our stores that weigh up to 60 pounds to our customers. In the days leading up to the storm, we received thousands of these same-day orders to help customers prepare and protect their homes. Customers were able to get critical items they needed like water, sand, buckets and batteries without having to leave their homes, and it continues to be a helpful option for many who need supplies in the wake of the storm. And we continue to optimize our parcel network in Q3, another important step in our journey to enhance our omnichannel fulfillment capabilities. We rebalanced our network to ensure our parcel stores are optimally located close to shipping hubs, and we have upgraded our technology and hardware to support faster fulfillment. Ahead of the holidays, we are on track to meet our goal of decreasing shipping times by 50%. And these are just a few of many examples of our tenacious focus on perpetual productivity improvements or PPI that are scaling across our stores over time. Shifting to Pro, I would like to thank our Pro team for delivering outstanding results once again this quarter, driving Pro comps over 16% for the quarter and 36% on a 2-year basis. We are leveraging our new MVPs Pro Rewards and Partnership Program to capitalize on this continued demand by engaging Pros and incentivizing purchases and building long-term loyalty. Our program is laser-focused on helping Pros grow their business because we know that when Pros succeed, we succeed. This partnership-based approach is already paying off with higher-than-expected adoption rates and overwhelmingly positive feedback from our Pros. We recently asked all of our regional Vice Presidents to find Pros who do not want to sign up for our loyalty program so we can talk to them and understand why, but that proved to be a real challenge because once Pros hear the benefits, they are eager to join. So awareness and continued execution will be the key to our ongoing success. As I close, I would like to thank our associates once again for their commitment to Lowe's and our customers. Without them, the strong results that we delivered this quarter would not be possible. Now I'll turn it over to Brandon.
Brandon Sink:
Thank you, Joe. I would like to begin this morning by providing additional details regarding our recent announcement of our intention to sell our Canadian business. As Marvin mentioned, despite making meaningful progress in improving our Canadian retail business over the past few years, it has continued to lag our U.S. operations and sales growth, operating profit and return on invested capital. In fact, the Canadian business represents approximately 60 basis points of dilution on our full year operating margin outlook. And during the quarter, we recorded a pretax noncash impairment charge of $2.1 billion related to this business.
Looking ahead, this transaction makes us a U.S.-focused business and gives us a clear line of sight to meaningful long-term improvement of our sales productivity, operating margin and return on invested capital in particular. We are excited to share our updated financial targets at our upcoming Analyst and Investor Conference in December. Turning to our Q3 results. We generated GAAP diluted earnings per share of $0.25 compared to $2.73 last year. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. Excluding the $2.1 billion asset impairment charge, we generated adjusted diluted earnings per share of $3.27, an increase of 20% compared to third quarter of 2021. This increase was driven by a combination of top line growth, strong P&L management and disciplined capital allocation. Q3 sales were $23.5 billion with comparable sales up 2.2%. Comparable average ticket increased 8%, driven by product inflation, 80 basis points of commodity inflation and higher Pro sales. Of note, FX represented a 30-basis point headwind to consolidated comps. Higher average ticket was partly offset by comp transactions declining 5.8%. Of note, comp transactions have improved significantly as we move through the year with Q3 over 730 basis points higher than Q1 and 60 basis points higher than Q2. U.S. comp sales were up 3% in the quarter, while sales in Canada were down 10.2% in USD, with roughly half of the decline attributable to a stronger dollar. Pro sales were up 16% in the quarter, driven by broad-based strength across all categories. DIY sales trends improved from Q2 with strong performance across many core home improvement categories as consumers spent more time at home following summer travel activity. DIY project-related demand also increased sequentially due to lower lumber prices. On Lowes.com, sales increased 12% in the quarter partly driven by strong appliance sales. Finally, we estimate that the net effect of storm-related sales year-over-year was relatively flat as we cycled over Hurricane Ida in the prior year. Our U.S. monthly comps were up 4% in August, 3.4% in September and 1.4% in October. On a 3-year basis, U.S. comps increased 33.5% in August, 37.8% in September and 42.1% in October. Gross margin was 33.3% of sales in the third quarter, up 20 basis points from last year. Product margin rate was up 110 basis points versus the prior year as we cycled over a lumber margin pressure in the third quarter of 2021, which was triggered by a steep decline in prices that began last July. Higher product margin rate was partly offset by 30 basis points related to higher domestic and import transportation costs as well as the expansion of our supply chain network, along with 35 basis points of pressure from shrink. Adjusted SG&A of 18.7% of sales levered 41 basis points driven by higher sales and substantial improvement in productivity. Adjusted operating profit was $3 billion, up 7% versus the prior year. Operating margin rate of 12.71% of sales levered 54 basis points, driven by both higher gross margin and SG&A leverage. The adjusted effective tax rate was 24.5% below the prior year rate. Inventory ended the quarter at $19.8 billion, up $3.1 billion from the same quarter last year largely driven by product inflation and higher freight costs with units roughly flat to prior year. This morning, we are increasing our full year 2022 financial outlook based on stronger-than-expected flow-through year-to-date. Please note that our outlook for operating margin, diluted EPS and return on invested capital are all adjusted to exclude asset impairment and expected transaction costs associated with the sale of our Canadian retail business. We now expect 2022 sales of approximately $97 billion to $98 billion, representing comparable sales of flat to a decline of 1% as compared to prior year. Please note that at the midpoint of the range, this implies that fourth quarter comparable sales will be slightly positive. This reflects our expectations of continued strong Pro performance and steady DIY trends. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We continue to expect gross margin rate to be up slightly as compared to the prior year. As you look ahead to the fourth quarter, keep in mind that we are cycling over the second round of lumber inflation in 2021, which benefited product margins. We also expect continued shrink pressure next quarter. Given our disciplined focus on expense management, we now expect adjusted operating margin of approximately 13% for the full year. And we are raising our outlook for adjusted diluted earnings per share for the year from $13.10 to $13.60 to our updated range of $13.65 to $13.80. This reflects better-than-expected SG&A leverage as well as higher-than-planned share repurchase activity. We expect capital expenditures of up to $2 billion this year. Additionally, given our larger-than-expected $4.75 billion notes offering in Q3, we expect to accelerate share repurchase activity that we had originally planned for 2023 into this year. We now expect $13 billion in share repurchases in 2022. And finally, we are raising our outlook of adjusted return on invested capital to above 37% for the year. Now turning to our best-in-class capital allocation strategy. In Q3, the company generated $1.7 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned $4.7 billion to our shareholders. During the quarter, we repurchased 20.5 million shares for $4 billion. We also paid $666 million in dividends at $1.05 per share. Capital expenditures totaled $403 million in the quarter as we continue to focus on high-return projects that support our growth objectives. We ended the quarter at 2.5x adjusted debt to EBITDA and we are well on track to reach our target leverage of 2.75x in 2023 while also maintaining our BBB+ rating. Finally, we delivered return on invested capital of 27.6% inclusive of a 590 basis point impact related to the asset impairment recorded in the third quarter. In closing, I'm confident that we will continue to deliver shareholder value through our leading capital allocation strategy while investing in our associates and our business to drive long-term sustainable growth. And with that, we'll open it up for questions.
Operator:
[Operator Instructions]
And our first question today comes from the line of Simeon Gutman from Morgan Stanley.
Simeon Gutman:
Marvin, I wanted to maybe play devil's advocate for a second on housing. This idea that it's just taking a long time for all these pressures to catch up to the consumer in the segment. For all the reasons you cited, plus there's been some labor and product shortages. So curious how much you debate that and that there is a certain level of home price depreciation that's going to eventually weigh on this customer.
Marvin Ellison:
No, I appreciate the question. And here's what I would say. When we look at markets around the country where we saw an aggressive increase in home prices during the pandemic, now you can see some of those prices start to fall. Those markets are performing at the same rate of performance as other markets. So we're already seeing due to the life cycle of home price appreciation and home price declines around the U.S., signals of kind of what the broader macro may look like in months, quarters and years in the future.
The great thing about operating stores in every state and in virtually every ZIP code is that you have a pretty good sample size of kind of what's currently happened, but also what future trends may look like. And we're not trying to spend the data. I mean, trust me, we're looking at this every day like you are, but from a different vantage point, trying to understand demand patterns. But the reality still remains that home prices have appreciated at record levels, as I said in my prepared comments, on average, $330,000 per home. The facts are that homes are older than they've been since World War II. And 2/3 of our business is nondiscretionary because when your house get older, things break. That's just commonplace. The facts are that we have more personal disposable income today than we had before the pandemic. And that's primarily in the bank accounts of homeowners. And the fact we saw it was still 1.5 million to 2 million homes under current demand because of the lack of home building coming out of the financial crisis in 2008, 2009. So those are just facts. And when we look at and try to forecast our business, we have to ask one simple question. historically, what data points correlate closely to demand patterns for lows. And what I just outlined to you are the data points that correlate to demand patterns, and that's what we look at.
Simeon Gutman:
Yes. That's a fair point. I'll jump off of housing and maybe go back to the business. If you look at the things Lowe's can be doing better, and obviously, you're executing against all the plans that you put in place since you've joined. Does it involve higher CapEx, maybe reallocation of CapEx? Or is it mostly execution in process?
Marvin Ellison:
Well, I would say from a CapEx standpoint, we have no expectation to go above our current capital allocation dollar amount of roughly $2 billion per year. We'll have our investor conference next month, and I can just give you a little bit of a precursor. That's what the number is going to be for next year. So as we look at things that we still have to catch up, and I'll be very transparent, we're not where we want to be. We still have a supply chain transformation process that's underway, but we can get all that accomplished and stay within that $2 billion CapEx dollar amount.
We still have significant IT investments that we need to make. We made incredible improvement, but all those things also fall within that current allocation of CapEx. Bill is working to continue to improve merchandising and pricing systems. Again, those things are all mapped out. They're costed out, and we have a good understanding of it. And we feel like at $2 billion of CapEx will allow us to achieve all of these things. And again, we'll speak to those in more specificity next month in New York. But what I will say to you is, yes, are we working on execution? We are, but I can tell you right now, I couldn't be more pleased with our ability to execute at a high level and arguably the most difficult retail environment of our lifetimes. Anytime you could be a $100 billion company, and you can be so dependent on the global supply chain, and you can manage inventory with basically flat to negative units for the whole year as we have, that tells you that the degree of execution and collaboration is at a high level.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Your big competitor yesterday talked about seeing some early signs of deceleration in the business in areas like grills, are you seeing any of those similar signs? And separate what do you think drove the acceleration in October on a monthly -- on a 3-year monthly stack basis?
Marvin Ellison:
So Michael, I'll take the first part of that. I'll let Bill Boltz come in and provide some perspective. But when we look across all of our merchandising departments. We don't have any really red blinking lights of concern relative to certain categories, certain items, certain SKUs. Obviously, when you start to get into different times of the year, we're going to have performance changing based on customer demand.
So we didn't have an anticipation that grills would be a top-selling category in the third quarter. It tends not to be the same with patio. And as we spoke to a lot of detail last quarter, we do believe there was some degree of pull forward in some of these more seasonal discretionary categories. But we are not seeing anything that feels or looks like a trade down or consumer pullback. I mean, to the contrary, the third quarter was our best performing DIY quarter of the year. And that customer segment tends to be kind of the indicator for us on the overall health of our business. The Pro has been strong all year. And the good news is for the first time this year, we saw continued strength in Pro, and we saw sequential improvement in DIY. So that is something that gives us confidence that things are headed in the right direction. I'll let Bill talk about what performed well in the third quarter relative to product categories that really gave us a really strong 2- to 3-year stack for that mark.
William Boltz:
Yes. Thanks, Marvin. And Michael, I think just a couple of things. We see -- as we go into Q3, we see a shift away from a heavy reliance on seasonal like we do typically in Q2. Yet there was still some seasonal business to be had in Q3, and that helped us as the weather was favorable. We -- as I said in my prepared remarks, our building products business continued to perform well, and we continue to see strength really across all of our Pro-related categories. And then the shift to indoor, as you see, appliances, kitchen and bath, flooring, paint, those businesses, both on a DIY and the Pro side continue to do well. And then holiday with Halloween and then the early sets of our trim and tree categories were what we saw in Q3. And then our online business continued to perform well in Q3 as well.
Joseph McFarland:
Michael, this is Joe. I'll add just one additional point. And that's our new MVP Pro Rewards Program that we have been discussing. And so when I look at our adoption rates being way better than expected, the new Pro CRM platform and then just a combination of our strong credit offering along with Pro loyalty gives us a lot of confidence in that business as well.
Marvin Ellison:
Awesome.
Michael Lasser:
But my follow-up question is at the risk of pulling forward a little bit of your messaging from a couple of weeks now. Your SG&A dollars have been very well contained over the last few quarters, leading to the idea that maybe Lowe's doesn't have as much cushion in its cost structure in the event that there could be a downturn in home improvement demand, either because of housing or just a weakening labor market. Why is that wrong?
Marvin Ellison:
Well, I would say it's wrong based on the performance in Q1, just use that as your data point, the season broke late top line was not what we anticipated yet we still leverage operating margin for the quarter. We see that as an example of the levers that we now have in place to be agile. As I said in my prepared comments, we've got a lot of experience sitting around this table. There's very few things that we have not seen.
We have a really strong playbook developed. And we think that if the market turns more negative than we may anticipate, then we have the ability to pull those levers and perform really well. As a matter of fact, we're not giving you the details, Brandon is going to spend a bit of time next month at the investor conference outlined some of those levers and the agility we built so that we can be really, really swift to react to any market conditions.
Operator:
Your next question comes from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
Congratz. Nice quarter again. My first question, again, I don't want to have the risk of sign nitpick I mean given the strength in the business, and as Michael just pointed out in his question, the -- basically the 6 accelerating trends through Q3, and then you talked about the initial strength in seasonal with the Mummy sales. Why not lift sales guidance for the year, especially in a when you're lifting earnings guidance?
Marvin Ellison:
So I'll give you the philosophical perspective, and I'll let Brandon give you the financial perspective. As you know, Brian, there's a lot of unknown out there. And so we're not going to be overly bullish for no reason. You had a midterm election that still candidly hadn't been quite determined. You have aggressive action from the Fed. You have global geopolitical events happening. And so we're just being, what I'll describe as appropriately conservative. Do we have confidence in our business? Absolutely.
Do we have confidence in what we're going to deliver for the holiday season, you bet we do. And we think we have a great plan for the balance of this quarter and going into next year. But in an environment where there's so much concern in the macro. We just felt it was appropriate to just be conservative. So our decision not to live guidance has nothing to do with our lack of confidence. It's just more about being prudent and not being overly aggressive in an environment where there's a lot of on asset micro questions. So I'll let Brandon add some additional detail.
Brandon Sink:
Yes, Brian, this is Brandon. As I indicated in my prepared remarks, we looked at 3-year comps did see sequential improvement as we moved across the quarter. The Q3 exit rates were strong. Bill mentioned the improvement specifically in the interior DIY-related categories. The midpoint of our full year guide is flat to down 1%, which implies a slightly positive comp for Q4. And if you recall back in August, we were guiding actually to the bottom end of that range of flat to down 1%. I will cite that the commodity volatility and the impact Q3 to Q4.
With lumber where it is, we've actually seen a benefit of 80 basis points to comps in Q3. If the pricing runs out into Q4, we're expecting that to actually flip to a 90-basis point drag. So that's about 170 basis point swing. Again, that's taken where we are from a benchmark perspective of below about $500 and running that out and comparing that to where lumber prices inflated round 2 of last year. So all in, excluding lumber, and the differences I just cited, the Pro comp momentum is expected to continue and the DIY trends that Bill mentioned are expected to continue through Q4.
Brian Nagel:
That's very helpful. I appreciate the color there. Then my follow-up question, in separate topic. there is with regard to supply chain. So Marvin, you keep talk -- you highlighted that there's a lot of success that you've had in improving the low supply chain internally. By most measures, now the external environment for supply chain is getting better with shipping costs and such. So I guess the question, are you seeing that? And then recognizing you haven't given guidance yet for 2023, but to the extent these external supply chain issues continue to correct. Could that be a tailwind of some sort as we hit over the next several quarters?
Marvin Ellison:
Yes. Look, it's a great question, Brian. And without getting in front of what we're going to discuss next month, I would say that the short answer is, yes, there are elements of the supply chain that definitely will give us some cost advantages next year. Brandon is going to be very transparent and very detailed on kind of what we see going into next year.
And obviously, supply chain is going to be a big component of that. In addition to just the overall cost environment for supply chain, we're going to talk about strategic initiatives as well that we're excited about because as far as much work as we've done in supply chain, as I mentioned earlier, we still see it as one of our key opportunities to improve. There's not a great retailer in the world that doesn't have a great supply chain, and we're committed to having a great supply chain.
Operator:
Our next question comes from the line of Liz Suzuki with Bank of America.
Elizabeth Lane:
Just as you think about the makeup of comp going forward between transactions and average ticket. You mentioned that in some categories where you saw inflation moderate. You saw a subsequent increase in transactions. Does that give you confidence going forward that as inflation does start to moderate it will be -- that average ticket decline or lower growth rate would be offset by a pickup in transactions?
Brandon Sink:
Yes, Liz, this is Brandon. I think on the inflation front, we do continue to see high single-digit inflation this quarter, inclusive of about 80 basis points that I mentioned earlier of commodity inflation. Our consumer does continue to be resilient. We haven't seen any significant trade down. In fact, we've actually seen trade up in place across a number of categories.
And our Q4 forecast, which we're focused on at this point, we're expecting that to continue at the high single-digit mark. We are going to get some relief related to lumber pricing that I mentioned earlier, so that net 170 basis point swing. But for Q4, that's the forecast is that the inflation is going to continue to lift our ticket, which is going to be the primary driver of our comp and it's going to be offset by transactions being down in Q4.
Elizabeth Lane:
And then just looking out beyond Q4, as you think about the potential outlook for comps going forward and how that ticket versus transactions could play out. I mean, one of the pushbacks that we get is that if ticket remains -- if ticket starts to come down, but transactions remain negative, that would be a severe headwind to comp. I'm just curious how you're thinking about that outlook going forward.
Brandon Sink:
Yes, Liz, we're going to hold until December to really give you a deep view there. We'll have an updated view of the macro, the comp scenarios within that and specifically the makeup of our comp and we'll plan to go into details there on December 7.
Operator:
Our next question comes from the line of Zack Fadem with Wells Fargo.
Zachary Fadem:
So following up on the SG&A dollar question, as you've been able to take out a couple of hundred million of SG&A in both Q1 and Q2. And while Q3 was basically flat, it looks like your Q4 SG&A embeds a pretty notable step-up in trend, even excluding the extra week. So can you just help me understand the puts and takes on the SG&A line in a little bit more detail and perhaps talk through the impact of the efficiency initiatives? And then also to what extent you're able to flex up and down labor with the lower volumes today.
Marvin Ellison:
So Zack, I'll take the first part of that, and then I'll let Brandon and maybe, Joe, provide some additional detail. So for us, I think the key thing to understand is we have what we call PPI perpetual productivity improvement initiatives. And we're going to go into some level of detail on how this has become more of cultural process across the whole company at the investor conference next week. But specific to your question, we still believe that we have technology investments that we can make in the store environment specifically to where we can continue to drive SG&A leverage while improving customer service.
But it's easier to drive SG&A leverage, if you're just pulling payroll out indiscriminately. But what Joe and his team has done we've actually improved leverage in the store from an expense and payable standpoint and concurrently drove up customer service. And that's the key. And that's really all about technology investments. So we think that there's still additional initiatives on our project road map that will continue to give us those benefits. I'll let Brandon take the more financial part of your question and then if Joe can add something else about payroll and how we can adjust it rather quickly relative to the demands that we're seeing from the consumers in our stores.
Brandon Sink:
Yes, Zack, this is Brandon. The only thing I would add implied our SG&A is expected to lever in Q4. And just as a reminder, we are cycling an incentive payout from 2021 in Q4. But I would just add to what Marvin said, continuing to drive substantial PPI initiatives store tech modernization, front-end transformation, managing back office spend.
So we're really proud of the progress that we've made, as we mentioned earlier, expecting to significantly outperform from an EBIT standpoint even in declining sales for the full year. And we'll tell you more about what we have in store 2023 in December.
Marvin Ellison:
And Zack, I'm going to let Joe talk about the activity-based model that drives our payroll system in the stores. So you can get a sense that we just don't have a blanket approach. We generate payroll based on a number of transactions and footsteps, and we think that's the best way to look at it. So Joe, you can expound on that.
Joseph McFarland:
Yes. And so thanks, Marvin. What I'd tell you is with our labor system that we have implemented in the last few years, this is really detailed, is down to by store, by department, by day, by time of day, in addition, as you think back in the last several years, our 60-40 initiatives to align the associates with customers and then the tasking activities.
We've gone through a series of steps that continued pay go-forward dividends for us. And we have a lot of confidence in our ability to navigate to continue with the large investments we've been making. I think in 2023 will be a transformative year for us from an IT system standpoint and the ease of what we're doing.
Zachary Fadem:
Got it. Appreciate all the color there. And then, Marvin, you've mentioned in the past about 2/3 of your business is tied to repair and maintenance activity. And then the remaining 1/3 of your business, to what extent would you say those sales are tied to housing turnover or home price appreciation? And then considering the slowing in these housing metrics, how do you characterize the current demand environment for repair and maintenance activity, which is more stable and recurring versus sales that are perhaps more discretionary or bigger ticket in nature.
Marvin Ellison:
No. Zack, it's a fair question. What I will tell you is that we're seeing strength in both areas. So obviously, when you see 19% growth in Pro, 10 consecutive quarters of double-digit Pro growth, then that tells you that there's big ticket projects going on that are remodel in nature but are also what I would call upgrade in nature. We talked about trading up in place, and that is a phenomenon that we're seeing because the 1.5 million to 2 million shortages of homes in the high interest rate environment is just incentivizing homeowners to keep their low fixed rate and modify their existing home.
And so because of that, you're seeing a combination of older homes getting the maintenance and repair to falls in that 2/3. But then you see the other 1/3 to simply upgrading and improving the environment, a new kitchen, finishing the basement, a new bathroom, et cetera. And so we're seeing a combination of all of those things. And as Bill walked through the different merchandising department of performance. You can see it embedded in all of those different results.
Operator:
The next question comes from the line of Jonathan Matuszewski with Jefferies.
Jonathan Matuszewski:
Great. Great results. My first question is on inventory. It looks like the inventory sales spread widened a bit sequentially in 3Q. From our store check, it looks like your in-stock positions are the best they've been in years. So is it safe to say that the majority of that inventory increase year-over-year is tied to average unit cost? And on that topic, how should we think about inventory levels tracking at the end of 4Q? That's my first question.
Brandon Sink:
Yes. Jonathan, this is Brandon. So I would say inventory overall, we feel, is in a really solid position. Balance is up 19% and driven exclusively by product cost inflation and freight units are flat. As you mentioned, our in-stock rates continue to improve across all of our categories.
We're continuing to make investments in Pro specifically in those high demand SKUs. We feel like we got the right levels to support the expected demand that we see for Q4 and into '23. And in reference to Q4, we do expect the inventory to build over Q4 with early ordering, I think for springs consistent compared to pre-pandemic levels. We are seeing a bit of unpredictability in the supply chain due to the zero-COVID policy in China. But just also as a reminder, when we look at our seasonal businesses, specifically, we do start setting south and deep south in Q4, and then we're also maneuvering around Chinese New Year, which is the latter part of January. So it's going to be critical that we're in stock for spring, and we're making those decisions based on lead times and supplier health across each of our categories.
Jonathan Matuszewski:
That's really helpful. And then a quick big picture question on Pro for you, Marvin. Lowe's continues to have great traction there. It looks like the multiyear comp held up this quarter at 36%. So when you think about the recent share gains with the Pro, curious if the drivers have evolved at all. If you could talk through how much new Pro customer acquisition has been driving Pro sales versus greater wallet share from existing Pros? That would be great, and whether you're seeing any change in those 2 drivers?
Marvin Ellison:
Thank you for the question. We don't give a lot of external information on number of new customers down to that level of specificity. But what I will tell you is that our new loyalty program is absolutely driving new Pro customers and it's driving more return visits of existing customers, which is exactly what we wanted. And a key data point is this, when a Pro customer is enrolled in our Pro Rewards platform and credit, they shop 3x more.
So that is the key data point. And so in Joe's scripted comments, he talked about the adoption rate and how it really comes down to our ability to engage the Pro. And when we engage them and educate them, they tend to adopt the program. So I'll let Joe provide a little bit more context on Pro. But we're really pleased with the progress and equally pleased that we saw the DIY customer come back strong in third quarter than we've seen them all year.
Joseph McFarland:
Jonathan, and then just a couple of things to add. First off, our Pro team here at Lowe's is just full of deep experience inside sales, outside sales, and they've done a really nice job. And so we're still in the early stages of the MVPs Pro Program, but very, very pleased with the adoption that we're seeing. So we've spoken a little bit in the past about our Pro CRM platform. So we have the ability to better anticipate Pro's needs and drive sales.
And then this really does a nice job of what we call leveling the playing field so that every Pro is important and has the ability to earn points no matter what the size. And so things like purchase-based offers, then completing different actions to deepen their relationship with Lowe's. And so we'll continue pressing forward here, but very pleased with the Pro progress.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you at our Analyst and Investor Conference on December 7.
Operator:
Thank you. This concludes the Lowe's Third Quarter 2022 Earnings Call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2022 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations. Please go ahead.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. In the second quarter, our total company comparable sales declined 0.3%, while U.S. comps increased 0.2%. For the quarter, Pro sales remained strong. In fact, this is the ninth consecutive quarter that we've driven double-digit Pro growth. As a reminder, at Lowe's, 75% of our sales are driven by the DIY customer while 25% of our sales is from the Pro. And while underlying home improvement trends remain strong, our DIY sales were lower than expected in the second quarter and the first half of the year.
As I mentioned on our previous call, the timing of spring disproportionately impacts DIY sales as many seasonal categories like lawn and garden are heavily concentrated in DIY. In addition to spring arriving late, it also ended early, quickly moving from a cold winter to a hot summer in some regions. This showed in the planting season and pressured lawn and garden sales. Also, while we plan for a modest sector pullback this year as we lap outsized DIY consumer demand, we now believe that certain categories like patio and grills are disproportionately impacted by the unprecedented demand from 2020 and 2021. This unprecedented demand was likely fueled by the combination of 3 rounds of government stimulus, an increase in consumer savings rate and a temporary shift away from spending on services towards spending on goods, including home improvement products. These factors drove more discretionary purchases over the past 2 years than it was possible to precisely measure at the time. And some of you have asked whether we're seeing consumers trade down in their purchase activity. At this point, we are not seeing indications of material trade down. If anything, we're seeing the opposite with continued strong demand for our new and innovative products at higher price points. Bill will provide more context on our customer spending trends later in the call. To summarize, our DIY trends, despite slower sales in select discretionary categories like patios and grills, the DIY customer remains resilient, which reflects continued strong home improvement demand trends. Now turning to Pro. We continue to outperform the market, delivering growth of 13% and 37% on a 2-year basis. We're particularly pleased with the momentum we're seeing with our Pro loyalty program, MVP's Pro Rewards, which is designed to make every Pro feel like an MVP regardless of the size of their business. Because time is money for Pros, one of the most valuable ways that we can serve them is by saving them time with enhanced fulfillment. Therefore, we are actively piloting convenient fulfillment options, including a new Pro fulfillment center in Charlotte, and gig network solutions that offer same-day delivery for both Pro and DIY. Joe will provide a further update on our strategic initiatives to improve Pro penetration later on the call. On Lowes.com, sales grew 7% this quarter, representing a sales penetration of nearly 10%. We're continuing to invest in omnichannel capabilities because we believe there is still tremendous runway for further growth ahead. In Canada, Q2 performance lagged the U.S. And as a reminder, because our Canadian business is more heavily weighted towards lumber, it disproportionately benefited from record high lumber prices last year. Let me now discuss our operating performance for the second quarter. I'm particularly pleased with the operating discipline that we've developed across our business, which is demonstrated by our ability to improve operating margin once again despite lower sales. During the quarter, operating margin expanded 12 basis points, and we delivered diluted earnings per share of $4.67, which is an increase of nearly 10% versus last year. The progress also reflects our team's disciplined focus on our perpetual productivity initiatives or PPI. Not only did PPI support our first half operating margin improvement, it will also help to drive operating leverage for the balance of the year and for the next several years. Joe will discuss the success of our PPI initiatives in more detail later in the call. Now I'd like to address some concerns that I've heard from our shareholders about the home improvement market. I want to begin by clarifying that the market dynamics that pressure the home builder are not necessarily the same market dynamics that pressure the home improvement retailer. At Lowe's, the 3 highest correlating factors of home improvement demand are home price appreciation, the age of the housing stock and disposable personal income. While housing turnover is important, it does not index at the same rate as home price appreciation, housing age and disposable personal income. And while we acknowledge that housing turnover has slowed, home prices and home equity remains at record highs, which gives customers confidence that they will get a return on the investment that they make in their homes. And also importantly, those homes keep getting older. More than half of the homes in the U.S. are over 40 years old and millions more built at the peak of the housing boom in the early 2000s are now starting to turn 20 years old, which is a key inflection point for big-ticket repairs. In terms of disposable personal income, household wealth is still at an all-time high. Consumer savings are roughly $2.6 trillion higher than they were pre-pandemic. And 75% of that excess savings is concentrated in middle- and high-income households who are more likely to be homeowners, which highlights another key benefit of our industry, our core customer is the homeowner. In addition to having significantly more disposable income, most homeowners are benefiting from lower fixed mortgage rates. And as low housing supply and high interest rates make moving less desirable, homeowners are motivated to invest in their current homes to fit their needs. This is one of the key reasons that home improvement can win in markets when housing turnover is strong and when it slows as we saw in the mid-1990s when home improvement spend grew despite rising interest rates and a slowdown in housing turnover. Now shifting to trends in Pro. We continuously survey our Pros and their confidence in their job prospects is the highest it's been in years. The Pro is busier than ever, and the strength of the Pro backlog speaks to the significant pent-up demand for their services. In short, we are fortunate to operate in this retail sector and despite the macro uncertainty and unprecedented seasonal demand in the past 2 years, our long-term outlook for the home improvement industry and the Pro customer remains positive. As I close, I would like to personally thank our associates for their hard work and dedication. In recognition of some of the cost pressures they are facing due to high inflation, we are providing an incremental $55 million in bonuses to our hourly frontline associates this quarter. These associates have the most important jobs in our company, and we deeply appreciate everything they do to serve our customers to deliver a best-in-class experience. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. In the second quarter, U.S. comparable sales were up 0.2%. I'd like to walk you through the trends that we are seeing in the business, beginning with our DIY results. As Marvin mentioned, we had a short spring moving directly from winter to summer in many areas of the country, impacting demand for outdoor garden products like fertilizer, chemicals and live nursery. After 2 years of outsized growth in home-related sales, we plan for sales to slow in certain categories this year. And our disciplined planning process enabled us to mitigate many of the inventory pressures you're seeing across the retail industry.
But certain categories were still down more than expected, like patio furniture and outdoor grills, which is consistent with trends across the broader market. But even within patio, our newly designed Origin 21 items sold out first in most stores, like our exclusive Brennfield egg chair that retailed at $628. Another interesting trend from the quarter is the ongoing demand for innovation, reflecting underlying consumer strength. Rather than seeing trade down, in many cases, we are seeing customers trade up, spending more to purchase the latest technology like battery-powered products available in the EGO, Kobalt, CRAFTSMAN and Skill brands. In fact, one of our top-performing products this quarter was an EGO 56-volt self-propelled mower that retailed for over $700. This unit dramatically outperformed our sales forecast despite being one of the most expensive battery mowers in our assortment, proven what we have said before that value doesn't have to be low priced. In Refrigeration, we continue to see consumers trade up to higher-priced products in brands like KitchenAid, Samsung and LG, with features and benefits that serve a busy family's lifestyle. And while client sales were below our expectations, we continue to take incremental share and lead the market as the #1 appliance retailer in the U.S. We also continue to source new products that make projects easier for our DIY savvy customers, like our expanded STAINMASTER lineup, including laminate flooring, sheet vinyl and tile, which are getting overwhelmingly positive customer feedback due to how easy they are to install and keep clean. Or how about our new build-in Batten product, a Lowe's exclusive? This new pre-sized and miter molding makes it easy and cost-effective for the do-it-yourself or to do highly intricate designs like wanes coating. And for the Pro, it saves them time on these jobs as well. Customers can transform a wall in a day for less than $300. And across the store and within each of our merchandising categories, we offer value at all price points and feature leading products from our all-star brands like Trex, Owens Corning, John Deere, EGO, Honda, KitchenAid, Samsung, LG, Kohler, Moen, Whirlpool, Husqvarna and Aaron's. Shifting gears now to our Pro customer, we delivered broad-based and strong results with positive comps across rough plumbing, building materials, paint, electrical, millwork and hardware. We are pleased with the traction that we are making with this important customer and we continue to optimize our Pro assortments to ensure we offer the products Pros need from the brands that they know and trust. This quarter, we launched Eden Creek, a liquid additive that improves the quality, durability and sustainability of concrete projects. We also launched the new stack lithium battery technology in our line of FLEX cordless power tools, making Lowe's now the only destination to have this new battery technology available in both FLEX and DEWALT, which brings more power in a smaller package. And in millwork, we also were the first to market with our own reliable stock exterior black trim vinyl window, an increasingly popular trend to give homes a more premium look, with some Pros even buying pallets of these products before they even hit our shelves. We also added JELD-WEN prefinished interior doors, which come pre-painted from the factory, saving Pros the time and expense required to paint the door. These additions have further strengthened our portfolio of trusted programs like Bosch, Crescent, DEWALT, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner. In our lumber business, comps declined modestly as we cycled over record high prices in the previous year. However, unit volumes were up significantly year-over-year, which reflects the strong underlying project demand. Turning now to Lowes.com, sales grew 7%, building on top of the tremendous growth we have seen over the past few years. We continue to invest in the online user experience by expanding and enhancing our assortments, building out and improving our visualizer and configurator tools, and enhancing the delivery experience to make it easier for our customers to track their orders. As I close, I'd like to thank my entire merchandising team, along with our finance, inventory and supply chain teams for their disciplined inventory management and planning process in a complex retail environment. And lastly, I'd also like to thank our vendor partners for their continued partnership and hard work to ensure our customers have the products they need for every home improvement project they tackle. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thank you, Bill, and good morning, everyone.
Let me begin by expressing my appreciation for our associates. They delivered strong customer service and profitability this quarter due to their commitment to our perpetual productivity improvement initiatives or PPI. Over the first half of the year, we have made meaningful strides. I'd like to spend some time now discussing what we are focused on for the remainder of 2022, including how we continue to simplify our store processes. Earlier this year, we launched what we call Project Simple in our stores, one of our many PPI initiatives with a focus on further reducing daily duplicative tasks that distract from customer service and drive needless expense. In fact, as we continue rolling out Project Simple, we expect that it will eliminate over 80 nonproductive hours per store per week in the second half. In February, I discussed the launch of our game-changing, new store inventory management system, or SIMS. While we are just 6 months into the implementation, we are already seeing strong results. With the improved inventory visibility, we are reducing nonproductive hours the associates spend searching for product while also improving the customer shopping experience, in-store and online. And in the second half, we will leverage SIMS for an exciting new feature, prescriptive pack down. This new process will provide specific downstocking instructions to our associates based on sell-through rates. So they know whether the product needs to go directly on to the shelf or the end cap bypassing the top stock altogether. This drives a more efficient, proactive replenishment and inventory planning process. As these examples illustrate, PPI is not a static set of initiatives that will expire at a predetermined date. PPI's perpetual process of ongoing initiatives that will continue to deliver productivity, not only in the second half, but for many quarters to come. Now shifting our focus to the Pro. We continue to deliver incredible results with Pro comps of over 13% in the quarter. In fact, this is the ninth quarter in a row that we have driven double-digit Pro comps. Even in a quarter that is traditionally our most DIY-heavy, we saw Pro penetration of over 23% in the U.S., an increase of over 500 basis points from 2019. And we are further enhancing our Pro offering with our new MVPs Pro Rewards and Partnership Program. This Pro loyalty program launched in the first quarter, and it continues to outperform our expectations. In July, we launched MVP's Bonus Points in conjunction with our first-ever Lowe's MVP bonus days event with a focus on the products that Pros use every day. Pros earn extra bonus points on our leading brands such as DEWALT, Valspar, FLEX, Metabo, A.O. Smith and Frigidaire. Our Pros can redeem their points for other products or gift cards in the MVP Pro Reward Center. It is their choice, and we made it easy for all Pros to benefit. As our MVP's Pro Rewards program continues to mature in the second half, we are excited to present our Pros with compelling offers that will be tailored just for them. Before I close, let me discuss the investments that we are making in our most important asset, our associates, as we strive to become the employer of choice in retail. We recently announced expanded scheduling options for our full-time associates. Most full-time associates can now request a fixed 4-day work week, fixed days off or even choose their preferred shift providing them with predictability on their terms. This is a significant improvement in our associates' quality of life, and it is another way that we are differentiating ourselves from other retailers. As Marvin mentioned, to help our frontline hourly associates during this period of high inflation, we are awarding an incremental bonus of $55 million. Also for a designated time frame, we are providing our associates with an additional 10% discount on everyday household and cleaning items. Associates can now purchase these products at a 20% discount, which we hope will ease the burden of inflation impacting many of these items. We will continue to look for meaningful ways to improve our associates work-life balance, while providing them with the tools to build a career at Lowe's. I would like to thank our associates once again for their commitment to Lowe's and to our customers. Now I'll turn the call over to Brandon.
Brandon Sink:
Thank you, Joe. Let me begin with our Q2 results. We delivered diluted earnings per share of $4.67, an increase of 9.9% compared to prior year as we drove productivity in a dynamic operating environment. Q2 sales were $27.5 billion, with comparable sales down 0.3%. Comparable average ticket increased 6.1% as higher Pro sales and product inflation drove higher average ticket. This was offset by comp transactions declining 6.4% as we cycle over 2 years of outsized growth in DIY sales.
Comp transactions improved over 650 basis points sequentially from Q1. U.S. comp sales were up 0.2% in the quarter. Our sales were impacted by the shortened spring season, lower demand in certain DIY discretionary categories and lower-than-expected lumber prices. This was partially offset by a 13% increase in Pro customer sales. On Lowes.com, sales increased 7% in the quarter. Our U.S. monthly comps were down 1.5% in May, up 0.9% in June and up 1.1% in July. Gross margin was 33.24% of sales in the second quarter, down 54 basis points from last year. This is consistent with the expectations that we discussed in May. As expected, product margin rate was down 35 basis points versus the prior year. Lumber prices declined significantly from late April through mid-June. As we sold through our higher-cost inventory layers, product margin rate was pressured. Higher transportation costs, both import and domestic as well as the expansion of our supply chain network, also drove 35 basis points of pressure. Additionally, we experienced 10 basis points of shrink pressure largely due to live goods damaged by unseasonable weather. These impacts were partly offset by 30 basis points related to more favorable product mix. Despite the product cost pressures in the quarter, gross margin for the first half was up slightly compared to the first half of 2021. This reflected our ability to effectively navigate a volatile lumber market over the first half of the year as well as product cost inflation. I'm very pleased with the strong cross-functional collaboration from the teams as well as our diligent planning efforts. SG&A of 16.22% levered 80 basis points relative to Q2 2021. We drove substantial productivity across the enterprise in the quarter against slightly lower sales. Operating profit was $4.2 billion, up slightly versus the prior year. Operating margin rate of 15.39% of sales levered 12 basis points as SG&A leverage was partly offset by lower gross margin rate. The effective tax rate was 24.5%, in line with prior year. Inventory ended the quarter at $19.3 billion, up $2 billion or 11.6% from Q2 last year driven by product cost inflation of 15%, while units were down low single digits. This morning, we are affirming our full year 2022 financial outlook. We now expect that our 2022 sales will be near the bottom of our range of approximately $97 billion to $99 billion for the year, representing comparable sales towards the bottom end of the range of down 1% to up 1% for the year. This reflects our first half results and our second half expectations of continued Pro momentum and improving DIY sales trends. We continue to expect Pro to outperform DIY for the remainder of the year. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We continue to expect gross margin rate to be up slightly as compared to the prior year. Given our better-than-expected flow-through in the first half, we now expect operating margin to be at the top end of our range of 12.8% to 13% for the full year. Our ability to lever gross margin and SG&A despite lower-than-expected sales reflects the company's focus, hard work and effective investments over the last several years. Taking all of this into consideration, we now expect diluted earnings per share for the year to be at the top end of the range of $13.10 to $13.60. At Lowe's, we remain committed to our best-in-class capital allocation strategy. For 2022, we continue to expect approximately $2 billion in capital expenditures and $12 billion in share repurchases. Finally, we are affirming our outlook of return on invested capital above 36% for the year. Turning to our shareholder-focused capital allocation strategy. In Q2, the company generated $2.7 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned $4.5 billion to our shareholders. During the quarter, we repurchased 21.6 million shares for $4 billion. We also paid $524 million in dividends at $0.80 per share and we announced a 31% increase to $1.05 per share in support of our 35% target dividend payout ratio. Capital expenditures totaled $344 million in the quarter as we invest in the business to support our strategic growth initiatives. We continue to make progress towards our target of 2.75x adjusted debt-to-EBITDAR, ending the quarter at 2.23x, and we remain committed to maintaining our BBB+ rating. Finally, we delivered return on invested capital of 34.5% in the quarter, up 548 basis points versus last year. As I look ahead, I'm highly confident that we are making the right investments in our people and capabilities to support our business and drive meaningful long-term shareholder value. And with that, we will open it up for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is DIY comps are negative and units are down. the units appear to be bottoming or still decelerating. And do you have a view if we rebaseline this year or there's more to go in '23?
Brandon Sink:
Yes. So, Simeon, this is Brandon. Just as we look at DIY specifically, the business was heavily weighted to DIY seasonal in the first half of the year, I think, underperformed a bit just due to the weather, the pull forward that we mentioned in patio and grills. Second half of the year, transitioning more to the core the interior of the store. And in particular, post-July 4, over the last 6 weeks, we've seen continued momentum building in these categories.
We've seen a clear step-change in the business, 1- to 3-year comps improving, again, in particular, in Pro and core interior. And then I'll point back to transactions, Q1, Simeon, down 13. We saw improvement in Q2 down 6. So we like the momentum we're seeing and optimistic around the step-changes again that we're seeing in the second half.
Marvin Ellison:
Simeon, this is Marvin. I think it's important to note that when you look at the first half of the year, the first half is obviously more seasonal. And so we had weather impacts that drove a lot of our negative units, if you think about outdoor lawn and garden, chemicals, et cetera. And then if you think about what we talked about the unprecedented demand we saw in the last couple of years in some of these DIY discretionary categories, specifically, patio and grills. We're not going to experience the seasonality of the business in the second half of the year, and we're not going to experience that unprecedented overlap in those 2 highly seasonal discretionary categories.
Simeon Gutman:
And maybe, Marvin, if I can ask you a follow-up. I know we have this Analyst Day later in the year, and you're coming off of a couple of years of historic top line growth, and you've been able to get to margin goals much faster. Do you sense or do you feel that these gains keep going as long as sales productivity keeps rising? Or do you feel like there's any part of you that says, "Hey, we could pause, reinvest and then we can even drive faster growth in the out years?
Marvin Ellison:
Simeon, it's a really good question. I think it depends on the financial category. So I'll remind you that home improvement is a $900 billion marketplace. And I think it's easy to just focus on the 2 largest players and determine the overall market share gain just based on that, but this is a really fragmented marketplace. So on the revenue side, we absolutely believe that we have an incredible wrong way to continue to grow, just focus specifically on the fact that our Pro penetration is hovering around 23% to 25%. And we know we can get that number significantly higher.
Now the good news is, as Joe mentioned, is increased 500 basis points since 2019. So on the sales revenue side, we think we have an incredible opportunity to continue to grow. On operating margin, I mean, we said consistently that 12% was not a plateau. It was a baseline. Now we're going to say the same thing about 13%. We think when we hit that plateau, it's just going to be another baseline that we can continue to grow from. Joe talked about the importance of our PPI initiatives that is not a static list, but this is something that we see benefit in future quarters and candidly future years. So in both those areas, we think that we have room to grow, and we look forward to providing a very detailed outlook at the December conference.
Operator:
Next question comes from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
We wondered if you could talk a little bit more about your inventory composition cost per unit versus units. And then this inventory seem to be lower than your competitor. Just what is your view on current in-stocks? And are you chasing any categories?
Marvin Ellison:
So, Kate, I'll take the first part of that, and I'll let Brandon and Bill jump in. I would say, first and foremost, I am extremely pleased with the disciplined collaboration and planning that's taken place to put us in a really good inventory position vis-a-vis the retail industry. Any time you could have units declining in this environment with supply chain constraints and just incredible difficulties in forecasting, it points to a lot of hard work.
So the headline is we feel really good about our current inventory position, and we feel good about our in-stock position in the second half of the year versus last year. So I'm going to let Brandon talk a little bit about the financial expression and I'll let Bill talk about where we are and where we feel like that we're in a much better position versus what we've been in past years and past quarters.
Brandon Sink:
Kate, this is Brandon. The only thing I would add in the prepared remarks, we talked about units being down. I think it has allowed us to make the needed investments, in particular, in the Pro space as we've seen momentum there. To continue to support demand, we've had improved in-stocks and in certain areas that we struggled a bit through the pandemic. So as Marvin said, really pleased where we are from an inventory position.
We're managing seasonal, just like we would every year. In-stock levels are better than they've been here over the last 2.5 years. And any expected exit of seasonal fully included in the margin expectations that we have for second half.
William Boltz:
And Brandon, the only thing I would add is that the quality level of the inventory is good, although there are still categories across the store that we want to see improvements in. And so we're continuing to work with our vendor partners to do that, working with our supply chain teams in order to expedite that product to the store into the shelf and the teams are working on those. And -- but the quality level of inventory this year versus last year is dramatically better than it's been.
Operator:
Our next question is from the line of Peter Benedict with Baird.
Peter Benedict:
First question, just like the operating agility you guys have shown has been impressive, clearly. How do you ensure you're not sacrificing service levels as you manage these SG&A dollars? Any metrics that you can share that maybe give you confidence that service levels in the stores are still holding up?
Marvin Ellison:
Peter, it's a really good question. Obviously, we pay very close attention to what we describe as service levels versus as task levels. And the thing that Joe and the store operators have done an incredible job is investing in service while taking hours away from tasks. So when you see that SG&A leverage, it's not like the old days where you just kind of rip payroll out and you risk service.
What Joe and his team have done a masterful job of is pulling hours away from non-customer-facing parts of the store, taking some of those dollars to the bottom line, but then reinvesting dollars on the service side. So I'll let Joe give you some specifics. But the headline is likelihood to recommend up for both DIY and Pro in the quarter with SG&A leverage, and that is not easy to do. So, Joe, you could provide some detail.
Joseph McFarland:
Thanks, Marvin. And listen, I think it goes back to the focus that we've had on our associates. And again, with the PPI initiatives, we're moving unnecessary daunting tasks replacing them with technology and just enabling the associates' time on the floor to be more productive. We've done things, the flexible scheduling. We've talked many times in the past about our new labor management engine. And so as we continue moving forward, we measure every single day, every single week, and we're very pleased with the progress we've made both in the operational expense and the customer experience.
Peter Benedict:
That's helpful. That's great. And then just I guess -- next question would just be around what kind of metrics do you guys watch internally that would maybe signal to you, maybe a softening of demand, whether it be Pro or DIY relative to trend? Are there any categories? Are there any behaviors? I know you're watching it constantly. But just curious kind of what you have your eyes on as you kind of navigate this volatile environment.
Marvin Ellison:
Look, as you can imagine, there are quite a few things that we look at. And I think the thing that I'm most pleased with, when I look around the table of my team is there's a lot of experience, a lot of people who live through quite a few different iterations of macro slowdowns in the home improvement space. So we have some pretty effective playbooks on the merchandising side, on the store operations side, on managing cost and inventory. I think it's one of the reasons why we've demonstrated quite a bit of agility in some of these unique times. Having said that, I'll let Brandon give you a little bit of the things that we look at just to make sure that we have our finger on the pause of the health of the business.
Brandon Sink:
Yes, Peter, I would just call out just in this dynamic environment, I think really important for us to look at unit trends in particular. So between the merchant teams, the finance teams, week in, week out, we're down at a very detailed category assortment level. We're looking at 1-, 2- and 3-year trends and what -- how much of the business is being driven by inflation, ticket, the offset, how much we're driving in terms of units and demand. We've mentioned some of these categories in seasonal where we've seen units get back to pre-pandemic levels. We talked about patio and grills.
So starting to understand and get comfortable and the flip side is we're seeing great unit growth in other areas like the Pro business that we want to continue to feed. So looking across the assortment, looking at those impacts, how that impacts inventory replenishment ordering and the drivers of the business teams are really focused on that.
Operator:
Our next question comes from the line of Steven Forbes with Guggenheim Securities.
Steven Forbes:
I wanted to start with the Pro. So, Marvin or Joe, you mentioned Lowe's MVP loyalty program, and I realize it's new, but curious if you can note what tier the majority of Pros sit in today and whether you saw any sort of early signs of Pros tiering up during the quarter as we look out to the back half?
Marvin Ellison:
Steve, so let me just -- I'm not going to answer that question specifically, let me say that first. So but I'll give you just some thoughts on the Pro loyalty program. We talked about the 13% comp growth in Pro and 37% growth on a 2-year basis. And we think that the foundation of what's driving that is really monetizing the investments we've already made from a service, staffing and technology.
I think the second reason why you're seeing growth is the investments in brand that Bill talked about in his prepared comments and that's an ongoing process. Fulfillment is improved as a third kind of component of improvement. And we know that we have work to do to continue to make fulfillment easier for our Pro customers. And that's one of the things that, as I mentioned, that we're piloting a fulfillment center gig network, and we're excited about the possibilities. And then the last foundational point is what you asked is loyalty. And we think our new MVP program is incredibly successful in the early stages. And so how do I define that? Customers that are engaged in Pro loyalty and credit spend 3x more than Pros that don't. I mean, to me, that's the key metric that we look at. Do we understand the level of Pros that's tiering up we do, we don't want to discuss that externally. But what I will tell you is all the events that we've launched this year, leveraging points and Pro loyalty have exceeded our expectations, and we have a lot more to come. And we'll provide some level of granularity in the future, but it's too early to share it externally, but I will tell you that we're pleased with the progress.
Steven Forbes:
I appreciate the color, Marvin. And then maybe just a quick follow-up for Brandon. Based on the gross margin guidance, it sort of implies a relatively flattish outlook for the back half. Clearly, we got the supply chain build-out and transportation cost pressure. So maybe there's any help on the offset if it's from mix or just product margin strength?
Brandon Sink:
Yes. We have -- we feel like we have a pretty good handle on the gross margin drivers of the business here over the second half. We expect modest product margin improvement, as you mentioned, offset by higher supply chain costs. That's inclusive of distribution, transportation. We mentioned the drag in Q2 and the expanded network. Shrink credit, fairly neutral as we look across the second half as it relates to other contributors to margin. So full year unchanged as it relates to guiding to slightly up from a gross margin standpoint. We feel really, really good about our ability to deliver that.
Operator:
Our next question is from the line of Scot Ciccarelli with Truist Securities.
Scot Ciccarelli:
So another DIY question. I know you bounced around this a little bit, but we -- the cycling of stimulus, the short spring season, that all makes sense as reasons why DIY would be negative. And I know this is an opinion, but I guess the question is, what gives you confidence that the softer trends you've seen in DIY over the last few months, isn't the beginning of the slowdown following several years of accelerated demand?
Marvin Ellison:
It's a fair question. So, Scot, I'll take the first part, and I'll let Brandon provide some context. So when you look at DIY and you look at the first half, I think it's important to understand that a lot of the negative impacts have been relatively isolated in discretionary categories. We talked a lot about patio and grills. But candidly, for the last 2 or 3 years with the lack of mobility that we've all had and the amount of time we spend at home, once you make an investment for patio furniture and grill is really not an overriding demand to do it again a year or 2 later, and we understand that.
And also, we talked quite a bit about the shortened weather season of spring and how that put a lot of pressure on lawn and garden outside categories, and that's almost exclusively for us, DIY-specific. So when we try to put in characterization, what drove the DIY slowness in the first half, we can be very specific on that. But as we look at the back half, we know that a shift is coming based on our business trends. And I'll let Brandon just provide a little context on the trends we are seeing. And when we look to the interior of the store, what we believe will happen in the back half of the year.
Brandon Sink:
Yes. So, Scot, I think confidence, just given the first half isolated impacts that Marvin called out around the weather, the DIY discretionary, I mentioned earlier just momentum that we're seeing in the business, in particular, post-July 4 and again, looking at 1-year and 3-year comps, clear step-change that we're seeing in the business there. And then I think last, just as we look at the second half and really the structural sort of setup of the business, it's less seasonal. It's definitely interior-focused as we get into the core categories. And we think that, just coupled with the momentum, again, that we're seeing with the Pro, we feel like that plays really well when we look at the second half outlook that we have on the business.
Joseph McFarland:
Yes, Scot, just add one thing to that. So in a recessionary environment, as you look at the DIY, that tends to shift more to the repair categories versus the big ticket. And so there's a lot of indicators out there that we watch on a very regular basis.
Operator:
Next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
You lowered the comp outlook to the lower end of the range, but articulated the view that your earnings will be at the high end of the range, how low could your comps be in the back half of the year and you still hit the EPS guidance for the full year?
Brandon Sink:
Yes. So, Michael, this is Brandon. I would just tell you, we're very focused on delivering what the most likely scenario that we have with the business, which is updated in our outlook. So we're looking at top line being down 1%. We're really confident given the ability to manage gross margin, the step-up that we're seeing with SG&A leverage and how that's translating to profit expansion and EPS. Confident in that scenario, confident delivering on what we have in the guide. And that's where we are at this point in time.
Marvin Ellison:
And Michael, this is Marvin. The thing that we often talk about internally is that expense is typically relative to sales and expense as a percent of sales and percent of revenue. And so we have proven that we have levers that we can pull so that we can ensure that as revenue goes down, then we can, at the same point, bring our rate of expense down. And that's something that we feel very confident in our ability to deliver upon. And I think Q1 and Q2 of this year should represent that.
Michael Lasser:
Okay. And my follow-up question is on the nature of where sales stands today versus where they were in 2019. Marvin called out patio furniture and grills as categories that have been well above the trend line in demand. Seasonal and outdoor is about 20 -- excuse me, 10% of the business. Appliances and Other 10% to 15% of the business. Is that the right way to think about the risk of those sales being kind of over-earning from the last couple of years? And how much risk is there that this above trend performance in those categories start to leak into other areas of the business, lighting, flooring, other areas that could be more episodic in nature?
Marvin Ellison:
Michael, it's a really good question. I think you can appreciate that this has been one of the most difficult environments to forecast and to build any kind of consistent modeling on. So what I will say to you is we pay close attention to all the trends, and we are obviously now looking at what we call pre-pandemic sale rates and understanding where we have reverted back by category to those pre-pandemic levels. And so we know where we are and what categories are in those specific run rates, and we know which categories are not.
And our job is to pay really close attention to those merchandising categories to ensure that we're in a good insight position, that we have good presentation, that were priced right. And that's our best attempt to try to manage it. We'll have a much better answer for you as we wrap up the kind of the back end of the year. Because of the uniqueness of these overlaps, it's really tough to answer that question with any precision just coming out of the second quarter.
Michael Lasser:
Understood.
Operator:
Our next question is from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Curious for your strategy in regards to promotions and pricing as we move into the back half, considering what you're seeing with units and where you sit with inventory if you're changing relative to the first half.
Marvin Ellison:
Eric, this is Marvin. Short answer is no plans to change any of our philosophical approach to promotions and pricing. Our key is to be competitive. And again, we've invested in some sophisticated tools that give us real-time visibility to our competitors so we can be price right every single day. I'll let Bill talk more about his thoughts on promotion and pricing just to reinforce that we have a consistent philosophy that we plan to stick with.
William Boltz:
Eric, thanks for the question. Just a couple of things and just a couple of reminders. We've been on this journey for our merchandising strategy, pricing strategy over really the last 3-plus years. And that has the playbook that we're working to follow and really trying to unwind from what was a high-low pricing strategy to an everyday competitive price strategy. And so the work that we've done between the merchants, the finance team to prop up, the resources to manage and monitor price on a daily, weekly basis is really allowing us to do that. And we feel really good about being very competitive, good line of sight on those key SKUs that matter.
And then from a promotion perspective, it's all about being there when the customer expects us to be there. So obviously, we've got Labor Day event coming up here in the next couple of weeks. You go into the holiday season, Black Friday. And so we'll continue to supplement those events with key offers and be there with value for the customer and then work really hard to provide that value day in and day out in the store with the changes that we've made through our end cap strategies, flex strategies, et cetera.
Eric Bosshard:
Just a follow-up within that. What have you seen when you have run events, you ran some July 4 events. And I'm just curious, have you seen different consumer engagement with promotions in this environment? Or now relative to the past, are these resonating? Again, I'm just asking, as you look at negative units and a bit softer sales and a bit more inventory. Historically, you promote more, I understand the new Lowe's is less focused on that. But is the payback from those things similar or different? Is the consumer responding similar, different on those?
William Boltz:
Yes, I think there's a couple of things. There's -- first, there's a time and an opportunity to put stuff on value. And so if you think about first half of the year and you think about mulch and live goods promotions and those types of things that get the customer in the door and drive traffic, they play a certain role for us in the role of the category of certain merchandising businesses. And then you have new and innovation, as I said in my prepared remarks, where the customer is finding value in that.
And a good example is that EGO lawnmower that I talked about in my opening remarks, it's a $700 unit, and it was by far one of our best-selling products, best unit driving products in the assortment. So it's not low priced. It's not on promotion, and it was just out there and the consumer has adopted that battery platform, and they love the product. So it's really a combination of both, and that's the blend that we're trying to manage. And in the appliance business, as you know, hundreds of thousands of appliances break every day. So you've got to be out there with an offer in the appliance business day in and day out. So that's how we're playing it.
Marvin Ellison:
Eric, this is Marvin. And I really appreciate the question because we're in this unique environment with customer demand, especially coming out of that outsized demand in certain discretionary categories during the pandemic. So we are closely monitoring any of our -- we call it, Tier 1 holiday promotions just to see our customers respond. The biggest difference at Lowe's today versus when I arrived about 4 years ago is that there is a rigorous analytical process that we go to coming out of all types of promotions just to look at, did we get the return on investment.
And so what we're not going to do, to Bill's point, is just kind of follow historical trends just because we're going to evaluate whether or not we got a return when the customer responded and we'll adjust accordingly. And we've been doing quite a bit of adjusting because the customers are responding differently because this is such a unique environment. But as I said earlier, we're anxious now look at the back half of the year, we feel good about the trends as Brandon outlined. We feel good about how the customer is shifting on the interior parts of the store because that's where we're really strong and we feel we're well positioned. And we'll have a much better assessment looking at the full year going into next year relative to some of these customer engagement to some of these events.
Operator:
Our next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So my first question is also a follow-up on the DIY side. Marvin, there were some headlines that talked about the improvement continuing into August and Brandon's comments certainly echo that. Have you seen DIY flip to a positive trend? And then as a follow-up, last year, post-Labor Day, you talked about that consumer coming back from sort of vacation and reengaging in DIY. So how are you thinking about the ability for that to sustain -- what you're seeing now to sustain against the step-up you saw last year?
Marvin Ellison:
Well, I'll repeat what Brandon said. We've seen a step change post-July 4 in our business, and that continues into the month of August. But it's early, but early means that the trends that we anticipated, we're seeing those trends, and we're seeing even better than we anticipated in certain categories. So that's a good news. But I'll just let Brandon kind of reiterate why we have confidence in the DIY consumer as we look at the back part of the year.
Brandon Sink:
Yes, Chris, I'm not going to get into too much detail just specifically on DIY comps. But I would say just a response, as I mentioned over the last 6 weeks, especially as we've moved more to the interior of the core, the DIY business within the home decor categories, I think, has been notable, and that's where we're seeing momentum. And then I'd also just call out there's other areas, lumber is going to be a mix between Pro and DIY, but sort of just given where pricing is at that point, too, we're seeing nice response there, and we're seeing activity that we continue to see momentum building as we get into August here.
Christopher Horvers:
Got it. And then some of the commodities of -- some of the input commodities for a lot of your products have come down recently. You've -- Marvin, since you came on board, you've introduced some very sophisticated pricing and cost deconstructing capabilities. How are you thinking about your intent in the near term to go back at the vendors from -- for some price rollbacks?
Marvin Ellison:
Well, before Brandon was elevated to his more prestigious position, he did that work for us in merchandising with Bill. So I'll let him give you some specifics on that.
Brandon Sink:
Thanks, Marvin. So, yes, Chris, I would say, just given rate tightening that we're seeing from the Fed, monitoring the commodity markets, we're definitely expecting some normalization as we move across the second half and into next year. We have built as Marvin has mentioned, the disciplined product cost management process. We feel like we have the insights to the cost drivers across our suppliers. We understand where it's coming from in terms of commodities, labor, transportation.
And as raw materials down, we're positioned and prepared to renegotiate prices with our suppliers. We're actually very much underway in certain areas with Bill and his team. And then from a pricing perspective, like we always do, we're going to leverage a portfolio approach if and when we call back the dollars, but we're always going to ensure that we're going to be competitive there as we approach pricing.
Operator:
Our next question coming from the line of Michael Baker with D.A. Davidson.
Michael Baker:
Maybe a follow-up. I did want to question the Pro business a little bit and 2 questions. One, Pro business, up double digits for Pro, that's great, but it did slow a little bit from last quarter on a 1-year and a 2-year basis. So wondering what to make of that. And then these comments on this being a little bit better. I guess DIY, but any comment on how the Pro business is doing in the last 6 weeks or so?
Marvin Ellison:
Yes. Thanks, Mike. This is Marvin. We feel good about the overall sales volume in the Pro business. And as Joe noted, second quarter is typically our highest DIY penetrating quarter of the year. But when we look at the Pro business, we feel incredibly positive on the momentum and just the daily volume we're seeing across all geographies relative to what we were seeing 2 or 3 years ago. And we think it's very sustainable than it's proven to be.
And we think as we get into the back half of the year with our new Pro loyalty program, with improved job-like quantity in stocks with some of the brands that Bill outlined that we're going to see this momentum continue. And as I said, it's not just about Pro loyalty, Pro loyalty is one of the foundational pieces of the strategy in addition to all the investments we've made in the store, the brands, the fulfillment improvement. And also, just as a reminder, our U.S. reset project last year, literally improved all the adjacencies, specifically for the Pro customer, and we think those things are paying dividends. So that business is performing really well and is performing really well vis-a-vis the DIY and the same trends we're seeing post-July 4 for DIY. Pro is also taking those same positive trends and performing well.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our third quarter earnings call in November.
Operator:
Thank you. This concludes the Lowe's second quarter 2022 earnings call. You may now disconnect at this time.
Operator:
Good morning, everyone. And welcome to Lowe's Companies' First Quarter 2022 Earnings Conference Call. My name is Kevin, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President, Investor Relations. Please go ahead, Kate.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Before we turn to our first quarter results, I would like to announce that we will be hosting an Analyst and Investor Conference in-person on Wednesday, December 7, from 8:00 a.m. to 1:00 p.m. Eastern Time in New York City. For those of you who are unable to attend in-person, the event will also be live-streamed on video. At this event, our executive leadership team will provide updates on the key growth initiatives in our Total Home strategy and our long-term financial targets. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone.
In the first quarter, our total company comparable sales declined 4% with the U.S. comps down 3.8%. Excluding our seasonal category, sales were in line with our expectations for the first quarter. Looking at sales goals on a 2-year basis, total company comps and U.S. comps were up approximately 20%. In Pro, we delivered growth of 20% and 64% on a 2-year basis. We also saw solid DIY demand for core nonseasonal home improvement projects. However, we experienced a delayed spring selling season due to prolonged unfavorable weather that impacted spring-related categories. In fact, to put this into historical context, the past April was the coldest in over 20 years and one of the wettest in recent memory. But now spring has finally arrived, and we are seeing the anticipated improvement in our seasonal sales in the month of May. I would like to provide some perspective on the impact that a very delayed spring has on our do-it-yourself or DIY sales. As a reminder, roughly 75% of our sales are to the DIY consumer in many seasonal categories like live goods, outdoor power equipment, grills and patio furniture are more heavily concentrated in DIY. And while spring was delayed across all geographies, the season came particularly late in the north, where sales were down double digits in many of our northern markets. And at the same time, sales in our Florida, Charlotte, Nashville, Houston, Atlanta, Dallas and Richmond regions were ahead of our sales expectations, even though spring weather was unfavorable in those regions as well. Simply stated, the further north you look, the larger the negative impact to our seasonal categories. Although the late spring postponed our DIY sales, our Pro customers continue to shop to fuel their strong business demand. And our recent Pro surveys indicate that the majority of our Pro customers continue to report strength in their business and a full slate of projects for the year. At Lowe's, we see spring as a first half event. And as I mentioned, we are encouraged by the improved sales trends we're seeing in the month of May. We're also ready to capitalize on the increased demand with our enhanced assortment, strong inventory position, improved supply chain capabilities and seasonal staffing in place to serve our customers. Later in the call, Bill will discuss our plans to win spring again this year, while Joe will discuss how we are serving our customers during this busy season. Importantly, our Total Home strategy has given us the agility and flexibility to deliver operating margin improvement even when sales decline. During the quarter, operating margin expanded approximately 65 basis points, leading to diluted earnings per share of $3.51, which is an increase of over 9% versus last year. These results reflect great operational discipline in addition to excellent execution in a number of key initiatives, including our enhanced labor management tools, our perpetual productivity improvement or PPI initiatives, and our improved pricing capabilities. Our Total Home strategy also enabled us to win with both the Pro and DIY customer in Q1 as we elevate our product assortment and provide our customers with the products and brands that they need across all of their home improvement projects. Let me now discuss the progress that we're making with our Pro customer. As I mentioned, we delivered Pro growth of 20% in the quarter on top of 36% comps last year. The progress with this very important customer is reflected in the nearly 600-basis-point increase in Pro sales penetration in the U.S. from approximately 19% in Q1 of 2019 to approximately 25% in 2022. Later in the call, Joe will discuss how we continue to drive growth in Pro with the early success of our Lowe's MVP's Pro Rewards and Partnership Program that was launched in the first quarter. On Lowes.com, sales grew 2% on top of over 36% growth in the first quarter of 2021, which represents a 2-year comp of over 39% and nearly 10% sales penetration. As we enhance our omnichannel offering, we are gaining traction with consumers who increasingly expect a fully integrated shopping experience. We're also expanding our market delivery strategy by adding other big and bulky products in Florida including patio, grills and riding lawn mowers to the appliances that we already deliver from our cross-dock terminals. By adding these incremental products, we're better leveraging our fixed costs while enhancing customer service at the same time. We've also converted our fourth geographic area, the Tennessee, Kentucky region to this new delivery model. And we're on track to convert our full portfolio of stores to market delivery by the end of 2023. Turning to our results in Canada where our performance lagged the U.S. in Q1. Last year, Canada's results benefited from record high lumber prices due to the higher lumber mix in our Canadian business. In closing, despite some increased uncertainty in the macro environment, our long-term outlook for the home improvement industry remains positive. Homeowner balance sheets are very strong, and their confidence to purchase big-ticket items is supported by continuing home price appreciation. Other factors like the extension of remote work, the age of the housing stock, millennial household formation and baby boomers preference to age in place, all are long-term tailwinds for home improvement. And over the past few years, we have greatly improved our operating capabilities so that we now have the agility needed to respond in this dynamic macro environment. These enhanced capabilities will allow us to continue to take market share while expanding our operating margin. And as a reflection of Lowe's' commitment to the community, at the beginning of the year, we announced a new community impact program called Lowe's Hometowns. This is a 5-year $100 million investment to improve the communities in which we live and work and to ensure we remain committed to giving back to our customers. And before I close, I would like to welcome Brandon Sink to his new role as EVP and Chief Financial Officer. Brandon brings tenure, home improvement expertise and strong financial and operational acumen to this role, and we're excited to have him on the executive leadership team. I would also like to take a moment to thank Dave Denton for the contribution he made as CFO in the past 3 years. And at Lowe's, we believe that our store associates are a competitive advantage, and I would like to close by thanking our frontline associates for their hard work and dedication. And with that, I will turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone.
In the first quarter, U.S. comparable sales declined 3.8%, but were up 19.7% on a 2-year basis. This quarter, we delivered a strong positive comp in building products, driven by our momentum with the Pro, while sales in home decor came in above our expectations driven by solid DIY demand. However, comps and hardlines were down compared to prior year as a delayed spring season impacted seasonal categories. We are particularly pleased to see improved demand in seasonal categories over the past few weeks as the spring weather has finally arrived. In the quarter, 10 of 15 categories were above company average while 8 categories were up over 20% on a 2-year basis. Within our home decor division, paint and flooring delivered the strongest comps this quarter. Inside our paint category, the biggest growth drivers were in interior and exterior paint and primers as our in-stocks continue to improve throughout the quarter. Also, our investments in our Pro Paint offering continue to pay off as we've enhanced our Pro service model, expanded associate training and have built out our job site delivery capabilities. We are building on this momentum with the recent launch of our new, incremental paint reward program for our MVPs Pro customers, in addition to the other meaningful rewards they have already received. Within flooring, luxury vinyl was once again the top contributor as our consumers continue to prefer the low maintenance and stylish solutions that this product category has to offer. We also refreshed our STAINMASTER carpet lineup, continuing to reflect current styles and consumer preferences. And in late March, we launched our first extension of the STAINMASTER brand in tile. And right behind tile, we are launching new laminate and luxury vinyl products in STAINMASTER as well. We're excited to have the STAINMASTER brand within our portfolio and to extend its high-performance characteristics and stain-resistant warranty to these new product categories. With this new brand lineup, we are offering innovative and functional products for the home, all with a great value for our customers. Now turning to building products. We continue to see broad-based strength across key Pro categories, including electrical, building materials, rough plumbing, millwork and lumber, driven by strong Pro demand and competitive in-stock positions. Building on last year's strong performance, we delivered a positive 38% 2-year comp in building products, which continues to reflect the persistent underlying strength in consumer demand for larger core home improvement projects and, to a lesser extent, commodity inflation. Over the past several years, we have been focused on expanding our brand and product offerings to meet the needs of our Pro customers. In this quarter, we are excited about the introduction of Owens Corning new fiberglass rebar known as Pink bar. This Pro family product is stronger than traditional steel rebar and 7x lighter which makes it both easier for the Pro to work with and less costly to ship. We are also excited to announce the national expansion of the APOC roof coating brand, which is a leading manufacturer in roofing and an important strategic partner to Lowe's. These new products and brands are strong additions to our outstanding Pro brand portfolio, which already includes other powerful brands like Bosch, Crescent, DEWALT, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner. Now looking at our performance in hardlines. As I mentioned earlier, our seasonal categories were impacted by delayed spring. As the weather has finally broken over the past few weeks, we have now seen higher demand across the seasonal categories. And it's important to remember that spring is always a first half event. And while this year's spring season has started slow, the teams are focused on delivering a successful spring again this year. From the convenience and quality of the EGO, Kobalt, CRAFTSMAN and Skill brands with their zero-emission rechargeable equipment to our other leading brands such as John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN, we offer the products that our customers need to have the best-looking yard in the neighborhood. We are also continuing to expand our private brand lineup with new products in Origin 21, our new modern brand as well as our popular allen + roth brand, which is tailored to the more traditional taste. SpringFest, which is our new approach to spring, is a multiweek event, and we leveraged several strategic promotions for popular spring items like mulch, soils and hanging baskets to deliver great value for our customers. And we are well positioned to capitalize on the late surge in spring demand, and I look forward to updating on this first half event on our second quarter call. Now looking at Lowes.com. As Marvin mentioned, we saw a positive 2% sales growth in the quarter and over 39% positive growth on a 2-year basis. We continue to enhance the user experience on Lowes.com and our omnichannel capabilities, which is critical for consumers who increasingly expect flexibility and seamlessness in their shopping experience. Our new paint and countertop visualizers are driving better conversion rates and we also enabled our customers the ability to order bagged goods online for in-store pickup ahead of the spring season. And as Marvin mentioned, our enhanced supply chain capabilities, including our expanded coastal holding facility network are now in place to enable us to flow product quickly to where it's needed as weather breaks across the country. And we continue to leverage our scale and carrier relationships to secure capacity and work to mitigate cost increases within our supply chain. Before I close, I'd like to once again thank our vendor partners and our merchants for their hard work and dedication. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. I would like to begin by thanking our frontline associates for their continued commitment to serving our customers, especially in this busy spring season. We are laser-focused on delivering a consistent and high-quality customer experience. At the same time, we have labor aligned to demand patterns so that we effectively managed our payroll this quarter even in a lower sales environment. The investments that we've made over the past several years and our enhanced labor management tools are clearly paying dividends as we flex labor across stores and departments so effectively that we continue to achieve strong customer satisfaction scores.
Also, the technology enhancements that we've made over the past several years enable our associates to spend 60% of their time serving customers and only 40% on manual tasking activities. As a reminder, as recently as 2018, 60% of all associated time was allocated on tasks that did not support the customer. We flipped this ratio by enabling more and more capabilities on our associates handheld mobile devices, which eliminated many time-consuming tasks. This is in addition to new technology that has enhanced our point-of-sale checkout, modernized project management, improved inventory visibility and digitized in-store pricing for appliances and lumber. This improved associate productivity has not only driven profitability, but it has also enhanced our customer service. And we continue to unlock further productivity through our Perpetual Productivity Improvement or PPI initiatives. As a reminder, our PPI initiatives are not onetime efforts but rather a series of initiatives that are scaling across our stores over time, all of which contribute to operational efficiency as well as a culture of continuous improvement. As Marvin mentioned earlier, the success of our PPI initiatives contributed to our strong operating margin performance in Q1. Now I would like to take a few minutes to discuss our strong Pro results in the first quarter when we launched our MVPs Pro Rewards and Partnership Program, which is centered around creating a business partnership with our Pro. We are really pleased to see the better-than-expected adoption rates for the new program and we expect to build on this momentum with the Pros as we launch enhanced features to the loyalty program in the coming months. Through this program, we are also gaining valuable insight about our Pro customers that will enable us to better anticipate and meet their project needs through our Pro CRM platform and allow us to continue to expand our share of wallet with these valuable customers. And we're expanding our Pro fulfillment capabilities with our new Pro fulfillment center in Charlotte, where we are stocking the top SKUs that Pros consistently need in job lot quantities. As we pilot this new approach to Pro fulfillment, we are building on our existing job site delivery capabilities handled through our stores and Lowe's Pro supply branches today. Although we are pleased with our 600 basis points of growth in Pro penetration over the past 3 years, improving our fulfillment capabilities will allow us to accelerate this growth and continue to gain market share. In addition to the success of our new Pro initiatives, I am pleased with our strides to become the employer of choice in retail. As a company, we are committed to investing in continuous learning and development throughout our associates careers through Lowe's University as well as a new debt-free education program that we just announced. Through this initiative, more than 300,000 associates are eligible to participate in over 50 academic programs free of charge. These programs are designed to help associates excel in their jobs today and built toward their future careers within Lowe's, including pathways into supply chain, logistics, data analytics, cybersecurity, technology and more. Finally, I'm pleased to report that we are in a better position from a hiring and staffing standpoint than we were at this time last year. We accelerated our associate hiring process through new technology that dramatically reduce the time it takes process applications. These new tools ensure that we capture the best candidates in the pipeline and helped us staff up quickly for spring. Looking forward, we are making the right investments to continue to drive productivity while also enhancing our customer service, and we are well positioned to serve our customers to meet the surge in demand for spring products. As I close, I would like to once again thank our store associates for their relentless focus on serving customers and driving productivities in our stores. With that, I will now turn it over to Brandon.
Brandon Sink:
Thank you, Joe. I'd like to begin by saying what an honor it is to serve as Lowe's CFO. Over the past several years, we've made tremendous progress transforming Lowe's into a leading omnichannel retailer with a world-class finance organization. I'm extremely excited to be joining the executive leadership team in my new capacity as we continue our momentum.
Now turning to Q1 results. We delivered diluted earnings per share of $3.51, an increase of 9% compared to prior year driven by improved gross margin rate and disciplined expense management against lower sales. As expected, we lapped our most difficult sales comparison of the year, given the approximately 300-basis-point benefit from government stimulus last year. Q1 sales were $23.7 billion with a comparable sales decrease of 4%. Comparable average ticket grew 9.1%, driven by higher Pro sales, increased levels of product inflation and 150 basis points of commodity inflation. This was offset by comp transaction count declining 13.1% due to a later start to spring as well as the impact of cycling over government stimulus and storm recovery in the prior year. Keep in mind that comp transactions increased 11.8% last year, which results in a 2-year comp transaction count decrease of 2.9%. U.S. comp sales were down 3.8% in the quarter and up 19.7% on a 2-year basis. Our Pro sales outpaced DIY with 20% sales growth in the quarter as we continue to build on our momentum with the Pro driven by our elevated product and service offering. And while demand for core DIY categories remain strong, lower sales in seasonal categories pressured sales by approximately $350 million in the quarter or approximately 150 basis points. On Lowes.com, sales increased 2% in the quarter and over 39% on a 2-year basis. Our U.S. monthly comps were up 8.5% in February, down 7.8% in March and down 6.9% in April. In March, we cycled over the third round of government stimulus and the storm recovery sales in Texas while April sales were negatively impacted by unfavorable weather. Looking at U.S. comp growth on a 2-year basis from 2020 to 2022, February sales increased 34.5%, March increased 25.3% and April increased 6%. Gross margin was 34.03% of sales in the first quarter, up 74 basis points from last year. Product margin rate improved 50 basis points as we leveraged our disciplined pricing and product cost management strategies to effectively manage product cost inflation and lumber price volatility. Also, higher credit revenue drove 25 basis points of benefit to gross margin this quarter, while a favorable product mix drove 20 basis points of benefit. These benefits were partly offset by 10 basis points of pressure from live goods damaged by unseasonably cold weather as well as 10 basis points of planned pressure from increased distribution costs. SG&A of 18.19% levered 21 basis points compared to SG&A in Q1 last year. As Joe mentioned, we drove improved store labor productivity which was offset by lower fixed cost leverage against lower sales and increased wage rate. Operating profit was $3.3 billion, in line with prior year. Operating margin rate of 13.96% of sales levered 67 basis points versus prior year. Our ability to leverage operating margin despite a decline in sales reflects our improved operating capabilities that enable us to rapidly adjust in a dynamic operating environment. The effective tax rate was 23.7%, in line with prior year. Inventory ended the quarter at $20.2 billion, up $2.6 billion from Q4 levels in line with seasonal trends. This reflects a $1.9 billion or 10% increase from Q1 2021. Our inventory balance reflects an approximately 13% increase from both product and commodity inflation, while balances were also higher than expected due to a late breaking spring. Now turning to our 2022 financial outlook. Our Q1 performance was in line with our expectations, excluding seasonal categories. However, as Bill mentioned, spring is truly a first half event and the timing is driven by when weather breaks across the country. Over the past 2-plus weeks, we are seeing improved trends in our seasonal categories, which is reinforcing our confidence that we will deliver first half results in line with our full year guide. This morning, we reaffirmed our full year 2022 financial outlook. We continue to expect 2022 sales in a range of $97 billion to $99 billion for the year, representing comparable sales of down 1% to up 1%. We continue to expect Pro to outpace DIY for the year. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We continue to expect gross margin rate for the full year to be up slightly as compared to prior year. However, as lumber prices declined several weeks earlier than we expected, gross margin pressure will shift into Q2 as we continue to turn through our higher cost inventory layers. As a result, we now expect to see our gross margin for the first half to be up slightly compared with our gross margin in the first half of 2021. We also continue to expect operating margin in the range of 12.8% to 13% for the full year, driven by a slightly higher gross margin rate and continued execution of our PPI initiatives. We are also confirming our outlook for diluted earnings per share in a range of $13.10 to $13.60. In 2022, we still expect capital expenditures of approximately $2 billion, and we remain committed to our disciplined capital allocation strategy with approximately $12 billion in share repurchases this year while also supporting our 35% target dividend payout ratio. Finally, we are affirming our outlook of return on invested capital above 36% for the year. Now I'd like to close by reviewing one of our value creation drivers at Lowe's, our shareholder-focused capital allocation strategy. In Q1, the company generated $2.6 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned $4.7 billion to our shareholders. During the quarter, we repurchased 19.2 million shares for $4.1 billion, and we paid $537 million in dividends at $0.80 per share. Capital expenditures totaled $343 million in the quarter, as we continue to invest in the business to drive growth and enhance returns. We ended the quarter with $3.4 billion of cash and cash equivalents, which includes proceeds from our $5 billion notes offering in March. This larger-than-planned bond issuance enabled us to slightly accelerate our share repurchase plans in the quarter. The balance sheet remains extremely healthy, and we continue to make progress towards our target of 2.75x adjusted debt-to-EBITDAR, ending the quarter at 2.24x. Driven by both strong operating performance and a disciplined capital allocation strategy, we delivered return on invested capital of 33.8% in the quarter, up 380 basis points versus last year. In closing, we are confident in our trajectory and excited for the substantial opportunity ahead of us as we continue to grow our market share, expand operating margin and deliver meaningful shareholder value. And with that, we are now ready for questions.
Operator:
[Operator Instructions] Our first question today is coming from Greg Melich from Evercore.
Gregory Melich:
I have 2 questions. One is just to understand the shift of spring and stimulus. Should we be looking at a 3-year comp when we think about how that flows in, in the second quarter, sort of in the mid-30s? And then my second question is on inventory.
Brandon Sink:
Greg, this is Brandon. Just as I mentioned in my prepared remarks, we came out of April, U.S. comps down 7% for the month. And I'll say early on, we feel really good about our trends in May, especially within our seasonal categories comping positive and above the company average as spring is breaking across the country. We have some of our biggest volume weeks ahead with Memorial Day, Father's Day, J4. We're pleased with the sequential sales improvement, confident in the full Q2 recovery of the $350 million. And then when we look at the balance of the year, I think with the weather trends, Q2, $350 million. We're going to continue to see the Pro strength 20% comp in Q1, [ 64% ] 2 year. Inflation is going to continue to be a bit of a tailwind for us as well. But all that being said, our range is down 1 to plus 1. We're confident in that go-forward for the full year. And that yields Q2 to Q4. That's a slight positive comp over the balance of the year for the 1 year.
Gregory Melich:
Perfect. And then on inventory, you mentioned the 10% growth that inflation was -- and mix was about 13% of that. Am I -- does that imply that units are actually down 3% year-on-year.
Brandon Sink:
Yes, Greg, Spot on. Inventory balance was up 10%, and we have in the prepared remarks price and commodity inflation, along with carrying additional seasonal inventory in Q2 -- heading into Q2 is pressuring both dollars and terms. I will remind the group every year, we do manage our seasonal inventory to the first half and we have a strong holiday lineup upcoming and a couple of other things. We continue to strategically invest in inventory to support the Pro, job locked quantities and we've had a couple of constrained categories where we've made in-stock improvements, in particular, in paint and appliances. But we're in our best in-stock position since the beginning of the pandemic, and I'll kick it over to Bill, if there's anything more he wants to add there.
William Boltz:
No, I think, Brandon, I think you hit it. I think the key for us is making sure that we're focused on sell-through the seasonal buys that we've made. We shared with you during the fourth quarter call that we brought in some of the seasonal inventory ahead of the season. And so we're focused on working through that through the first half of the year.
Gregory Melich:
And you guys haven't seen any trade down, it sounds like?
Marvin Ellison:
Greg, this is Marvin. The answer is no. As you can imagine, we spent quite a bit of time looking at this literally on a daily, weekly basis with the DIY and Pro customer across geographies, online, and we've seen no material trade down in our business.
Operator:
Our next question is coming from Brian Nagel from Oppenheimer.
Brian Nagel:
First off, Brandon, congratulations on your new role.
Brandon Sink:
Thank you, Brian.
Brian Nagel:
My question, and I get -- maybe I'll direct it to Marvin primarily, but thanks for all the detail on the call. And I guess what I'll say is there, as analysts following where the news of weather disruptions are now well documented. As you look at the business, what gives you the greatest confidence that these slower spring sales were, in fact, weather-related and not indicative of a now say be more cautious consumer pulling back on discretionary spending?
Marvin Ellison:
Brian, this -- it's a really good question. This is Marvin. So I'll take the first part, and I'll let Bill just give more of a product-specific assessment. So when you take a look at the quarter, the month of February was really strong, 8.5% of positive comp in the U.S. In the month of March, we were running to a stimulus overlap and so we were anticipating that negative comping March was, and we had really difficult weather on top of stimulus. And then April, as we mentioned, was the coldest in over 20 years. And when we start to look at the categories and their anticipated performance, it was obvious to us that this was a weather-driven event.
The good news is, well, I mean, we operate in all states. So we could easily look at the southern parts of the country where we were in something relatively close to seasonal weather and all of these categories were performing exceptionally well, live goods, outdoor power, grilled patio, et cetera. And then the moment we get a glimpse of weather in some of these northern markets, those categories would take off and perform well in the moment, the weather would shift. I mean, obviously, you'd see the decline. So the way we analyze this literally on a daily, weekly basis is very obvious to us that the Q1 impact was driven by weather. And as Brandon and I both mentioned in our prepared comments, as we look at the month of May, I mean we're pleased with the trends we're seeing. And that also reflects that the moment we are getting to what is more of a seasonal weather environment, those same categories that underperformed in April, are now overperforming the company in the month of May. So I'll let Bill add any other details.
William Boltz:
No, I think the only thing to add, Marvin, is that we're also seeing strength out of new and innovative product. And so you look at the strength of like the EGO brand and the battery-powered outdoor product just continuing to perform very well. The strength of John Deere, the strength of Aaron's in the riding mower segments doing very well. And as you touched on, as we saw green shoots of weather throughout the first quarter, we saw the strength in project -- outside project businesses like live nursery, like exterior Pro projects. So it just gives us good confidence that we can carry that through Q2.
Joseph McFarland:
Brian, I'll just add one additional comment there. If you look at our Pro growth that Marvin mentioned earlier at 20%, and then you look at the strength and the health of that Pro -- strong Pro market trends we're seeing, our revamped Lowe's Pro offering, the expanded Pro product that Bill mentioned earlier in his prepared remarks, the deeper inventory and then the launch of our new MVP program. And so I think we've got good confidence in the underlying trends there.
Brian Nagel:
That's all very helpful. I appreciate it. And I guess just one really quick follow-up. So as we think about these seasonal sales and the weakness that happened in Q1, is it fair to assume that basically, all the sales should be made up here in Q2? In other words, there's really no lost demand?
Brandon Sink:
Brian, that's correct. It's fair to assume that the $350 million would shift in fall of Q2.
Operator:
Your next question is coming from Simeon Gutman from Morgan Stanley.
Simeon Gutman:
So the first quarter earnings, at least beat the Street handily and you're not making any change to the year. I think the second quarter, it sounds like you'll make up some sales. And so the first half will be the same. The fact that first quarter was better, did it -- and by the way, no one is getting paid or rewarded for raising any outlook. So I guess, implicitly, it means that something was taken out. I don't know if that's the right way to think of it or just there's conservatism. So curious your thoughts around that? And anything that is changing in the second half, the way you're looking at the business since you have some head start here in the first quarter.
Brandon Sink:
Yes. So Simeon, this is Brandon. A lot of this is timing-related and specifically around gross margin. So as I said in my prepared results remarks for Q1, 74 basis points of improvement driven by product margin rate mix. We also benefited from proprietary credit. But keep in mind, the benefits on the product margin side are temporary in nature, especially -- can be temporary in nature, especially in periods of inflation. Cost layers are going to lag and that's true for both commodity and product-related inflation.
So as we cycle into Q2, we do expect some level of step back, specifically due to lumber deflation that began. We began seeing that late March. And then we have some other variables, such as shrink in credit. We expect that to largely be neutral over the back half. And then the supply chain, inclusive of market delivery build-out, higher transportation costs are going to be a slight drag, which is consistent with what we've guided and what we've messaged. So it's mainly margin, it's mainly timing as the cost layers turn a bit of a step back. But for overall margin, modest improvement in margins for first half and up slightly for the full year. So that's the reason we didn't flow the beat to the full year.
Marvin Ellison:
So Simeon, this is Marvin. I think it's important for me to note that we're really pleased with the profit performance in the first half. For a retailer our size is really difficult to have declining sales on a year-over-year basis and have leverage from an operating margin and gross margin perspective. That took a lot of work and a lot of operational discipline from the supply chain, cost management, payroll and expense management, et cetera. And to Brandon's point, we're in this unprecedented environment of lumber inflation and deflation. And so we're just planning conservatively because as we say, the last couple of weeks, we start to see lumber starting to shift, and we're just anticipating that, that's going to give us some headwind in Q2.
Simeon Gutman:
That's helpful. My follow-up, it's related on fuel prices. And Brandon, you just touched on transportation costs. Does this mean that you're adjusting your pricing as well real time? I know you mentioned you'll feel a little pressure, so maybe you don't fully offset it. And does the level of inflation help your business on the top line? Or you assume that there might be some unit degradation as pricing may continue to tick higher?
Marvin Ellison:
So let me take -- this is Marvin. I'll take the first part of that. We've spent a lot of time putting in improved systems from a pricing standpoint. So we are scraping and we're doing pricing analysis real time, both in-store and online by geography. One thing that Bill put in place early on when he arrived is that every day competitive pricing strategy where we've gotten off this high-low promotional cadence that Lowe's was known for to more of an everyday competitive price. And the only way you can be competitive every day is you have to have a good line of sight to the competitive prices of your competition by category, by geographic location.
And so we've done a lot of that. And in some cases, with inflation -- product inflation, we have to carry that forward to the consumer. But in a lot of cases, we're just focused on being competitively priced. And I'll let Brandon provide some financial specifics of what that looks like.
Brandon Sink:
Yes, Simeon, I would just add to your question on fuel costs, transportation, also add import container cost into that mix. The teams have done a great job just giving us visibility to where those costs are, when they're going to hit. And it is correct to say as we manage the totality of the portfolio that, that's a consideration set along with direct costs from the vendor. So we are managing that appropriately, managing in this retail environment. So that would be the only additional thing I would add to the comment.
On transportation, in particular, on fuel, it is a more minor cost of the overall portfolio. When we look at the totality of supply chain, and we feel like we're doing some other things like managing trailers, intermodal and leaning into some of those other things to also help offset that.
Operator:
Next question today is coming from Karen Short from Barclays.
Karen Short:
So I had a couple of questions. Just in terms of how you think about traffic versus ticket with respect to your guide, can you maybe talk about that a little bit more? And then within your margin structure, I mean, I do think there's definitional differences with you and your largest competitor on how you actually think about square footage. But can you maybe just give us an update on -- in terms of your 13% operating margin or and/or bridging the gap with your largest competitor?
Brandon Sink:
Yes. Karen, let me start with the first question, and I'll pass it back to Marvin to get the second point. So on the ticket transaction side, I'll point to Q1 ticket, specifically inflation, a little bit harder to pinpoint. But we do believe from an inflation standpoint, we ran high single digits during Q1, and that's inclusive of 150 basis points from lumber and commodity. And I'll say the finance and merchant teams are still in the thick of this. We're working with our suppliers day in, day out to figure this out.
I will say, however, as we lap second half of '21, we do expect the inflation impact to start to moderate. We're expecting mid to high single-digits positive over the balance of the year. And then on the transaction side, as we mentioned in the opening comments, DIY was a primary driver of the decrease there for Q1. It was down double digits, partly planned due to the Texas storms and the stimulus, the weather miss from spring delayed accelerated that. We do believe Q1 will be our low watermark on transactions for 2022 and that, that transaction decrease should moderate as we cycle through the balance of the year. So net-net, mid to high single-digit positive ticket expected over the balance of the year, offset by down transactions is the formula that will get us to the flat comp, and we expect that dynamic to narrow ticket and transactions as we move through the balance of the year.
Marvin Ellison:
Karen, I'll take the other question. When you think about our operating margin and you think about kind of the more structural differences between us and our largest competitor, I think it really comes down to the penetration of DIY versus Pro. I think that's an obvious reflection in the first quarter. The good news for us is, we're not setting a Pro penetration target. We just have an expectation we're going to continue to improve that business. And if you think about my prepared comments, in the last 3 years, we've been increasing our Pro penetration by roughly 600 basis points. So we feel like that we're headed in the right direction.
But as you think about overall operating income, we're very pleased with our performance in the quarter, and we have a very good line of sight to getting us to that 13% and beyond just based on executing our Total Home strategy, focusing on Pro, online and all the work that Bill's team is doing on private brands and how we're continuing to grow that business. In the private brands specific initiative, it drives margin improvement. It gives the customer great innovation and style and we can do it all at a really competitive price and it's a key point of differentiation in addition to all the investments we're making in infrastructure, whether that's supply chain or operations and infrastructure. Again, we feel like we have a clear line of sight, and we're going to continue to execute to that, and we have an expectation that we're going to be on track with delivering on that expectation.
Operator:
Your next question today is coming from Christopher Horvers from JPMorgan.
Christopher Horvers:
So my first question is just following up on the May commentary. You talked about DIY now running ahead of the total company average comp. If you're still getting 20% growth in Pro backing into that math, that will sort of cleanly get you above the mid-single-digit comp. Is that math reasonable?
Brandon Sink:
Yes, Chris, this is Brandon. I don't know that we said that DIY is going to be running ahead of Pro in Q2. I would say the majority of the $350 million that we expect to recover is going to be reflected in the DIY business. But the Pro DIY dynamic, certainly unique in Q1, just given the environment we've been in and what we've been cycling, but that breakout in that dynamic, Q2 to Q4 should start to normalize a bit. But Pro is absolutely going to be expected to outpace DIY, grow 2x that of market, which will translate to our guide of down 1% to up 1%. And I'll just remind you, the seasonal performance in the seasonal business through the first couple of weeks outperforming expectations in the balance of the business. So that's how I would answer your question.
Christopher Horvers:
Okay. Sorry, I thought you said outperforming the company average. It was outperforming expectations.
Brandon Sink:
Correct. Correct.
Christopher Horvers:
Got it. All right. Sorry about that. And then in terms of -- Marvin, in the press release, it seems like you added just a line around sort of increased macro uncertainty. To an earlier question, you mentioned not seeing any trade down effect in a very responsive business to the weather. So can you expand on that? Is there something you are observing? Is it just simply given all the puts and takes on the consumer being less fulsome now versus maybe 3 months ago?
Marvin Ellison:
It's really more of an acknowledgment of what we're all seeing in just a broader macro economy. And I think what's interesting for home improvement is that, we're aware that we have inflation concerns. We're aware that there is rising interest rates. But as we look at the home improvement sector, we still remain very confident in the outlook and we're very confident in the sector. And so I'll just repeat what I've said. We've seen no material trade down from our customers. We closely monitor Pro and DIY. We look at it intently as you can imagine.
And when we think about the key economic drivers of our business, it remains home price appreciation. It remains the age of housing stock, it remains those things that give the homeowner confidence and continuing to invest in the home. And as we talk to our Pro customers, they're booked up for the year. We talked to our DIY customers, they would just wait for the sun to come out. And so we feel good about the home improvement sector. And my statement was just more of an acknowledgment of the broader macro environment that we're all seeing.
Operator:
Your next question today is coming from Liz Suzuki from Bank of America.
Elizabeth Lane:
So we've written recently about how 95% of the base of U.S. homeowners are not impacted by interest rates and that housing turnover isn't really as important as home price appreciation. But the pushback we've gotten is that those 5% of homes that do change hands presumably see a greater degree of renovation spending. So my question is, have you seen any reliable stats on how much the average homeowner spends on renovation when they prepare a home for sale and when they purchase a home? Because we're just trying to get a sense of what that portion of the home improvement market is actually impacted by rising rates.
Marvin Ellison:
Liz, it would be anecdotal at best. So we don't have any firm data to represent that. But our view of it and our conversations with Pros and consumers, you tell us that your statement is correct. But again, we don't have any fact-based data to support that.
Elizabeth Lane:
And then just a quick follow-up on how product innovation has contributed to average ticket. I mean, the growth in average ticket is obviously more than just inflation. So what do you view as the categories where product innovation may be accelerating the normal replacement cycle and how much of a tailwind that could be when inflation does ultimately normalize?
William Boltz:
Yes, Liz, it's Bill. And so what we're seeing with product innovation, we really see it across the store, across every category. But in areas like appliances, you see customers trading up to smart appliances to better quality appliances. As I mentioned in an earlier question in response, battery outdoor power equipment with the EGO brand specifically. You're also seeing it in the likes of gas-powered outdoor power with John Deere and Aaron's, all innovative products there. You're seeing it in paint. So just really across the categories, you see innovation.
And we're also able to offer that in our private brands with the introductions of STAINMASTER. So you're seeing that now start to weave its way in. I talked about -- it's already been in carpet and now you're seeing in tile, vinyl, laminate flooring. So you got Origin 21, which is a new modern brand for us, again, offers great innovation and great value.
Marvin Ellison:
And Liz, this is Marvin again. I just want to reinforce the point on the value of home price appreciation to consumer confidence. And it's one of the reasons why I think home improvement is a unique retail sector in kind of this macro environment where there are a lot of questions about the health of the consumer. What our data tells us and it correlates historically is when your home value is going up, you simply have more confidence to invest in that home because you see it as an investment and not an expense.
And we have unprecedented home price appreciation, but we also have an unprecedented supply-demand issue for the availability of homes. So our data tells us, this is less of bubble and it's more of a supply-demand issue where you have 1.5 million, 2 million homes of demand versus the availability. And so if you think about what Bill said about trading up, our customers, they feel more comfortable investing in home because they think they're going to get a return on that investment. And I think that's the value of home price appreciation to our business.
Operator:
Our next question today is coming from Zach Fadem from Wells Fargo.
Zachary Fadem:
Can you help me reconcile the sequential step-down in SG&A dollars? How much would you quantify as seasonal versus what would you call structural or PPI-driven? And then how should we square the Q1 SG&A takeout versus the balance of the year?
Marvin Ellison:
So Zach, this is Marvin. I'll take the first part of that, and then I'm going to let Brandon and Joe provide some context. So relative to payroll, we have an activity-based payroll model that allows us to flex hours up and down based on sales velocity by location of store, but also by department. That is a significant contrast to what we had in place when I arrived in summer of 2018 that we literally were riding complete the schedule from Mooresville, North Carolina and sending that out to every store on a weekly basis, irrespective of volume trends. So I'll let Joe talk about payroll, so you can get a view of why we were able to leverage as effectively as we did in Q1 and how we think that's a sustainable result that we'll see for the balance of the year.
Joseph McFarland:
Yes. Thanks, Marvin. Listen, from a payroll standpoint, I think it's important to think about the PPI initiatives as not just onetime initiatives, but ongoing initiatives. And so as we look at our ability to leverage SG&A through different initiatives, centralized RTVs and get down a whole list of the PPI initiatives. So this is not a onetime, but it's going to continue. And I think we've done it very effectively because both Pro and the do-it-yourself customer are showing increased LTR and service scores. So I think that just kind of points to some good productivity.
Brandon Sink:
Yes. And the only other thing I would add, Zach, so SG&A leveraged 21 basis points. That's consistent with the earnings algorithm we have for the full year in the range of what we would expect. I think the good news there being able to leverage against our quarter with the highest expected negative comp is going to be a great proof point for us and as we move through the year. And then in this inflationary environment, I think, to Joe's point, really being able to use those workforce optimization tools, understand truly within the business, both in the supply chain and in stores, what are volumes, what are units, what are transactions and being able to flex the model against that demand and understand the split between the drivers of the business has been really powerful for us. So I'll just add to that.
Zachary Fadem:
Got it. And with the spread between your Pro and DIY comps widening to about 30 points in the quarter, I realize the weather and seasonal component will normalize. But as you think about the balance of the year, how do you square overall industry Pro industry growth versus DIY this year? And is it fair to assume your Pro business can track at a double-digit rate from here?
Marvin Ellison:
Well, Zach, we talked about our expectation to grow 2x the market in Pro. We think that, that is achievable based on the list of Pro-related products that Bill and his merchant teams have added to our assortment based on our new MVP Loyalty Program that's exceeding expectations on the number of enrollments. And one other really interesting data point, if we look at the Pro customers currently enrolled in our new MVP Loyalty Program and our credit program, they're spending 300% more than Pro customers not enrolled. So it gives us a lot of confidence that our Pro growth is sustainable.
And not to mention with some other initiatives that we are filing to include job site fulfillment that we think will give us an opportunity to start in the future to serve a larger Pro. So based on all of those initiatives, we feel like that our Pro growth will continue. Look, it's challenging, none of us have a crystal ball, obviously, and there are a lot of dynamics in our Pro DIY mix. Having said that, we factored all those things into our guidance, and we think that the guidance, as Brandon reinforced is reflected on our view of how we think the DIY Pro mix will play out for the rest of the year.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our second quarter earnings call in August.
Operator:
Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2021 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone. Our results once again beat expectations this quarter, with comparable sales up 5% for the total company and 5.1% for the U.S. on top of over 28% growth last year. This resulted in comp sales of 34.5% for the total company and up 35.2% for the U.S. on a 2-year basis. These results capped of outstanding financial results for fiscal 2021 with sales of $96.3 billion, up 6.9% on a comparable basis and earnings per share of $12.04, up 36% on an adjusted basis.
With these outstanding results, 100% of our stores earned a quarterly Winning Together profit-sharing bonus. This $94 million payout is $24 million above the target payment level. And in recognition for their hard work throughout the pandemic in 2021, we are awarding an incremental discretionary bonus of $265 million to our frontline associates. Altogether, we rewarded our frontline associates with bonuses of over $350 million in the fourth quarter. As Joe will discuss later in the call, financial support of our frontline associates is consistent with our commitment to being an employer of choice in the retail industry. Our Total Home strategy continues to gain momentum, as we grow our share of wallet with both Pro and DIY as they increasingly rely on Lowe's as a one-stop solution for all their project needs. In looking at our results this quarter, I'm particularly encouraged that our growth was broad based and balanced across product categories, across both DIY and Pro, both online and in-store. In Pro, we delivered growth of 23% and 54% on a 2-year basis. And we are building on our momentum with the Pro with the launch of our new Pro loyalty program, MVPs Pro Rewards and Partnership Program. We redesigned our loyalty program based on feedback from our Pro customers who expressed a desire for a business partnership rather than a series of stand-alone transactions. Our data shows that Pros who leverage our loyalty and credit offering spend 300% more than Pros not engaged in these programs. Our Pro business is off to a strong start this year, and we're excited about the national launch of our MVPs Pro loyalty program. I look forward to providing updates on this critical initiative throughout the year. Now turning to our DIY customer, where we delivered growth on top of exceptionally strong demand last year. Later in the call, Bill will discuss how we continue to grow our DIY market share by elevating our private brands product assortments in our home decor category. On Lowes.com, sales grew 11.5% on top of 121% growth in the fourth quarter of 2020, which represents a 2-year comp of 147% and nearly 11% sales penetration. Our intuitive online shopping experience and expanded on-trend assortments are resonating with our customers. And while we're pleased that our online sales have more than doubled over the past 2 years, we still have tremendous growth opportunity in front of us. And as part of our efforts to enhance our omnichannel experience, we are expanding our same-day and next-day fulfillment capabilities. With that in mind, we're actively piloting several gig network solutions, including partnering with Instacart in several markets with same-day DIY home delivery. And building on the success we gained in the Florida and Ohio Valley regions with our market delivery strategy, we completed the conversion of our third geographic area, the Carolina region, during the fourth quarter. By way of reminder, in the market-based delivery model, big and bulky products flow from our supply chain directly to customers' homes. This replaces the highly inefficient store delivery model where each store acts as its own distribution and transportation center for these products. As we continue to expand our market-based delivery model, we're freeing up space in our 10,000 square foot store back rooms, which on average are considerably larger than our competition. And we are testing out different options to drive both greater in-store fulfillment and expanded delivery alternatives for both Pro and DIY customers. In a few minutes, Bill will discuss our continued investments in online as we create a best-in-class integrated omnichannel shopping experience. During the quarter, operating margin expanded approximately 115 basis points, leading to diluted earnings per share of $1.78, which is a 34% increase as compared to adjusted diluted earnings per share in the prior year. These results reflect our disciplined focus on driving operating leverage through our perpetual productivity improvement initiatives or PPI, as well as the ongoing benefits of our new pricing strategies. Joe and Dave will discuss these initiatives in further detail later in the call. Turning to our results in Canada where performance lagged the U.S. The Canadian leadership team continues to drive productivity through proven technology and processes that have delivered great results in the U.S. Before I close, I'd like to share my perspective on the home improvement market, as well as our opportunity to continue to win share. Our outlook for the home improvement industry remains strong, supported by a very healthy consumer balance sheet, especially for homeowners and continuing home price appreciation. Persistent solid demand for homes despite an uptick in interest rates is also expected to support residential investment. In fact, we're encouraged by the strengthening millennial household formation trends that will support home buying in the coming years. Other trends remain favorable, including baby boomers' increasing preference to-age-in-place. And with the extension of remote work for some employees, we're expecting a permanent step-up in repair and maintenance cycle. And as a reminder, 50% of the homes in the U.S. are over 40 years old and will continue to require investments for upkeep and approximately 2/3 of Lowe's annual sales are generated from repair and maintenance activity. Therefore, we're encouraged that the macro environment for home improvement remains very supportive. As we close the year, we continue to give back to the communities where we operate, with total donations of $100 million in 2021 well over our pre-pandemic levels. And we're pleased that our efforts to enhance our brand reputation while supporting our associates and driving long-term value for our shareholders and was recently recognized by Fortune Magazine as they named Lowe's the #1 Most Admired Specialty Retailer for the second year in a row. This is the first time in our history that we received this recognition in back-to-back years. In closing, I'd like to extend my heartfelt appreciation to our frontline associates. As I travel the country every week visiting stores, I continue to be struck by their commitment to supporting our communities while providing excellent customer service. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. In the fourth quarter, U.S. comparable sales increased 5.1% and 35.2% on a 2-year basis. We delivered positive comps in all 3 merchandising divisions in the quarter with growth across Pro and DIY customers. Growth was well balanced with 12 of 15 merchandising departments comping positive and was broad-based on a 2-year basis with all 15 departments up more than 18% in that time frame.
Beginning with our Home Decor merchandising division, flooring and appliances delivered the strongest comps in the quarter. In flooring, vinyl flooring once again led the way as we continue to see consumer preference shifting towards this affordable and stylish solution. Lowe's already offers a wide selection of vinyl flooring products, including several Pergo WetProtect options. And this year, we look forward to extending our own trusted STAINMASTER brand with its high performance characteristics and lifetime stain-resistant warranty across a full range of flooring products, including laminate, tile and vinyl. Within appliances, sales of ranges, cooktops, along with dishwashers were the strongest in the quarter. As we continue to extend our private brand offering, we recently launched Origin 21 across several product categories in home decor. This is our new modern brand designed for the trend-setting millennial consumer, while our ever popular allen + roth brand is tailored to the more traditional style. Now turning to our performance in hardlines. The team delivered an exceptional holiday season. Customers were active early and shopped often in our trim and tree category, which drove excellent sell-through in this holiday category. Seasonal, outdoor living and lawn and garden delivered standout performances, as customers continue to enhance their outdoor living spaces with new grills, patio heaters, fire pits, as well as live goods for the yards and garden. With the home serving as a center for entertainment, our customers are making the most of their homes, inside and out. We continue to build on our #1 position in outdoor power equipment with further share gains in battery outdoor power equipment, as we drove over 37% growth in this area for the quarter and over 118% on a 2-year basis. Both DIY and Pro customers enjoy the convenience, reliability and the power of our innovative battery-powered products available in the EGO, Kobalt, CRAFTSMAN and Skill brands. In this spring, we are thrilled to expand our exclusive lineup of EGO battery products with their new 52-inch zero-turn riding mower with features that include a fabricated deck and power to mow up to 4 acres on a single charge. Also new for EGO is the industry's most powerful handheld battery-powered blower with power that will outperform the leading gas blower with 765 cubic feet per minute of blowing capacity. These new products will complement our existing lineup and assortments from powerful brands, such as John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN. This spring, we will launch our new Origin 21 patio collections, as well as our new style selection replacement cushions. These cushions are made with 100% recycled plastic bottles and they are fade-resistant, UV-protected as well as easy to clean. Now turning to the building products division. Our comps were very strong driven by broad-based balanced growth across lumber, electrical, rough plumbing, millwork and building materials. We are pleased with the continued momentum we are building with the Pro as we work to expand our brand and product offerings to meet their project needs. New this year will be a full range of CertainTeed roofing, insulation and gypsum products. As a leading manufacturer of building products for both residential and commercial construction, CertainTeed is an important strategic partner that we are proud to add to Lowe's as we continue to enhance our Pro offering in the building materials category. We also continue to build out our Pro power tool program with the introduction of the new DEWALT power stack battery technology, which is the smallest and most energy-densed battery pack on the market. These new products and new brands are strong additions to our Pro brand arsenal, which already includes other great brands like Bosch, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner.
Moving to Lowes.com. As Marvin mentioned, we delivered sales growth of 11.5% in the quarter and 147% on a 2-year basis in the fourth quarter. We are focused on further enhancing our omnichannel capabilities in 2022 across 3 key areas:
expanding our online assortment; enhancing the user experience; and improving fulfillment. First, we are expanding our Lowes.com assortment to meet our customers' design and lifestyle needs. For example, within Lowe's Livable Home products, we will offer a range of products to help our customers adapt to their changing mobility needs. At the same time, we will continue to enhance the user experience with continued upgrades to the visualization and configuration tools, like kitchen visualizer and Measure Your Space.
Finally, as we continue to improve our fulfillment capabilities, our customers can now track their appliance delivery in real time, and we will soon be leveraging enhanced technology to further streamline the buy online, pick-up in store experience for our customers through an improved store execution process. As we look ahead to spring, we are well positioned to capitalize on what we expect to be another strong spring season. Consistent with our approach over the past year, we have worked hard to land our spring product early. Through an expansion of our network of coastal holding facilities, we are better able to manage the flow of imported product enabling us to quickly flow product where needed as spring arrives across the country. As one of the largest importers in the U.S., we continue to leverage our scale and carrier relationships to secure capacity and work to mitigate and manage the impact of cost increases across our supply chain. Before I close, I'd like to extend my appreciation to our merchants and inventory and supply chain teams, along with our vendors for their hard work and continued support. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. I would like to begin by thanking our frontline associates for delivering tremendous results in 2021. In recognition of their outstanding efforts, we awarded the discretionary year-end bonus of $6,000 for assistant store managers, $1,000 for department supervisors, $800 for full-time hourly associates and $400 for part-time hourly associates. As Marvin mentioned, the combination of Winning Together and this discretionary year-end bonus will result in a payout of over $350 million for our frontline associates this quarter. As someone who started his career in home improvement as an hourly associate, I understand how meaningful this type of financial recognition is for our hourly associates. At Lowe's, our people are truly our most valuable asset. When it comes to recruiting and retaining top talent, we strive to be an employer of choice. From the moment that a candidate applies for a position at Lowe's, we are committed to creating a positive impression. We have invested in leading technology that accelerates the hiring process, so that we are processing applications in a matter of minutes rather than the weeks that the manual process required as recently as last year. We also continue to improve our onboarding process so that our new hires can quickly come up to speed, leveraging the technology and product knowledge that is readily available to them on their handheld mobile devices via the Lowe's University application. As I mentioned on our last call, we are also leveraging our new Lowe's University in-store training labs to provide the ongoing training that our associates need to build their skills and confidence so they can continue to progress in their career.
Over the last 3 years, we have created valuable career opportunities for our associates with the incremental 10,000 department supervisor roles and 1,600 ASM positions that we have added. Since 2018, we have also invested well over $2 billion in incremental wage and equity programs for our frontline associates to ensure that we continue to offer a strong competitive wage and benefit package to our associates. I'm really pleased to report that our investments to position Lowe's as an employer of choice are paying off. Heading into spring, we anticipate being even better positioned than last year from a hiring perspective. And we are also confident that we will continue to drive productivity in our operations through our perpetual productivity improvement or PPI initiatives. As a reminder, this is not a single win. It is a series of improvements that are scaling across our stores over time. In fact, we are working on over 20 different PPI initiatives in our store operations this year. To highlight just a few key PPI initiatives, we have just launched a new store inventory management system, or SIMs across all of our stores. This platform gives store associates real-time visibility to inventory in their store. This includes inventory in the home bay location as well as product in the top stock and cap, off-shelf and back stock room. This new system will eliminate the countless nonproductive hours associates have been spending looking for product. I'm also excited about our continuing efforts to eliminate the ancient green screen technology with the launch of our simplified user interface to other selling stations throughout the store. First introduced at our front-end registers, we are beginning to implement this new technology across the sales floor. With this new platform, we are accelerating the associate training process and facilitating cross-training in other departments. This new technology will free up our associates to focus on providing excellent customer service while reducing customer wait time. While these 2 initiatives are just a few of the PPI deliverables planned for this year, we expect that these 2 initiatives alone will drive $100 million in productivity this year. Looking forward, we will continue to leverage technology to reduce manual tasking for our associates while also enabling them to deliver better service to our Pro and DIY customers. I would like to close once again by thanking our store associates for their continued hard work and dedication and the great results we achieved together this year. With that, I will turn it over to Dave.
David Denton:
Thank you, Joe. I'll begin this morning with a few comments on the U.S. economy as it relates to the home improvement sector. As Marvin indicated, the consumer backdrop remains favorable, as we are confident that home improvement demand will remain strong despite an uptick in interest rates. Historically, when interest rates have risen against a strong economic backdrop, the home improvement sector has delivered solid growth. During these periods, housing affordability was supported by growth in jobs and personal income, which offset the impact of higher borrowing costs. Today, housing affordability remains above the pre-pandemic average. The market is expecting moderately higher interest rates in the coming quarters. But keep in mind, rates are increasing off historic lows. Home equity has increased due to rising home prices and consumer savings are about $2.5 trillion higher than pre-pandemic levels, positioning consumers for continued residential investments. Given all these factors, we are expecting another strong year of demand in the home improvement market.
Now let me turn to capital allocation. We remain committed to be best-in-class when it comes to our ability to create value for our shareholders through our strong capital allocation program. In 2021, we generated $8 billion in free cash flow driven by outstanding operating results, and we returned $15.1 billion to our shareholders through both share repurchases and dividends. During the fourth quarter, we paid $551 million in dividends and repurchased approximately 16 million shares for $4 billion. This brought the total to $13.1 billion in share repurchases for the year, ahead of our expectations of $12 billion. This reflected better-than-expected financial performance and our commitment to return excess cash to shareholders. Capital expenditures were $597 million in the quarter and nearly $1.9 billion for the full year as we continue to invest in strategic initiatives to both drive growth and enhance returns across the business. Our balance sheet remains very healthy. Adjusted debt-to-EBITDAR stands at 1.98x, well below our long-term leverage target of 2.75x. As I mentioned at our December 15 investor update, we are planning to return to our leverage target over the next 2 years, driven by our shareholder-focused capital allocation strategy. With that, I'd like to turn to the income statement. In the fourth quarter, we reported diluted earnings per share of $1.78, an increase of 34% compared to adjusted diluted earnings per share last year. This increase reflected better-than-expected sales growth, improved gross margin rate and favorable SG&A leverage, driven by our productivity initiatives. In the quarter, sales were $21.3 billion, reflecting a comparable sales increase of 5%. Comparable average ticket increased 9.4% and with higher ticket sales in appliances, flooring and seasonal and outdoor living and 90 basis points of commodity inflation in both lumber and copper. In the quarter, comp transaction count decreased 4.4%, but on a 2-year basis, comp transactions increased 8.9%. We continue to gain traction with our Total Home strategy as reflected in Pro growth of 23% and positive DIY comps on top of extremely strong DIY growth last year. On Lowes.com, sales increased 11.5% in the quarter. U.S. comp sales increased 5.1% in the fourth quarter and 35.2% on a 2-year basis. We saw acceleration in both our Pro and our DIY comp sales trends from our third quarter performance. By month, our U.S. comparable sales were up 8.1% in November, up 7.4% in December and down 1.3% in January. Recall that we cycled over government stimulus in late December and early January of last year. But looking at U.S. comp growth on a 2-year basis from 2019 to 2021, November sales increased 33.8%, December increased 37.4% and January increased 33.9%. Gross margin was 32.9% of sales in the fourth quarter, up 115 basis points from last year. Product margin rate increased 65 basis points, driven by our disciplined pricing and cost management strategies. Improvements in both shrink and credit revenue benefited gross margin by 50 basis points and 25 basis points, respectively. These benefits were partially offset by roughly 30 basis points of pressure related to higher transportation and importation costs, as well as the expansion of our supply chain network. I'd like to spend just a moment addressing the recent increase in lumber prices. We are confident that we have an effective strategy to carefully manage our inventory and rapidly adjust pricing. Although we are planning for our lumber margins to be compressed when prices decline, we are confident in our outlook for gross margin rate to be up slightly in 2022. Turning to SG&A. We levered 15 basis points versus LY, driven by higher sales and our relentless focus on productivity. This quarter, we incurred $50 million of COVID-related expenses as compared to $165 million of COVID-related expenses last year. This reduction in these expenses generated 60 basis points of SG&A leverage. Additionally, we incurred $150 million of expenses related to the U.S. stores reset in the fourth quarter of last year. As we did not incur any material expenses related to this project in '21, this generated approximately 75 basis points of SG&A leverage versus LY. These benefits were pressured by 100 basis points related to the discretionary year-end bonus of $215 million for our store-based frontline associates. Operating profit was over $1.8 billion in the quarter, an increase of 21% versus LY. Operating margin of 8.7% for the quarter increased 115 basis points over last year, largely driven by higher gross margin rate, as well as favorable SG&A leverage. The effective tax rate was 25.3% in the quarter, which is in line with prior year. At year-end, inventory was $17.6 billion, up $920 million from Q3 and in line with seasonal trends and consistent with our effort to land spring products earlier. Driven by both improved operating performance and a disciplined capital allocation strategy, we delivered return on invested capital of 35% for the year, up 760 basis points from 2020. Now turning to our 2022 financial outlook. We closed out 2021 ahead of the expectations that we presented at our December 15 investor update. Month-to-date, February, U.S. comparable sales trends are in line with our fourth quarter performance on a 2-year basis. And based on the continued momentum that we are seeing in Pro sales, as well as higher expectations for commodity inflation, we are raising our sales outlook for 2022 to a range of between $97 billion to $99 billion for the year, representing comparable sales of down 1% to up 1%. Now please keep in mind that our outlook assumes that lumber pricing will return to a more normalized level in the second half of the year. We continue to expect Pro to outpace DIY in 2022. Keep in mind that we are cycling over an estimated 300 basis points of stimulus in the first quarter. Also, as a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We now expect gross margin rate in 2022 to be up slightly as compared to the prior year. With higher projected sales, improving gross margin outlook and continued execution of our PPI initiatives, we are raising our outlook for operating margin to a range of 12.8% to 13% from a prior range of 12.5% to 12.8% for the full year. We are also raising our outlook for diluted earnings per share to a range of $13.10 to $13.60 from a prior range of $12.25 to $13. In 2022, we continue to expect capital expenditures of approximately $2 billion and share repurchases of approximately $12 billion. Finally, we are raising our outlook for return on invested capital to above 36% from our original outlook of approximately 35%. In closing, we are off to a great start in 2022. We have significant runway ahead of us to both grow our market share, expand operating margins and deliver meaningful long-term shareholder value. And with that, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
I wondered if you could maybe talk a little bit more about inflation, how you're viewing inflation as part of the comp sales guide for 2022.
David Denton:
Yes. Kate, thank you for the question. As we think about next year, if you look at our guide of down 1 to up 1, we would expect units to be modestly down and our average ticket offsetting that almost dollar for dollar.
Katharine McShane:
Okay. And based on what you said about February, it does seem like there may have been an acceleration from what you saw in January into February on a 1 year. Is it right that you're seeing better trends in February than January? Should we really just be thinking about things on a 2-year stack?
David Denton:
Kate, it is true, we are seeing better trends in February than January. But on a 2-year basis, you need to think about it, our trends in February, consistent with the 2-year trends for the fourth quarter, which is really solid.
Operator:
Our next question comes from the line of Mike Baker with D.A. Davidson.
Michael Baker:
On the Pro side, in the past, you've talked about it as being anywhere between 22% and 25%. Your orange competitor yesterday bumped there, talk of what the Pro is to 50%. They used to say somewhere in the low to mid-40s. I understand that it's hard to get the exact number, but any update on what you think on an annual basis the Pro penetration is? And then more importantly, what do you think it can get to?
Marvin Ellison:
Yes. Look, I think your first statement is directionally correct on what and where the penetration is. We just know the business continues to be very strong. If you think about 23% comps in the quarter and 54% on a 2-year basis, I mean, we feel great about that business. And I think you noted, we spent quite a bit of time over the last 3-plus years making not only investments in adding products to our assortment, but also our service levels fulfillment. And we're very pleased, as I mentioned in my prepared comments with the launch of our new Pro loyalty program. And as I mentioned as well, we're seeing a 300% increase in Pro sales for Pros engaged in our loyalty and credit program. And so Pro is going to be a significant part of our growth this year, and we still feel very encouraged by the progress.
Michael Baker:
Okay. And as a follow-up, DIY, you said up on strong gains last year, fair to say up in the low single digits, slightly up something in that range, just what the math suggests?
David Denton:
That's correct. We saw expansion in growth in both, obviously, the Pro, but importantly, the DIY as well.
Operator:
Our next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is on EBIT margin. Now that it looks like you could get to 13% in '22. If you look at the model in the out years, and I know you haven't really given anything past this, is the correct way to think about moving past 13%, it's productivity-driven, meaning it's all throughput as sales per foot keeps rising?
David Denton:
Yes, I think that is correct. Simeon, we're excited about in December to come back as a complete management team and really outline the building blocks for our progression above and beyond our 13% level as we think about our EBIT margins. But yes, I think about productivity as the main driver of that, as we continue to lean into both the Pro business, as well as healthy growth in our DIY business.
Simeon Gutman:
And my follow-up is on inventory. There's been -- there's this big divergence in Q4 now between you and Home Depot. And if we try adjusting to see if there's a catch-up, it doesn't look like it's the case. And so I guess, Marvin, when you got to Lowe's, I think it was the first and maybe even the second spring where you put Lowe's on the offensive in terms of inventory. So the question for you is, are you pleased with what you've bought so far? And are you pleased with the visibility of what's coming in for this spring and even for the year?
Marvin Ellison:
Short answer is, absolutely. I give a lot of credit to Bill and the merchant team, Don Frieson and the supply chain team for working in a very collaborative fashion to make sure that not only are we fully good about what we have from a product category, but also the quality of the inventory. And as Dave mentioned in his prepared comments, the coastal holding facilities that we established on both the East and Western Coast have given us the ability to land import product early, take possession of it, which on a temporary basis, will elevate inventory levels, but we feel that's a prudent thing to do to make sure that we have that product available out of that global supply chain, so we can get it to our RDCs and our stores. But we do feel good about where we are. We feel good about the investments we've made in job like [ qualities ] with Pros. And we think headed in the spring, which, as you know, is a significant sales period for us, we're in really good shape.
Operator:
Our next question comes from the line of Scot Ciccarelli with Truist Securities.
Scot Ciccarelli:
Obviously, business is still exceptional but what kind of impact are you projecting from higher interest rates on the housing market? And what is your framework for those projections?
David Denton:
Yes. Scot, kind of in my prepared remarks, we talked about that interest rates do have an impact to some degree. But if you go back and historically look at periods of time when interest rates have risen, at the same time, we had really good economic backdrop. Actually, the home improvement sector has benefited from that. And I think if you cycle into '22, you see that same kind of economic climate now. So we feel like the demand profile of the sector is really healthy, number one. And number two, many of the efforts that we're embarking upon and actually beginning to gain some traction, we're going to actually disproportionately take share in the marketplace. So we feel like we're really nicely positioned to deliver a really solid '22 and think about the future growth of this business in a really healthy manner.
Marvin Ellison:
Scot, this is Marvin. Just one point to add. I do think that home improvement oftentimes gets combined with home building relative to interest rates. And obviously, the sectors are entirely different. And I think that we look at historically, that's why I think Dave's comments are so important that historical trends will show convincingly that high interest rates, combined with other positive macro indicators, do not have a negative impact on home improvement. Now home buying, I'm sure it's a totally different equation, but we want to make sure that there's a line of delineation between the 2 sectors.
Scot Ciccarelli:
So just to be clear, guys. So there -- at this point, there's no assumed degradation in sales trends because of higher interest rates?
David Denton:
That's correct.
Operator:
Our next question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
Can I just -- can you just delve into the factors a bit more about what's driving the increase in the comp outlook in 2022? So to what extent are you expecting a higher level of market growth versus what you laid out in December? To what extent are you assuming more share gains? And then how does that compare to your expectations on price inflation and how lumber will play out?
David Denton:
Yes. I think there's really 3 things that are driving our increase in our guide from a top line perspective. One is we do think the market is going to perform a bit better. And by the way, we still think we're going to -- and believe and plan for us outpacing the market from a growth perspective. Secondly, we are seeing higher levels of commodity inflation than what we planned back in December, largely in lumber. So that is ticking our sales progression up slightly in the first half of the year. And then third, we're seeing really strong sustainable performance in our Pro business. And that demand has been really consistent through Q4 and we're leaning into Q1 in a very consistent manner -- in healthy manner from a Pro business perspective.
Marvin Ellison:
Chris, I'm going to just add a little commentary on the Pro business, this is Marvin. We did a cost survey stated Pro that we issued out publicly. And just a couple of interesting data points. When we talk to Pros and DIY customers, both said that they see continued investment in the home. The DIY, I said at a pace of 50% today, we're going to do DIY projects and a roughly 50% say they would hire Pro. And then when you talk to our Pro customers, we have in detail, they continue to let us know that their book of business is more robust than they've ever seen it. They have projects lined out for balance of this year. Some projects may carry over into '23. And health of that business is very strong. And I think all the investments that we made in our merchandise assortments, in our service levels, in our stores, in our supply chain is driving that business. Again, 2-year comp in Pro is 54%, that's pretty good.
Christopher Horvers:
Understood. And then can you also talk about the gross margin a little bit, the shrink and the credit performance were quite strong and gross margin came in better than expected. How do these sort of proceed into 2022? And what's elevating your gross margin outlook relative to what you talked about in December?
David Denton:
Yes. Listen, I think first and foremost, we're just extremely pleased with the performance from a shrink perspective. I think the store teams and the loss prevention teams have just done an excellent job of managing that. And now it's becoming a bit of a tailwind for us as opposed to a headwind, which was historic. I think as we lean into '22, think about a few things happening.
In general, for the full year, we expect the gross margin to be up slightly, product margin to really lead the charge there as we really manage pricing costs very effectively. Our shrink and credit programs, think about that was largely neutral to our performance versus '22 versus '21. And then we'll have a little bit of headwind as we think about both rates and supply chain and our continued build out in the supply chain ecosystem.
Operator:
Next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Marvin, I think you mentioned earlier today that about half of Lowe's sales growth in the second half of last year was due to product inflation. Home Depot mentioned yesterday they got around 800 basis points of comp benefit from product inflation. At what point does the consumer start to push back or the industry experience an elastic response from all the inflation that's being passed through, especially as there's a return to normalcy, mobility increases and the interest in other categories shift on a return to normalcy?
Marvin Ellison:
Well, Michael, look, I'll give you just a more of a philosophical perspective based on the trends that we see. So we are very confident that there are certain trends that will sustain. You have millennial household formation trends that are much more robust than any of us had anticipated pre pandemic. You're also seeing the investments in the home that will maintain simply because there are so many millions of people working from home permanently that even as we hope and pray the pandemic will dissipate, you still will have millions of people who permanently work from home that's going to drive certain investments in repair and maintenance that we think will [ sustain going past ] 2022.
And the work that the merchants and the finance team has done to drive cost out and to make sure that whatever price increase is driven by inflation we are pushing toward our customers, we're still doing that at a very competitive price because we're taking a multitude of actions to ensure that we're trying to drive other factors of cost out. Look, you know this, I think we're one of the only large retailers that reported -- that's reporting an increase in gross margin for the quarter and for the year from a basis points standpoint. And also we're guiding that for the balance of '22, we're going to see gross margin rate continue to improve. That gives you an indication that we have some degree of confidence we can manage this. I'll let Dave provide more of the financial specifics on kind of what we've seen and what we see going forward.
David Denton:
Yes, Michael, I would just add that -- to Marvin's comments here, we really put in a very robust process and analytical tools around this, such that we're measuring and monitoring as we take increases from a cost perspective. First, we push back on that when appropriate. We take a portfolio approach to adjusting our pricing and then we measure and monitor the performance from a unit velocity perspective. And we adjust as needed, when we need to do that such that we get the best price point from a consumable perspective, but importantly, what also drives the economic value here at Lowe's.
Michael Lasser:
My follow-up question is Lowe's has some very interesting initiatives that are either in the early stages or just about to launch, most notably the supply chain transformation and the launch of the Pro loyalty program. So could you give a breakdown of the financial impact that you've seen from both of those programs as you've tested them and then what you factored in as far as the contribution from each of those in the year ahead?
David Denton:
Well, maybe I'll take the contribution. Just from a planning perspective, these programs are well planned and well thought out. We have a substantial financial model associated with that. We test and learn as we go. And so we have a -- we feel like our plan for 2022, we have a very good line of sight to performance being driven out of those 2 programs. So first and foremost, we kind of checked that box. And then I'll let Marvin chat about the programs you like.
Marvin Ellison:
No, look, I'll just repeat what I said on the Pro. We tested a loyalty program. All of 2021, we've made different tweaks to it based on feedback and surveys from our Pro customers. We feel like we have a program that's going to drive differentiation and adoption. And as I mentioned, when customers engage in the Pro loyalty and our credit program, we're seeing a 300% increase in sales. And then we think that we're going to see some level of retention and engagement with our Pro customers based on the loss that will be happening within the next couple of weeks. So again, excited about the test and learn environment we've created. And to Dave's point, I mean we put a lot of robust processing in place to ensure that we have good visibility to what we think each of these programs will deliver.
Operator:
The next question is from the line of Steven Zaccone with Citi.
Steven Zaccone:
I had a question on the DIY side of the business. So it sounds like most of the guidance raise is contemplated on the Pro and then commodity inflation. But can you comment if your DIY outlook has changed in 2022? And then larger picture on DIY, there's a thesis we'll eventually see a give back of spending in the category, but it seems to still be accelerating as of late and is still strong. What are you seeing in terms of purchase activity or project sizes from your customers that gives you confidence in the sustained strength in DIY?
Marvin Ellison:
Steve, thanks for the question. Our DIY sales were very, very strong in 2020. So year-over-year, we had tough comparison, we were able to grow that business even on top of some really aggressive sales last year. One of the things that we're leaning into as part of our Total Home strategy is private brands. And private brands specifically in the core-related categories. I'm going to let Bill Boltz talk a little bit about what we're leaning in there and how we believe that, that's going to give us some level of continued growth and differentiation.
William Boltz:
Yes. Thanks, Marvin. And just a little more color around the DIY business. I think as we head into spring, as we mentioned in our prepared remarks, we talked about a couple of key private brands that will play a big role in the spring with the Origin 21, which we're excited about that. That's a new modern brand. So you'll see it introduced in patio. You'll see it in some of decor categories in our stores. And then allen + roth, we've worked really hard over the last 18 months to enhance that brand. And so that's more of a traditional style. And so that will play a big role as well.
And then we're really excited about the expansion of STAINMASTER. STAINMASTER, as you know, we acquired a year ago. It was largely a carpet brand, but we have opportunities to use that in other categories in flooring, really building off of its characteristics. And then along the same lines, as we look into the spring season, our live goods and nursery business very strong, has been on a really nice run over the last couple of years, and that plays a large role in our DIY business as we go into spring as well. So we're really -- we're optimistic around the DIY business as we had in the first half of the year.
Marvin Ellison:
And Steve, we're students of history, and we know that one of the strategic mistakes historically at Lowe's was to overcompensate and over-penetrate in private brands in Pro-related categories. And so Bill and his team have been very, very specific to continue to lean in to national brands on the Pro side. But on the DIY side, specifically home decor, the customers are telling us overwhelmingly that they love our design capabilities of private brand. And so we're going to lean into that for differentiation and also for a margin rate benefit. And again, we think we're off to a great start.
Operator:
Our next question comes from the line of Liz Suzuki with Bank of America.
Elizabeth Lane:
How much market share do you think you've taken in the last 3 years? And if the supply chain disruptions normalize and some of your smaller competitors are able to get product again, do you see some of those share gains moderating?
Marvin Ellison:
Liz, it's a fair question. But I will repeat what I've said a couple of different times. Home improvement does not have great market share data that we can glean very specific answers to. What I can tell you based on just our on-the-ground analysis is that we are, in fact, taking market share. It's hard to grow a business this size by over 35% on a 2-year basis and it's not coming from somebody. We also are aware that there are winners and losers in retail based on the efficiency of your supply chain. We are fortunate that we are one of the largest importers of containers. And we have great supplier relationships that the merchants continue to foster. So do we believe that we're winning? We do. Do we think we'll continue to take market share in 2022? As Dave said earlier, we absolutely believe we will. And we think we'll take it across Pro and on -- and DIY, both in-store and online. But again, it's hard to give you a lot of specificity because the data set is not [indiscernible].
David Denton:
And Liz, but from our internal data, we continue to -- our data suggests that we're performing 200 to 300 basis points ahead of the market pretty consistently. And that will be our expectations going forward as well to outperform the market.
Elizabeth Lane:
Great. And just, I mean, how much do you think that the expansion into home decor and new product categories increases your total addressable market?
Marvin Ellison:
It's a great question. We can only go by the feedback that we receive from our customers when we do surveys and we do different types of focus groups and what they are telling us is that they are more brand-agnostic when it comes to home decor-related categories and they are more concerned with quality and good style and price. And what Bill and his team has done with the launch of Origin 21 and with the continued improvement in allen + roth as an example, gives us a lot of confidence and we're really excited about STAINMASTER.
As Bill mentioned, you're going to see it going into more hard-surface flooring, but we have some other really exciting ideas that we'll be sharing over the next couple of quarters, but we're going to extend this very, very recognizable and high-quality brand in the other home improvement categories that customers, I think, will be very excited about.
David Denton:
Rob, we're going to take one more question, please.
Operator:
The final question will be coming from Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things, if I could. First of all, the last 2 years have been relatively unique in terms of pricing and promotion and mix with a pretty aggressive consumer and Pro customer. As you think about '22, and it sounds like you think '22 kind of largely feels like the last couple of years, is your strategy the same with pricing, promotion and mix? Or do those efforts normalize a bit towards what we had seen historically?
David Denton:
Eric, I think they're going to be fairly consistent. Our plan is fairly consistent in '22 versus '21. And -- but I'll let Bill comment on that, too.
William Boltz:
Yes, Eric, it's Bill. And so as you know, over the last couple of years, we've been on this journey of getting to more of an everyday competitive price and trying to wind down what has historically been here a very high low approach to marketing and promotion. And we've very successfully been able to do that. And that's now given us the runway to continue to provide value in a number of different ways to our consumers, both through special buys, special values, unique offerings. And so that's the journey we're on and that's what we're excited about. But being able to get off of that, what historically high-low approach allows us to be in this everyday competitive price in the home improvement business and that's what we wanted to be on.
Eric Bosshard:
Okay. And then secondly, within the guide for '22, which I think you spoke to negative units and price offsetting that to get to comp dollar growth, haven't had a negative unit plan or outlook in quite some time for your business. I'm curious how you'd marry that up then with your inventory strategy and also with how you manage labor specifically in terms of the investment or the growth in both of those areas in a year where the outlook is reasonably for negative units?
Marvin Ellison:
So Eric, I'll take the first part of it, and I'm going to let Joe just talk a little bit about how our new labor system allows us to make real-time adjustments by store, by department based on ticket and transaction. You have to understand that one of the reasons why you're going to see negative units is because the DIY customer in the heart of the pandemic made types of purchases that they're not going to make in an era where there is less concern around the virus and less nesting at home.
We had cleaning purchases that drove a lot of transactions, not a lot of ticket. We had a lot of garden purchases and drove a lot of transactions, not a lot of tickets because people were at home and they were staying busy. Categories like paint, a lot of activity, not a lot of ticket. And so as we normalize year-over-year, we've got to see those activities are not sustainable. So when we say that the ticket is not as though we believe that we're seeing less customer traffic, we're just seeing DIY customers have different projects than they had when they were confined to their homes and staying busy with just random different projects around the house. And that's the difference. So when we look at that, we just made it really transparent around how we view the inputs to what's driving sales. And we have no concerns that we're having a traffic issue or we have a customer demand issue. This is just more normalizing over unique activity in the middle of the pandemic. So I'll let Joe talk about our labor system and how we can manage it based on all those inputs.
Joseph McFarland:
Thanks, Marvin. And Eric, you remember just a few years ago, we put together just a topnotch workforce management team, and we developed a labor model that is activity based. So this labor model has served us well as sales have taken off and exceeded expectations from an appropriate leverage standpoint and does the same in balancing out the ticket and transaction. We're very pleased with our staffing and our outlook for '22.
Kate Pearlman:
Thank you all for joining us today. We look forward to speaking with you on our first quarter earnings call in May.
Operator:
This will conclude today's conference. Thank you for your participation. You may now disconnect your lines at this time.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2021 Earnings Conference Call. My name is Darryl, and I will be your operator for today's call. [Operator Instructions] As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you and good morning, everyone. Here with me today are Marvin Ellison, Chairman, President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release in our Investor Relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Thank you, Kate, and good morning, everyone.
I'd like to begin by taking a moment to extend my thoughts and prayers to those who are impacted by the ongoing pandemic as well as the many wildfires. At Lowe's, we remain committed to the health and safety of our associates and customers while supporting the communities in which we operate. The resilience of our customers and our associates is something that I admire on a daily basis. Now turning to our results. We are very pleased with the performance for the second quarter. During the quarter, comparable sales declined 1.6% for the total company and 2.2% for the U.S. And on a 2-year basis, comp sales were positive 32% for the total company and for the U.S. Our outstanding 2-year performance was driven by great execution of our Total Home strategy, which allowed us to win with both the Pro and DIY customers while meeting the aggressive growth demands across Pro, Lowes.com and our Installation Services business. As anticipated, during the quarter, we saw a decline in DIY demand versus last year as many families transition back to pre-COVID purchase patterns and weekend mobility after Memorial Day. But because of the agility of our Total Home strategy, we were able to capitalize on Pro demand driving growth of 21% this quarter and 49% on a 2-year basis. This level of Pro growth would not have been possible without our intense focus on the Pro customer over the past 24 months. This intense Pro focus includes our U.S. stores reset project that we executed last year. This reset has allowed us to create a more intuitive store layout for the Pro aligned across product adjacencies, so Pros can quickly and easily locate all products they need for their jobs. And as a reminder, our core Pro customer is a small- to medium-sized business owner. These customers shop frequently across the store, impacting numerous product categories. And as we continue to capture more of their spend, we will continue to increase productivity across the top and bottom line of our stores. Later in the call, Bill will discuss how we will continue to expand our Pro product offerings and then Joe will discuss our enhanced online experience for the Pro. We also delivered double-digit growth this quarter in our Installation Services. We continue to expand the products available for installation, and we're leveraging our enhanced e-commerce platform and our revamped business model to deliver a better customer experience. We expect our Installation Services business to continue to play an important role in our Total Home strategy as customers increasingly look to us to provide an end-to-end turnkey solution for their home project needs. And at Lowes.com, sales grew 7% on top of 135% growth in the second quarter of 2020, which represents a 9% sales penetration this quarter and a 2-year comp of 151%. Our enhanced omnichannel offering continues to resonate with our customers who increasingly expect total flexibility in shopping however, whenever and wherever they choose. We're also pleased with the performance of our Canadian business. In the second quarter, Canada delivered comp growth in line with the U.S. despite several COVID-related operating restrictions. We also continued to elevate our product offering, which is another pillar of our Total Home strategy as we help fulfill the aspirations of our customers to upgrade their homes and style. And we delivered strong positive comps across kitchen and bath, flooring, appliances and decor on top of 20% growth in these categories last year. The 17% growth we experienced in ticket over $500 was in large part driven by these categories, reflecting continued consumer confidence in investing in their homes. This also reinforces the consumers' confidence in Lowe's as the right destination for their home decor needs. And during the quarter, operating margin expanded approximately 80 basis points leading to diluted earnings per share of $4.25, which is a 13% increase as compared to adjusted diluted earnings per share in the prior year. In the face of unprecedented lumber price volatility during the second quarter, our improved operating performance reflects the benefits of our new price management system along with our disciplined focus on perpetual productivity improvement, or PPI. Bill and Joe will discuss both these initiatives in more detail later in the call. I'd now like to take a moment to discuss a very important milestone in the company's transformation. When I joined Lowe's as CEO back in July of 2018, I discussed the importance of transforming and modernizing our supply chain. The foundation of this transformation is transitioning the company from a store-based delivery model to a market-based delivery model for big and bulky products. I'm pleased to announce that this quarter, we completed the conversion of our Florida region to a market-based delivery model for appliances and other big and bulky items like grills, riding lawn mowers and select patio furniture. In this new delivery model, product flows from the bulk distribution centers to cross-dock terminals directly to customers' homes, bypassing the stores altogether. This replaces a legacy store delivery model where we hold appliances in stockrooms and storage containers behind our stores and then leverage store-based trucks and associates to deliver these products to customers' homes. To say this legacy process is inefficient would be an extreme understatement. The new market-based delivery model is already driving higher appliance sales, improved profitability, lower inventory, higher on-time delivery rates and improved customer satisfaction. And we're freeing up space in our stockrooms, which will enable us to expand our same-day and next-day Pro and DIY fulfillment capabilities in the near future. We plan to roll out the market-based delivery model across additional regions by the end of the year and then complete the rollout across the U.S. over the next 18-plus months. With this new delivery model, we will continue to drive sales, inventory turns and operating leverage through a technology-driven, simplify and customer-centric process. Before I close, I'd like to share my perspective on the home improvement market as well as Lowe's opportunity to win in this market. The outlook for the home improvement industry remains very positive. Residential investment is expected to remain high due to historically low mortgage rates while home prices continue to appreciate. We're also pleased that we continue to see higher household formation trends and longer-term wallet share shift to the home. It's also worth noting that any near-term pressures on housing turnover is not related to an economic downturn as typical. In fact, there is more housing demand than supply, resulting in home prices continuing to rise. And because of this, consumers have an increased confidence in repairing and remodeling their homes. As a reminder, approximately 2/3 of Lowe's annual sales are generated from repair and maintenance activity. Further, our research shows that it will take years for the supply of homes to meet the projected demand. This remains a very positive indicator for home improvement. In addition, the customers' mindset regarding their home is very straightforward. As long as their home is increasing in value, they see upgrades and enhancements to their home as an investment and not an expense. Looking ahead, although the business environment remains uncertain, we are confident that our Total Home strategy provides us with the agility to operate with profitability in times of high and low customer mobility. And finally, I would like to extend my heartfelt appreciation to our frontline associates. As I travel the country on a weekly basis visiting stores, I'm continually inspired by the hard work and commitment of our associates to support our communities while providing excellent customer service. And with that, I will now turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone.
U.S. comparable sales were down 2.2% in the second quarter but up 32% on a 2-year basis. We drove solid positive comps in our building products and home decor divisions. And while we delivered a terrific spring over the first half of the year, the pivot in consumer behavior after Memorial Day resulted in negative comps in our seasonal categories this quarter. However, growth was broad-based on a 2-year basis with all product categories up more than 15% in that time frame. In building products, we delivered double-digit comps in electrical and lumber driven by strong Pro demand as well as high levels of inflation. And as Marvin mentioned, our merchandising and finance teams navigated through unprecedented lumber price volatility this quarter. Our enhanced pricing systems enabled us to effectively mitigate the impact on our product margins. Dave will provide more detail on the near-term impact of the lumber price decline on our margins and sales, but I'm confident that our talented teams have the right pricing tools and processes to continue to manage through elevated levels of inflation and pricing volatility. I'm also pleased with our performance in home decor as DIY customers continue to rely on Lowe's for their home remodeling needs. By leveraging our Total Home strategy, we delivered positive comps across appliances, kitchens and bath, flooring and decor on top of over 20% growth in these categories last year. Capitalizing on our #1 position in appliances, we delivered strong comps in the category this quarter with particularly standout performance in washers and dryers as well as refrigerators and freezers. Countertops, kitchen cabinets and vanities were the strongest contributors to our kitchen and bath comps as our customers continue to appreciate the new on-trend, coordinated styles that are available in our own allen + roth brand. Vinyl flooring was the top-performing category within flooring driven by new and innovative WetProtect product from Pergo. It's a leading brand in this category that is exclusive to Lowe's, and this product provides peace of mind to our customers with its guaranteed waterproof protection for both the flooring and sub-floor. We also delivered a strong spring season in the first half of the year that kicked off with the launch of our new SpringFest event. We were very pleased that our customers took advantage of the strong product offerings to help make the most out of their outdoor living spaces. In this quarter, we delivered over 30% growth in battery-operated outdoor power equipment. Both our DIY and Pro customers are drawn to the convenience and the quality of the EGO, Kobalt, CRAFTSMAN and Skill brands with their zero-emission, rechargeable equipment. And the addition of the EGO and Skill brands only bolsters our #1 position in outdoor power equipment, and they truly complement our other leading brands such as John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN. We continue to add new brands and products to our lineup, especially for our Pro customer. This quarter, with the launch of FLEX Power Tools, we featured an in-store demo station for our new FLEX cordless power tools. This brand is exclusive to Lowe's and delivers innovation to the power tool category, bringing more power and faster charging time than its competition. We also introduced the Mansfield brand across our bath department with drop-in tubs, showers and toilets. Another exclusive in the home center space, Mansfield is a strong Pro brand and their products are made right here in the United States. And I'm excited to announce that we'll be bringing more U.S.-manufactured product to Lowe's this fall with the launch of SPAX fasteners. SPAX is the market leader in multi-material construction screws. Their industry-leading innovation delivers some of the most advanced fasteners on the market. The addition of SPAX to the fastener program now rounds out the Pro assortment in this category that our Pro customers need. The addition of Flex Power Tools, Mansfield plumbing products and SPAX fasteners, continues to enhance our Pro brand arsenal, which already includes strong Pro brands such as Simpson Strong-Tie, DEWALT, Bosch, Spyder, GRK, FastenMaster, ITW, Lufkin, Marshalltown, [ S Wing ], Eaton, SharkBite and LESCO. As Marvin previously discussed, we delivered strong sales growth of 7% and a 2-year growth of 151% on Lowes.com. This quarter, we enhanced our omnichannel customer experience with the launch of our virtual kitchen design, which enables customers to create their dream kitchen, allowing them to work on their projects seamlessly between Lowes.com and the specialists on our virtual central design team. As part of our Total Home strategy, we are launching virtual search in our stores, which now allows a customer to hover their smartphone over a product and explore an endless aisle of similar items on Lowes.com. This is just one example of how we continue to integrate the online and in-store shopping experiences. And looking ahead, we are excited about the upcoming fall and winter holiday seasons as our customers will turn their attention to doing their homes and outdoor living spaces as the weather cools. We are confident that our Total Home strategy will enable us to continue to elevate our product assortment and allow us to take market share across our DIY and Pro customers. We will also continue to leverage our new price management system to effectively manage our product margins with a disciplined approach to vendor cost management and a data-driven portfolio approach to pricing to further enhance and refine our everyday competitive price strategy. And before I close, I'd like to once again extend my appreciation to our vendor partners and our merchants for their commitment to serving our customers. Thank you and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone.
For the second quarter, we continued to drive improved execution in our stores with our associates laser-focused on serving customers and maintaining a safe store environment. In early August, in response to the surge of the Delta variant, we reinstated mask requirements for all of our associates regardless of their vaccination status. I'm appreciative that our associates are once again rising to the dynamic challenges presented by this pandemic. I'm pleased to announce that for the sixth consecutive quarter, 100% of our stores earned a Winning Together profit-sharing bonus, resulting in a $91 million expected payout to our frontline hourly associates. And because our efforts once again exceeded expectations, this represents an incremental $20 million over the target payment level. We're also very pleased that our PPI initiatives continue to gain traction, driving operating efficiency again this quarter as we leverage store payroll through operational process improvements and technology enhancements, reducing the amount of time our associates spend on tasking activities so they can focus instead on serving the customer. During the quarter, we maintained strong staffing levels despite isolated labor shortages in some areas of the country. We continue to enhance the labor scheduling system that we launched in 2019, which allows us to align our payroll hours with customer traffic patterns. It also enables us to respond rapidly and effectively to changing market conditions so that we can ensure that we continue to provide great customer service while also driving operating leverage. This year, we've installed our homegrown self-checkout solution in over 550 stores that did not have any self-checkout capability for our customers. This Lowe's-designed self-checkout was built with the home improvement shopper in mind, featuring a simplified user interface, multiple ways to scan product and the ability to use Lowe's military and credit card discounts. This new solution is already driving higher customer adoption rates and incremental payroll leverage. And with the digital signs fully rolled out across lumber and appliances, we are not only driving labor savings but also enhance product margins as we can now adjust prices more quickly to protect share and margins during periods of price volatility. As previously discussed, our online penetration for the quarter was 9%. And with approximately 60% of online orders picked up in the store, our dedicated in-store fulfillment teams are an integral part of the Lowe's omnichannel customer experience. We are continuing to leverage technology to improve efficiency in the customer experience, whether customers get their orders the front desk or through curbside or through their favorite option, our new pickup lockers. Now let's turn to our performance of the Pro customer. As discussed earlier, Pro continues to outpace DIY with Pro comps of 21% for the quarter and 49% on a 2-year basis. We continue to expand our digital connection with the Pro customers. We just completed the migration of Lowe's for Pros to the cloud. This important step in our Pro business evolution enables enhanced features, faster updates, improved site stability and more personalized offers for the Pro. One new feature is rapid reorder, which enables our Pro customers to quickly reorder items that they frequently purchase through Lowe's. We are focused on making the Pro shopping experience both online and in-store as easy and intuitive as possible. We're also growing our Pro loyalty program as we look for innovative ways to expand our members-only benefits. Every day, we are striving to demonstrate that Lowe's is the new home for Pros. Looking ahead, I'm excited about the second half of the year as we leverage our Total Home strategy to build on the momentum in Pro and Installation Services while also meeting the needs of the DIY customers as they continue to tackle interior and exterior projects to improve their homes. Before I close, I would like to once again extend my appreciation to our frontline associates along with other executive and senior officers as well as merchants and field leaders. I'm out visiting stores on a weekly basis to ensure that we continue to engage with and support our frontline associates in this challenging operating environment. I'm incredibly proud of this team and their continued hard work and dedication. With that, I'll turn it over to Dave.
David Denton:
Thanks, Joe, and I'll begin this morning with a few comments on the company's strong capital allocation program.
In the second quarter, we generated $2 billion in free cash flow driven by continued strong operational execution and consumer demand. We returned $3.6 billion to our shareholders through a combination of both dividends and share repurchases. During the quarter, we paid $430 million in dividends at $0.60 per share and we announced a 33% dividend increase to $0.80 per share for the dividend paid on August 4. Additionally, we repurchased 16.4 million shares for $3.1 billion and we have $13.6 billion remaining on our share repurchase authorization. Capital expenditures totaled $385 million in the quarter as we invest in the business to support our strategic growth initiatives. We ended the quarter with $4.8 billion in cash and cash equivalents on the balance sheet, which remains extremely healthy. At quarter end, adjusted debt-to-EBITDAR stands at 2.08x, well below our long-term stated target of 2.75x. With that, now I'd like to turn to the income statement. In Q2, we generated diluted earnings per share of $4.25, an increase of 13% compared to adjusted diluted earnings per share last year. During the quarter, we drove improved operating leverage as we executed against numerous productivity initiatives across the company. My comments from this point forward will include approximations and comparisons to certain non-GAAP measures where applicable. Q2 sales were $27.6 billion with a comparable sales decline of 1.6%. Comparable average ticket increased 11.3% driven by over 400 basis points of commodity inflation, mostly in lumber, as well as higher sales of appliances and installations. This was offset by comp transaction count declining 12.9% due to lower sales to DIY customers of smaller ticket items like cleaning products, paint, mulch and live goods. In Q2, we cycled over a period when consumer mobility was limited, so many of our customers were tackling smaller projects around their homes. Also in Q2 of this year, DIY customers pulled back on purchasing lumber and related attachments due to extremely elevated lumber prices in the quarter. Keep in mind that comp transactions increased 22.6% last year, which results in a 2-year comp transaction count increase of 6.8%. As Marvin indicated, our investments in our Total Home strategy gave us the ability to pivot during the quarter and led to outperformance in many of our key growth areas with Pro up 21%, online up 7%, Installation Services up 10% and strong positive comps across DIY decor categories. U.S. comp sales were down 2.2% in the quarter but up 32% on a 2-year basis. Our U.S. monthly comps were negative 6.4% in May, negative 1.8% in June and a positive 2.6% in July. After Memorial Day, there was a noticeable increase in consumer mobility and consumers engaged in the opportunity to travel and spend in other discretionary categories. We saw a related decline in DIY customer traffic in our stores on the weekends while weekday traffic remained strong. Looking at U.S. comp growth on a 2-year basis from 2019 to '21, May sales increased 32.5%, June increased 32% and July increased 31.5%. Gross margin was 33.8%. As expected, gross margin rate declined 30 basis points from last year but was up 165 basis points as compared to Q2 of '19. Product margin rate improved 40 basis points. Our teams effectively managed product cost and pricing this quarter despite unprecedented volatility in lumber prices. Our teams continue to minimize vendor cost increases driven by higher commodity prices and elevated industry transportation costs. Also, higher credit revenue drove 30 basis points of benefit to gross margin this quarter. These benefits were offset by 20 basis points of pressure from shrink and live good damages from the extreme weather conditions in the West, also 25 basis points of mix pressure related to lumber and 20 basis points from less favorable product mix in other categories. Supply chain costs also pressured margin by 35 basis points as we absorbed some elevated distribution costs and continue to expand our omnichannel capabilities. Our supply chain team continues to leverage our scale and carrier relationships to minimize the impact of these distribution costs experienced across the retail industry. Now I'd like to spend just a moment discussing the near-term impact from the steep drop in lumber prices beginning in early July. Since that time, we have been selling many of our lumber products at compressed margins because we had previously purchased these products at higher cost. However, we expect that by the end of August, we will have substantially sold through these higher cost inventory layers. And despite these short-term pressures, we are still expecting that our gross margin rate to be up slightly for the full year versus last year. SG&A at 17% of sales levered 135 basis points versus LY driven primarily by lower COVID-related costs. We incurred $25 million of COVID-related expenses in the quarter as compared to $430 million of COVID-related expenses last year. The $405 million reduction in these expenses generated 145 basis points of SG&A leverage. These benefits were offset by 20 basis points of pressure from higher overall employee health care costs. Operating profit was $4.2 billion, an increase of 6% over LY. Operating margins of 15.3% of sales for the quarter was up 80 basis points to the prior year. This improvement was generated by improved SG&A leverage, partially offset by lower gross margin. The effective tax rate was 24.4%, and it was in line with prior year. At the end of the quarter, inventory was $17.3 billion, down $1.1 billion from Q1 and in line with seasonal trends. This reflects an increase of $3.5 billion from Q2 of 2020 when our in-stock positions were pressured due to elevated demand levels and COVID-related supply disruption. Current inventory includes a year-over-year increase of $665 million related to inflation, the majority of which is attributable to lumber. Now before I close, let me comment on our current trends and how we are planning the business for the second half of this year. Clearly, we continue to manage our business in a very fluid environment with the Delta variant trends injecting new uncertainty into the forecast. However, given our strong first half performance, Lowe's is clearly tracking well ahead of our robust market scenario that we shared with investors back in December of 2020. Our outlook assumes that the home improvement market will moderate somewhat in the second half given lower levels of commodity inflation and a continued increase in consumer mobility driven by return to work and school. We are expecting Lowe's mix-adjusted market demand to be essentially flat for the full year. This relevant market view reflects Lowe's higher DIY mix and lower online penetration. Now in this revised scenario, we expect Lowe's to deliver sales of approximately $92 billion for the year, representing 2-year comparable sales growth of approximately 30%. Month-to-date, August U.S. comp sales trends are materially consistent with July's performance levels on a 2-year comparable basis. As expected, we are already seeing a several hundred basis point improvement in comp transaction count over the Q2 levels, partially driven by increased unit sales of DIY lumber and related attachments as DIY customers who were sitting on the sidelines reengaged after lumber prices dropped. Importantly, we expect gross margin rate to be up slightly versus the prior year as we leverage our pricing and promotional strategies to mitigate the impacts of product and transportation cost inflation. With elevated sales levels projected and our current productivity efforts taking hold, we are now raising our outlook for operating income margin to 12.2% for the full year. We are expecting a 10 basis point negative impact from elevated cost inflation. Furthermore, we are tracking well ahead of our operating plans. And as such, we now expect to incur higher-than-planned incentive compensation, resulting in 20 basis points of pressure. Together, these expenses represent 30 basis points of operating margin deleverage relative to the $92 billion revenue outlook. Without these offsets in expenses, we would be expecting an operating income margin of 12.5% for the full year. When I consider our outlook for the business for the remainder of this year, I'm very pleased that we are now expected to deliver approximately 145 basis points of operating margin improvement over 2020. This reflects a disciplined focus on driving productivity and operational excellence across the organization. We are planning for capital expenditures of $2 billion for the year. Furthermore, we expect to execute a minimum of $9 billion in share repurchases. In closing, we are operating in a great sector expected to benefit from the secular tailwinds over the next several years. We are investing in the business and our Total Home strategy to drive long-term growth so that we continue to outperform the market and drive meaningful long-term shareholder value. With that, we are now ready for questions.
Operator:
[Operator Instructions] Our first questions come from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
Just given the changes in the Pro with all the brand additions you've made and the changes you've made to the store plus the change we've seen in terms of sales mix towards the Pro, can we assume that the sales mix for Pro for Lowe's is higher than the 20% to 25% you've quoted in the past? And how did the Pro comp of 21% compare to your plan for the quarter?
Marvin Ellison:
Kate, this is Marvin. I'll take the question. I would say that Pro outperformed our original plan. We knew that we would see a greater shift to Pro versus DIY based on what we saw in the first quarter. But the 21% comp and the 49% 2-year comp is something that exceeded our original expectations.
Having said that, if you take a look at our Pro penetration from 2018 to today, it's roughly a 300 basis points improvement. But as our total sales continues to grow, the overall Pro penetration still hovers around 25%.
Katharine McShane:
Okay. And just with regards to gross margin as a follow-up question, it seems that your guidance for gross margin being up slightly for the year implies that gross margins can be flat to up in the back half. Is there any way to delineate what Q3 looks like versus Q4?
David Denton:
Kate, it's Dave. I'm probably not going to give that level of granularity. I would say what is important, you have it exactly right, we do expect gross margin in the back half to be up slightly and certainly up for the full year.
Operator:
Our next questions come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question, it's a little theoretical on actually '22, and I know you haven't given guidance on this yet. The question is, if the business grows next year, if the industry grows next year, is there any cost pressure that we're seeing from this environment that could preclude margins from growing in a sales growth environment?
And then alternatively, if sales are flat or decline slightly, are there enough levers in the transformation of this business to allow margins to grow? And I'm just trying to understand what sort of buttons in FLEX and how you think about managing the business going into next year.
David Denton:
Simeon, this is Dave. Maybe I'll start. I'm sure Marvin will maybe chime in here a bit as well. Is -- clearly, as we stated today, we had an objective to get to 12%. Now just with the strength of the business, seeing line of sight to above 12% at this juncture, clearly, we have aspirations and targets to get to 13%, and we're still tracking nicely to those -- to that objective.
As we said, we are experiencing cost pressures from an industry perspective. Our model and what we put into the business and invest in the business allows us to be flexible and pivot such that in periods when sales are flat or sales are going up slightly, we can actually lever the business. So it's our expectation that we would continue to make progress as we continue to march to that longer-term goal of 13%.
Marvin Ellison:
Simeon, this is Marvin. The only point I'll add is we're very pleased that over the last 3 years, we've been able to put systems and organizational structures in place that really supports Dave's point of the agility we have.
If you go back to first quarter of 2019 when we had the cost and price issues, we had no internal mechanisms to manage that effectively. We've now rolled out a new modern price management system. Bill Boltz, Dave Denton and the merchants and finance team have created cost mitigation teams that work on a daily basis, helping us to manage cost retail and making the right decisions that first we'll think about the customer and how we can deliver value on an ongoing basis. So in summary, we now have levers that we can pull that we didn't have in the past. And so Dave's point is exactly correct, we think we can manage this effectively today and in the future.
Simeon Gutman:
And then maybe the related follow-up and thinking about the composition of the different margins, the gross margin and the SG&A, I know -- I think conceptually, the growth shouldn't really be going up much. But within the transformation, there are certain things that are targeted on the gross margin line like some of the supply chain initiatives that should lower some -- take some costs out of the business. So is the principal still the same where gross is still sort of rangebound and it's SG&A leveraged is how the margin expansion should come from here?
David Denton:
Yes. Simeon, that is correct. Keep in mind that we're making really nice progress from a product margin perspective. We continue to expand in that area. At the same time, we're investing in supply chain. And as we invest in supply chain, that essentially dilutes gross margin, but it relieves us of SG&A in the store. So therefore, the flow-through is very productive on the bottom line. But again, you have a geography shift as costs move up in the gross margin but out of SG&A.
Operator:
Our next questions come from the line of Zach Fadem with Wells Fargo.
Zachary Fadem:
So within the context of your 12.2% EBIT margin outlook, could you parse out the impact from the productivity enhancements you've been making across the business, things like market-based delivery, labor scheduling, digital signage, et cetera? And as we think about the back half of the year, should we expect these benefits to widen? Or are there any offsets from incremental investment like resets, et cetera?
Joseph McFarland:
There's no incremental projects that we're putting on our plate at this point in time for the balance of the year. I think the playbook that we launched at the beginning of the year continues to hold true because we're making the right investments in our business, and we don't see a need to change that.
Having said that, if you look at the back half of the year, we are making investments in supply chain. We're -- as Marvin indicated, we now have launched Florida. We're going to roll it out into other markets for the balance of the year. So that's putting some pressure on us as we plan, but you're going to see SG&A leverage come through as we continue to invest in productivity. It's going to drive performance, and we're going to overlap COVID-related expenses that are nonrecurring in the back half of this year, both of which is really driving SG&A productivity.
Marvin Ellison:
And Zach, this is Marvin. The only thing I'll add is, Joe mentioned in his prepared comments our rollout of our proprietary developed self-checkout and how that's not only creating a better customer experience, it's also helping us to leverage payroll expense the correct way by implementing technology that reduces manual labor spend.
And we talked about our PPI initiatives where we have a long list of technology enhancements that Joe is working with Seemantini, our Chief Information Officer, that's allowing us to improve productivity, improve the customer experience and reduce tasking hours, and all of that is part of the equation of us now tracking toward our 13% operating income long-term target.
Zachary Fadem:
Got it. And then you called out some reluctance or elasticity in the first half of the year given the rise in lumber and building material prices. So with pricing now starting to come in a bit and July, August comps inflected positive, could you talk about whether you think projects were delayed at all in the first half and to what extent this could be a driver of reacceleration in the second half?
Marvin Ellison:
So I'll let Joe take that and let him just talk specifically about what we're hearing from our Pro customers about their book of business and also as we look at our Installation Services business, what we see in our own pipeline.
Joseph McFarland:
So Michael (sic) [ Zach ], a couple of things. First, starting with the services, we definitely believe in the project business of this install business. And when you look, there were definite categories delayed, things primarily outdoor projects, fencing, decking. As you looked at the peak in lumber prices, we found where customers were not willing to continue to invest based on the price. At the same time, we mentioned in the prepared remarks the strength in kitchen and bath, our interior category has really outperformed in the second quarter, delivering over 20% comp.
So as we look at the shift from exterior to interior, we look at the focus of the total home, we look at our focus on the Pro business, we migrated to the Google Cloud, we rolled out Pro loyalty and we continue to add enhanced features and we're seeing great response from the customers from services standpoint, also the Pros from Lowe's being the new home for Pros.
Operator:
Our next questions come from the line of Michael Lasser with UBS.
Michael Lasser:
Marvin, the general perception is that the DIY market is going to slow considerably and Lowe's will be disproportionately negatively impacted by that given the mix of business. How would that be wrong?
Marvin Ellison:
Well, I'm not saying that is wrong. I think that also may consider that we're not going to improve our Pro business. So as I mentioned in my prepared comments, we've been working diligently for 24 months to really have a solid Pro business. One of the reasons why we delivered a 32% 2-year comp is because 49% of our Pro comp drove that in that 2-year basis.
So if you look at it in isolation, Michael, that probably is a true statement, but it's a dynamic business. Dynamic in the nature that we're improving our Pro business reflected by the results, dynamic in the nature that we're going to continue to take market share with the DIY customer with the things that we're launching in Decor, how we're enhancing the allen + roth brand. We just acquired STAINMASTER as a brand that we're going to expand. So I think that the dynamic nature of DIY and our growth in Pro I think will put that synopsis into questions.
David Denton:
Yes. Michael, this is Dave. Just don't forget that what has happened here over the last 18 months is a reemphasis back on the home and what you're seeing is despite the fact that the market is open -- or the U.S. market is opening up, you're still seeing a large contingent of work from home, school from home, utilizing their home for other activities other than just dwelling.
So I believe that over time, there is a secular trend and tailwind to this industry both from a Pro and from a DIY perspective. It -- I assume demand will mitigate a little bit, but it's not going to fall off the floor either.
Michael Lasser:
Got it. Super helpful. My follow-up question is, can you quantify the comp and margin lift that you've seen in Florida? And you mentioned that you're going to roll this out to other markets through the rest of the year. How quickly can you have this up and running across the country across all of your markets?
Marvin Ellison:
Well, I mentioned in the prepared comments, we're looking at an 18-plus month rollout cycle because we want to ensure that we do it efficiently and there is a significant amount of change management, change management from a process standpoint for our associates and change management in putting new systems in so that we can basically create virtual inventory and not have inventory on hand to sell, which is exactly what a market-based delivery model is.
We're very pleased with what we're seeing in Florida. We're pleased with the inventory reduction, the lift in sales, the productivity, the expense reduction. But we're a big company. And we want to make sure, as the old saying goes, we go slow to go fast, so we can do this efficiently. But we're excited about the possibilities. And as I said, this is the foundation of our supply chain transformation. And Don Frieson, our lead in supply chain, joined the operations team, deserve a lot of credit along with IT for allowing us to have the success in Florida that we're now confident that we can roll this out to the whole company.
Operator:
Our next questions come from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk -- just to check our math. So it seems like you're a 1% to 2% comp quarter to date. Is that right? And can you talk about what you're seeing on the Pro versus DIY trend as some of the schools have gone back? Maybe in the south, are you seeing more of a focus on the home and expect that sort of the DIY business can hold in as people get back in their homes?
Marvin Ellison:
Chris, as you can respect, we want to -- we don't want to get too granular on our inter-quarter data. We felt it was prudent to share August trends just based on the unique nature of our business environment. But if you go back to Dave's comments, we compare August month to date to July on a 2-year comp basis. That -- so that's how we're looking at the business. We think with the extraordinary business results we saw in 2020, the best way for us to measure our business is to look at it on a 2-year basis.
Now having said that, we feel great about the trends that we're seeing across Pro and DIY. We believe that for the balance of the year, the Pro customer will outperform DIY just based on the year-over-year overlaps. But as Dave said, we're equally confident that the DIY will continue to invest in their home because of home price appreciation, because of the age of housing stock and because of the simple nature that as your home increases in value, you have more confidence to invest. So we feel great about our performance. We feel so much in strong support that we raise our outlook on the top and bottom line, and that reflects that we have a pretty good line of sight to how the rest of the year should play out.
Christopher Horvers:
Yes. Absolutely.
Marvin Ellison:
Yes. And I'll just an additional comment. Your question specifically on south and performance in the second quarter, we were very pleased with Southern division's performance from a Pro standpoint.
Christopher Horvers:
Got it. Yes. The 2-year CAGR sequentially was very strong. And following up on the gross margin side. So you did go slightly above the prior guidance. So is the pricing sophistication and maybe credit driving that improved outlook? And just to foot back to that 10 basis points, it sounds like lumber pressure, that would all accrue, that's an annual impact and that's basically all going to impact the third quarter.
David Denton:
Well, I think what we said is we're now, at the moment, experiencing margin pressure in lumber, and that's going to cycle through here by the end of August. We feel good about that. We continue to invest and focus on both our cost management and our pricing ecosystem here at Lowe's. And I think between the merchant and finance team, we have a really good analytical process that we're driving performance in those areas, and we have now really good line of sight to seeing gross margins up this year despite the fact that we are making investments in supply chain that is compressing margin from a cost perspective.
Operator:
Our next questions come from the line of Steven Zaccone with Citigroup.
Steven Zaccone:
I wanted to focus on the Pro side of the business since you're having outperformance thus far in 2021. Can you talk a bit about market share performance, maybe how you feel relative to the competition thus far?
Marvin Ellison:
Steve, I would say, as I have said in previous calls that home improvement market share data is suspect at best because the data set is not great. As we look at our growth in Pro, anytime you grow the business, 49% on a 2-year basis, you can assume pretty confidently that you're taking market share. And we think that, that market share is coming from a host of competitors, both small and large.
I think it's also reflective that Lowe's has not had a coherent Pro strategy in the past 10 years. And I think Joe McFarland and his team along with Bill Boltz and the merchants have done a really nice job of getting us a line on Pro. What I'd like to do is I just want to be able to take a moment and talk about some of the Pro brands that we've been able to add in brands that are untapped that we think will continue to allow us to take share in this business.
William Boltz:
Yes. Thanks, Marvin. So Steve, in my prepared remarks, I mentioned we're getting ready this quarter to round out our fastener program with the launch of SPAX, just a great program in the fastener segment, already complementing other brands that the merchants have brought in with the likes of GRK, FastenMaster, Power Pro One.
And then across other parts of our business, we announced Mansfield, that's a strong Pro brand in the plumbing space. We've had success getting Honda to join the Lowe's family, which is a big deal for us; another great program, LESCO fertilizers that we talked about in the first quarter. And then we've had just real good success of getting other brands like Marshalltown, ITW, Lufkin. I named a bunch of them, and we're just -- we're fortunate that these brands have recognized the value of what we're doing at Lowe's with the Pro strategy and recognize that it's an opportunity for them to grow as well.
Steven Zaccone:
Great. Just a follow-up on the e-com side of the business since you're still seeing some growth there on top of the strength last year, what are the priorities to continue to drive growth there this year? And I guess longer term, where do you think penetration could fall for that side of the business?
William Boltz:
So Steve, this is Bill. So on the Lowes.com side, obviously, continuing to enhance product assortments, continuing to make sure that content is enriched in all of the kind of the basic fundamentals are key to continuing to build this out. But as we said in our prepared remarks, we've had new enhancements that we've been able to leverage, the kitchen design program, virtual search. We've also, as Joe mentioned, migrated the Lowe's for Pros over to the cloud. We moved all of Lowes.com to the cloud a few months back. All of those initiatives are helping, making it easier and faster to make enhancements to the Lowes.com business on a weekly basis. And then the merchant teams are continuing to look at ways in which we test new products and test new brands and doing different things. So working with our brand advocates to make sure that we're putting the right stuff out there in front of the customer, the recommended products that go with a product so that you can buy the whole project.
So just a lot of great things going on with the Lowes.com team. And they continue to bring enhancements on a weekly basis to make sure that we're relevant. And we see this as a nice opportunity for us over the next 3-plus years to continue to grow our business.
Marvin Ellison:
And on the penetration question, we'll probably end the year around 10%. And we are purposely not trying to set penetration targets. We're really trying to be more customer-centric and create an environment for a customer to shop any way they choose. I mean we talk about omnichannel, and that's an overused term lately. But in essence, we just want to give the customer choices to shop, in store, online, pick up in a locker, curbside, in store, ship from store, and just provide a multitude of options. And we'll let the penetration kind of land where it lands.
Operator:
Our next questions come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things. First of all, the lumber gross margin impact on the year is likely worse than what you initially anticipated. Can you talk a bit about what's better on the other side of that? And within this, could you also address the promotional investment in 2Q and 2H and what you're doing there and how that's having an influence on gross margin as well?
David Denton:
Eric, this is Dave. Obviously, it was hard to predict how gross margin was going to play out specifically for lumber this year, but obviously, we are experiencing some pressure at this point in time. I would say what we've done is taking a portfolio approach across our business and making sure that we're managing gross margin holistically such that we can deliver upon the objectives and the commitments we have from an investor perspective. So there's -- the offsets to that are fairly comprehensive across the portfolio of products.
And I'd say from a promotional standpoint, I'll ask Bill to comment on this, but we want to make sure that we're relevant on key holidays and Tier 1 events, but we're not nearly as broad and/or as deep from a promotional standpoint as we would have been back in 2019.
William Boltz:
Yes, Dave. And Eric, I think I'd add, we've talked about this in the past. We've been on this march for an everyday competitive pricing strategy. And we wanted to make sure that when we got here, we wanted to unwind this high-low strategy that had been in place across a lot of categories. So when you think about pressure from lumber, how does it get offset elsewhere, it gets offset elsewhere by not having some of these categories on a heavy promotional drug. And so we know that we can compete every day on a competitive pricing basis, and that's the work that the team has been doing.
And then you put all the efforts that we've talked about with the pricing, the cost team, the finance team collaboration with the merchants in addition to our field merchants and our field leaders out in the field, we can -- we're on this march now for opportunities local to do different things and to enhance margins that way. So from an event standpoint, very typical events in Q2 with Memorial Day, Father's Day, July 4 and a kind of a more normal event approach. And as we look at the back half of the year, similar trends as we look at the second half. So nothing crazy.
Eric Bosshard:
Great. And then just one follow-up. The sales guidance for the second half implies some degree of moderation from 2Q or July, August, and there's lots of ways to look at the numbers. Encouraged by the operating margin move up, but the sales guide still seems a little bit conservative. How would you characterize the sales guidance? And is there something else we should be thinking within what that considers?
David Denton:
Eric, this is Dave. I don't think you should read into that too much. I think at the end of the day, we're just operating in a very fluid environment. We just want to make sure that we have line of sight to what we're going to deliver for the full year.
Yes, typically, sales do moderate in the back half of the year. I think we've just taken a realistic appropriate approach to thinking about how our back half is going to play out, and this is how we're planning it.
Marvin Ellison:
Eric, this is Marvin. The point I'll add to that is, you can appreciate that this is a really unique environment and a very difficult environment to forecast. And you have quite a few retailers who's not even given any guidance at all or outlook on the second half of the year because of that. We wanted to be as transparent as possible, but we also wanted to be slightly conservative. Because there's so much fluid activity happening in this environment, we felt that it was prudent to be conservative, but also, we felt it was equally prudent to be as transparent as possible on how we're seeing the business. But to Dave's point, don't read too much into that.
Operator:
Our next questions are from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I'd like to start just to make sure I got the inflation number right. The 400 bps, was that just lumber or was that inflation that we could compare to the average ticket growth of 10%?
David Denton:
It was everything, but it was primarily focused on lumber, though. It's predominantly lumber.
Gregory Melich:
Got it. So it's probably lumber commodities, but it's not like there's another 200 bps there that would have been rest of box inflation.
David Denton:
That's correct.
Gregory Melich:
Got it. And then the follow-up was really -- Marvin, you spoke in the prepared comments and there were several questions along the way on the marketplace rollout for big and bulky. Could you help describe what that means in practical terms to both the DIY and the Pro business? Some of that -- what it does to OpEx and CapEx for the next 18-plus months as you're rolling it out?
Marvin Ellison:
Yes. We talked early on in the supply chain transformation that we're going to be making a $1.7 billion investment over a 4-year span. This whole market delivery transformation is included in that overall supply chain transformation. So we're not increasing any capital spend to achieve this or to roll this out over the next 18-plus months. But really what this means, it just gives us the ability to create a more efficient, modern delivery process.
So as an example, in the markets today where we don't have market delivery, when you come in to buy an appliance, the associate is going to sell you an appliance based on the in-stock that they have in their store or in a storage container. If it's not physically within their eyesight, they will not sell that appliance. And let's say you do sell it, then you will literally have to call the customer via telephone to arrange a delivery scheduled time. So imagine in 2021 that you don't have the ability to go online and create a virtual schedule for delivery. So all of that is being shifted and transformed to a more modern delivery model. So we keep the inventory centrally, so we got inventory reduction, we have less damage. Joe and team are using less SG&A in the stores to move things around, load things up, drive trucks. And more importantly, it gives us the ability to hold inventory centrally to create, in some cases, same-day, next-day delivery options for customers in a model that we just can't replicate without having this fully rolled out. So we're very excited about it. This is just one of the many steps in our supply chain transformation, but this is a foundational step. And again, we're going to get this done. We just want to be prudent and not get over our skis and overburden the company from a change management standpoint, but we couldn't be more excited about what we're seeing in Florida.
Joseph McFarland:
And listen, Greg, to Marvin's point, this is a really innovative approach to kind of how we're going to market from a supply chain perspective. But as we roll this out, to your point, we do experience some compression because as we ramp these up the first few months, we're not at full capacity. And so we experienced some margin headwinds as we get up to speed. But that is all contemplated in our 12.2% guide and our objective to get to 13% as well. So this is consistent with that narrative over the long term.
Operator:
Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
Operator:
Good morning, everyone, and welcome to Lowe's Companies First Quarter 2021 Earnings Conference Call. My name is Melissa, and I will be your operator for today's call. As a reminder, this conference is being recorded. I would now like to turn the conference over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release in our investor relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Good morning, everyone. I'd like to begin by thanking our frontline associates for their continued hard work and commitment to the company. We would also like to extend our thoughts and prayers to our associates in India, who are grappling with an aggressive resurgence of COVID in the country. At Lowe's, we have associates in Bangalore, India in our digital, information technology and finance functions who played a key role in our transformation efforts over the past 2 years. To help our team in India safeguard their health, we sent personal protective equipment to our team members there. We've also made financial commitments to support nonprofit organizations in India that are working to respond to this humanitarian crisis.
As we have moved into the second year of the pandemic, we remain focused on our #1 priority, which has always been protecting the health and safety of our associates and communities. And with that in mind, in Q1, we invested nearly $60 million in support of COVID safety protocols. Now turning to our results. Our outstanding performance continued this quarter with total company comparable sales growth of 25.9%. Our U.S. comps were 24.4% with broad-based growth across all geographic regions and divisions. In fact, for the quarter, comp sales for all 15 U.S. regions exceeded 18% and all U.S. divisions exceeded 20%. During the quarter, operating margin expanded 313 basis points on an adjusted basis, leading to diluted earnings per share of $3.21, which is an 81% increase on an adjusted basis over the prior year. Our outperformance in operating margin was supported by our continued transition to an everyday competitive price strategy as well as our disciplined pricing and product cost management strategies. Our improved operating margin also reflects the progress of our operational transformation driven by our perpetual productivity initiatives or PPI. Bill will discuss our everyday competitive price strategy, pricing and product cost management, and Joe will provide details on our PPI initiatives later in the call. On Lowes.com, sales grew 36.5% on top of 80% growth in the first quarter of 2020, which represents a 9% sales penetration this quarter and a 2-year comp of 146%. With customer demand for an integrated omnichannel shopping experience only increasing, we continue to invest in our omnichannel capabilities. Pro comps outpaced DIY comps with over 30% comps in the quarter. Although this has been a 2-year journey, I'm very pleased with the progress that we made with our Pro customer. We began by addressing the basics, ensuring that we were carrying the brands and products that Pros need in the job lot quantities, and also provided the excellent service this busy customer expects. And now we've shifted to the more strategic phase of growth in the Pro by resetting the layout of our stores with the Pro in mind and deepening our relationship with the Pro through a loyalty program that provides them with members-only benefits. Joe will discuss more about the specific initiatives that we're undertaking to serve the Pro, both online and in-store later in the call. The small- and medium-sized Pro is our target customer. This customer is a frequent shopper who purchases products in multiple departments, which drives increased productivity throughout the store. And I'm confident that we have a compelling growth opportunity as we continue to improve our engagement with this highly valued customer. In addition to the strength in Pro, we delivered over 60% comps along with significant increase in customer satisfaction in our installation services business. We've overhauled this business and improved the service offering by consolidating our provider network and implementing industry-leading technology. And although all of us are looking forward to a post-COVID world, our research tells us that the importance of the home will remain elevated for many years to come. And given the increased importance of the home, this quarter, we launched SpringFest, our new reimagined approach to the season. Our campaign provided inspiration for home projects so our customers could transport themselves to the destination of their choice without ever leaving the sanctuary of home. In a moment, Bill will discuss the outstanding results that we were able to generate from this reimagination of spring. Now turning to Canada. We delivered comp growth that outpaced the U.S. despite several COVID-related operating restrictions. I'd like to thank the new Canadian leadership team for all of their hard work as well as the frontline associates in Canada for their resilience and commitment to continuing to serve our customers in this challenging operating environment. This quarter, we also announced the acquisition of STAINMASTER brand, which is the most recognized and trusted carpet brand on the market today. With this acquisition, we're building on our decade-long exclusive position as the only national home improvement retailer to carry STAINMASTER carpet. This is an important step in our Total Home strategy as we seek to elevate our product assortment and provide consumers with the products and brands they trust for every project across the entire home. We see great potential to extend the STAINMASTER brand in other product areas where we can continue to leverage its high performance characteristics. This acquisition also expands our private brand portfolio joining the family of private brands, including allen + roth, Kobalt and Project Source. We're focused on expanding our private brand penetration with a balanced brand strategy that includes a powerful national brand portfolio that appeals to both Pro and DIY customers. At the same time, we'll offer a select number of high-value private brands, building consumer loyalty for these products. Our results in the first quarter continue to give me confidence that we're making the right investments to accelerate our market share gains through our Total Home strategy by enhancing our investments in Pro, online, installation services, localization and elevating our product assortment. These initiatives will allow us to drive sustainable growth as we deliver a total home solution for our Pro and our DIY customers. Before I close, I'd like to, once again, extend my appreciation to our frontline associates. In the first quarter, I had an opportunity to visit stores in 9 of our 15 geographic regions. As I observed our associates hard at work serving customers through very challenging circumstances, my respect and admiration continues to grow. In recognition of these efforts, we decided to close our stores and distribution centers on Easter Sunday for the second year in a row to give our associates a much deserved day off to spend with their families and loved ones. I'm also pleased to announce that for the fifth consecutive quarter, 100% of our stores earned a Winning Together profit-sharing bonus, a record $152 million payout to our frontline hourly associates. This represents an incremental $70 million above the target level. While the near-term macro outlook remains uncertain, we're confident that we will continue to outperform the market driving both market share gains and improved operating efficiency. Our 2-year plus journey to transform Lowe's has given us improved operating capabilities and a technology infrastructure that's dramatically enhanced, which in turn makes us more agile and able to respond quickly to any potential changes in the business environment. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. We delivered U.S. comparable sales growth of 24.4% in the first quarter. Our compelling offerings, great values and improved in-stocks allowed us to capitalize on the continued strong demand for home improvement products. Consistent with recent trends, growth was broad-based across Pro and DIY customers, in store and online and across product categories. In fact, 13 of 15 merchandising departments generated comps over 15% and all merchandising departments were up more than 20% on a 2-year comp basis.
As Marvin described, we were extremely pleased with how consumers responded to our SpringFest event. Similar to our approach to the winter holidays, we extended this event across 4 weeks to create a new sense of excitement and to prompt return trips, while also avoiding congestion in our stores. We offered 4 different weekly giveaways of garden-to-go kits that provided everything needed for a fun spring project, and also strengthen our customer connection through a required MyLowe's activation online. The success of this event was due to the great organizational alignment across our stores, marketing and merchant teams. Turning now to our top-performing categories. Lumber again delivered the highest comp driven by strong Pro demand and unprecedented inflation in the category. Over the past year, as lumber products have been in tight supply, our merchants have worked closely with our suppliers and successfully secured new sources and additional product to ensure that we can maintain a competitive in-stock position in the category. Strong in-stocks in this tight market have allowed us to continue to strengthen customer relationships, especially with the Pro. In addition to lumber, we delivered comps exceeding 30% in electrical, decor, kitchens and bath and seasonal and outdoor living. Our electrical category posted strong comps in the quarter driven by inflation in copper as well as solid demand from the robust repair/remodel market. In support of our total home market share acceleration strategy, we drove strong engagement with our customers as reflected by increased sales in decor and kitchens and bath. The strong sales in our decor category were driven by great performance in home accents as we continue to elevate our product assortments, especially with our recently refreshed allen + roth brand. In fact, this quarter, our merchant teams launched new spring collections that span across the broad array of product categories through a lifestyle point of view with inspirational on-trend designs that gives our customers the confidence they need to decorate their homes in style. Our kitchens and bath department outperformed in the quarter as homeowners continue to enhance their living spaces and economic stimulus supported bigger ticket projects. Finally, seasonal and outdoor living benefited from the early demand in patio and grills as homeowners embrace the arrival of spring. We also saw strong sales in the newly launched battery-powered EGO and SKIL brands as consumers are attracted to the convenience and the quality of their zero-emission rechargeable outdoor power equipment. In fact, during the quarter, EGO delivered some of their largest weekly sales results in the history of their brand. The addition of EGO and SKIL has only strengthened our #1 position in outdoor power equipment and truly complements the leading brands we carry such as John Deere, Honda, Husqvarna, Ariens, and CRAFTSMAN. And during the quarter, we continued to see strong demand for our other powerhouse brands like Weber and Char-Broil, which remain the top 2 brands in outdoor grilling. We were excited to add new brands to our arsenal, including the exclusive launch of FLEX cordless power tools. The FLEX brand is known by the most discerning builders, contractors and trade professionals, and this new lineup of power tools offers the latest innovation, more power and faster charging than the competition. We are also excited to bring the LESCO brand of fertilizer to Lowe's this spring, a brand that is trusted by landscape pros and knowledgeable homeowners alike. The addition of FLEX power tools and LESCO fertilizer further complements our powerful Pro brand lineup which already includes Simpson Strong-Tie, DEWALT, Spyder, Bosch, Eaton and SharkBite. As Marvin mentioned, we delivered strong sales growth of 36.5% and a 2-year growth of 146% on Lowes.com. We continue to enhance the online customer experience with improved search and navigation functionality that allows consumers to easily shop for products across categories. Additionally, we continue to see strong download rates of our mobile app as we are working to enhance our customer loyalty through a great mobile experience. As Marvin mentioned, we delivered a solid improvement in our product margins this quarter driven by disciplined vendor cost management, improved and enhanced pricing systems and our continued transition to a more relevant everyday competitive price strategy that is complemented by targeted seasonally relevant promotions. All of these initiatives are part of our ongoing merchandising excellence strategy. We will continue to leverage and refine these capabilities as we deliver strong everyday values to our consumers, while we continue to manage our product margins by taking a data-driven portfolio approach to pricing. Our Total Home strategy will continue to allow us to expand and elevate our product and brand assortments and take market share. Before I close, I want to thank our vendor partners and our merchants for their continued focus on taking care of our stores and our customers. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. In the first quarter, our associates were laser-focused on providing excellent customer service, supporting a safe store environment and delivering record sales volumes. As Marvin mentioned, 100% of our stores earned Winning Together profit-sharing bonus, a record $152 million payout to our frontline hourly associates. I would like to thank our associates for their continued dedication in providing world-class customer service.
As Marvin mentioned, our focus on perpetual productivity improvement or our PPI initiative continued to yield results during this quarter as we leverage store payroll by using technology to reduce tasking hours, improve customer service and increase sales productivity. For example, we rolled out digital signs first in appliances, and most recently, in our lumber department. These signs cut down on associate tasking labor and they also support better product margin performance as we can now more rapidly implement price changes in line with the market. We are also leveraging an improved freight flow app, creating a fully digital process that gives our associates better line of sight to when products will arrive at our stores. The app which was developed in-house, even help store associates to prioritize the incoming merchandise so they can quickly and efficiently position the product on the sales floor for our customers. And we launched secure mobile checkout, which we are using to improve speed of service in high-traffic areas inside the store and on the exterior of the store in areas such as outside lawn and garden and under the Pro canopy. This checkout app developed in-house is allowing us to take care of customers from scanning items, tendering payment and printing or e-mailing receipts before they even join the line. Our customers are delighted with the solution, especially on busy weekends. We are also driving productivity in our in-store fulfillment. This quarter, we expanded our contactless shopping options by completing the rollout of BOPIS lockers to 100% of our U.S. stores in April. Customers really enjoy these touchless easy-to-use lockers. In fact, this has already become the highest-rated store fulfillment options. Having BOPIS lockers in 100% of our U.S. stores will allow us to expand our omnichannel capabilities, further improve customer satisfaction and limit customer congestion at our service desk. Turning to our Pros. As Marvin mentioned, Pro outpaced DIY in the quarter with over 30% comps. We continue to gain momentum with the Pro through our improved in-stock inventory levels, our enhanced service offerings and our new Pro loyalty program. Our Pro sales associates have also begun to leverage our new CRM platform to proactively engage with our Pro customers and sell the entire project to them. Our most compelling growth opportunity with the Pro is expanding the share of wallet with our existing customers. Our new CRM platform as well as the redesigned store layout that aligns product adjacencies enable us to more effectively serve their needs for the entire project across all of their jobs. And we continue to enhance the shopping experience for our Pro customers, small- to medium-sized businesses who are always pressed for time. We are launching a tailored shopping experience created specifically for Pros to ensure that the time they spend away from their job site is efficient and productive. We're introducing new convenience products at checkout and services like dedicated Pro trailer parking and phone charging stations, all designed to help add value to each trip the Pros take, thus cutting down on the number of stops they make throughout the day. We're also enhancing their online experiences with the ongoing migration of Lowe's for Pros to the cloud. This will give our Pro customers access to incremental options that our DIY customers already have on Lowes.com, and it will allow us to more quickly add new Pro-only features in the future, including a personalized app experience. Both in-store and online, we continue to demonstrate that Lowe's is on a mission to be the new home for Pros. As Marvin mentioned, we are seeing terrific momentum in our installation business with over 60% comps this quarter. As a reminder, just 2 years ago, this was a money-losing business with poor customer satisfaction. Although we are lapping Q1 2020 results that were pressured by COVID, we are very pleased with the overall execution and trajectory of this business. In closing, I cannot be more pleased with the improvements we are making in our stores as reflected in our strong Net Promoter Scores and a recent third-party study. Our executive officer, senior officers, merchants and field leaders are out visiting stores on a weekly basis to ensure that we are listening to and supporting our frontline associates. This remains a very difficult environment to operate retail stores in and I could not be prouder of the accomplishments of this team and their commitment and hard work from our frontline associates. With that, I'll turn it over to Dave.
David Denton:
Thank you, Joe. I'll begin this morning with a few comments on the company's robust capital allocation program. In Q1, we generated $4 billion in free cash flow driven by improved operational execution and continued strong consumer demand. We returned $3.5 billion to our shareholders through both a combination of dividends and share repurchases.
During the quarter, we paid $440 million in dividends at $0.60 per share. We also repurchased 16.8 million shares for $3.1 billion at an average price of approximately $182 a share. We have approximately $17 billion remaining on our share repurchase authorization. Capital expenditures totaled $461 million in the quarter as we invest in our strategic initiatives to drive the business and to support our growth. We ended the quarter with $6.7 billion of cash and cash equivalents on the balance sheet, which includes proceeds from our $2 billion notes offering in March. In addition, we entered into a $1 billion term loan facility in April, which remains undrawn. Our balance sheet remains extremely healthy with adjusted debt to EBITDAR at 2.07x at the end of the quarter, well below our long-term target of 2.75x. Now turning to the income statement. In Q1, we generated diluted earnings per share of $3.21, an increase of 81% compared to adjusted diluted earnings per share last year. This growth was due to strong sales growth, improved gross margin rate and SG&A leverage as a result of a strong execution across many facets of our business. Please note that in the prior year quarter, there was a very modest impact on diluted earnings per share related to the Canadian restructuring effort. My comments from this point forward will include approximations when appropriate and comparisons to certain non-GAAP measures where applicable.
Strong sales growth was driven by several factors, including:
a continued consumer focused on the home; a favorable weather backdrop across the country; commodity inflation, especially within the lumber category; consumer support from the March government stimulus package; and our improved execution as we continue to elevate our product and service offerings. Q1 sales were $24.4 billion driven by a comparable sales increase of 25.9%. This was a result of a balanced contribution for both ticket and transactions as comparable average store ticket grew 14.1% and transaction count grew 11.8%, with strong repeat rates from both new and existing customers.
While a little difficult to measure, we estimate that the March government stimulus checks drove 300 basis points of growth, while commodity inflation benefited comps by 460 basis points in the quarter. Lumber and other commodity prices remained at elevated levels versus last year. U.S. comp sales were up 24.4% in the quarter, consistent with the results from the past few quarters. Growth was well balanced across DIY and Pro customers, selling channels, geographies and nearly all merchandise departments. Our U.S. comps were 24% in February, 35.9% in March and 13.9% in April. February comps were negatively impacted by the harsh winter storms that hit Texas and several other states, while March were positively impacted by storm recovery and the third round of stimulus. Additionally, we began cycling last year's COVID-related spikes in demand in the second half of April and those more difficult comparisons impacted April comps. Looking at U.S. comp growth on a 2-year basis from 2019 to '21, February sales increased 30.3%, March increased 48.1% and April increased 37.1%. Gross margin was 33.29%, up 19 basis points from last year and up 183 basis points as compared to Q1 of '19. Product margin rate improved 165 basis points. As Bill mentioned, our teams effectively leveraged our merchandising excellence strategy to manage product cost and retail pricing throughout the quarter. While we are seeing inflation in some product categories, our merchants work to diligently mitigate and minimize vendor cost increases. Additionally, our supply chain team leveraged our scale and carrier relationships to minimize distribution cost pressures experienced throughout the retail sector. On the pricing side, our shift to an everyday competitive price strategy continue to benefit our margins in Q1 as we leverage enhanced pricing tools to improve margin across the array of products that we sell. We began to see improving trends from our increased focus on shrink control this quarter, with shrink improving sequentially from Q4 of 2020. However, results pressured gross margin by 15 basis points versus last year. We expect that our shrink performance will continue to improve as we move throughout the year.
These benefits to product margin rate were partially offset by:
90 basis points of pressure from product mix shifts due to lumber inflation and a less favorable product mix; 20 basis points of pressure from supply chain cost as we continue to invest in our omnichannel capabilities; and 20 basis points of pressure from credit revenue.
SG&A of 18.4% levered 288 basis points compared to adjusted SG&A in LY driven primarily by lower COVID-related costs as well as operating cost leverage resulting from strong sales and our ongoing productivity from our PPI initiative. As anticipated, we incurred nearly $60 million of COVID-related expenses as compared to approximately $320 million of COVID-related expenses last year. The $260 million reduction in these expenses generated 140 basis points of SG&A leverage. Additionally, strong sales and a focus on efficiency and productivity allowed us to generate leverage of 100 basis points in operating salaries, 35 basis points in occupancy expense and 5 basis points in advertising. Now operating profit was $3.2 billion, an increase of 63% over LY. Operating margins of 13.3% of sales for the quarter was up 317 basis points to the prior year driven by both improved operating leverage and improved gross margin rate. The effective tax rate was 23.5%. The tax rate was slightly lower than expected primarily due to a tax benefit related to the divesting of certain employee stock options. We continue to build up our inventory levels throughout the quarter to meet the sustained high levels of customer demand while improving our in-stock position. At quarter end, inventory was $18.4 billion, up $2.2 billion from Q4 levels, in line with seasonal patterns. This reflects an increase of $4.1 billion from Q1 of 2020 when inventory levels were pressured due to unexpected spikes in demand as well as COVID-related supply disruptions. Of note, this includes a year-over-year increase of $780 million related specifically to inflation. Now before I close, let me comment on our current trends and how we are planning our business for the balance of 2021. Our year-to-date results are tracking ahead of the robust market scenario that we covered in our December investor update. The underlying drivers of home improvement demand appear to be more resilient and stable than we originally forecasted. Those factors build our confidence in our ability to deliver strong results on top of an exceptional year in 2020, including 12% operating margins and flat gross margin rates for the year. We remain confident that our Total Home strategy will enable us to capture market share. We are very encouraged by our performance in Q1, including our strong sales volume even as we began to cycle last year's mid-April surge in demand. Month to date, May U.S. comp sales trends are materially consistent with April performance levels on a 2-year comparable basis. Looking forward, year-over-year comparisons remain difficult throughout the remainder of the year. Also, we continue to see COVID restrictions in some areas across Canada. As markets reopen, we are closely monitoring consumer behavior, anticipating a potential modest shift in spending away from the home. We remain agile and ready to respond to whatever environment we face this year with our focus on gaining market share throughout 2021, while improving operating margins. With regards to our quarterly performance, please note that we are cycling particularly high gross margin levels in Q2 of LY. In the prior quarter, there was an industry-wide pullback in promotions and a more favorable product mix. As a result, we currently anticipate a moderate decline in gross margin rates in Q2. Despite this moderate year-over-year decline, our gross margin rate is expected to expand nicely over pre-pandemic 2019 levels. Investments in pricing, vendor cost management and our everyday competitive promotional strategy have been driving improvements in our gross margin performance over the past 2 years. As I stated earlier, we continue to expect to deliver flat gross margin rates for 2021. Further, we expect the business to generate robust levels of free cash flow. We plan to invest $2 billion in CapEx this year to drive future growth and returns as we continue our disciplined approach to capital allocation with $9 billion in planned share repurchases this year while also supporting our dividend. In closing, we are very excited about the momentum in our business and our ability to deliver significant shareholder value over the long term. With that, we are now ready for questions. Thank you.
Operator:
[Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is, can you provide an update on where Pro penetration can move to over time and maybe some level of growth that you expect going forward? And I'm asking because I think part of the margin story is getting higher sales per foot, and I think Pro seems to be a big opportunity there. So curious, I don't know, Marvin or Dave, if you can just update us on that area.
Marvin Ellison:
Simeon, this is Marvin. We purposely have not set a target for Pro penetration. As I mentioned in my prepared comments, we really started focusing on the basics. And now we're elevating to a more strategic phase in Pro. We also stated a while back that we estimate our Pro penetration today as between 20% and 25%. Now having said that, based on my history in this business, in the space, in Joe's history and experience in this space, we can see over time our Pro penetration getting between 30% and 35%. And we think that's the trajectory that we're currently on, but we have purposely not set a target because I've learned in the past when you set a target then you can oftentimes hit the target, but you do it at the expense of running a good business, and we're just really focused on serving the customer right now.
Simeon Gutman:
Okay. Fair enough. Can I ask you a macro question to whoever? And I wanted to ask, there is this school of thought that this industry, this home improvement industry, is a mid-single-digit grower, right, that did 4 or 5x that over the last 4 quarters. And so that school of thought says, hey, this industry needs to digest this growth. We may not grow going forward maybe in '22 or it may be flattish at best. And the other side is that people have spent more on their homes, there's more invested capital, so there's more maintenance repair and that we could sort of comp it. And then maybe there's a housing cycle on top of this. Curious where you shake out and what's your best guess or what some of the debates you're having on this topic are.
Marvin Ellison:
Yes. Simeon, it's a good question. I'll take the first part. I'll let Dave provide any financial perspective. But I mean we're very excited and we're very bullish on the home improvement industry in general. If you look at the macro factors that really impact this business and have historically impacted this business as things like low mortgage rates, rising home prices, the age of housing stock, improved household formation trends and also strong consumer balance sheets, I mean all of those specific macro factors are pointed in the right direction for us. In addition to that, when there's home price appreciation, that actually benefits home improvement. It may not benefit the overall housing market, but when consumers decide to stay in their existing home and make investments in upgrading the home, that correlates to really strong home improvement sales.
And as the housing stock continues to age, we're in a repair and maintenance business, that's a significant part of what we do. So when we look at home improvement, we see really robust year-over-year growth potential relative to the macro. And then if we look at just the things that we control. I mean we've been very transparent that there have been many strategic mistakes made in this business over the past 5-plus years. And so we have what we believe is enormous upside in revenue and operating income by continuing to invest in really smart, strategic initiatives that we think will drive the business forward. And we think Q1 reflects our ability to do that with our gross margin and operating and comp performance. I'll let Dave add any additional comments if he has them.
David Denton:
Yes. Simeon, the only other thing that I would add is that obviously, over the next several years, we anticipated that the millennial customer would begin to migrate into the home ownership position. I think what has happened through COVID is that macro trend has probably accelerated. So probably given the industry segment a bit more tailwinds as we think about the next several years.
Operator:
Our next question comes from the line of Liz Suzuki with Bank of America.
Elizabeth Lane:
So if sales are running above the robust market scenario, do you think the sales upside could be reinvested into additional initiatives and to gaining market share and deepening the competitive moat? Or should we think about there potentially being upside to the 12% operating margin that was discussed in that robust demand scenario?
David Denton:
Liz, this is Dave. I'll start with that question there. I think what you're looking at here is we have a very specific investment thesis really as we launched it in 2020 and into '21. And I think if you look at the thesis that we have and all the priorities that we have, I think we feel like we're very well positioned making the right investments to grow our business long term, improve our operating performance.
I do think we're also very focused on the fact that we can't really predict the macro in the back half of this year, but we are very committed to doing 2 things:
one is we're going to grow market share this year; and two, we're going to improve our operating margin performance. And we do expect that to be -- if the market holds up with a robust or above robust, around 12% operating margin, and that's our focus for this year.
Elizabeth Lane:
Great. And just one quick follow-up which is, which [ are ] the 2 categories comped below 15%? And what was the 2-year growth there?
William Boltz:
Yes. Liz, this is Bill. So all categories achieved the plus-20% draw on a 2-year basis, but the 2 categories below the company were paint and our hardware business, driven largely because of everybody painting last year during the pandemic. And then the hardware business driven by safety and masks and some of that business that spiked last year in the quarter.
Operator:
Our next question comes from the line of Michael Baker with D.A. Davidson.
Michael Baker:
Okay. A couple -- and hate to be short-term focused here, but the -- first of all, April did fall off versus March on a 2-year basis a little bit. Do you think that's because of the stimulus that occurred in March? And then playing that forward, if we take that 2-year trend into May and for the rest of the quarter, you should be about flat in the second quarter. Is that a fair way to think about the expectations for the quarter?
David Denton:
Yes. I'll -- First, as you look at, I guess, our performance by month through the quarter, if you look at it on a 2-year stack basis, yes, March was somewhat inflated if you think about tech, the recovery from the storm in Texas and other states as well as stimulus hitting that period. So I think we feel very good about kind of how we ended the quarter and the trends as we cycle into May from a sales perspective. And I think, listen, we're not giving guidance for the quarter. We continue to be focused specifically on making sure that we have great service. We have -- that we're in stock in the right categories, and we're supporting our consumers across our marketplace. And I feel like we're gaining momentum as we think about our business, both in 2020 and here as we cycle into '21.
Marvin Ellison:
And Michael, this is Marvin. The only point I'll add to that is we were up against a 20.4% comp in the month of April in the U.S., and we comped almost 14% on top of that. So we feel really good about that. That exceeded our expectations, we think exceeded our internal plans. And it also demonstrates to us that even going up against some of the spike demand from last year, we still can perform at a high level. So we actually felt great about our performance in April. But it demonstrates when you're up against significant surge in demand, you're going to see sales comp pressure, and that's to be expected.
Michael Baker:
Yes. Sure. Okay, that makes sense. And to follow up and not to ask a tough question, particularly on a 25% comp against a 12% actually, really, really incredible and strong. But you talked about market share gains -- a simple look at the growth of the market using the NAICS sales in building material, garden equipment and supply stores, that did grow a little bit faster than you did this quarter. So I wonder how you think about what market are you looking at? Or what number you're looking out to underpin your market share, gain comments for the quarter and the year?
Marvin Ellison:
Michael, coming from someone who has worked in a couple of different retail formats, I've always said that home improvement has probably the most suspect market share data on a short-term basis of any retail segment. So to be quite candid, when we look at the amount of growth we delivered in the sales revenue that we generated and we look at it on a 1-year or 2-year comp basis, we can't [ quabble ] about losing market share.
We're really focused on the broader market. And we've said consistently that in this COVID environment, and this is going to be current and post-COVID, the retailers that are:
most capitalized and can make investments in omnichannel and omnichannel fulfillment; and creating different channels with customers to shop; and can lean into technology; and can also leverage the supply base as our merchants and supply chain were able to do over the past quarter will win and will take broader market share. And we believe that we did that. And so we feel very, very comfortable with our market share position and performance and with our prospects for the rest of the year.
Operator:
Our next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So a couple of questions. My first question is on the product margin benefits that you're seeing on the pricing side. Should these accelerate over the year, given that some of this -- the learning builds somewhat -- sort to, say, in the systems? And to what extent is it more sensitive to sort of highly seasonal and markdown-prone quarters, like a 2Q and a 4Q versus the third quarter?
David Denton:
Yes. Listen, I think -- this is Dave. We've had -- we've made a lot of investments from a product cost management and pricing perspective infrastructure here at Lowe's and feel very confident between the merchant and finance team on kind of managing that. It is not necessarily seasonally related. This is really about managing our everyday price and cost in a more effective manner overtime. I do think that we're still in the early stages of this journey as we think about the next several years to improve our performance here. Clearly, at the moment, we're -- as we said in our prepared remarks, there are some inflation pressures in our business that we're managing through. I do believe that we have -- we're continuing to invest in these tools and technologies to enable us to improve our margin performance over the longer term.
Now keep in mind, Chris, I just want to go back to what we said of our long-term financial algorithm here is really to maintain kind of flattish gross margins over time with the fact that we would improve the product margin, but we'll reinvest some of that product margin in the supply chain to drive performance and growth over the long term.
Christopher Horvers:
Got it. Understood. And then in terms of -- as a follow-up on the 12% margin question, if you do end up beating that minus 2% sales outlook, I guess, why wouldn't you be above a 12%? Is there an offset, perhaps bonus and employee incentives? Is it a headwind from lumber inflation that creates a rate headwind that more than offsets the natural leverage of beating the robust scenario sales guide?
David Denton:
Yes. Chris, I just want to get ourselves focused. Listen, first and foremost, we've said about the fact that we've got to gain some market share. We've got to improve operating margin performance here, and we're trying to get to our 12% in the short term here. Beyond 12%, we have objectives and we believe we can expand it further, but let's at least get to our 12% margin first. And so we're just kind of laser-focused on making sure that we're delivering upon our commitments from that perspective.
Marvin Ellison:
And Chris, this is Marvin. You can appreciate the challenge we have, looking at the overall macro outlook for the business with all the dynamics occurring in the marketplace. The good news is, is the better the macro performs, the better we'll perform. We feel great about the things that we control and some of the tools and some of the processes we put in place and some of the decisions of the leadership team are really paying dividends. And as David said a couple of times already today, we're committed to outperforming the broader market and improving operating margin. And if the macro improves significantly above the robust scenario then our business will perform equally as well. And that's how we're approaching it.
Operator:
Our next question comes from the line of Chuck Grom with Gordon Haskett.
Charles Grom:
You guys spoke about the big increase in lumber pricing. Depot said the same thing yesterday. Curious what you're seeing on the demand side and unit velocity over the past few months.
Marvin Ellison:
I will -- I'll start it off. What I can tell you is we're just really pleased that the merchants were able to create such strong supply relationships that we could keep up with demand in an unprecedented environment of unit demand. So I'll let Bill talk about units and how we're performing and kind of how we feel about the rest of the year.
William Boltz:
Yes. Chuck, I think, to echo Marvin, I think demand continues to remain strong and all the preparation that was done coming off of last year has certainly enabled us to fulfill that demand going forward. All the work that's being done right now is to maintain that as we go through the rest of the year and continue to manage the needs of the Pro customer, make sure that we can take care of them first. I mean that's really what we're focused on in that job lot quantity and making sure that we're right by market, and that's been the focus of the team.
Charles Grom:
That's great to hear. So just a follow-up would be just on the installation business, you talked about a 6% comp in the quarter. I guess I'm curious like what penetration of the business is that today? How big can you grow that? And then also just from a profitability perspective, how it compares to the rest of the business?
David Denton:
Yes. Chuck, that business is in the mid-single digits penetration for our business. And we do think we have a big runway here. As Joe indicated in his prepared remarks, is that business was something that really wasn't invested in historically and was something that we had a really, I'd say, poor service model historically and was not the best from an operating performance perspective financially. I think we've now turned that business around and have a really nice foundation as we think about growing it. So I'll ask Joe to give a couple of comments on it.
Joseph McFarland:
Yes. Thanks, Dave. I'll just make a few comments. You heard in my prepared remarks the performance, very, very pleased that we've attracted industry veterans that really understand the complexities of being inside the home, and especially in the COVID environment, in all the platforms that we have been focused on, the consolidation of installers across the country, and remaining laser-focused on the programs that we really want to drive, and that's all under the same umbrella as our Total Home strategy. So we're very pleased with the team's efforts. I'm very pleased with all of our installer partners across the country and looking forward to a great continued momentum here.
Operator:
Our next question comes from the line of Scott Mushkin with R5 Capital.
Scott Mushkin:
So I had a little long-term strategic question when you guys think about your business into 2022. As you look at your strategic priorities, what do you think drives incremental growth for Lowe's, kind of company specific? What are your top 3 type of things as you look out over the next 18 months?
Marvin Ellison:
Scott, this is Marvin. I think it goes directly to our total home market acceleration strategy where we talk about continuing to invest in online, which is really more omnichannel focused, making sure that we're investing in our installation services business and also improving our overall performance with the Pro. As I mentioned in my prepared comments, I mean all of our customer segments are really important, and we are focused more intently on being a customer-focused business. The Pro adds a different dimension because of the frequency of how the Pros shop and also how the Pro shops throughout the entire store. And one of the strategic mistakes made in the past here is not understanding that customer and understanding the economic value of that customer.
So we're going to continue to stay really focused on that customer. But I would say those 3 things, omnichannel, ensuring that we can continue to have a really robust and seamless installation service business and focusing on the Pro are 3 of our priorities. But the whole Total Home strategy encompasses what we're going to be leaning into for the next couple of years.
Scott Mushkin:
That's great. And then just like looking out at the back half of this year, are you guys seeing any signs that this very high level of inflation is crimping demand at all? Or is that not something you're seeing?
Marvin Ellison:
We're not seeing it. I'll give you thoughts. I'll let Dave give a more financial perspective. I mean we feel really good about this business and this business model. As I look at home improvement as an overall retail sector, I just think that even though we're all just totally fatigued, both mentally, physically with the pandemic, and there's nothing that we can say positive about operating through with all the health and safety issues that we've all dealt with both business and personal, when you look at the macro for home improvement, it's a very positive backdrop. And as we look at forward-looking quarters and into next year, even with the inflation we're seeing in certain areas, specifically lumber and copper, we just don't believe that that's going to create an impediment for growth or significant headwinds for this business sector.
I'll let Dave add any other comments.
David Denton:
Yes. The only thing I would add is -- just to reconfirm what Marvin said, we see no slowdown in demand at this point in time across our business and our categories. And I think if you speak to our Pro customers, we're hearing from them that they, one, are very busy at the moment, and two, have extremely long backlogs at this point in time. So I think this demand will continue for some period of time.
Operator:
Our next question comes from the line of Brian Nagel with Oppenheimer & Co.
Brian Nagel:
Congrats on a nice quarter. The first question I wanted to ask, you've talked a lot about the various scenarios for 2021 and the operating margin and market share opportunities for Lowe's. How do you look at expense levers? I think you may have talked about this a bit in your prepared comments, but how do we think about the expense levers to the extent that sales proved choppier through the balance of 2021?
David Denton:
Yes. So obviously -- this is Dave. Obviously, the biggest expense lever we have is how we manage operating salaries across our business and probably labor a little bit in the supply chain. I think what we've done is we've -- we have invested in tools, in processes to really allow us to effectively manage that labor component and really adjust it based on demand that we're seeing from a profile perspective. With that, I'll turn it over to Joe.
Joseph McFarland:
Brian, thanks for the question. And I will point out the 3 major points of the PPI initiative that we talk about. First is the investment in technology to reduce the tasking hours. We've been doing that very effectively. Secondly is the improvement in customer service with those changes. And then finally, the overall sales productivity and sales per square foot productivity at the stores. And I think we've given some examples
Brian Nagel:
Got it. That's very helpful. And my follow-up question, with regard to sales, clearly, for Q1, then given the commentary with regard to May, I mean, sales have stayed very, very strong, rather broad-based. But as you look at your business on kind of a market-by-market basis, are you seeing any difference in sales trends in regions of the country, markets of the country, that have opened up faster, where, presumably, consumers are getting back to what -- to their normal lives quicker?
Marvin Ellison:
Brian, it's been -- when we talk about broad-based, it's more consistently broad-based than any time I can remember in my career. I mean we have 15 geographic regions and 3 divisions. And as I had said in my prepared comments, I mean all of our regions were in north of 18%, all divisions north of 20%. And when we look at top 40 markets or look at our top metropolitan areas, it is just surprisingly strong and consistent, with very few outliers in the negative.
And so that points to us that there are just good underlying financial metrics and balance sheet positive aspects for customers that is showing up in how they spend in our business. It also demonstrates that we're running a more consistent business. But the short answer is we're not seeing any negative outliers. When we look at customer mobility with -- and even when we were seeing COVID spikes around the country and vaccination rates, we still didn't see any major differences in overall revenue performance in those pockets of the country. So we feel good about that. And it points to what we believe will be very positive signs for the rest of the year, and that's what we're hoping and praying for.
Operator:
Our final question this morning comes from the line of Steven Forbes with Guggenheim Securities.
Steven Forbes:
I wanted to focus on the Pro. You mentioned 30% sales growth in the Pro. But curious if you could sort of remind us or speak to the contributions from existing versus new customer growth. And if there's any sort of quarterly variation in the Pro sales penetration rate that we should be cognizant of as we work our way through 2021.
Marvin Ellison:
Steve, the results from Pro equally balanced between new and existing customers. As Joe mentioned in his prepared comments, the key for us will be just continuing to get a larger percent of wallet of our existing customers. If we didn't attract one new customer and we were able to get a greater percent of spend from existing customers, that would solve our Pro penetration for the next 2-plus years. So that tells you that our greatest opportunity is just getting our existing customers to buy more. But at the same time, with the loyalty program that Joe and his team launched, we're seeing incredible growth in new customers, and we're seeing also customers be very attracted to our new credit program, and that's a great sign for us to see the acquisition of new customers. Joe, I don't know if there's any other points you would make.
Joseph McFarland:
Yes. Thanks, Marvin. The only thing I would add, we started our journey in the Pro over 2 years ago. We talked a lot about the basics, the price service, the right brands. And now we're focused on that strategic phase of the Pro growth. So things like building out our Pro loyalty database, the new CRM, the redesigned store layout and the tailored shopping experience. So we believe that we have attracted a lot of new customers. We're growing the wallet of our existing customers. And again, I'm very pleased with the Pro team, their focus and everything that, that team has accomplished in the last 2 years.
Steven Forbes:
And then just a quick follow-up, right, regarding Pro wallet share based on the CRM data that you have, right? Any sort of color or current data that you can share as it relates to the wallet share, right, or trip share of the small- and medium-sized Pro customer that you're focused on?
Marvin Ellison:
Steve, we're not going to publicly share a lot of that detail. Obviously, we're tracking it. But for competitive reasons, we typically don't share it externally. What I can tell you is that we've been pleased with the launch of loyalty and CRM, both programs are exceeding expectations. We had some delays, or, I'd say, pauses in the rollout due to COVID, we're now leaning into it. We are excited about the amount of data that we're collecting, and we're more excited about the feedback from our customers on how they feel about the visibility of what they're buying, how they're buying it and just the overall connectivity. So we look forward at some point in the future to sharing more details. But for now, I mean, we're not going to share a lot externally other than to say we feel great about the progress we're making in the trajectory of the business, specifically with that customer.
Operator:
Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
Operator:
Good morning, everyone. Welcome to Lowe's Companies' Fourth Quarter 2020 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that a notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our Investor Relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Good morning, everyone. I'd like to begin by thanking our frontline associates for their efforts to serve our customers and communities during the ongoing pandemic. In recognition of the efforts and the unique challenges posed by the pandemic, we invested over $100 million in incremental financial assistance for our frontline hourly associates in the quarter, which brought our total COVID-related support for hourly associates to over $900 million for the year.
We remain laser-focused on our highest priority, which has always been protecting the health and safety of our associates and communities. And in the quarter, we invested $65 million in support of store safety protocols and our communities. For the year, we invested nearly $1.3 billion in COVID-related support for our associates, store safety and our communities. Now turning to our results. For the quarter, we delivered total company comparable sales growth of 28% over the prior year and 41% growth in adjusted diluted earnings per share to $1.33. Those results cap off a fiscal 2020 where comp sales increased 26% and adjusted earnings per share grew 54% to $8.86. Looking at the fourth quarter results from a geographic perspective in the U.S., growth was broad-based, with comparable sales growth exceeding 19% across all 15 geographic regions and exceeding 25% for all U.S. divisions. On Lowes.com, sales grew 121% as customers shifted more of their shopping online, especially over the holiday season. We continue to enhance our omnichannel retailing capabilities in store operations, on Lowes.com and across our supply chain, with our goal to meet customer demand to shop however, whenever and wherever they choose.
Once again, DIY comps outpaced Pro comps in the quarter, driven by consumer mindset that remains focused on the home. During the pandemic, the home has come to serve 4 primary purposes:
a residence, a home school, a home office and the primary location for recreation and entertainment.
In addition to the strength in the DIY customer, our continued focus on the Pro is a very important component of our total home market share acceleration strategy. And Pro continues to show strong momentum, evidenced by the mid-20s comp in the quarter and nearly a 20% comp for the year. Part of our Q4 success in Pro was driven by our steps to tailor our service offering for these busy customers, even redesigning the footprint of our stores to facilitate a fast, intuitive shopping experience for our small and medium-sized Pro. Pros are rewarding our efforts with their repeat business, returning to shop our stores over and over again. Looking forward, we're focused on further enhancing our service levels, both in-store and online, to meet the needs of our new and existing Pro customers. Joe will discuss our efforts to grow market share in Pro later on the call. Now turning to Canada. We delivered comp growth in the mid-teens despite several COVID-related operating restrictions that went into effect during the quarter. The new Canadian leadership team made tremendous progress in 2020 and remains focused on improving operational efficiency by executing a retail fundamentals playbook to drive greater labor productivity and improve gross margins. And as I mentioned earlier, we're gaining traction with our new Total Home strategy, which is our commitment at Lowe's to provide everything a customer needs for their home. As an example, during the quarter, we quickly pivoted from a successful holiday Season of Savings event to launch 2 events to support our Total Home strategy in January, a home organization event and a bath event. During the home organization event, we provided our customers with storage solutions for their home and garages, freeing up valuable space for other activities. The bath event helped our customers find everything they need from paint to fixtures to toilets and tubs and even towels to upgrade their bathrooms. And for the customers who didn't want to do-it-yourself, we provided installation services. Truly a total home solution for a dream bathroom. Both events helped us to close out the fourth quarter with very strong sales in January. Looking forward, I am confident we're making the right investments to leverage our Total Home strategy, while we shift our focus from retail fundamentals to accelerating our efforts to gain market share. As a reminder, our Total Home strategy will drive market share acceleration by enhancing our investments in Pro, online, installation services, localization and elevating our product assortment. We are confident that these initiatives will allow us to drive sustainable market share growth as we deliver a total home solution for our Pro and DIY customers. Before I close, I'd like to once again extend my heartfelt appreciation to our associates for their dedication to serving our communities in this time of need. Doing the most challenging personal and professional year in many of our lives, our associates made enormous sacrifices for our customers and communities. And I'm very pleased that the marketplace is taking notice as reflected by Fortune magazine recently recognizing Lowe's as the #1 Most Admired Specialty Retailer, bestowing that honor on Lowe's for the first time in 17 years. We're humbled by the recognition, but we also know that 2021 will be a very unpredictable year. Even with the vaccine rollout underway in the U.S. and Canada, we continue to grapple with numerous challenges presented by COVID-19. And although the business environment remains uncertain, we're confident that we will continue to drive market share gains and operating efficiency. Also, our newly developed operational agility allows us to quickly respond to a wide range of potential macro outcomes in 2021. And we will not lose focus on our #1 priority, which is supporting the health and safety of our associates and our customers. And with that, I turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. We delivered U.S. home improvement comparable sales growth of 28.6% in the fourth quarter. And consistent with the trends we've seen since the second quarter, growth was broad-based across both DIY and Pro customers, in-store and online and across all merchandising departments. In fact, all 15 merchandising departments generated positive comps of over 16%.
Great execution, combined with our compelling product offering of well-known national brands, balanced with high-value private brands, ensured that we were well positioned to meet the continued elevated demand for home-related projects during the quarter. Lumber was, once again, the top performer, driven by strong unit demand across Pro and DIY customers, as well as commodity inflation. Our merchants and our supply chain teams did an exceptional job in working with our vendor partners to keep up with demand and to ensure that our stores were stocked with job lot quantities. Several other categories posted comps above 30%, including building materials, which was driven by strong demand for roofing and gutters. An improved level of in-stock and an exceptional customer service have allowed us to continue to grow our Pro business in these Pro-focused building product categories. Our seasonal and outdoor living, lawn and garden and paint categories also delivered comps above 30% in the quarter, reflecting the consumers' continued focus on the home. Our seasonal and outdoor living team delivered a successful holiday season with a holiday trim a tree program that exceeded the customers' expectations. The team also leveraged our selection in key brands to drive strong sales in grills, patio heaters and fire pits, as these categories were strong throughout the quarter as consumers continue to enjoy their outdoor spaces. Outdoor power equipment was driven by sales of chore-related product, such as snowblowers, generators and pressure washers, as customers navigated the weather and worked to maintain their outdoor areas. Continuing the theme of enhancing the outdoors, we saw strength in lawn and garden, with notable outperformance in holiday-related live nursery, along with growth in hardscapes, outdoor planters and cleaning products. And finally, our paint category also continued its strong performance with both interior and exterior stains delivering strong comps as the weather early in the quarter remained favorable. Now turning to our online results. As Marvin mentioned, we delivered sales growth of 121% on Lowes.com, our third consecutive quarter with over 100% comps online. And during the quarter, we continued to enhance the user experience as we simplified the search and checkout features to speed up the process for customers shopping online. And we are also now working on replatforming LowesForPros to the cloud to be completed in the first half of this year, which will significantly enhance the features that we offer to these time-pressed customers and then further build out our loyalty with the Pro. As we discussed last quarter, we have been resetting the layout of our U.S. stores with approximately 95% of our resets now complete. We expect to drive greater sales productivity per square foot by achieving 3 key objectives with this investment. First, driving Pro sales through a more intuitive and faster shopping experience as we've now placed relevant products adjacent to each other and added a Pro flex area for grab-and-go products at the front of the store. Second, increasing our localized product assortment by eliminating unproductive bays without planograms or what we call junk bays, which now opens up space for new products, better tailored to the local market. And then finally, third, driving more transactions by moving the basket-building category of cleaning products to the main power aisle of the store. We're confident that our stores are now easier to shop for both Pro and DIY customers, which positions us well to accelerate our market share gains. I'd like to offer my sincere appreciation to all the teams across the company who work so diligently to execute on this strategic initiative in such a short period of time. We also continue to elevate our brand and product offerings. We are continuing to build on our position as the leading appliance retailer in the U.S. with the addition of Midea and Hisense appliances to our stores.
And Lowe's will soon become the exclusive home improvement provider of Mansfield plumbing products. This addition will make Lowe's the only home improvement retailer to offer customers the top 3 toilet brands in the U.S.:
Kohler, American Standard and Mansfield.
As we transition to spring, we're in a great position to safely serve customers, and our teams have already been preparing by completing our new spring sets as we anticipate the arrival of the season around the country. Leveraging our leading position in outdoor power equipment, we have a wide selection from EGO, the top-selling brand in battery-powered OPE, to John Deere, CRAFTSMAN, Husqvarna, Honda and Aaron's. In addition, we will have a terrific selection of patio furniture, including our refreshed allen + roth patio program, complemented by a wide array of grills as we continue to leverage the 2 leading brands in outdoor grilling, Weber and Char-Broil. We're confident that our products will inspire customers that are looking to upgrade their outdoor space, which we think will continue to remain a retreat for many this spring season. We're continuing to make changes to improve traffic flow within our outdoor garden centers to ensure social distancing while shopping, as well as showcasing inspirational vignettes and utilizing enhanced vendor support, all of which will drive a great spring season in lawn and garden. And finally, we are excited to deliver new innovation in flooring with the launch of Pergo WetProtect technology available in laminate, engineered wood and rigid luxury vinyl, and offering guaranteed protection for both the flooring and subflooring. This new level of total moisture protection is a great Lowe's exclusive product that will provide peace of mind for consumers and further differentiate our flooring offering. This spring, we will demonstrate to consumers that we provide everything they need to make their homes and backyards functional and safe, a reflection of our Total Home strategy. I'm looking forward to sharing more with you about our reimagined approach to spring on our next call. And before I close, I'd like to express my thanks for the resilience and dedication showed by our merchants and vendor partners during what was truly an extraordinary year as these teams work tirelessly to meet the high levels of demand for our products and services. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. This past year presented challenges that few of us could have imagined. Lowe's has always been at the forefront in responding to crisis in our communities, and our associates rose to the challenge once again in 2020.
In recognition of the outstanding efforts of our associates, in January, we announced a bonus of $300 for each full-time associate and $150 for each part-time associate. This $80 million bonus brought the total COVID-related assistance to our associates to over $900 million in 2020. And I could not be more pleased to announce today that for the fourth quarter in a row, 100% of our stores are under "Winning Together" profit-sharing bonus totaling $90 million. And because of their efforts, once again exceeded expectations, this represents an incremental $30 million over the target payment level. And we're supporting our communities again through hiring as we bring on more than 50,000 seasonal and full-time retail associates this spring to ensure that our customers get the exceptional service they expect from Lowe's. This builds on the more than 90,000 associates hired into permanent roles over the past year. 2020 changed the way the customers shop with Lowe's. Nowhere is this more evident than the 111% sales growth on Lowes.com for the year. And with roughly 60% of these online orders fulfilled in our stores, we needed to dramatically expand our fulfillment capabilities to support this increased demand. We began by rapidly rolling out curbside pickup in the first quarter, and then we began to launch touchless BOPIS lockers in our stores a few months later. We now have BOPIS lockers in over 1,200 stores with the goal of rolling out lockers to all U.S. stores by April. Providing multiple contactless pickup options for our customers, we are meeting consumer demands to shop Lowe's in whatever way they choose. And we've continued to enhance the mobile app to improve the customer pickup experience. This quarter, we began rolling out geofencing technology that alerts our stores when customers are on their way to pick up their orders, enabling quicker fulfillment when they arrive at the store. Last quarter, we announced that we were standing up dedicated fulfillment teams to handle all in-store fulfillment orders. All of these enhancements from the easy-to-use BOPIS lockers and the new geofencing technology, to the focus on the fulfillment teams, have already driven improvements in customer satisfaction and speed of service. Importantly, the fulfillment teams are also improving productivity as they leverage enhancements that we've made to the picking app. This is evidenced by a dramatic reduction in the number of hours needed to fulfill orders for pickup. In fact, we can now fulfill orders 6x faster on average than 1 year ago. Now let's turn to our performance with the Pro. As Marvin mentioned, we delivered mid-20s comps in the fourth quarter. We continue to enhance our Pro loyalty offering by providing Pros with the tools they need to get the job done. This time of the year, our Pros are focused on not only their project pipeline, but they also need to close their books just like any other business. As a true partner to the Pro, we are now providing our Pro loyalty members with a $100 discount on TurboTax. Our Pro loyalty members can also export up to 24 months of transaction history, expediting their year-end close process. It's value-added offers like these that truly differentiate our Pro loyalty offering. Throughout 2020, we continue to raise the bar on our offering for the Pro, with better service levels, the right brands and products and the job lot quantities they need. Every day, we are demonstrating that Lowe's is executing our commitment to be the new home for Pros, which is reflected in the strong repeat rates that we're earning from new and existing customers. I'd like to offer a special thanks to the entire Pro team for a fantastic year. Job well done. And I'm looking forward to building on this momentum as we continue to grow our Pro penetration. And one way that will drive greater Pro penetration is through our newly launched Pro customer relationship management, or CRM tool. Rolled out to all stores in late January, this new technology provides our Pro desk with the tools to manage, grow and retain Pro accounts through consistent and data-driven selling actions. We will also be able to associate any transaction regardless of tender type to a specific Pro account, allowing us for better record-keeping for their business. Store associate training is currently underway, and we expect that the targeted outreach enabled by this tool will facilitate stronger and more personal relationships with our Pro customers. Over the past few years, the store operations team has made considerable strides in improving productivity in our stores, with technology enhancements that free up our associates to spend more time in the aisles serving customers. As we move into 2021, we are kicking off a new productivity initiative in-store operations that we are calling our perpetual productivity improvement, or PPI. This key productivity initiative will play a critical role in our continued multiyear improvement in operating profit. Through PPI, we will leverage new processes and technology to deliver continuous productivity enhancements. Some of the most significant technology initiatives under PPI are modernized checkout infrastructure, industry-leading in-store workforce management tools, new touchscreen POS, expanded rollout of digital signs, incremental functionality deployed to the handheld devices and enhanced store inventory management systems, to name a few. These perpetual productivity improvements will help us to move toward our multiyear goal of achieving $2.5 billion to $2.7 billion in store OpEx productivity that we set at the December investor update. I look forward to updating you on the progress we are making towards these important productivity initiatives on future calls. With that, I'll turn it over to Dave.
David Denton:
Thank you, Joe. I'll begin this morning with a few comments regarding the company's robust capital allocation strategy. In fiscal 2020, we generated $9.3 billion in free cash flow driven by outstanding operating performance, and we returned $6.7 billion to our shareholders through both a combination of share repurchases and dividends.
During the fourth quarter alone, we paid $452 million in dividends at $0.60 per share. We also repurchased 21.1 million shares for $3.4 billion at an average price of approximately $160 a share. This brings the total to $5 billion in share repurchases for the year. We have approximately $20 billion remaining on our share repurchases authorization and plan to utilize our strong cash flow to drive significant long-term shareholder value. Capital expenditures totaled $619 million in the quarter and $1.8 billion for the full year as we invest in the business to support our strategic growth initiatives. We ended 2020 with $4.7 billion of cash and cash equivalents on the balance sheet. And along with $3 billion in undrawn capacity on our revolving credit facility, we have immediate access to $7.7 billion in funds. We remain confident that we have ample liquidity to navigate any unforeseen circumstances. At the end of the fiscal year, our adjusted debt-to-EBITDA ratio stands at 2.2x. Now I'd like to turn to the income statement. In Q4, we generated GAAP diluted earnings per share of $1.32 compared to $0.66 last year, an increase of 100%. In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. In Q4, we delivered adjusted diluted earnings per share of $1.33, an increase of 41% compared to the prior year. These results were driven by higher-than-expected sales volume reflecting a continued consumer focus on the home, a modest benefit from the next round of government stimulus checks as well as strong execution across our operations. Operating margin improved in the quarter as our strong focus on cost control and productivity continued to pay dividends. Q4 sales were $20.3 billion, driven by a comparable sales increase of 28.1%. This was due to comparable store average ticket growth of 14.2% and transaction growth of 13.9%, with strong repeat rates from both new and existing customers. Commodity inflation drove a benefit of approximately 300 basis points to comps in the quarter as lumber continues to experience rising prices. U.S. comp sales were up 28.6% in the quarter. And consistent with our results for the past few quarters, growth was well balanced across both DIY and Pro customers, selling channels, merchandise departments and geographies. Our U.S. monthly comps accelerated through the quarter, were 23.8% in November, 28% in December and 35.7% in January. As Marvin mentioned, the company pivoted quickly from a strong holiday selling season in late December to launch bath and home organization events in early January. January sales also benefited modestly from the second round of government stimulus. Adjusted gross margin was 31.8%, down 9 basis points from last year. Despite cycling over significant improvements last year in our process to more effectively manage product margin, product gross margin rate improved 125 basis points driven by continued execution on our pricing, cost management and promotional strategies. We took a less promotional stance across all categories, including our focus on EDLP and appliances, which benefited margin in the quarter. In addition, strong demand from holiday products led to good sell-through and minimal seasonal write-offs in Q4. These benefits to adjusted gross margin were offset by 40 basis points of pressure from inventory shrink, 40 basis points of pressure from supply chain cost, 35 basis points of pressure from lumber installation and 20 basis points of pressure from lower credit revenue. Adjusted SG&A of 22.3% levered 42 basis points to 2019. As we anticipated, we incurred approximately $165 million of COVID-related expenses. These investments included approximately $100 million in financial assistance for our frontline associates and approximately $60 million related to cleaning and other safety-related programs, as well as approximately $5 million in charitable contributions. These $165 million of COVID-related expenses negatively impacted SG&A leverage by approximately 80 basis points. As expected, we incurred approximately $150 million in the U.S. stores reset project, which negatively impacted SG&A leverage by approximately 75 basis points. As Bill mentioned, the resets have been completed in approximately 95% of our stores. These incremental costs were offset by payroll leverage of approximately 105 basis points related to higher sales volume and improved store operating efficiencies, occupancy leverage of approximately 30 basis points and advertising leverage of approximately 25 basis points. Adjusted operating income margin of 7.6% of sales for the quarter was up 41 basis points to the prior year as operational productivity improvements were offset somewhat by significant investments in our stores and supply chain to drive long-term growth. In addition, increasing investments in short-lived technology and store fixture assets is resulting in higher levels of depreciation versus our historical run rate. The adjusted effective tax was 25.8%. The tax rate was slightly lower than expected due to better-than-anticipated performance of our Canadian business in Q4. We continue to build up our inventory levels throughout the quarter to meet the sustained high levels of customer demand. At year-end, inventory was $16.2 billion, and lumber inflation increased inventory values by approximately $240 million. Now before I close, let me talk about our current trends and how we're planning our business in '21. Although February is the easiest comp this year, we are encouraged that the strong broad-based sales trends that we saw in the fourth quarter have continued this month, apart from the impact of the recent winter storms. Looking at the balance of the year, our approach to 2021 remains consistent with how we outlined our planning at our December investor update. Like many companies, we have limited visibility into future business trends. It remains unclear when there will be a widespread availability of the COVID vaccine and whether there will be additional COVID-related restrictions like we're experiencing in the Canadian business today. Given the near-term uncertainty, at our December investor update, we outlined 3 different market-based scenarios on how the mix-adjusted home improvement market might perform, be it weak, moderate or robust performance levels. Keep in mind that our business is more heavily weighted in DIY and less penetrated in online than the broader market, both of which create modest downward pressure on the Lowe's home improvement market outlook. These 3 market scenarios would result in total sales expectations ranging from $82 billion to $86 billion for the year. While each scenario represents a top line decline from 2020 as we cycle this unprecedented industry growth, we continue to expect that our sales result will outperform the market as our initiatives are focused on delivering market share gains. Additionally, in each scenario, we expect our adjusted operating margin to increase year-over-year, ranging from 11.2% to 12%, depending upon the demand environment. And consistent with my comments at the investor update in December, embedded in each of these scenarios are the incremental investments in frontline associate wages and equity programs that totaled $1.4 billion through 2019 and 2020. At the same time, we have implemented a slate of perpetual productivity initiatives that Joe mentioned earlier. And we are investing to drive operational efficiencies in our business. We will also lap significant nonrecurring spend from 2020. While it's still very early in the year, we are seeing market trends essentially in line with the robust market scenario. This scenario assumes the relevant home improvement market will experience a modest contraction this year, and our sales would approach $86 billion. We will remain agile to react rapidly to any changes in the market, and we are able to quickly flex store labor, advertising and incentive comp expenses. And consistent with what we outlined at Investor Day, we are expecting $9 billion in share repurchases this year. Our repurchases activity should be roughly ratable by quarter but a little more concentrated in the first half of the year, given the robust cash flow generation driven by our spring selling season. And we are planning for approximately $2 billion in capital expenditures in '21. So in closing, we remain extremely excited about the future of our business and its ability to continue to deliver sustainable shareholder value. With that, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
Congrats on all the progress. Dave, I wanted to follow-up on the guidance point here. Obviously, not full guidance, but the scenarios you discussed in December. If I recall, it included gross margin relatively flat. Given the pressure as you saw in the fourth quarter, I'm just curious, should we be thinking about gross margin in '21 down slightly, but maybe more benefits from SG&A to still get to the same EBIT margin outlook? How should we be thinking about that?
David Denton:
Yes. Seth, Happy New Year. Good question. Just I think, most importantly, is we're really focused on operating income and margin expansion as we cycle into this year. Clearly, we're focused on improving our gross margin performance, as you've seen us do that consistently through 2020. We continue to make really nice progress from a product cost perspective.
I think what you're also seeing us do is we're investing from a supply chain perspective to make sure that we're building out in the future to meet the needs and demands of consumers in the future. So I think we're excited about that. I do expect that gross margin over the longer term, think about it flattish. We are experiencing some headwinds as we think about inflation from lumber, but nothing has materially changed from what we discussed in December, Seth.
Seth Sigman:
Okay. That's helpful. And then just a follow-up question about demand. Obviously, the strength you've seen has been pretty broad-based. Beyond some of the seasonal variations that you've been seeing, I'm just curious how you see the consumer or the customer evolving their focus in the category? How are the types of projects changing? And part of the question is whether you're seeing an acceleration in some of the bigger projects that may have been constrained during parts of this year. Because it does feel like the mid-20s Pro comp that you pointed to, does seem like that's an acceleration. So I just wanted to get a little bit more context on that.
Marvin Ellison:
So Seth, this is Marvin. I'll take part of that, and I'll let Joe comment a bit on Pro. As we've said, 2021, to state the obvious, is a very difficult environment to forecast. And I think all your questions are relevant. And what we can say is when you look at the comp cadence for the month during the quarter, you saw us accelerate throughout. You look at the month of January, which is a significant sales performer, and both Dave and I discussed the importance of our Total Home strategy leaning into those 2 events, the bath event and the home organization event, that gives you an indication that the customer is still in the project mindset as they continue to find ways to make their home more livable and more comfortable for all the various activities that COVID has forced upon us.
So the short answer to your question is we feel great about the mood of the customer. We feel great about the trends relative to big ticket, small ticket, Pro and installations. And all the work that we put in place the last 2 years in our retail fundamental strategy just gave us a good position and platform to service the customer effectively across all those different categories. I'm going to let Joe talk a little bit about Pro because, again, we're very proud of the performance. As we mentioned in the prepared comments, we delivered mid-20% comps in the quarter for the year. We're hovering around 20% comps. And this was in an environment early in the year where the Pro business became very soft just because of the normal occurrences of customers not being comfortable allowing strangers in their homes. I'll let Joe discuss a little bit more on our excitement around Pro.
Joseph McFarland:
Thanks, Marvin. And Seth, thank you for the question. You're correct, from Q3 to Q4, we did see a nice comp acceleration. We're excited about the underlying demand in the Pro space. As we look at the kind of robust pipeline that's out there in the Pro space, thinking about the expanded product offerings that we've had throughout the year. In addition, I mentioned in my prepared comments, the benefit from TurboTax and the progress that we're making to help these Pros expedite their year-end close.
And then in addition, we've been focused on all the fundamentals. And as we continue to move forward, confident that things like our U.S. stores reset and the area that we created for Pros and the ease of Pros to shop. In addition, very excited about the growth of our new Pro loyalty platform, along with the integrated CRM that rolls out. And very excited about what's happening inside the Pro business.
Operator:
Our next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is on the outlook or the perspective, if you will. Dave, you mentioned that the business is tracking towards a robust case. And I know robust, I don't know if it was couched as a base case for you or not, but I think we're interpreting it as one. Do you have any more confidence in that? Or are you expecting some twist and turns as the year goes? Or the fact that we're tracking there gives you confidence that -- more confidence in that scenario?
David Denton:
Listen, I think we're only a few weeks into the year, but I think we feel encouraged by the trends that we're seeing at the moment. So I think we -- as Joe and Marvin just articulated, I think the health of the Pro business is sustainable and it's actually accelerating a bit. So I think we feel really good about that. At the same time, the consumer remains healthy and continues to invest in the home to support both their living needs but also their educational needs for the kids, in many cases, and continue to invest to make sure that, that is an asset that is sustainable for them going forward. So we're encouraged at this point, but pretty early still.
Marvin Ellison:
Simeon, this is Marvin. And what I'll add to that is, we'll go back to the same theme that you'll probably hear us say all morning. Obviously, we can't predict with any high degree of precision what 2021 macro will look like. But we're confident in 2 things
We believe that 2020 was not an anomaly. We believe it's a reflection of a lot of hard work and retail fundamental implementations we put in place across Lowes.com, Pro, merchandising, store operations, IT infrastructure. And we believe that those initiatives and our Total Home market acceleration strategy is going to allow us to continue to take market share and, at the same time, improving operating income.
Simeon Gutman:
Okay. And my follow-up is in the robust case of 120 basis points, I think, for margin expansion. I don't know if we said, but how much can you look at that amount and divide it among top line dependent versus internal execution or transformation dependent. I don't know if we looked at it that way or if we could bridge it versus the other scenarios.
David Denton:
Yes. I would just encourage you maybe to go back and look at our Analyst Day presentation. I had a building block slide in that presentation that walked us from kind of where we -- where our guidance was for the end of 2020 to a 12% margin rate perspective. And I think it does show a little bit of -- kind of how gross margin might perform as well as how SG&A is going to perform. And again, this is largely about, in aggregate, gross margin rates being relatively flat and us improving our SG&A performance across the business.
Operator:
Our next question is coming from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
I wondered if there was any way you could update us on what Pro is as a percentage of your sales today? I feel like there is some ceiling with your stock price or valuation because the thinking is, is you just don't have as big of exposure to the Pro as your main competitor. But with the comps that you've put up in 2020 and all the initiatives, I wondered if there was any further insight into what that percentage of sales is today.
Marvin Ellison:
Kate, this is Marvin. The best way that I'll answer that is we're going to pretty much stick to our 20% to 25% penetration. We're going to reevaluate that, obviously, coming out of 2020. The key is that, as you know, DIY significantly outpenetrated the Pro during the year. So we know that the 2020 data may not be a good, consistent data set to look at relative to Pro and DIY penetration. So we probably need to cycle through the first half of 2021 to get that data really balanced out. What I can say is, in Joe's prepared comments and also in mine, we laid out some of the specific initiatives related to the Pro.
One of the key things that we focused on arriving at Lowe's a little over 2 years ago, is one of the main reasons why we had a gap relative to sales per square foot productivity and operating income by store was because the Pro penetration was significantly less than what it should have been. Pros drive productivity in multiple product categories throughout the entire store. And so part of our focus on the Pro is because we know it's going to be critical for us to improve overall productivity from a space perspective as well as driving operating income throughout the store. So we'll get back to you later in the year on an answer. But the key is we're going to be focused on it, and we think we're making great improvements.
David Denton:
And Kate, I'll just add that we look at it a little bit the opposite. We are underpenetrated, but that is the big opportunity we have. And all the investments we're making is going to allow us to really accelerate in that business segment pretty significantly over the next several years.
Katharine McShane:
Okay. And then my follow-up question is just on wages and how we should think about that in 2021 relative to what was paid in 2020, especially considering the number of bonuses that were given to associates during that time.
Marvin Ellison:
So Kate, this is Marvin. I'll take it. And if Dave wants to provide any additional financial analysis, he can. But I think at the highest level, what we've laid out for operating income targets for 2021, what we laid out at the investor update in December and what Dave mentioned in his prepared comments, reflect any investments we intend to make in our associates. The good news for us, and Dave mentioned this earlier in the morning, that from the year 2019 and 2020 made a $1.4 billion investment in incremental wages, equity programs and other associate-related benefits, and that was pre-COVID.
So other retailers candidly are catching up to the work investment that we already made going into COVID, so we don't have an enormous bogey, so to speak, that we need to make from an investment standpoint to catch up. We've been on a pathway to get our wages up. That's why we're very proud to say that we are one of the highest wage retailers from an hourly associate perspective in the U.S. So we don't see 2021 as anything that will be materially different than that. Obviously, we'll look at how the business is tracking, we'll look at the needs of our associates. But any investments we plan to make has already been factored into any financial guidance or at least the range of guidance that Dave has discussed in December and this morning.
Joseph McFarland:
So Kate, it's Joe, and thanks for the question. I'll just add a few things to what Marvin said. And over the last 2 years, we've been taking steps from a store operation standpoint to simplify the store structure, if you think about some of the updates we've given, our 4 levels of sales associate on the sales floor and all the work we've done. And so in addition, the labor management tools and the workforce management initiatives the team has laid out, I feel very good about the balance of ticket and transactions in our transaction-based labor model, and that will continue, to be able to deliver on the operational efficiency we need to.
And then finally, for the spring hiring season, we feel that we've done a nice job addressing any difficult-to-hire markets. We measure the pipeline of sales associates coming in by position by market, so we've made adjustments where we need to and feel confident going forward.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Given the introduction of the PPI initiative, is it likely that you'll come in at the high end of the profitability scenario, even if you don't come in -- even if you come in at the middle end or low end of your sales scenario for 2021?
David Denton:
Michael, it's Dave here. Clearly, what we're doing is we're working really diligently to improve the productivity across our business. And Joe has kicked off a pretty major effort to do that. But we're doing it really across all segments of our operation.
That's probably a little bit more specific guidance, if you will, so we're probably not going to go there. But I'll just say that as a management team and as a business, we're controlling what we can control. We're making sure that as we look at these sales scenarios over time is that we're improving our operating income performance. And we're dead set on improving that. We're very focused and adamant about going after that. And I think we have a very good line of sight to that.
Michael Lasser:
Okay. And it seems like you're going to have more takes than puts on your gross margin this year with supply chain pressures, probably inflation drag for at least the near term, and what's likely to be at least some return to a more promotional environment. So in that scenario, with your gross margin already declining in the fourth quarter, how do you keep it flat in 2021? What are the offsets?
David Denton:
Well, listen, we're focused in a few different areas. We've just enhanced our pricing and promotional tools, from a merchandising perspective. I think the merchants have just kind of taken a step back and looked at, from a promotional cadence perspective, how to think of more of an EDLP type environment, at the same time going out and negotiating special buys in certain areas to drive real value from a consumer perspective. I think we're getting a lot more efficient on how we layer in and out of our online business to drive both top line and improve profitability. At the same time, we do need to manage our supply chain to be more efficient as we think about same day, next day deliveries to the home and to the job site.
So all those levers are things that we're working on that we're actively using to manage our gross margin performance. And yes, we do have some headwinds, but we're also -- that's part of our job is to manage those headwinds to improve performance over time. And again, with a real focus, once again, Michael, on improving our operating income flow through, that's the opportunity we have.
Michael Lasser:
Okay. And then...
William Boltz:
Michael, this is Bill. I'll just add a couple of comments to that. As we've said over the last couple of years, we've been on a journey to get to more of an everyday competitive price. And so getting credit for what we're doing and less of this high-low approach that we had been typically on prior to this leadership team coming in. And then we have done a lot of work in the last 18 months around our localization initiative, and it's one of our key unlocks and part of our Total Home strategy as we go forward that gives us the opportunity from a margin perspective as well. So we're confident that we can deliver on what we said back in December.
Michael Lasser:
If you could just clarify that, though. Where do you stand today in terms of your pricing position versus where you might have been a year ago? If you can use that as a lever to offset some of the gross margin headwinds that you might experience in next couple of quarters.
Marvin Ellison:
Well, look, this is Marvin. What I'll say, Michael, is it's a work in progress. What I can tell you is the set of tools that Bill and the merchants currently have today versus what we had 2 years ago is truly a night and day difference. So it gives us the ability to have localized pricing and we can price now in more smaller clusters. I mean 2 years ago, we were using blunt instruments to price in broad markets. Now we can get down to individual locations.
In addition to that, Joe talked about the expansion of things like digital signs. It may not sound like a big deal, but there are parts of the store where you have frequent, rather volatile price-changing activities, a lot of labor goes into that. And if you can put a digital process in place, it allows you to capture the different costs and retail changes in a way that actually can benefit gross margin. And localization, to Bill's point, solves a couple of major significant issues. But one is you have the right product in the right market. So your exit strategy doesn't just destroy your gross margin because you're clearancing everything just to get it out. I'd use the example at the December update when Bill, Joe and I walked in the store in West Philadelphia and saw riding lawn mowers and big, deep seating patio sets, and sheds and other products that was just waiting for markdown to happen because it was simply in the wrong location from a geographic perspective. So Bill's team is working to solve all of that, so we can have the right product in the right location so we don't take deep markdowns to exit. So all of those things will play a role in giving us -- to create our own internal headwind to go up against some of the investments we're making, like in supply chain. So we'll keep you updated on the activities.
Operator:
Our next question comes from the line of Karen Short with Barclays.
Karen Short:
I know, as you said, you're kind of trending or contemplating you'll probably be at the robust end of your guidance range. But I guess if you end up actually even slightly better than that, how should we think about operating margin opportunity? Would there be upside to that? Or would you reinvest and kind of maintain the cadence that you'd indicated previously? And then I had one follow-up.
Marvin Ellison:
Sure. Yes, ma'am. So Karen, this is Marvin. The best way to answer that question is the simple statement is that we expect to outperform the market and gain share in 2021. So if the market performs better than our robust scenario, that would be music to our ears, because we would believe that it would only provide us with upside opportunity on the top line and on the bottom line. So again, we're going to just have a very, very singular focus on taking market share and improving operating income. And if the macro improves better than our forecast and better than we anticipate, that will be only good news for us.
Karen Short:
Great. And then I just wanted to see, I don't know if you'd be willing to provide this, but would you be willing to give us some color on the number of Pro loyalty members and then just a quick update on timing of combining the Lowe's credit card with the low -- with the Pro loyalty program? Or does all of that happen at the same time as you migrate to the cloud?
Marvin Ellison:
So I'll take the easiest part of the question, and that is, no, we're not going to provide you with the number of loyalty members from a competitive perspective. What we can tell you is that we're very pleased with the adoption rate and we're very pleased with the returned visit as a result of that. I'll let Joe talk about the merging of credit and the platform.
Joseph McFarland:
Yes, Karen, this is Joe. And thank you for the question. We will be migrating our credit platforms and our Pro loyalty platforms together. We have every intention. That is a part of -- it's a huge part of the benefit. Again, we've been very encouraged by the new sign-ups in Pro loyalty, how the Pro customers are responding. We've been very pleased also with our new credit acquisition from a Pro standpoint. And so with those underlying themes, although we won't release the number of Pros, we're excited about what the platform is delivering and all the work that the Pro team has done.
Operator:
Our next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk about how you think stimulus helped the business there in January? A very strong comp, obviously at 35%. What do you think the lift was? And how would you compare that lift to what you saw last Spring when stimulus hit?
David Denton:
Chris, Dave here. Yes, I do think stimulus, as we cycled into the new year, did help our comps. We estimate somewhere between 50 and 100 basis points from that perspective. I think as stimulus has gone on for a while now, I think the performance and the impact of it has been -- has moderated a little bit. So I think we do see it -- when those trap checks do hit, we do see an inflection kind of up a little bit, but it has not been nearly as dramatic as it was when it first hit basically a year or so ago.
Christopher Horvers:
Understood. And then as you think about -- just to square the T on the gross margin. So in the slides, you have flat gross margin to 12% in the robust scenario. Is there any potential cadence around that? You do have the freight pressures probably earlier, maybe shrink in supply chain investments. So a flat relative to 2020, do you expect it to be maybe down a bit in the first half and then up in the back half and net flat that way?
David Denton:
I think that's a little bit more specific than probably what we could give you some color on at this point in time. I'd just say that at the end of the day, back to Marvin's point, is our focus this year taking market share, improving operating income. That's just are 2 things that we're focused on just consistently, and you'll continue to hear us talk about that, demonstrate our performance in those 2 metrics.
Operator:
Our next question is coming from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Curious in regards to the supply chain investments, Pro and online obviously areas of growth and accelerating growth. But what I'm curious to understand is the incremental investments you're making in both of those areas, some of them you've made already, some that are in process. How will the customer experience be different in those areas in '21? And where I'm really trying to end up is in terms of the share gains that you're making in both of those areas, what do you think about the future of that, especially in terms of payback from where you're investing incrementally?
Marvin Ellison:
So Eric, this is Marvin. And early on, we committed to a $1.7 billion supply chain infrastructure investment between the years of 2019 and 2023, and we're well on the pathway to achieve that. Specific to your question, we're trying to create a market-based delivery model, which will transition the pressure of delivery from our individual stores to a market-based model. In addition to that, we're trying to develop a fulfillment model that will serve a customer any way they choose to shop in this omni-channel ecosystem that we're creating.
So relative to a customer, how will it be different? It would be different that you will have a more seamless delivery with better visibility to appointment, scheduling and arrival, specific to any big and bulky items starting with appliances. So for the DIY or the Pro, if you're in the appliance space, you're going to have a more seamless opportunity to purchase a product. Just to take you back to how this has been done historically, when a customer purchases an appliance, the scheduling process is done by an associate calling the customer at home and going through a manual process to try to find a date that best fits the availability of the product and the customers' schedule. To say it's clucky and inconvenient will be an understatement. Now we've transitioned to a digital scheduling model where a customer can choose their own date based on prepublished openness in our system. And our associates have total visibility to inventory, whether it's in their store or in a market-based distribution center. What we're doing on the Pro side is also trying to create more of an omni experience. You're going to see us launching Pro lockers later this year. And you're going to see us improve our job site delivery with Pro and have a lot more flexibility around that. So those are 2 ways that those customers will see a difference. And there are a lot of other activities underway that Joe in operations partnering with the supply chain, but we'll wait till a later day to get into those.
Eric Bosshard:
Okay. That's helpful. And then one question for Dave. The incremental margin of the business in '21, in an upside sales scenario, does the incremental margin change? And I guess what I'm trying to get a sense of is, obviously, in '20, there were incremental investments made through the year as sales came to the upside and were necessary, but diluted the incremental margin of the business. Does that same story play in '21 in a better sales scenario? Or can the incremental margin either be sustained or expand in an upside sales scenario?
David Denton:
Yes. Eric, I would say that it should expand a little bit in upside scenario, just given what we've done in 2020, to your point.
So great. So Rob, with that, we're going to take one more question, please.
Operator:
That question will come from the line of Greg Melich with Evercore ISI.
Gregory Melich:
Great. I'd love to follow-up on inflation. So I think you called out 300 bps in the fourth quarter. What percentage of your sales, is that really looking at the commodities? And any number you have for the full year? And if you could even talk about the ability to pass through some rise in input costs outside of those commodities, that would be great.
David Denton:
So yes, largely, the inflation has been centered primarily in the lumber category. If you think about it from that perspective, and again, about 300 basis points. This is -- from a commodity standpoint, this is something that we're very used to managing. And largely, those are passed on ultimately to the consumer at the store.
Gregory Melich:
And for the full year, would that number have been 150 basis points as we're thinking about what it -- how it impacts '21?
David Denton:
Yes. I don't know that off the top of my head. But obviously, inflation in the back half of the year was higher than the first half of the year, so it's certainly less than 300 basis points. And we'll keep -- obviously, we'll keep -- we watch it daily.
Gregory Melich:
Got it. And then my follow-up question sort of goes back to really supply chain. I know you have the plan, and it's coming along. Just given the investments ramps we've seen on -- particularly in supply chain, not just from your number 1 competitor, Home Depot, but from Amazon, from Walmart, where CapEx is sort of up significantly from where it was a year ago. Is there anything you're seeing that you're planning on leaning more into as you get through the first year or 2 of that $1.7 billion plan, whether it's more market delivery operations, more centralized fulfillment? Anything on that as to what you're seeing them do and how you want to respond.
Marvin Ellison:
No, Greg, I think COVID and the pandemic really taught us all about responding to the needs of the customer in a more dramatic way. And also, it taught us how quickly consumer preferences will shift, specifically when it comes to how customers desire to receive products that they purchase. We feel like our strategy is sound. We're the #1 appliance retailer in the U.S. and we do it the hard way. We deliver it from every store, and that is not an optimal way to manage such a large amount of inventory and such a large expense from a transportation perspective.
So going to a market-based model is going to unlock an enormous amount of productivity, not only from a store labor perspective but on how we manage billions of dollars in inventory around the company. So market-based delivery is absolutely the way to go. In the moment, we bill the process for appliances, it opens up other product categories like riding lawn mowers and sheds and patio furniture and grills. So this market-based model is going to be incredibly important for us. We opened up a dot-com fulfillment DC in Southern California this past year. It gives us the ability to have 2-day delivery from an e-comm perspective to every U.S. location. We're also opening up 3 additional e-commerce fulfillment centers. That's relatively new to our strategy, to answer your question, and that's going to give us the ability to create more same-day next-day delivery opportunities. And we're aggressively building out our bulk distribution centers and our cross docks to help with the market delivery. In addition to that, we're going to be leaning into Pro job site delivery, and we have a couple of initiatives underway that we're working on to make that a reality. So the short answer to your question is we benchmark a lot. We look at what's working in the marketplace, but we feel really good about the strategy we've laid out. And there's a reason why most retailers delay supply chain transformations because they're very hard to do. And we're committed to it and we understand the benefit of it. And we're going to make the right investments, and we believe is going to allow us to be competitive in out-years. But as an investment, we know we're going to have to lean into for the next couple of years. But again, it's something we're very committed to.
Operator:
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2020 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations.
Kate Pearlman:
Thank you and good morning, everyone. Here with me today are Marvin Ellison, our President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our Investor Relations website. Before we discuss our third quarter results, I would like to announce that we will be hosting a virtual investor update on Wednesday, December 9, from 8 to 10 a.m. Eastern Time. Marvin will discuss several growth opportunities that are expected to facilitate further market share gains. Dave will discuss our opportunities to drive operating efficiencies and sustainable shareholder value, and he will also provide an update on our financial targets. After our prepared remarks, we will host a Q&A session. We look forward to speaking with you again soon. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Good morning, everyone. I'd like to start out by taking a moment to extend my thoughts and prayers to all the individuals and communities impacted by the many wildfires, hurricanes and other natural disasters as well as the COVID-19 pandemic. There is no doubt that this has been a very challenging year for many of us.
Although our Lowe's associates are dealing with the same challenges facing the rest of the country, I continue to be inspired by their commitment to serve our customers and communities while juggling a multitude of pressures and obstacles at home. Throughout all the uncertainty we face, we continue to be guided by 3 key priorities. First, our highest priority as a company will always be protecting the health and safety of our associates and customers through a safe store environment and shopping experience. And we believe that our strict in-store safety and social distancing protocols implemented in a consistent, uniform manner has built trust with our customers. Our second priority remains providing support for our community, including health care providers and first responders. And our third priority is financially supporting our associates during this challenging time. In support of these priorities, we've invested an incremental $245 million in the third quarter to support our associates. We've now invested more than $1.1 billion in COVID-related support for our associates, store safety initiatives and communities through the first 9 months of this year. Now turning to our results. For the quarter, we delivered total company comparable sales growth of 30.1% over the prior year and 40% growth in adjusted diluted earnings per share to $1.98. At the same time, we're also making critical investments across our operations to position the company for long-term growth. Our U.S. home improvement comps was 30.4% driven by consistent and strong project demand from both DIY and Pro customers throughout the quarter. In a continuation of trends from Q2, growth was broad-based across channels, product categories and geographies. In fact, growth exceeded 15% across all merchandising departments, 20% across all geographic regions and triple digits on Lowes.com.
DIY comps again outpaced Pro comps in the quarter driven by a consumer mindset that remain focused on the redesigning the functionality of their home. Consistent with the redefinition, in the third quarter, customers continued to shop at Lowe's as they took steps to shift their home to serve 3 primary purposes:
a home school, a home office and their primary location for recreation and entertainment. We're pleased that customers continue to choose Lowe's as a retail of choice for these very important projects.
Our Pro business remained strong in the third quarter with comps exceeding 20%. Our investments to improve our product and service offerings and overall customer experience is resonating with the Pro customers. We're seeing a significant number of new Pro customers rediscover Lowe's, and we're seeing them come back to buy from us over and over again. We're well positioned to continue to attract new Pro customers while also growing share of wallet with existing Pro customers. We launched a significant merchandising investment in the third quarter to reset the footprint of our U.S. stores, shifting to a project-focused versus a product-focused store layout. We believe these changes will create a more intuitive shopping experience for our customers, especially to Pro. And we redesigned the layout of our stores to improve product adjacencies and bay productivity with the goal of increasing sales per square foot. Bill will provide more detail on this very important reset initiative in a moment. From a geographic perspective, we had broad-based growth with positive comparable sales growth exceeding 20% across all 15 geographic regions and all 3 U.S. divisions. Regions that outperformed the total company comps were Atlanta, Houston, Los Angeles and New York. We also continued to see strong sales trends in urban areas. In fact, comp sales in our urban markets outperformed remote or rural markets by over 500 basis points. Our strength in our urban markets reflects the improvements we've made to our product and service offerings for the Pro customer as well as enhanced omnichannel capabilities to serve customers increasingly shopping online. On Lowes.com, sales grew 106% as we continue to see an increase in both DIY and Pro customer demand for contactless shopping options. We have made tremendous progress over the last 2 years with the right investments to improve our omnichannel retailing capabilities, enabling us to meet the ever-increasing expectations of customers to shop whatever way they choose. And we continue to invest in our supply chain network as we opened new cross-dock delivery terminals, bulk distribution centers and e-commerce fulfillment centers to expand our fulfillment capabilities. And while we've seen exponential online growth this year, we still have tremendous growth runway in front of us as Lowes.com business is meaningfully underpenetrated, with online representing only 7% of our sales. Supported by our modern cloud-based platform, our talented dot-com and technology team has a detailed road map towards becoming a best-in-class omnichannel retailer. Turning to Canada. We posted positive comps that exceeded 25%, supported by strong Pro and DIY demand as well as early success implementing our retail fundamentals playbook to improve operating efficiency while driving sales. This was a very important quarter for us as we drove strong top line results while continuing to make significant investments across merchandising, Lowes.com, store operations and supply chain that will enable us to capitalize on current trends and will position us as a company to drive sustainable growth. 2020 has demonstrated to all of us how quickly shopping behaviors can change. And I'm proud of the agility that we've shown to adjust our business model to serve an unprecedented number of customers in store and on Lowes.com. We also understand that agility will be important as we hopefully pivot to a post-COVID retail environment later in 2021. However, we understand that creating an efficient and world-class omnichannel experience will determine retail winners and retail losers in the future. Therefore, we're pleased with the current development of our omnichannel strategy thus far and remain committed to making the necessary investments to provide our customers with choices to shop any way they choose. And over the near term, our investment thesis will remain laser-focused on enhancing the growth and profitability of our core retail business. Before I close, I'd like to again express my sincere appreciation for the tremendous efforts of our associates to support our customers and communities when they need us most. The country continues to face significant challenges presented by COVID-19, and this is still a very unpredictable business environment. However, our #1 priority as an essential business will always be supporting the health and safety of our associates and our customers. I look forward to speaking with you again at our investor update on December 9 with a discussion focused on the market share growth opportunities that lie ahead of us. With that, I'll now turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 30.4% in the third quarter. Our continued strong execution, combined with elevated brand and product offerings, enabled us to effectively serve the sustained increase in customer demand driven by the increased importance that customers are placing on their homes.
Similar to the second quarter, growth was broad-based across both DIY and Pro customers, in-store and online, and across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeded 15%. Lumber led the way, again driven by strong unit demand across Pro and DIY customers, supported by our continued investments in job lot quantities, and the strength of our merchants and our supply chain teams in sourcing these high-demand products. In addition to lumber, we delivered above-average comps in decor, lawn and garden, and seasonal and outdoor living. Within decor, our growth was driven largely by the strength in furniture, including accent furniture and accessories, along with the strong results in home organization, as customers continue to update and create new spaces for home offices and remote schooling. In lawn and garden, there was broad-based strength across the business, though most notably within live goods and landscape products, as customers actively engaged in outdoor landscaping and other fall exterior projects. Our seasonal and outdoor living team also delivered comps above the company average this quarter driven by customers looking to extend their outdoor entertaining space, with fire pits and patio heaters being the accelerated product category for this fall. We continue to strengthen our position as the #1 destination for outdoor power equipment with the recent addition of EGO, which is the top-selling brand in battery-powered outdoor power equipment, to our all-star lineup, which includes John Deere, CRAFTSMAN, Husqvarna, Honda and the Ariens brands. And we continue to leverage our other powerhouse brands like Weber and Char-Broil, which continues to be the top 2 brands in outdoor grilling. Now turning to our online results. As Marvin mentioned, we delivered sales growth of 106% on Lowes.com. With the replatforming of Lowes.com to the cloud, we have been rapidly deploying enhancements to deliver a better customer experience, including enhanced online delivery scheduling, so that customers can more efficiently self-serve and select the delivery time that is most convenient for them or easily reschedule as the need arises. We also made it easier to shop by product collection with over 500 collections and growing. So customers can now purchase a patio set without it involving a time-consuming search for each individual item. I'm also excited that we now have the capability to ship products that require special handling, items like lithium-ion batteries. This capability now enables us to handle online orders of EGO, Kobalt and Skill battery-powered products, along with other products powered by lithium batteries or items that may require care in shipping and handling. And as Marvin covered in his opening remarks, we are resetting the footprint of the store, so that's more intuitive shopping experience for our customers, especially for the Pro. For example, the reflow of our rough plumbing and electrical aisles are 2 key areas for the Pro that needed to reflect how the Pro shops. We are now placing all of the relevant products adjacent to each other, such as pipe cement next to pipe and the necessary fittings next to their respective pipe category. We are also eliminating merchandising bays without planograms. We call these junk bays, thus opening up space for higher-velocity, higher-demand items and categories that will better reflect the local market. We are on track to have the reset complete for over 90% of our stores by fiscal year-end. And as part of this store reset, there'll be 2 other noticeable changes. First, we are adding a Pro-Flex area, similar to what we did earlier this year in our seasonal areas, making it easier for the Pro to grab and go. And then second, we are moving the cleaning category to the main or the first aisle of our stores. This is just another example of ways we are working to improve the productivity in this highly visible area of the store. And as we look to close out the year, we are building on our momentum around the holiday season that began with our first-ever drive-through, curbside trick-or-treating event at our stores, where we gave away candy and pumpkins to hundreds of thousands of families who are excited about the holidays but may not have had the same door-to-door trick or treating available in their neighborhoods as in years past. And we feel that this will be a holiday season like no other, when our customers will no doubt be spending much more time at home. And because of that, we're helping our customers invest in the time and memories that they're creating at home. And we're planning to deliver a season of savings for the holidays over an extended period to avoid creating congestion in our stores. Consistent with our approach throughout 2020, we continue to expect reduced promotional activity compared to the prior year. Overall, we've delivered outstanding results this year, and I can't say enough about the unbelievable efforts of our vendor partners and our merchants who have worked extremely hard to keep up with the unprecedented demand. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. This year, we faced operational challenges unlike anything I've encountered in my career, whether it's in response to a hurricane, flood, tornado or global health crisis, Lowe's associates take pride in the role they play to keep families safe in their homes and businesses running in challenging times. Our associates have also remained steadfast in their commitment to providing a safe shopping experience in our stores so our customers feel comfortable returning for another shopping trip to Lowe's.
In recognition of the outstanding efforts of our team, we have provided financial support to our hourly associates with 2 additional $100 million bonuses this quarter. Full-time associates received $300 and part-time associates received $150 in each payment, while Lowe's covered the cost of the tax gross-up again. This brings our total COVID-related financial assistance to our associates to over $800 million this year. And I'm thrilled to announce that for the third quarter in a row, 100% of our stores have earned their "Winning Together" profit-sharing bonus totaling $104 million. Once again, their efforts exceeded expectations, so this represents an incremental $31 million over the target payment level. I was also really pleased to see the strong frontline associate morale, reflected in their impressive level of engagement in our recent annual associate survey. Our associates indicated that they feel supported by the company during this challenging year and that they are energized by their work. And we're supporting our communities through hiring as we're bringing on 20,000 associates across our U.S. stores and distribution centers this holiday season to support elevated levels of customer demand. This year, we've hired over 155,000 associates through our seasonal hiring programs, and many of these seasonal hires have transitioned to a more permanent role within the company. The pandemic has changed the way we all live, work and shop. This is evident in our increased customer demand for contactless shopping options this year. This quarter, we began adding touchless BOPIS lockers to our stores to complement our curbside pickup and BOPIS pickup at checkout. We're focused on rolling out these lockers to our major metro markets by Thanksgiving. And we are standing up dedicated fulfillment teams at our stores who are already improving speed of service and customer satisfaction with their consistent focus on this important function. We're also raising our game with the Pro as we expand our brand and product offerings to meet their unique needs. We are adding to our Eaton electrical product assortment, which is a go-to solution for the Pro working on a home remodeling project. And we are now the largest distribution partner for SharkBite, which provides push-to-connect plumbing products that make projects fast and easy, a must-have for any plumbing project. Combined with the power of Simpson Strong-Tie, DEWALT, Spyder and Bosch brands, this broader offering in Eaton and SharkBite builds out our arsenal to ensure that we have a competitive offering that meets the needs of our Pros across the variety of projects that they handle. And we kicked off a multiyear national rollout of our tool rental program to increase our relevance with the Pro, as over 70% of Pros rent tools at least once a year. In August, we celebrated the grand opening of our first tool rental location in Charlotte, where we provide high-quality tools for both Pros, DIYs and weekend warriors through a convenient online platform that allows customers to reserve their tools ahead of time. We are encouraged by the early results and the strong feedback from our most frequent Pro customers in the Charlotte area. Looking at our third quarter results. I'm really pleased with the comps exceeding 20% that the Pro team delivered. We are consistently meeting the needs of our Pro customers with job lot quantities that are available every week, efficient service focused on getting them back on the job site quickly and the products they're looking for. We're winning new Pro customers, and they're coming back to our stores again and again. And we continue to drive efficiency by streamlining our store operations as we leverage technology to improve customer service and alleviate the task and responsibilities for our Red Vest associates. This quarter, we leveraged the new intuitive touchscreen POS at our registers to easily cross-train other associates on the cashier position. These new touchscreen registers not only speed up cashier training from the old green screens, they also provide our customers with a faster checkout experience. This is consistent with our store simplification approach, which leverages new technology to make our associates more productive while also improving customer service at the same time. With all these store technology processes and improvements under our belt, we are well on our way to hit our target of 60% service and 40% tasking by the end of the year. And it's paying off with high customer satisfaction scores as we acquire new customers who keep coming back to shop at Lowe's. Thank you, and I will now turn the call over to Dave.
David Denton:
Thank you, Joe, and good morning, everyone. I'll begin this morning outlining the company's strong capital allocation program. In the first 9 months of 2020, we generated $10.3 billion in free cash flow driven by very strong operating performance. In the third quarter alone, we paid $416 million in dividends. We also announced a dividend of $0.60 per share, a 9% increase that will be paid in the fourth quarter of this year.
During the quarter, we reinstated our share repurchase program and repurchased 3.6 million shares in the open market for $621 million. I continue to expect our share repurchase program to be a significant contributor to long-term shareholder value creation. We incurred capital expenditures of $462 million as we invest in the business to support our strategic initiatives, including our omnichannel capabilities. In October, we took advantage of a favorable interest rate environment to reduce our interest expense through a cash tender offer for $3 billion of our higher coupon bonds. As a result, we recognized a loss of $1.1 billion on the extinguishment of debt. To fund the tender offer, we issued $4 billion of unsecured notes. This issuance consisted of 7-, 10- and 30-year notes with a weighted average interest rate of 2.17%, which is a record low in the company's history. These efforts further strengthen our capital position by lowering our interest expense over the longer term. We now have $8.2 billion of cash and cash equivalents on the balance sheet. And combined with $3 billion in undrawn capacity on our revolving credit facilities, we have immediate access to $11.2 billion in funds, which we are confident is more than enough liquidity to navigate any uncertainty. At the end of Q3, our adjusted debt-to-EBITDA ratio stands at 2.3x. Now turning to the income statement. In Q3, we generated GAAP diluted earnings per share of $0.91 compared to $1.36 last year, a decrease of 33%. And as I just mentioned, the company incurred a $1.1 billion loss on debt extinguishment this quarter. Now my comments from this point forward will include certain non-GAAP comparisons, where applicable. In Q3, we delivered adjusted diluted earnings per share of $1.98 per share, an increase of 40% compared to the prior year. These results were driven by higher-than-expected sales volume as well as our strong execution to meet elevated customer demands. Q3 sales were $22.3 billion, an increase of 30.1% on a comparable basis versus the prior year. This is driven by transaction growth of 16.4% and comparable sales average ticket growth of 13.7%. We continue to see strong repeat rates from both new and existing customers. Commodity inflation drove a benefit of approximately 340 basis points to comps in the quarter. U.S. comp sales were up 30.4% in the quarter, with continued strength from both DIY and Pro customers and broad-based demand across geographies, merchandising departments and selling channels. Our U.S. monthly comps were consistently strong throughout the quarter with 28.9% in August, 31.8% in September and 30% in October despite a significant reduction in promotional activity versus LY. Gross margin was 32.7% of sales in the quarter, an increase of 28 basis points compared to the third quarter of '19. Product gross margin rate improved 65 basis points driven by continued improvements from our pricing, cost management and promotional strategies. Favorable product mix drove approximately 35 basis points of benefit. These benefits were offset by 30 basis points of headwind from lower credit revenue, 25 basis points of pressure from inventory shrink and 20 basis points of pressure from supply chain cost. And consistent with our long-term strategy, we are investing in our supply chain as we expand our network to stand up market-level delivery model for big and bulky products. We further expanded capacity for parcel shipments with the opening of a new direct fulfillment center on the West Coast. SG&A was 21.4% of sales in Q3, a 31 basis point improvement compared to LY. As we anticipated, we incurred $290 million of COVID-related expenses. These investments included $230 million in financial assistance for our frontline associates and approximately $55 million related to both cleaning and other safety-related programs, and approximately $5 million in charitable contributions. These $290 million of COVID-related expenses negatively impacted SG&A leverage by 130 basis points. We also incurred approximately $100 million in a large-scale strategic merchandising reset of our U.S. stores, which negatively impacted SG&A leverage by 45 basis points. These incremental costs were partially offset by payroll leverage of 90 basis points related to higher sales volume and improved store operating efficiencies, occupancy leverage of 35 basis points, 35 basis points of leverage in employee benefits and advertising leverage of 25 basis points. Adjusted operating income margin increased 55 basis points to 9.81% of sales. The adjusted effective tax rate of 23.9% was in line with the prior year. Now Q3 benefited from a $0.02 timing shift into Q3 at the expense of Q4. At $15.7 billion, inventory was higher compared to the prior year levels as we stocked up on product to meet elevated customer demand throughout the quarter. Also, lumber inflation increased inventory values by approximately $250 million. I'd now like to spend just a few minutes discussing our outlook for the fourth quarter. While the operating environment remains uncertain and we still have limited visibility into the longer-term trends, I'd like to share my perspectives about how we are planning the business in Q4. We expect that our top line growth will moderate from Q3 levels as outperformance in seasonal categories abates in the fourth quarter. This is consistent with natural demand patterns of the home improvement sector. For the quarter, we expect total and comparable sales growth of between 15% and 20%. Consistent with the prior 2 quarters, we anticipate that we will incur ongoing COVID-related operating expenses of approximately $75 million to support safety and cleanliness in our stores. In Q4, we will continue to evaluate the operating environment and assess any potential incremental associate financial assistance. We expect to incur approximately $150 million in expenses associated with the merchandising investment in our stores as we expect to complete the reset activity for over 90% of our U.S. stores by the end of the fourth quarter. Additionally, we will continue to invest in expanding our supply chain network. These significant investments, coupled with our fourth quarter typically being our smallest revenue quarter, should result in adjusted operating margin performance essentially flat to prior year levels. The effective tax rate is expected to be over 27%. Continuing our commitment to return capital to shareholders through value-enhancing share repurchases, our guidance assumes approximately $3 billion in share repurchases in the fourth quarter. We expect GAAP and adjusted diluted earnings per share of $1.10 to $1.20 a share. For adjusted EPS, this represents 22% growth at the midpoint over the prior year. We are now planning for approximately $1.7 billion in capital expenditures for the year with a continued focus on our omnichannel investments. In closing, I'm extremely pleased with our outstanding results for the first 9 months of the year. In an unprecedented operating environment, we remain focused on serving our customers and our communities, which led to an opportunity to grow market share earlier than we expected. I remain confident that we are making the right investments to drive sustainable growth. We have a strong balance sheet and we are committed to a disciplined capital allocation program, which will lead to a longer-term shareholder value creation. I look forward to speaking with you again soon at our investor update meeting on December 9. So with that, I thank you. We are now ready for questions.
Operator:
[Operator Instructions] And your first question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
I have a question, Marvin, if you step back and look at the transformation so far since you've gotten there and your ability to get to 12% margins and beyond. I know the stock is down a little bit this morning, and I think it's reflecting maybe a mismatch in timing of some investments and flow-through. But it doesn't look like much has changed with your goals and the path you're on, but I wanted to ask you if there's anything that you can be critical of that's something that's not playing out. Or is your reaction that things should only be stronger for Lowe's than what you envisioned when you got to Lowe's?
Marvin Ellison:
Simeon, this is a very good question. We actually feel great about the transformation. I mean, obviously, we don't have perfect visibility to the future and we had no idea, as no one did, that we'd be dealing with a global pandemic in the year 2020. But when I think about how far we've progressed in 2 years, when you look at the digital platform and our online business, the last 2 quarters growing 135%; last quarter, 106%. In the third quarter, we were at levels that we could not have even imagined just 12 to 16 months ago, merchandising initiatives, supply chain.
I think the key for us is that we're not really concerned about the short term. We know this is a great brand, we have a strong balance sheet and we're trying to make the right investments in the future. When I look around at the accomplishments of the team, I'm exceptionally proud because we're a little bit ahead of schedule, as Dave mentioned. And we think that we're going to start to lean into taking market share. And at the December 9 investor update, we're going to be a lot more specific about kind of where we are in this transformation and how we see the out-years and where we believe that we can really start to pick up additional market share. But overall, I couldn't be more pleased with the progress of this team.
Simeon Gutman:
Okay. And a quick follow-up is, I think year-to-date, we've incurred about $1.1 billion of COVID associate benefits and additional costs. How do we think about that into the fourth quarter and into 2021?
Marvin Ellison:
Well, I'll take the first part and see if Dave has any additional context. Dave mentioned that we're committed to fundamental expenses relative to cleaning and providing a safe environment for our associates and customers in our physical stores. And so that is something that we are committed to continuing to execute.
We're going to just monitor all other aspects of the needs of our associates and determine what, if any, additional investments need to be made in the fourth quarter. We've actually followed that philosophy for the last couple of quarters, and the fourth quarter won't be any different. I don't know if Dave has anything to add.
David Denton:
Yes. Simeon, this is Dave. The only thing I would add to that is that, obviously, in November, the associates will receive incremental compensation. And then in December, our "Winning Together" program kicks into play. And just given how the stores are performing, the vast majority if not almost all the stores are at max payout from that. So we're leaning into areas to compensate our associates tied to their needs but also tied to performance.
Operator:
The next question comes from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
I wondered if I could ask about Pro versus DIY, just if you saw a narrowing of the gap in performance between the 2 this quarter versus last quarter. And how should we be thinking about the Pro penetration in sales next year once you reset the store and leverage some of the initiatives that you've put in place the last year or 2?
Marvin Ellison:
Kate, it's really difficult for us to give you a very specific forecast on that. Obviously, this is the most difficult environment for any kind of a financial forecast. But I think at a high level, we anticipate that you're going to see that gap continue to close and the Pros will start to gain more of a penetration as we start to have less of the nesting effect when we get to this post-COVID environment.
One of the reasons we're making all of these investments in the Pro, and as Joe and I both mentioned, I mean we grew the business over 20% in the third quarter, is because we're anticipating this post-COVID retail environment and we know this customer is very important for us. So we expect that gap to continue to close as we get into 2021. The question is when and that's going to be, in large part, based on COVID and how the nesting effect of the DIY starts to minimize over time.
David Denton:
And Kate, this is Dave. I'd just add that if we step back and think about the financial algorithm of this company over the next several years, as we've said many times, we real strength in the DIY customer. You're seeing that in our numbers today. The opportunity over time is to really penetrate and grow our Pro business. And I think the investments we're making both in Q3 and Q4, and really as we cycle into next year, is really bolstering our business model around the Pro.
And so it's not going to be like a light switch that we're going to just turn on and the Pro is going to just elevate significantly, but this is each week and each month and each quarter kind of continue to push and grind ourselves out to grow that Pro business. And that's the objective we have here.
Katharine McShane:
Okay. And if I could just ask a quick unrelated follow-up, just with the news in the MRO space this week. I just wondered if you could remind us how you're thinking about your competitive positioning within the MRO segment. And does that change this week change anything when you think about supply chain investment for Lowe's?
Marvin Ellison:
Kate, it does not. I made the comment earlier in my prepared comments that we're committed to the core retail business. When we look at our investment thesis and we evaluate where we can gain the greatest return, it is in our core business.
Now we're going to continue to target the MRO segment in our current Pro strategy with our outside sales reps, but those reps are connected to the store and connected to our MSH model. And we feel like that, that model has the ability to scale. But our investment thesis, our focus, is improving our core business. And our core business is defined as our brick-and-mortar stores, our dot-com platform, our supply chain and all the other operational components that tie that together. And that's our omnichannel philosophy. We feel like we're in a good position, and we're going to continue to make those investments. And over time, that thesis may change. But in the short term and near term, we're just laser-focused on our core business.
Operator:
The next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Another expense-related question. I guess looking for some clarity, just in terms of kind of the way to think about the cadence. So pre-pandemic, the Lowe's story was very heavily centered on productivity improvements, SG&A leverage. Obviously, as COVID hit, you've incurred a lot of incremental expenses, COVID assistance for your associates, obviously, extra labor because of sales growth. How should we think about SG&A growth on, let's call it, a per-store basis? Or how are you going to frame it for '21, just in terms of the way we should think about those overall levels?
David Denton:
Yes. It's probably a little early to talk specifically about '21. But just in general, I think what you're seeing is we have a very focused effort around store productivity and managing both labor and costs within our stores. Couple that with the investments that we're making in supply chain, which is ultimately creating a market-based delivery model, that will ultimately put pressure a little bit on gross margin as we take delivery out of the stores, move it into the market, but relieve the stores of that burden from an SG&A perspective. So you'll see incremental flow-through as that model gets built out.
That's probably a 12-, 18-, 24-month process before that happens. But I think we're well on our way to continue to make investments, both from a technology perspective and an operational improvement perspective to drive productivity. So you should see us continue to get better, absent the effect of COVID. The one thing that is going to go forward is probably in the neighborhood of $70 million or so per quarter on incremental costs associated with safety and cleanliness. And I think that is here to stay for some period of time.
Marvin Ellison:
Scot, I'm going to let Joe McFarland talk a little bit about our productivity initiatives. I mean we're extremely proud of the fact that 18-plus months ago when we did an evaluation of our payroll spend in the stores, roughly 60% of all of our spend was going toward task and noncustomer-facing activity. And Joe has absolutely flipped that equation with the stores. I'm going to let him talk about that for a second.
Joseph McFarland:
Yes. Thanks, Marvin. Scot, we're -- we've been very pleased with the progress we're making on our 60-40 transition. As I mentioned in my prepared remarks, we're well ahead of that schedule. We'll hit the 60% service, 40% task by the end of this year. But that also allows us to continue to make investments in things like our fulfillment teams, the supervisors that we've added to the Pro area of the business and the incremental expense that we incurred there. So we're very pleased with the productivity, and we'll continue on that productivity march.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
So as you've gone through this transformation, you mentioned you're ahead of schedule in realizing some of the productivity or cost savings that you expected like the split between task and service, and yet now we're seeing maybe a bit of an acceleration in some of the investments of the business.
So are you entering a new phase of this transformation, where some of the low-hanging fruit has already been harvested in terms of the cost, and at the same time, investments are increasing, which could occur at a time where this wallet share shift that is benefiting the home improvement category, all of these come together such that we do see a bit of a retrenchment or some margin degradation in your P&L over the next few quarters?
Marvin Ellison:
Michael, this is Marvin. So as Dave mentioned, we're going to have a little bit more specificity on the December 9 investor update. But here's what I will tell you, we don't believe we're going to get entrenched, and we believe that there's still a large amount of opportunity in front of us to drive productivity.
We have a multiyear time line where we've mapped out initiatives from a merchandising perspective, operational perspective, supply chain, et cetera. We see productivity gains over the next couple of years, if we can. Obviously, those initiatives vary in size and scale, but we believe we still have enormous opportunity. And to put it in perspective of your comments, we've made the decision to accelerate this U.S. stores reset initiative because early tests gave us confidence that this would tremendously benefit our Pro customers, and it would create a much more intuitive shopping experience for our DIY customers. And so we took on $100 million of expense in the third quarter, and we're taking on roughly $150 million of expense, and that's going to get roughly 90% of our stores completed. That is an example of us not running this business quarter-to-quarter. We want to make sure that we're making the right investments that will have long-term benefits and create long-term productivity gains. And we believe that we're doing that, and that's going to be our focus. And when we update you all in December, we'll provide some perspective on how we see revenue and operational performance as well as profitability in 2021. But we feel really good about our progress, and we feel good about being in a position now to transition to a market share focus ahead of schedule.
David Denton:
And Michael, I'll just add that -- Marvin said something very important there, he said we decided to accelerate the program. This was not an incremental program that we didn't have on our road map. This was on our road map consistently over the last couple of years since we've been here. This is -- now we're taking the opportunity to lean into it. So I think that the original thesis of all the investments that we put forth, I think are very valid. We see a lot of runway to continue to fund those investments and drive performance going forward.
Michael Lasser:
So David, if I could just clarify that and add one unrelated question. Does that mean that some of those pull-forward of investments will come from next year, such that you will get a return on those dollars and you can be in better position to lever your SG&A even in a tougher macro environment?
And then my follow-up question is the big change in the cadence of the P&L this quarter was the discussion around lower credit revenue and shrink. How long are those going to be issues that weigh on the gross margin? And what has caused those to pop up suddenly?
David Denton:
Michael, just as you think about the investments we are making, yes, we're making these investments to improve our productivity in the years to come. So I won't speak specifically to '21. But yes, the things that we're doing today will benefit us going forward. And then secondly, I'll talk a bit about credit revenue and I'll speak -- have Joe McFarland talk about the actions we've taken from a shrink perspective.
On the credit revenue side of the house, yes, we're having a little bit of pressure there. And there's really 2 things that are happening. One is we are seeing a tender shift as the U.S. consumer has kind of pulled back on debt and your saving rate has increased. So we've seen a tender shift away from our private-level -- private-label credit a little bit into PIN debit. So that puts pressure on that line. And then secondly, we are forecasting some higher credit risk going forward just given the macro economy in the future. So a little bit of both of those things are driving that pressure. And then from a strength perspective, I'll let Marvin and Joe comment on that.
Marvin Ellison:
So Michael, I'll hand it to Joe to talk about 2 things, give a little bit of an explanation on shrink, our trends and some of the initiatives to reduce it; but also to give another example of a pull-forward initiative that we are in the midst of executing. So Joe, you can go ahead and cover those 2 things.
Joseph McFarland:
All right. Thanks, Marvin. So as far as the investments, I'll give you a quick example, discussed rolling out of the buy online pickup in store dedicated lockers. And so this was originally on the road map. This was approximately $30 million pull in expense to this year that we had from last year. This will allow us to continue to leverage our payroll expense and continue to drive our omni business. In addition, we have the new dedicated fulfillment team. So we feel very good about the investments we continue to make in the business.
In regards to shrink, we have been experiencing shrink pressures over the last several quarters. We have a good sense of where that lies. We understand the challenges. We have been making significant investments from a loss prevention standpoint, from a safety standpoint. And so we feel good about the trajectory. There were some challenges with being an essential retailer, being some of the only retailers open during the onset of the pandemic. I believe we're cycling some of that today. But again, as we continue to invest in market-level intelligence, in loss prevention and safety programs, we're confident in the payback.
Operator:
Our next question come from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
I'm surprised we've gotten this far into the call without the quarter to -- obligatory quarter-to-date question. I'll phrase it a little bit differently. You talked about seasonal mix being a driver of why you're expecting 15% to 20% comps in the fourth quarter. You did post the 30% in October. Are you just simply mix adjusting for seasonal mix and that drives you into the 15% or 20% -- 15% and 20%? Or are you assuming moderation in other categories?
Marvin Ellison:
So look, I'll take this, Chris, and I'll let either Bill or Dave jump in if they have additional comments. To say this is the most difficult environment to forecast in would be an understatement. What I can tell you is we feel great about our early trends in November. We feel very good about our ability to meet demand if it exceeds our 15% to 20% guidance. We'll have a much better perspective on Q4 when we speak to you and the other investors on December 9. But this is just our way of trying to frame up our best guess of where we think the business is headed in obviously the most difficult and complex forecasting environment that any of us have worked in.
And again, I'll leave it at that. And if we have more context and more detail on December 9, we'll be more than happy to share. But the key is we feel really good about the trajectory of our business, but this is our best estimate based on what we know today.
Christopher Horvers:
Understood. And then a question on, I guess, the medium- to long-term gross margin outlook. Previously, you had talked about mid- to high-32% range in the existed sort of -- existing sort of algorithm and so forth. Does '21 revert back down to this prior target? And if so, what are the drivers? Because year-to-date, you're performing very nicely in that regard. And so is it supply chain investments that causes some near-term pressures? Is it mix? Some promotional normalization?
And then longer term, how do you think about the opportunity to get into that 33% to 34% range given your largest peer does have a higher gross margin? Understood there's probably some efficiencies given scale, but at the same time, just trying to think about structurally the differences given all the work that you're doing in the box and around the supply chain.
David Denton:
No. We feel very strongly that the opportunity is ahead of us from a gross margin perspective. We're not going to give this back specifically. I will say there is some, I'll say, geographies on the P&L. We continue to push very hard in improving what I would consider our product-level gross margin performance. And part of this is just being very efficient from a promotional standpoint, being very efficient from a cost management perspective.
At the same time, we are investing in supply chain, and that's going to put pressure on gross margin, but it's going to relieve operating expense within our stores. The flow-through of that is very accretive to op inc. So I think you'll see some geography shifts there, but there's nothing that's going to revert back. It's not our anticipation that we would revert back to where we were prior to this year.
Operator:
Our next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
Nice quarter. I think investors are trying to understand the magnitude and sort of the net impact from the investments you're talking about and the pull-forward. So the question is, and I know it's been asked a couple of different ways today, but if comps are positive and you can sort of manage through next year from a top line perspective, can you continue to expand margin rate in FY '21?
Marvin Ellison:
Well, Seth, we're not commenting in detail on 2021 at that -- at this time. As we've mentioned a couple -- on a couple of different occasions, we're going to be updating you all on December 9, and we're going to have a little bit of perspective. And we're going to spend the majority of that presentation talking about the initiatives and actions we're going to be implementing to improve and take market share. And at that time, we'll have better perspective on '21, and we'll be able to provide a lot more context on what we're doing today.
David Denton:
And Seth, I'll just add, let's not get hung up on where we end '20 and where we end '21. The reality here is we set a target of 12% operating income flow-through. I think we're very focused on delivering upon that objective. I think we have very good line of sight to getting to that level and using that as just a stopping point to actually potentially go further after that. So I think our -- the investments that we're making, the focus that we have today is really on improving that flow-through over time. And we still see a very strong line of sight to that.
Marvin Ellison:
And Seth, this is Marvin again. The only other comment I'll make is, we were actually questioned earlier about the MRO space and if we are going to make any strategic changes based on actions in the marketplace. And one of the reasons why we're not is because we see so much upside in our core business. And we see an incredible opportunity to drive efficiency and productivity by continuing to make the right investments in merchandising systems, supply chain, operations.
And so to Dave's point, we see the 12% not as a pinnacle but as a milestone that we will hit, and then we will continue to drive improved productivity beyond that point. And again, we'll be able to provide more context at our investor update in December.
David Denton:
And we're going to take one more question, please.
Operator:
The next question is from the line of Elizabeth Suzuki from Bank of America.
Elizabeth Lane:
Great. I was a little surprised to hear that the product mix was favorable to gross margin, just given that lumber sales growth was so strong and it's usually a lower-margin category. Can you talk about the categories that helped out from a product mix standpoint in the quarter?
David Denton:
Yes. Liz, this is Dave. Actually, lumber did put some pressure on gross margin in the quarter as it typically does in an inflationary environment. Having said that, I'd say the merchandising and the finance team have done a really nice job from managing costs kind of across all the categories. And I'd say I can't call out just one category where we're seeing improvements because we're seeing improvements more or less up and down the P&L across all merchandising categories for the most part.
Operator:
Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2020 Earnings Conference Call. My name is Michelle, and I will be your operator for today's call. As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations. Thank you. You may begin.
Kate Pearlman:
Thank you, and good morning, everyone. Here with me today are
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our Investor Relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Good morning, everyone. I'd like to start out by thanking our associates for their tremendous actions to support our customers and communities across both the U.S. and Canada. We are grateful for their hard work and ongoing commitment to safety. Without question, this has been the most challenging personal and business environment that any of us have operated in. Throughout all the uncertainty that we faced in the second quarter, we never lost focus that our #1 priority as a company is protecting the health and well-being of our associates and customers through a safe store environment and shopping experience.
In the second quarter, we continued to prioritize the financial support of our associates and community while providing the customers with the products and services they need to manage and care for their homes. We were pleased and humbled that we were the first choice for many customers who needed home improvement items for their businesses and homes during this unprecedented time. And I would like to thank those customers who trusted us and for rediscovering Lowe's. More specifically, during the second quarter, we invested an incremental $460 million in support for our frontline associates, communities and store safety. Through the first half of 2020, the company has invested $560 million in incremental financial support for our associates. In recognizing that helping people make their homes better extends into our neighborhoods, communities and country, we've committed $55 million in grants to support minority-owned and rural small businesses. In total, during the COVID-19 pandemic, we've committed $100 million of assistance to those in our community who need it most. Our financial results this quarter demonstrate that we've experienced unprecedented demand in many of our business categories due to customers spending more time at home during the COVID-19 pandemic. However, these results could not have been realized without our efforts over the past 18 months to implement our retail fundamental strategy, which dramatically improved and modernized our business infrastructure. These modernization efforts have created technology and operational platforms to meet customer demand and grow our business during these challenging times. And some of these initiatives include hiring home improvement and retail subject matter experts in key leadership roles, which has allowed us to quickly make informed decisions and implement necessary changes during the COVID-19 crisis; replatforming Lowes.com from a decade-old infrastructure to the cloud and developing a top-rated mobile app that's allowed us to grow online sales triple digits; a customer-centric labor scheduling system that gave stores the flexibility to align payroll with the unique needs of the customer and the associate; deploying a new price management system to provide our merchants with better data to maintain cost discipline and take more strategic approach to pricing and promotions; enhanced Pro product and service offerings, combined with the new Pro loyalty platform, that helps us keep pros working and offers them meaningful rewards while providing us with better customer insights; and our field merchants and merchandise service teams who play an essential role in helping our stores quickly reconfigure to support social distancing and also respond to the significant increase in demand. While we still have work to do, we're pleased with the progress we've made thus far to modernize our company. And we're looking forward to building on this momentum in the back half of 2020 and for years to come. Now let me turn to our second quarter results. We delivered strong sales growth beyond our expectations with total company comp sales growing 34.2% over the prior year. Diluted earnings per share grew 75% to $3.74. Our U.S. home improvement comps was 35.1% due to robust project demand from DIY and Pro customers that was broad-based across channels, product categories and geographies. Overall, we saw a sharp acceleration from Q1 demand trends, including significant increases in the number of new Pro and DIY and millennial customers. DIY comps outpaced Pro comps in the quarter, driven by a consumer mindset that was heavily focused on the home and wallet share shifts away from other activities, like dining out, vacations and purchasing apparel. Pro sales were also strong with comps in the mid-20s with demand accelerating in May and remaining strong throughout the quarter. Our Pro performance was supported by the progress we've made with retail fundamentals, like job lot quantities and improved service levels. From a geographic perspective, growth was balanced across the U.S. store footprint with positive comps of 30% or more in all 15 geographic regions in all 3 U.S. divisions. Importantly, we saw strong sales trends in urban areas. In fact, comp sales in our urban markets outperformed remote or rural markets by over 500 basis points. This is an important data point because it reflects the success of our business model in all geographic settings as well as the importance of having a strong Pro business as well as an effective omnichannel strategy to compete in urban settings. Our Lowes.com comp sales grew 135% as Pro and DIY customers increasingly shopped online, driving online penetration to 8% of sales. And as I mentioned earlier, we completed the replatform of Lowes.com to the cloud during the quarter. This enabled us to improve site functionality and sustain triple-digit growth without any systems interruptions. I'm very pleased with the work of our CIO, Seemantini Godbole, and her team to complete this replatforming effort in record time. And in Canada, we posted positive comps that exceeded 20%, driven by similar consumer focus on the home as well as strong execution by our new leadership team. While we're pleased with their efforts to serve the incremental demand this quarter, our Canadian team remains focused on the work ahead to improve operating efficiency while driving sales. Looking ahead, we are confident that we'll continue to build on the momentum that we delivered in the first half. And in the second half of this year, we are reinvesting in the business to elevate our product, simplify our store environment and improve our service offering. These investments will include store resets to improve product adjacencies, bay productivity and sales per square feet. We're also advancing our supply chain infrastructure with our recent announcement that we'll open 50 cross-dock delivery terminals, 7 bulk distribution centers and 4 e-commerce fulfillment centers over the next 18 months. Our investments in our stores and investments in our supply chain evolution reinforces our commitment to becoming a world-class omnichannel retailer. We're making the right investments to drive long-term sales growth, operating profitability and sustainable shareholder returns. In closing, I'd like to reiterate how incredibly proud I am of our associates and their dedication to supporting customers in our communities during this time when they need us most. And with that, I'll turn the call over to Joe.
Joseph McFarland:
Thanks, Marvin, and good morning, everyone. Over the past 18 months, we've been steadily improving our store operating efficiency and customer service. And we remained laser-focused on supporting a safe store environment through a data-driven approach based on an analysis of store traffic trends across our portfolio.
As I previously indicated, we implemented numerous safety standards in the first quarter in support of social distancing and enhanced sanitizing and cleaning. We executed these standards in a consistent, uniform manner across our stores in the U.S. and Canada to protect the health and safety of our team members and the communities we serve. These standards included removing product to free up space for our customer, adding signage and floor markings and adding social distancing ambassadors and leveraging technology to monitor store traffic, which help store managers limit customers based on the footprint, in line with the regulatory requirements. In the second quarter, we added further safety measures by requiring all frontline associates to wear masks beginning in early May and by adopting a nationwide standard for all customers to wear masks in mid-July. In support of this standard, we are providing free masks for customers who need them. And our customers' appreciation for these efforts was evident in a significant increase in our brand reputation and engagement scores as we shifted our marketing away from promotional messaging and instead focused on our commitment to our communities. I'm also pleased that we delivered strong customer service for both Pro and DIY customers in the second quarter while maintaining rigorous safety requirements and driving 35% U.S. sales comps. This is a testament to the outstanding work of our frontline associates and our commitment to our customers and communities. The health and safety of our associates and customers has always been and will remain our highest priority. Our strong results this quarter would not have been possible without the extraordinary efforts of our frontline associates, and we continue to recognize these efforts with incremental financial assistance. We announced 2 bonuses for July and August, which totaled $230 million. Full-time associates are receiving $300 and part-time and seasonal associates are receiving $150 in each payout. In fact, each payout was grossed up for taxes, so the company covered the incremental taxes as well. Combined with the support provided earlier in the year, we have now invested $560 million in COVID-related financial support for our frontline associates. And in addition, I'm really pleased to announce that 100% of our stores earned a record "Winning Together" profit-sharing bonus this quarter totaling $107 million. Based on better-than-expected store performance, this represents an incremental $35 million payout to our frontline associates, above the target payment level. And we supported our communities by hiring over 100,000 associates for the spring. We are converting these seasonal associates to permanent positions at a much higher rate than in past years, which will help us meet the strong demand that we're continuing to see across our stores. In addition, each of these associates received telemedicine benefits for themselves and their families, even if they were not enrolled in Lowe's benefits program. I'd like to now spend a few moments discussing our initiatives in support of our Pro customer. When the pandemic hit, we recognized that we needed to step up our efforts to keep pros working. On June 1, we launched JobSIGHT for Pros in partnership with Streem. This is a free, augmented video chat service that allows pros to conduct virtual home visits with their clients without entering their homes, which opens up their job opportunities. This is just another example of how we're innovating to leapfrog our competition. And to further support their job pipeline, we recently announced a partnership with HomeAdvisor for our Pro loyalty customers. These customers will receive a free 1-year subscription to HomeAdvisor and a credit for an average of 10 free job leads as well as access to webinars hosted by industry experts on how to grow their business. Our Pro customers know that we've got their back and are committed to help keep them working, particularly in these uncertain times. And today, we are thrilled to announce a significant step in the expansion of our product and service offering for the Pro. We are beginning a multiyear national rollout of Lowe's tool rental program with the grand opening of our first location at our Central Charlotte store next week. As over 70% of pros are currently utilizing tool rental programs, this will provide a meaningful opportunity for Lowe's to deepen our relationship with this customer segment. After a successful pilot, we are launching this program nationwide with a broad product assortment, a fully equipped mechanic shop, a large store footprint and importantly, intuitive customer-facing technology that creates a fast, frictionless process for this time-pressed customer. I look forward to updating you on our progress against this important initiative on future calls. Turning to our services business. Installed sales delivered positive comps in Q2 with the results improving as we moved through the quarter as customers began to feel more comfortable allowing contractors back in their homes. And from a store technology perspective, we've also completed the rollout of our intuitive touchscreen point-of-sale system and checkout across all stores. This new interface dramatically reduces associate training time as compared to the cumbersome green screens and multiple interfaces that they were previously using and also improves the customer experience through a shorter checkout process. We also completed the launch of mobile printing across our store portfolio and installed digital signs in our appliance department. These initiatives reflect our ongoing efforts to modernize our store environment while giving our store associates more time in the aisles to serve our customers and move us further towards our goal of allocating 60% of their time to customer service and 40% to completing tasks. In closing, I'd like to reiterate my appreciation for our frontline associates and their continued hard work and commitment to safety in serving customers. Thank you, and I will now turn the call over to Bill.
William Boltz:
Thanks, Joe, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 35.1% in the second quarter, driven by broad-based outperformance across DIY and Pro customers as well as indoor and outdoor product categories. We delivered indoor comps of 30%, driven by strength in indoor categories, such as decor and lighting. We delivered strong growth across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeding 20%.
As customers continue to spend more time at home this quarter, we saw an acceleration in both indoor and outdoor project activity, including core repair and maintenance, along with projects to repurpose home space for work and study as well as discretionary indoor and outdoor projects to increase customers' enjoyment of their homes. We also continued to see robust COVID-related demand for essential cleaning products along with other home necessities such as appliances. During the quarter, we posted comps over 30% in core project categories, such as lumber, tools and paint, driven largely by extensive indoor and outdoor project activity from both the DIY and Pro customer. Importantly, we saw significant improvement in installation-heavy categories, such as flooring, millwork and kitchen and bath. In paint, we continued to drive strong sales of both interior and exterior paint and stains as well as applicators as our brand offering and service model positioned us to serve increased project demand with our paint products being key components of many home improvement projects. Lumber benefited from strong unit demand from both Pro and DIY customers as well as our investments in job lot quantities. And in tools, we saw strength across all segments of power tools, along with growth in tool storage and mechanics tools, driven by the CRAFTSMAN brand as customers took to doing projects at home. Our lawn and garden and seasonal and outdoor living teams also delivered comps above company average this quarter, driven by seasonal demand and customers focused on enjoying their outdoor space. Our strong execution and powerful brand assortment allowed us to meet the elevated demand with brands such as Weber and Char-Broil, the top 2 brands in outdoor grilling, and an outstanding outdoor power equipment lineup featuring John Deere, CRAFTSMAN, Husqvarna, Honda and the Ariens brands. And today, I'm particularly excited that we are building on our industry-leading portfolio of outdoor power brands with EGO, which is the #1 brand in battery-powered outdoor power equipment. Lowe's is already the #1 destination in outdoor power equipment. And the addition of the EGO brand to our arsenal now only reinforces that leading position. Beginning in December of 2020, Lowe's will be the exclusive nationwide home center to offer EGO's innovative battery-powered mowers, trimmers, chainsaws and blowers. In addition, Lowe's will begin offering select skilled battery-powered outdoor power equipment in late 2020, which includes mowers, leaf blowers and trimmers. The addition of the EGO brand furthers our commitment to expanding our assortment of sustainable products. EGO's battery-powered equipment is capable of matching or exceeding the performance of conventional gas items, which supports our corporate sustainability efforts. In hardware, we continue to expand our Pro brand offering with the national launch of Simpson Strong-Tie framing hardware and fasteners this quarter in conjunction with the Just For Pros customer acquisition event. This product offering meets a critical need for the Pro in building out their projects, so we're now able to further extend our relationship with the Pro customer by helping them fulfill all their hardware needs in one place. And as Marvin mentioned, we are pleased to see higher-than-expected online sales this quarter, along with a significant increase in downloads of our mobile app as well as improved customer ratings. We have also continued to enhance our omnichannel capabilities in the store with the launch of mobile check-in for curbside pickup that occurred in early July. This is also that customers can now let us know when they're on their way and when they've arrived at the store to pick up their order. And we added an internal order picking app to improve our associates' speed and accuracy in fulfilling these orders. We are also focused on other extensions of our omnichannel capabilities. With our transition of Lowes.com to the cloud now fully complete, the teams are working quickly to accelerate the front-end work and deliver improved customer-facing capabilities in the second half of this year, such as online delivery scheduling, online order tracking, a dynamic customized homepage, simplified search and navigation and an expanded online product offering to further enhance the customer experience and to continue to grow sales. As we look ahead to the second half of the year, we're excited to build on our retail fundamentals foundation. Consistent with our long-term plans, we are continuing with our merchandising investment in our stores with resets to address our product adjacencies that make it easier for the customer to shop, all with a focus on the Pro. This work will be done throughout the back half of the year. And we expect to touch the majority of our stores by the end of the fiscal year. And as we plan for the holiday season, when customers are expected to stay closer to home this year with a keen focus on home improvement projects, we are prepared and committed to serve their needs for fall preparation projects, remodel activity, space conversion projects, holiday decorating and gifting, along with core repair and maintenance activity. In closing, I'd be remiss if I didn't again express our appreciation for our vendor partners, who again went above and beyond to help keep our shelves stocked despite facing unprecedented demand and their own operational challenges related to COVID-19. Across building products, home decor and our hard lines businesses, there were a number of standout performances again this quarter. Thank you, and I'll now turn the call over to Dave.
David Denton:
Thank you, Bill, and good morning, everyone. I'll begin this morning with a few comments on the company's liquidity position and our capital allocation priorities. Last quarter, we decided to raise some incremental capital in light of the disruption in the global credit markets.
After issuing $4 billion in senior notes and increasing the capacity of our revolving credit facilities by nearly $800 million, we now have $11.6 billion of cash and cash equivalents on the balance sheet. Additionally, we have $3 billion in undrawn capacity on our revolving credit facilities. So in total, we have an immediate access to $14.6 billion in funds, and we remain confident that we have ample liquidity to navigate any unforeseen circumstances. At the end of our Q2, our adjusted debt-to-EBITDA ratio stands at 2.4x.
During the quarter, the company generated $11 billion in free cash flow, driven by exceptionally strong operating performance. In the long term, we remain committed to delivering robust shareholder returns through our disciplined capital allocation program, consisting of 3 main pillars:
first is strategically investing in our business to drive outsized returns; second is supporting our 35% dividend payout target; and finally, returning capital to our shareholders through value-enhancing share repurchases.
However, as you know, we have currently suspended share repurchases in light of the unprecedented environment created by the pandemic. We continue to support our dividend program, and we returned $416 million to our shareholders by paying a dividend of $0.55 per share in the quarter. And importantly, we are investing in growth initiatives to build on the momentum that we are seeing across our business. In Q2, capital expenditures totaled $382 million. We continue to prioritize investments in our omnichannel capabilities as our customers are shopping more online. Now turning to the income statement. In Q2, we generated GAAP diluted earnings per share of $3.74 compared to $2.14 last year, an increase of 75%. In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring. Now my comments from this point forward will include certain non-GAAP comparisons, where applicable. In Q2, we delivered adjusted diluted earnings per share of $3.75, an increase of 74% compared to the prior year. These results surpassed our expectations due to higher-than-expected sales, gross margin rate and SG&A leverage as well as our strong execution to meet robust customer demand. Q2 sales were $27.3 billion, an increase of 34.2% on a comparable basis versus the prior year. This was driven by transaction growth of 22.6% and total average ticket growth of 11.6% as we saw strong repeat rates from new and existing customers. U.S. comp sales were up 35.1% in the quarter with truly broad-based strength across all geographies and across both DIY and Pro customers. Lowes.com sales growth remained robust, increasing 135% in the quarter. Given all of our previously announced investments in the product and service offerings for the Pro, we were particularly pleased to see mid-20% growth for the Pro customer in Q2. Our U.S. monthly comps were strong throughout the quarter with 41.5% in May, 34.4% in June and 28.2% in July. It's important to note that we delivered these strong comps despite significantly reducing promotions during the quarter. Throughout the quarter, we saw strong COVID-related demand, driven by customers working on incremental projects to make their homes as safe and as functional as possible. It's clear that homes have become multifunctional spaces for many families, a place for work, for school and for residence. We've also seen wallet share shift away from other forms of discretionary spending, shifting into home repair and maintenance work. Our sales also benefited from excellent execution and strong service levels across our stores in response to this unprecedented demand. Of note, sales trends remained strong in areas of the country where COVID-19 had been resurging. In August, we've continued to see the strong broad-based sales trend that we experienced in July with strength across both DIY and Pro customers. Month-to-date, August U.S. comp sales trends are materially consistent with July's performance levels. Gross margin was 34.1% of sales in the second quarter, an increase of 197 basis points compared to the second quarter of '19. Gross margin rate improved 137 basis points, driven by benefits from our improved pricing and promotional strategies. Favorable product mix also drove approximately 60 basis points of benefit. SG&A was 18.4% of sales in Q2, a 90 basis point improvement over LY. The company delivered a substantial improvement in operating leverage despite $430 million of COVID-related expenses. These investments included $260 million in financial assistance for our frontline associates, approximately $75 million related to cleaning and other safety-related programs and approximately $95 million in charitable contributions.
While $430 million of COVID-related expenses negatively impacted SG&A leverage by 157 basis points, this was more than offset by:
payroll leverage of 110 basis points related to higher sales volume and improved store operating efficiencies; advertising leverage of 35 basis points; employee insurance leverage of 40 basis points; and occupancy leverage of 40 basis points. Adjusted operating income margin increased 311 basis points to 14.5% of sales, driven both by robust sales and improved operating efficiencies.
The effective tax rate of 24.4% was in line with our expectations and consistent with the prior year. At $13.8 billion, inventory was essentially flat compared to the prior year levels as the supply chain worked to meet elevated customer demand throughout the quarter. Now before I close, let me address our 2020 business outlook. As I indicated last quarter, we have suspended our guidance. In this unprecedented operating environment, we, like many other companies, have limited visibility into the future business trends, which result in an unusually wide range of potential outcomes for our financial performance. Having said that, I'd like to provide some perspective on the second half of the year. First, we expect that our top line growth will moderate somewhat from Q2 levels, although demand is still expected to remain strong as consumers continue to invest in their homes. Further, we expect that our improved product offerings and customer service will allow us to retain new Pro and DIY customers. Now keep in mind that both the third and fourth quarters are typically smaller revenue quarters, given the natural demand patterns of the home improvement sector. For the remainder of the year, we expect that promotional activity will increase modestly but will not return to the prior year levels. We will also be lapping harder prior year comparisons as our sequential gross margin performance improved as we moved through 2019. As such, we expect lower levels of gross margin expansion in the second half of 2020 relative to the second quarter. Turning to expenses. We anticipate that we will incur COVID-related operating expenses of approximately $70 million to $80 million per quarter to support safety and cleanliness in our stores. And importantly, we are making significant investments in our business to support the long-term growth and enhanced returns. Some of these investments include merchandising resets and expansion of our supply chain infrastructure. In the back half of this year, many of these projects are weighted more heavily towards expense rather than capital. Based on all of these factors, we anticipate that operating income margin flow-through will moderate in the second half versus the first half. We're still planning for approximately $1.6 billion in CapEx for the year with a continued focus on omnichannel investments. In closing, we are operating in a robust sector with strong underlying demand trends. We are investing in our business to further our capabilities, so we can continue to disproportionately capitalize on these trends. We have a strong balance sheet, and we remain committed to a disciplined capital allocation program, which should lead to long-term shareholder value creation. So with that, I thank you. We're now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Chris Horvers with JPMorgan. Our next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Nice quarter. I'm going to apologize, this will sound like the broken record question. I wanted to ask about the 12% EBIT margin target, realize an actual goal in terms of timing was never given, but that this environment probably speeds it up. Can you talk about 12%? I think some of the math to get there in the near term or medium term would imply that sales continued to grow at a nice rate but expenses actually get deleted or your productivity gets a lot better. So can you talk about the reality or the realistic nature of doing that in the next, call it, 12 to 18 months?
David Denton:
Chris, this is Dave. I think you're right. Obviously, we are very focused on delivering upon that 12% operating margin target. And keep in mind, that's just a step function. That's not the end. We think we can do better than that over time. It's clear at this point in time, we're trending a bit ahead of that, given just how our business is performing. But having said that, we still have a lot of investments that we're making to be sure that we can consistently deliver that 12% day in and day out.
I think you heard us talk about this morning that we're investing in assortment and merchandise in the store environment. We're making really important strategic investments in our online capabilities and technology platform as well as in our supply chain. And we continue to focus in those areas to make sure that we can consistently deliver both really strong top line performance, manage gross margin at a reasonable rate, leverage SG&A in a meaningful way, so we can deliver that off-base target over time.
Simeon Gutman:
And Dave, is there any different thought with regard to gross margin? I know that, right, it's benefiting in the near term from lack of promotions. And you're expecting that level of promotion to continue or to rise to be a little bit less of a benefit going forward. But is there some level -- or is the calculus of getting to the 12% any different, where gross margin ends up being a little bit better in that -- than you thought initially?
David Denton:
I don't know that there's anything materially that's changed there. Clearly, 2019, we had a bit of a step down in gross margin. Our objective in 2020 and beyond was to get our margin rate back. Keep in mind that we are making investments in supply chain that will disproportionately dampen gross margin rate but will allow us to lever SG&A more productively over time. So you have some natural kind of geography shift within the P&L, Simeon.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Marvin, do you think there's been any structural shift, meaning that this growth you're experiencing now won't just be a one-shot deal that will be given back next year when people go back to traveling and eating out? Said another way, under what conditions do you think you can comp positive next year when you lap all of this?
Marvin Ellison:
Mike, I think it's a fair question. Next year is difficult for all the obvious macro reasons. But we feel good about our business trends. And look, I don't want to minimize the impact of what we describe as retail fundamentals. We talked about getting foundational things in place here at Lowe's for the last 18 months. And they're paying dividends. Getting dot-com on the cloud, hiring an experienced team of home improvement and retail experts in key functional areas, new price management system, field merchants, focus on Pro, I mean, all of these things matter. And when we think about market share and we think about the sustainability of it, our data is pretty consistent that when customers shop us in store or online, they have a good experience. They come back. When customers shop us in our stores, especially in this environment and they feel safe, they come back.
We've done an analysis that suggests that our COVID-19 safety protocols in our stores are amongst the strongest in the industry. And Forbes ranked Lowe's #6 on their list relative to that. And our research tells us that when customers show up in our environment, specifically during this COVID-19 crisis and they feel safe and they feel well taken care of, they come back. And when you look at our first half results, it demonstrates that customers are coming back over and over again. And so we believe that of all the things within our control, if we can execute these at a continual high level, then the rest will take care of itself.
Michael Lasser:
Okay. Then my follow-up question is of the mid-20s percent Pro comp that you experienced, what portion of that came from new pros that Lowe's hasn't been regularly interacting with? And where did you grab these from? And maybe somewhat unrelated, Dave, you mentioned that promotions are going to pick up in the back half of the year. Why would that be the case if the environment stays the same?
Marvin Ellison:
Yes. So Michael, let me take the first part of the Pro question, then I'll hand it to Joe and he can give you a little bit more context. We feel really good about our Pro business. And we stated in the prepared comments that DIY outperformed Pro from a comp perspective. But we expected that in this environment. But we also know that we had increased performance in our urban areas. And we think that, that was driven by our improved performance in Pro as well as our omnichannel and online performance, which you have to have in those urban markets. So I'll let Joe just briefly cover a little bit about the Pro segmentation that we have.
Joseph McFarland:
Yes. Thanks, Marvin. Thanks for the question, Mike. Our strong Pro demand with comps in the mid-20s continues. And it's really around our -- the investments that we've been making in both the product and the service offerings. So it's things like our job lot quantities, our dedicated supervisors, our Pro parking, our loaders, et cetera, et cetera. And as we now move to the more strategic phase of our Pro growth initiatives, what we're really excited about the progress we're making, things like our Pro loyalty platform that's integrated with CRM, keeping Pros working through the partnerships that I've announced at HomeAdvisor and JobSIGHT, really excited about our announcement of the tool rental. And so as these Pro customers continue coming back, seeing new product additions like Simpson Strong-Tie, and so we feel very good about the future of our Pro business.
David Denton:
And Michael, as it relates to pros, I'll ask Bill to comment here a bit as well. But clearly, as we cycle in the back half of the year, we do think promotions will tick up just a little bit. I don't think it will be a material change. But I think it is important that we communicate really the value that we're offering to both consumers and the pros, the breadth of offering that we have at Lowe's. And I think because of that, you'll see just a slight tick-up, but I don't think a material change from a commercial cadence perspective. I'll ask Bill to...
William Boltz:
Yes. Just to -- Michael, just to add on what Dave was saying, I think we've clearly got to realize that gift centers and the holiday trim and tree programs were all committed for and bought prior to COVID happening. And so those were well in motion and on the way. And those are things that we have to work our way through based on how the consumer responds to those programs. But I think it's also important to clarify that during the quarter and during the first half of this year, we were dramatically less promotional all around building around our pricing and promo strategy that we've been working to put in place over the last 20 months, which has been a focus on everyday values and being priced right every day for our customer. And so really pleased with the traction that we're making with the teams. And I think as we look at the back half, it's not like we're going to go from one side of the road to the other and just get back into the promotional game.
Operator:
Our next question comes from the line of Chuck Grom with Gordon Haskett.
Charles Grom:
Great results. Marvin, I just wanted you guys could just speak to the opportunity on the digital front now that you've completed the migration to the cloud, I guess, just to size up the opportunity for you guys in the back half and even into next year.
Marvin Ellison:
Well, we think it's significant. I mean we've talked from the very beginning about the importance of modernizing our online business. And I just can't help but reiterate that just a year ago, we were on a decade-old platform. And we were slowing our growth because we were disappointing customers. So the ability for Seemantini and her team to get this replatforming effort done in the second quarter is monumental for us because it gives us so much agility and flexibility to build on that platform. We're not going to put any numbers to that, Chuck, because I think in this environment, it's really difficult.
But what we do know is that it will be impossible for us to deliver 135% comp as we did in the second quarter without that replatforming effort. Because our instability was such that back in Black Friday of 2018, the volume we had crashed the whole system. And we've had volume that exceeded that for probably 90 straight days. So that tells you where we were and where we are. I'll let Bill talk a little bit about some of the specific things coming online that we think will continue to build that business and open up to a whole new set of customers that will continue to rediscover Lowe's.
William Boltz:
Yes. I think it's important to note that during the quarter, all 15 departments grew at or above double-digit rates for dot-com. All -- and the migration to the cloud, obviously, allowed for speed, allowed for us to be nimble. But we've got improved checkout and navigation continuing to happen as we go through the back half. We've continued to work on separating freight from costs. And if you remember our comments on this before, this will help make sure that competitive pricing shows up online the way it needs to show up online, continue to enhance our curbside pickup, working with Joe's team in store, continuing to improve our buy online, pick up in store process to make that store picking faster. And in my prepared remarks, I talked about the store picking app, that's all around designing for the associate to be able to handle the customer with speed. So we've got a lot of efforts going in addition to adding SKUs and improving the content that we put out there on dot-com on a daily and weekly basis.
Marvin Ellison:
So Chuck, we're not trying to avoid answering the specifics of the question. It's just really tough to forecast. We just know that we have a much better platform that we can take that demand and manage it as it comes our way.
Charles Grom:
That's helpful. And then just taking a step back, the long-term sales per square foot target, I believe, is around $370. You're going to hit that number pretty easily this year. So I just to kind of build off of Simeon's question about margins but thinking about it from a sales productivity perspective, you're still about roughly $100 below your biggest peer. I'm just wondering if you guys just size up the opportunity of how much more productive your stores can be, that would kind of lend support that you guys actually should be able to comp to strong results in the next couple of years.
David Denton:
Yes. Chuck, Dave here. Obviously, we have a tremendous amount of opportunity here. Part of what we're doing is investing in our infrastructure such that our base can become a lot more productive day in and day out. And you heard Joe speak about all the investments we're making from a technology perspective within the store environment such that we can really leverage the hours that we have in our stores to put more of those hours to work facing customers and actually driving increased sales and productivity as we move volume through the box. So I think there's a big opportunity. You'll see us continue to talk about it and push on it. And actually, even leveraging the omnichannel environment will also help that. Because if we engage consumers both in the store and online, it really helps us leverage those fixed costs across our platform.
Marvin Ellison:
So Chuck, this is Marvin. And I'll just add this last point. So if you think about where the opportunity exists for us to increase sales per square foot, first, it starts with what Dave talked about and Bill discussed in his prepared comments regarding the work we're going to do in the second half to get our adjacencies corrected and to go in and drive more bay productivity based on how we are merchandising the floor and also creating a more intuitive shopping experience. This sounds very basic. But we all were surprised with the poor adjacency structure in our stores and how most stores don't even have planograms in the system. And so it's almost impossible to merchandise and to have a good replenishment strategy. So that's number one.
Number two, you have 3 things that are going to drive productivity in existing stores:
an increased penetration in Pro, an improved e-commerce and omnichannel infrastructure and a better install business. And we have negative comp in installed business last year. We've discussed dot-com to a high degree of detail and we've also talked a lot about Pro. And so all of these investments are part of our strategy to hit those targets that you talked about. And we think we're well on our way to making some progress.
Operator:
Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Scot Ciccarelli. I think one of your bigger productivity unlocks was shifting some of the big -- large inventory categories, like appliances, out of the stores and back into the fulfillment network. Can you update us where you are on that front? And related to that, are there any large productivity initiatives that you've maybe had to delay because of the unexpected sales surge?
Marvin Ellison:
Scot, I'll take it. This is Marvin. So I'll take the second part first. No, I mean, we hadn't really delayed any large project. Dave mentioned, to the contrary, we've decided to push projects up that drive productivity and also that impact the improvement of our omnichannel strategy because we believe that we're behind. And candidly, we want to come out of this COVID-19 crisis a better company than we were going into it. And we think we're making progress in that area.
Relative to supply chain and our transition of products like appliances out, we're in the early stages of that. I reiterated in my prepared comments that we are going to have an aggressive 18-month strategy to roll out, deliver cross-dock and bulk distribution centers and also online fulfillment centers. Our pilots have proven successful in getting appliances and bulk product out of our backrooms into more centralized, local distribution or delivery. And you're going to see us accelerate that in the back half of the year going into next year.
Scot Ciccarelli:
That's really helpful. And can you just give us a quick update on where you are in terms of the customer-facing hours versus tasking?
Marvin Ellison:
Yes. Let me hand that to Joe and he can give you some specifics.
Joseph McFarland:
Yes. Thanks, Scot. So we've made significant progress. We're ahead of our 60-40 goal. We continue to engineer out tasking in the stores to improve customer service. We are well on our way and ahead of our 60-40 goal.
Marvin Ellison:
Yes. And Scot, the last point I'll make, just giving credit to Joe's team and the IT team. Without some of the advancements in technology, like the new labor scheduling system, I mean, we would be in a much different position as a company, trying to serve the needs of the customer and the needs of the associates in this unique environment. But having a system that gives us the ability to manage to the unique needs of both customers and associates, that system was put in place last year, it's created just an enormous benefit to our ability to not only serve customers but to drive productivity. So proud of the progress of Joe and the operations team. And we think we'll hit that target before what we committed to because it's just the right thing to do for our associates but also for our shareholders.
Operator:
Our next question comes from the line of Steven Forbes with Guggenheim Securities.
Steven Forbes:
And Dave, maybe the first one for you, just given the number of facilities being stood up over the next 18 months. And you sort of mentioned the geography shifts in the prepared remarks. But can you help us better understand the P&L implications? I mean should we expect a net margin headwind, I guess, an incremental one, given the pull-forward here? Or are there enough offsetting factors to neutralize the initiative as you roll it out?
David Denton:
Steven, just keep in mind that what we have done here is consistent with our long-term plan because we were always in the mode of investing in the supply chain that we knew would drive incremental costs and dampen gross margin rate but would alleviate some SG&A pressure in the stores and across our platform. So I think the plan over the long term is consistent with that. Clearly, when you make investments in the short term, you have to stand up the facilities in advance for them being at full productivity level, so there will be some near-term headwinds. And that's somewhat of the commentary you heard me speak about as you thought about the back half of 2020 is really due to that fact.
Marvin Ellison:
Yes. I think -- and Steve, this is Marvin. The only point I'll add is, obviously, this is part of our plan. But we also have things we're implementing that will be offset. And I talked about the price management system. And the continued maturation of that system gives Bill and his team a lot more understanding to drive benefits relative to pricing and also having a more balanced promotional strategy.
Some of the things that Joe is putting in the stores from a productivity perspective that's helping us to get that balanced payroll, which also drives operating income improvement. So there will be offsets to go along with the investments we're making. This is not really a pull-forward. This is really a reminder of where we are in the process, so it keeps us on track. We're not getting off track, and we're not going to create any downside scenarios that we didn't anticipate.
Steven Forbes:
And then just a quick follow-up. I guess, Dave, again starting with you. As you noted, right, the expectation for, I guess, a moderation, right, in top line growth as we head into the back half of the year. But any context on how that pertains to both the DIY and Pro customers? Is there any sort of, I guess, dichotomy between the 2 channels or 2 customer segments?
David Denton:
Listen, I don't think so. Listen, I think we've seen really strong growth and retention of both new and repeat customers in our channel, both from a Pro perspective and DIY. I think just practically speaking, we're going into kind of the season which demand begins to moderate just from a natural progression perspective. And I think that's just what we're trying to call out as you think about the back half of the year. I think we're really nicely positioned from a merchandising perspective and from a labor perspective that we're going to really do well from a service perspective and have the right product in stores and online to meet the demand for these customers.
Operator:
Our next question comes from Seth Sigman with Crédit Suisse.
Seth Sigman:
Given the strength over the last few months, we get a lot of questions about pull-forward. I guess as you look at the composition of sales through the second quarter and then obviously early here in the third quarter, are you seeing any change in the types of projects that consumers are working on? Anything that maybe helps give you confidence that demand through this period has been incremental versus pull-forward? How are you guys thinking about that?
Marvin Ellison:
We do not see it as pull-forward. I think what we've tried to articulate is that this is a really unique environment, where most of us are forced to spend more time at home than we ever have in our lifetimes. And so those customers are finding projects around the house that have been on the list, they just hadn't got a chance to get to them or candidly they just didn't notice them. So we don't see this as a pull-forward. This is more of an incremental add.
In addition to that, as I mentioned, we've been running a negative install business for the past couple of years. And Bill Boltz and his merchandising teams made big investments last year in updating our flooring showrooms in our stores and updating our kitchen showrooms. We believe that those investments in the store has led to us improving our install business this year, along with the restructuring of the field team that Joe took on. So the short answer is we don't see this as pull-forward. We see it as incremental just based on the unique environment that we're in. And we also see it as market share gain. I mean it's difficult for a company our size to grow sales by 35% comp without having some significant market share gain that's happening as well.
Seth Sigman:
Right. Okay. That's helpful. And then just a question on the regional consistency. It's helpful to get that color and it's obviously a very good trend that it's been so consistent throughout this period. I'm just curious, have you seen any change in comps or the composition of categories in markets where COVID cases have started to pick up?
David Denton:
No. We have not. I think actually where COVID has picked up, we've seen very strong demand in those markets. And it's been pretty consistent, so we really have not seen a material change in there.
Operator:
Our final question comes from the line of Mike Baker with D.A. Davidson.
Michael Baker:
So I wanted to follow up on DIY versus Pro. And I think some of your comments suggest that DIY was maybe up closer to 40% in the quarter versus Pro up 25%. But has that gap narrowed this quarter? I think at one point, it was said that Pro is up mid-20s and you sort of implied that the whole company is up mid-20s in August. So that would imply that, that gap has narrowed. Is that a correct assumption?
Marvin Ellison:
I would say your assumption is correct on the ratio between Pro and DIY, relative to a composition change, not so much. I mean this is a unique environment. And most of 2019, our Pro comps outperformed DIY. The shift occurred, obviously, during this COVID-19 crisis, where customers are spending more time at home. And in some cases, they're still a little apprehensive to allow contractors in their home. So we think those combination of factors is driving the resurgence in DIY. We have to be more penetrated from a DIY perspective as a company. Our Pro business is growing, but DIY has always been a strength, and we think that we're benefiting from the current trends.
Michael Baker:
Okay, makes sense. One more follow-up on indoor versus outdoor. So you gave us the indoor comp. Could you just share with us the outdoor comp or percent of indoor versus outdoor and then we could back into the outdoor comp? But more importantly, how does that percent change as we go through the back half of the year? How much bigger does indoor get relative to outdoor?
Marvin Ellison:
Well, what I would say is we've given plenty competition information. So we're not going to give you any more specifics on ratios because we think we've given enough to provide context and color. But going into the back half of the year, this shifts inside versus outside just due to weather and seasonality. I'll let Bill talk a little bit about what our focus is on the inside and the back half because it's something that we've been working quite a bit on.
William Boltz:
Yes. I think to play off of Marvin's comments, as we shift to the fall business, it naturally shifts indoor. But in the southern parts of the country, there's still a lot of outdoor projects that get done as the weather cools. But for the northern markets, the Pro moves inside, the consumer moves inside, flooring, kitchens, bath, those types of projects, all about getting the home ready for the holidays is where the customers focus. And then you have your natural fall businesses, right? So fall businesses continue to play. Those are a little less seasonal than the spring time frame. And they're all really driven based on what Mother Nature brings. So that's really what drives the back half of the year.
Michael Baker:
Okay. One more which might be helpful for everyone, if I could. You talked a lot about COVID. Where we've seen the COVID spikes, business remained strong. I guess I'd be concerned about the opposite, where COVID is sort of calming down, are we seeing people move away from the home?
David Denton:
We have not actually seen our business in those areas actually improve.
Marvin Ellison:
So -- and the last point I'd make, we have 15 geographic regions. All 15 were 30% comp or higher. I mean that's a pretty unprecedented number. And that illustrates the consistency of demand across rural, urban and all types of geographies in the country. And we think that is also consistent with really good execution by the merchandising and stores team to drive the business as well as outstanding work from our store leaders out there every day, doing incredible job for customers and communities.
Operator:
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.
Operator:
Good morning, everyone, and welcome to the Lowe's Companies First Quarter 2020 Earnings Conference Call. My name is Michelle, and I will be your operator for today's call. As a reminder, this conference is being recorded.
I will now turn the call over to Kate Pearlman, Vice President of Investor Relations. You may begin.
Kate Pearlman:
Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.
I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our Investor Relations website. With that, I'll turn the call over to Marvin.
Marvin Ellison:
Good morning, everyone. This is an unprecedented time as we all navigate the ongoing global economic, social and health impacts of COVID-19. I'd like to start out by extending my best wishes for the health and safety to you and to your families.
Like most retailers, we began the first quarter focused on meeting our internal financial plan, while executing our Q1 retail strategy. However, due to the global health crisis caused by COVID-19, everything changed in late February, and we immediately pivoted by establishing a cross-functional COVID-19 task force, opening a company-wide command center and reprioritizing our Q1 objectives.
As a company, our focus shifted from running a business to achieve our financial plan to functioning as an essential retailer, operating in a pandemic with 3 key priorities:
first, creating a safe store environment for our associates and our customers; second, providing support for our community, including health care providers and first responders; and third, financially supporting our associates during this unprecedented time. As a result of these new priorities, in the first quarter, we invested $340 million to support our associates, health care workers, first responders and community. In addition, we've committed $50 million of charitable contribution for our communities to do our part in this time of need.
I'd like to begin by highlighting a few of the operational actions that we took in response to COVID-19, and later in the call, Joe will provide more details on these efforts. In early March, we shortened our store operating hours by closing 3 hours earlier each day at 7 p.m., so we could increase third-party cleaning routines and restock shelves. During the hours that our stores were open, we implemented several operational changes to ensure the safety of our associates and our customers. Including the garden centers, our stores average 144,000 square feet of space. To develop our social distancing safety procedures, our team took a strategic data-driven approach, tracking historical customer traffic patterns and identifying areas where customers tend to congregate. Based on this analysis, we implemented additional safety and social distancing protocols in 3 distinct areas:
point-of-sale checkout; outside garden; and the paint desk. Our store team was so effective at implementing and executing the enhanced safety guidelines that our customer service scores improved 200 basis points year-over-year in the first quarter. This is truly an incredible accomplishment and a reflection of our commitment to customer service, even in this unprecedented environment.
Also to provide our valued associates with a much deserved day off to spend with their families and their loved ones, we closed all stores and distribution centers on Easter Sunday. This decision negatively impacted sales and operating income, but it was absolutely the right thing to do for our associates. We have a unique and resilient business model that operates well when our communities need us most. Whether it's a hurricane, flood, tornado or a global health crisis, we are committed to being there for our customers. And I am pleased that over the past 18 months, we've established the agility to provide our customers with the essential products they need to keep their home safe and functional and their businesses running. None of our success in the first quarter would have been possible without the outstanding commitment of our store associates working under unprecedented conditions. Our field leaders also distinguished themselves during the quarter. Division Presidents, regional Vice Presidents, district managers and field merchants abandoned their normal routines and spent time each week visiting stores to provide leadership support and guidance for our store managers and frontline leaders. As someone who started out their retail career as a $4.35 an hour part-time store associate, I understand the importance of seeing the leaders of the company out on the front lines during a crisis. Let me now turn to our first quarter results, which reflect the benefits of our retail fundamental strategy, the improvement in our overall execution and the strength of our home improvement business model. For the first quarter, we delivered strong sales growth, with total company comp sales growing 11.2%. Our U.S. home improvement comp was 12.3% due to strong demand from both DIY and Pro customers. Overall demand strengthened as we moved through the quarter, and net sales momentum has continued into the month of May. For the quarter, DIY comp slightly outpaced Pro comp, and the uptick in DIY demand was partly driven by the arrival of spring weather in many Western and Southern geographies, as well as a customer mindset that was heavily concentrated on the home. We saw broad-based project activity, ranging from outdoor landscaping and other beautification projects to essential indoor, repair and maintenance work and long deferred home projects, the to-do list that customers hadn't previously tackled given their busy schedule. Comp sales for Pro was strong, supported by our focus on retail fundamentals, including job lot quantities, more flexible delivery and the improved service model that we put in place in 2019. And as you would expect, we saw increased demand in COVID-related products, such as cleaning supplies and appliances, like refrigerators and freezer. Partly offsetting these gains was softness in heavy indoor installation categories, such as kitchen and bath, as customers were reluctant to invite people into their homes. In total, we estimate that the net impact of COVID-related sales contributed approximately 850 basis points to our total company comp growth, which includes 80 basis points of cleaning product, 70 basis points of refrigerator and freezer sales and 700 basis points in acceleration of projects primarily for the DIY customer. As we move through the quarter, there was also a sharp uptick in sales on Lowes.com, as customers began to shop more and more online. Our investments in online infrastructure and progress to date with the Google Cloud migration greatly improved site stability and allowed us to effectively handle the increased traffic. For the quarter, Lowes.com sales were up 80% overall, with even stronger growth rates for our Pro customers. Online penetration increased to 8% of total sales. From a geographic perspective, we had broad-based growth with positive comps in all 15 geographic regions and all 3 U.S. divisions. Regions that outperformed the total company comps were Atlanta, Charlotte, Dallas, Houston, Nashville, Los Angeles, St. Louis and Seattle. And once again, the West was our top-performing geographic division. The geographic footprint of our stores in the U.S. also played a role in our strong sales performance in Q1. The COVID-19 crisis created less disruption in rural areas of the country where approximately 1/4 of our store base is located. Our rural stores outperformed the company comp in Q1 by over 250 basis points. Conversely, on average, our urban stores experienced more demand disruption from the COVID-19 crisis. Approximately 10% of our U.S. store base is classified as urban. This subset of stores underperformed the company comp by more than 400 basis points. In Canada, we posted negative comp sales as performance was adversely impacted by store closures and other regulatory-related operating restriction. We have initiatives in place to improve performance and remain confident in the long-term potential of our Canadian business. During the quarter, we shifted our marketing efforts by dramatically limiting our promotional messaging and instead highlighting our commitment to our communities and our appreciation for our frontline associates. In fact, as the presenting sponsor on ESPN for the NFL Draft, which posted record-setting viewership, we ran a campaign to spotlight and thank our associates and how they support their communities and the first responders in a time of crisis. Although actions like closing on Easter, reducing promotions, closing stores 3 hours early each day and limiting customer access to key areas, like paint and garden, limited our sales in the quarter, they are a reflection of our culture and to the fundamental commitment to the safety of our associates and our customers. Our Q1 results also showed that while consumers were sheltering in place this quarter, they had an opportunity to rediscover Lowe's, both in-store and online. And the improvements we made in our business over the last 18 months allowed us to meet the customer demand. I'm also pleased that during this time of high levels of unemployment in our country, Lowe's has hired over 100,000 store associates for the spring season. In addition, to assist other retails and operating safely in this exceptionally challenging environment, we shared our best practices with the Retail Industry Leaders Association. In fact, the only competitive threat we're focused on right now is the COVID-19 virus. Although our current and future environment is unpredictable, I am confident in our ability to execute and continue to provide the essential products and services that our communities need. And in closing, I am tremendously proud of our associates and would like to again express my heartfelt appreciation for their hard work and their dedication. And I also want to thank our vendor partners for their great efforts to step up to the challenges that this pandemic had presented. And with that, I will turn the call over to Joe to discuss the actions that we've taken to support our customers, operate effectively and keep our associates safe.
David Denton:
Thanks, Marvin, and good morning, everyone. I'd like to begin by echoing Marvin's appreciation for the tremendous work that our associates have done during this crisis across our stores and distribution network. As always, our highest priority is the health and safety of our associates and customers.
I'll now take a moment to review the operational changes that we implemented this quarter in response to COVID-19. We began with an immediate assessment of how to best facilitate social distancing in our operations and then quickly acted to implement the following:
additional signage and floor markers; adding social distancing ambassadors to manage customer traffic flow; leveraging new technology available on handheld smart devices to monitor store traffic, helping store managers limit customers based on the store footprint, in line with regulatory requirements; and we're moving product from our stores to help free up additional space for our customers, especially in high-traffic areas.
As Marvin mentioned, on average, our stores are 144,000 square feet in size, including the garden center. Therefore, we also deployed a data-driven process to implement additional safety measures in areas where customers tend to congregate, such as our point-of-sale registers, the garden center and the paint desk. For example, in our garden centers, we utilized our Merchandising Services Teams, or MSTs, to remove shelving in product to encourage customers to spread out. And at the garden center entrance, we set up one-way traffic flows and limited the number of customers entering at any one time. To ensure a clean, safe operating environment, we implemented more stringent cleaning procedures, added more hours for our third-party cleaning service and closed our stores 3 hours early at 7 p.m. to allow for increased cleaning and restocking activities. We also determined that keeping our stores open until 7 p.m. allowed for enough operating hours during the day to minimize concentration of customer traffic. Lowe's is one of the first retailers to install Plexiglass shields at the point-of-sale areas in all stores. We also distributed gloves and masks to our associates to wear during their shifts. As a reflection of our commitment to our associates, we provided them with additional financial assistance totaling $290 million in incremental investment in the first quarter. We made 2 special payments to hourly associates to help with unexpected expenses, one in March and one in May, with each payment consisting of $300 for full time and $150 for part time and seasonal associates. And for the month of April, we instituted a temporary wage increase of $2 per hour for all hourly associates. To further protect the health of our associates and those around them, we offered 14 days of emergency paid leave for all associates who needed it. And for those at high risk for severe illness from COVID-19, we offered emergency paid leave of up to 4 weeks. And to show our support to our dedicated frontline managers, we have provided them with an additional 2 weeks of paid vacation to recharge and spend time with their families. We also extended telemedicine services to all associates and their families, whether or not they were enrolled in Lowe's medical plans. And to do our part in protecting frontline medical workers and first responders, we committed $50 million of support to our communities this year, including approximately $10 million worth of essential protective products, including N95 masks. And as online demand increased, smart devices allowed associates to go buy online, pick up in store and parcel shipping orders more efficiently. In fact, this quarter, we rolled out curbside pickup in a matter of days. This rapid response would not have been possible without the technology we deployed in 2019. Our new customer-centric scheduling system and scheduling effectiveness tools also allowed us to monitor store traffic versus associate availability and deliver customized, tiered sets of priorities for stores based on their capacity level. As we look forward, we remain committed to our retail fundamental strategy and investing for future growth. In closing, I'm incredibly proud of how our associates responded and adapted to this challenging environment. They serve our customers and communities in a time of tremendous need, and we remain committed to supporting them as our most valuable asset. I'm really pleased to announce that 100% of our stores earned the Winning Together profit sharing bonuses this quarter totaling $87 million. Based on stronger-than-expected store performance, this represents an incremental $24 million payment to our frontline associates, above the target payment level. Thank you, and I'll now turn the call over to Bill.
William Boltz:
Thanks, Joe, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 12.3% in the first quarter driven by outperformance in essential DIY and Pro categories. 14 of 15 merchandising departments generated positive comps, with weakness limited to installation heavy product in kitchens and bath. We saw very strong COVID-related demand for essential cleaning products, along with other home necessities, such as refrigerators, freezers and DIY home repair products.
As customers isolated in their homes this quarter, they engaged in a variety of projects, which drove double-digit comps in core spring-related categories, paint and other critical repair and maintenance categories. During the quarter, we posted double-digit comps in lumber, which benefited from strong unit demand from both Pro and DIY customers, but continues to be driven by our improved investments in job lot quantities. Core Pro categories also performed well, with double-digit comps in rough plumbing, hardware and tools. Within rough plumbing, we delivered double-digit growth in pipe and fittings, as our expansion of job lot quantities in this area continues to pay off, along with growth in other essential categories, like air filtration, pumps and water filtration. Our hardware business benefited from the strength in fasteners and our general hardware categories, supported by the addition of Pro brands, like FastenMaster, GRK and Power Pro One, as these product categories are the critical project completers for both the Pro and the DIY customer. In tools, we continue to see a strong customer response to our CRAFTSMAN program, but we also saw strength from the launch of our new Kobalt XTR 24-Volt power tool platform, as both the heavy DIY and Pro customer are quickly recognizing the quality and performance of this great product. Within our key Pro tool brands, such as Dewalt, the #1 power tool brand in the industry, we continue to see nice growth across all segments, and we are pleased with the results we are seeing through the addition of our exclusive Dewalt 12-volt compact line of power tools. Lastly, we continue to showcase new and innovative tool products from Bosch, Lufkin, Spyder and Metabo HPT, along with Kobalt to build on the strength of our tools business. These brands, combined with our investment in job lot quantities and our improved Pro service model, are driving new customer trial and increasing our share of wallet with our existing Pro customers. As Marvin and Joe indicated, the progress we made on our strategic initiatives in 2019 positioned us to execute well this quarter. For example, having our merchants in place for the entire year allowed us to fully plan for the spring season and respond to the rapidly changing operating requirements we are currently facing. I'm also proud of our vendor partnerships and our recent brand introductions, both of which have allowed us to better meet the customer demand. I'd like to take a moment to mention just a few of the suppliers who made an extraordinary effort to keep our stores well stocked this quarter, despite their own challenging operating environments. Within our building products categories, some of our suppliers that deserve a special shout-out are Charlotte Pipe, ECMD, SharkBite and Idaho Forest Group. In home decor, 3M, [ monop ] and Samsung were true standouts. And in our hard lines business, Hillman, Bonnie, Oldcastle and MTD products went above and beyond in their responsiveness. And finally, I'd be remiss if I didn't give a big thank you to the efforts put forth by ZEP cleaning products, Safety Zone and Medline, as these 3 suppliers went above and beyond to provide us with hand sanitizer and gloves for our frontline associates. Turning back to our associates. Our field merchandising teams played a critical role in helping our stores adjust to the changing environment, along with being on the ground to respond to 10 tornadoes and 2 earthquakes that impacted parts of the U.S. during the quarter. And our Merchandising Service Team, or MST, also went above and beyond as they were ready to do whatever was needed during the quarter to help our stores respond to significant increases in demand. This quarter, our MSTs were key in our ability to quickly reconfigure our stores to support social distancing. The support of these teams is invaluable because they are the boots on the ground focused on taking the time-consuming tasks off the shoulders of our Red Vest associates. And looking ahead, we continue to make investments to drive future growth. And in the second quarter, we are excited about our rollout of Simpson Strong-Tie framing hardware and fasteners. These trusted Pro products will be available in stores nationwide, with an expanded assortment on Lowes.com, helping Pros to fulfill all their hardware needs in one place, saving them time and money. And as spring has now arrived across the country, we will continue to leverage our position as the #1 destination for outdoor power equipment in the U.S., with our leading brands, such as John Deere, Honda, Husqvarna, Ariens and CRAFTSMAN, to provide customers with an outstanding selection of products to help them complete their outdoor projects. At the same time, we're proud to offer our customers the top 2 brands in grilling, Weber and Char-Broil. As we've discussed previously, we remain focused on completing our Google Cloud migration in the second quarter to ensure that we build a strong infrastructure for Lowes.com. And the teams are working quickly to add capabilities to Lowes.com over the next 3 quarters that will further enhance the customer experience and to continue to grow sales on this digital platform. In closing, we remain committed to the work ahead to serve our customers and our communities as they navigate the public health challenge of COVID-19, while building capabilities to serve them even better in the future. Thank you, and I'll now turn the call over to Dave.
David Denton:
Thank you, Bill, and good morning, everyone. I'll begin this morning by reviewing the liquidity actions that we took during the quarter and provide an update on our capital allocation priorities. Given the uncertain economic outlook, we decided to bolster our liquidity to plan for any unforeseen disruptions.
In Q1, we raised $4 billion in senior notes and increased the capacity of our revolving credit facility by $770 million. After repaying $500 million of senior notes due in April of 2020, we now have $6 billion of cash and cash equivalents on the balance sheet as well as $3 billion in undrawn capacity on our revolving credit facility, which can be made available for any unanticipated needs and liquidity. We believe that we have more than adequate liquidity to manage through any of the potential scenarios that we could be facing. During the quarter, we also decided to halt our share repurchases program. Furthermore, we do not anticipate doing any more share repurchases this year beyond what we executed in the quarter. In Q1, we repurchased 9.6 million shares for $947 million at an average price of $98.45 per share. We remain committed to returning capital to shareholders through our dividend program. And as always, we look for ways to drive shareholder value over the long term. Also consistent with our capital allocation framework, we are continuing to prioritize investments in the business for future growth. In the quarter, capital expenditures totaled $328 million, and we are still planning for a total of $1.6 billion in capital expenditures through this year. In certain cases, we have reprioritized some capital projects to focus on the near-term need to improve our omnichannel capabilities, but our expectations for the total spend in 2020 remains unchanged. I'll now turn to a review of our operating performance, beginning with the income statement. In Q1, we generated GAAP diluted earnings per share of $1.76 per share compared to $1.31 in the first quarter of LY, an increase of 35%. In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring. My comments from this point forward will include certain non-GAAP comparisons where applicable. In Q1, we delivered adjusted diluted earnings per share of $1.77, an increase of 45% compared to the prior year. These results exceeded expectations largely due to stronger-than-expected sales and gross margin rate, particularly in the latter half of the quarter. Sales for the first quarter were $19.7 billion, an increase of 11.2% on a comparable basis versus the prior year period, with total average ticket growth of 9.7%, while transactions grew by 1.2%. U.S. comp sales were up 12.3% in the quarter, and we were encouraged to see strength in our performance across both DIY and Pro customers and across all geographies. Our U.S. monthly comps increased as we moved through the quarter with 5.1% in February, 8.9% in March and 20.4% in April. February's financial performance was largely in line with our expectations. But beginning of March, we saw sales impacted by COVID-related prep activities and customers working on long delayed projects as they sheltered in place. Also Lowes.com sales ticked up meaningfully in March as more customers increasingly utilized online shopping options. Sales continued to accelerate into April with a large step-up mid-month. Lowes.com sales also increased significantly with comps of over 150% in the month, while our installed sales declined approximately 50% as many customers were unwilling to allow installation work in their homes. The strong broad-based trends that we saw in April have continued into May, with strength across both DIY and Pro and across nearly all merchandising categories and all geographies. For May month-to-date, U.S. comp sales have been trending at or above April results, with strong double-digit comps across all geographic regions. Gross margin was 33.1% of sales in the first quarter, an increase of 164 basis points compared to Q1 of LY. Gross margin rate improved 110 basis points driven both by the actions that we took last year to lower product cost and improve our pricing and promotional performance as well as a 40 basis point benefit from lower promotional activities throughout the quarter. As Marvin mentioned, the company pulled back on promotional marketing in an effort to limit nonessential traffic given the stay-at-home orders across the nation. Gross margin also benefited from approximately 55 basis points related to favorable product mix. SG&A for Q1 was 21.3% of sales, an improvement of 45 basis points over the prior year. This included $320 million of COVID-related expenses incurred during the quarter, with $275 million in financial assistance for our frontline associates, approximately $35 million related to cleaning and other pandemic-related operating expenses and approximately $10 million in charitable contributions. While the $320 million of COVID-related expenses resulted in SG&A deleverage of 160 basis points, the impact was more than offset by payroll leverage of 105 basis points driven by higher sales and improved store efficiencies, advertising leverage of 40 basis points and employee insurance leverage of 25 basis points. Adjusted operating income margin increased 208 basis points to 10.16% of sales. Note that COVID-related expenses are not excluded from our adjusted results. The effective tax rate was 25.1% compared to 16.6% last year. The prior year quarter benefited from a change in approach related to the exit of our Mexico operations. The adjusted effective tax rate was 25%, above the prior year rate of 22.9%. At $14.3 billion, inventory is slightly lower than the prior year levels. Now before I close, let me address our 2020 business outlook. Despite our solid performance this quarter and strong sales momentum continuing into May, we are withdrawing our prior guidance for the full year 2020 sales, operating income and earnings per share. In this unprecedented operating environment, we, like other companies, have limited visibility into future business trends, which result in an unusually wide range of potential outcomes for our 2020 financial performance. However, going forward, we would like to provide additional transparency regarding our performance, so it is my expectation that we'll be giving more frequent periodic updates on our results throughout the second quarter. In closing, we remain confident about the future of our business and our ability to continue to drive sustainable long-term shareholder value. By the way, I'd like to extend my appreciation to the associates at Lowe's across the world who have risen to meet the challenges of this global health crisis. Operator, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is on sustainability of comps. I know it's an impossible question to really answer, and you're not going to provide much guidance. But from a planning perspective, right, there's a surge right now. Your inventory position looks pretty reasonable. So what are your expectations, if you could share how you're thinking about the surge and then leveling off? And then what should be a recession theoretically now and into the back half of the year?
Marvin Ellison:
Simeon, this is Marvin. I'll take the first part, then I'll let Dave take the second piece. You're right, this is a very unique and unprecedented environment that we're in. But what we can tell you is that we had very strong sales in April. And as Dave mentioned in his prepared comments, that momentum has continued into May. That includes a triple-digit comps in Lowes.com that also transitioned from April into May. We don't anticipate we're going to see negative comps, but we do anticipate that we're going to see sales start to moderate at some point in the latter part of this quarter and in the back half of the year.
What's interesting about this environment is that this is not a housing recession. If you go back to 2008, 2009, you're in a housing recession, and so the home improvement business was directly impacted. This is obviously different. And we're seeing still sustained strength from our homeowners because they're sheltering in place, and they're finding those projects around the house. Having said that, like every other company out there, we have very limited visibility to what's going to happen in the out months and out quarters, but we do feel as though, even in this unprecedented environment, we have a really good execution plan. And we think the results in Q1 reflected that. So I'll let Dave add anything.
David Denton:
Yes. Simeon, I'd just add kind of a couple of points. One, real time, we're tactically responding and managing to the increased demands for consumers for these essential products that they're seeing in our stores. So one, real time, we're working on that.
Secondly, importantly, we're still running our long-term playbook. We're making investments today to drive long-term shareholder value in the out year. So we have not deviated from that playbook. And three, we have developed a variety of, I guess, plans that can allow us to flex, both from a merchandising perspective to lean into more nondiscretionary-type items over the back half, if required; and secondly, being able -- with all the tools that we put in place operationally, to be able to flex our labor and operating expense profile to manage in a slightly softer demand environment.
Simeon Gutman:
Okay. And then my follow-up, is there -- I doubt, with plus-20 type of comp, it sounds like that's what you're running. Anything in DIY, yellow flags? And it sounds like the Pro is also pacing the DIY customer at the moment. Can you talk about anything you're hearing as far as the type of jobs and if their pipeline or backlog is starting to refill up?
Marvin Ellison:
Well, I think what's interesting is the strength remains in DIY. But for us, the Pro customer remains healthy, and that customer has transitioned primarily to outside project. Also as a reminder, our Pro customer is the smaller, what we call it, a pickup truck Pro. That Pro was less impacted in this forced downturn than the larger, more industrial Pro. So even though Pro was not as robust as DIY, our Pro's growth was still really strong in the quarter, and that strength continues. And their pipeline is more delayed and not canceled, and now you're starting to see those jobs pick up.
Another interesting data point is in the states that are beginning to reopen, we are seeing our stores outperform the total company comp in those locations, which, to us, is a data point, but it's a glimmer of hope that we're able to sustain our performance, even when there is a broader competitive landscape out there. But again, Simeon, there's a lot we don't know. There's a lot of uncertainty. But as Dave said, we have a lot of levers that we can pull from an expense management perspective. And Bill Boltz and Joe McFarland have really detailed playbooks from the 2008, 2009 period when we had to transition, in our old life, to a more repair and maintenance type of strategy. We know how to do that. So if that is a requirement, we have a very experienced team of merchants and operators that can make that pivot.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Marvin, I know you're not expecting negative comp, but should we look at that 850 basis points of COVID-related sales of simply pulling forward demand from future periods? And if that's the case, why wouldn't comps [ pulled forward ]?
Marvin Ellison:
Well, Mike, we don't see this as a pull-forward because these were projects that were on the customers' to-do list that they simply didn't have time to get to. I mean, as a reminder, I mean, we're in the essential retail business, and 2/3 of what we sell is nondiscretionary. And what we saw a lot is customers coming in and fixing things that they had just delayed. So we don't see it as a pull-forward at all.
Look, we're blessed to be open. We're very thankful that we're open. But this is, without question, the most challenging environment that any of us have ever worked in. And when we look at what the customers are buying and we look at the sustainability of it, we don't see what occurred in Q1. We don't see what occurred in April as a pull-forward. We just see it as a unique demand shift based on the competitive landscape and based on customers sheltering in place.
Michael Lasser:
Understood. And then a quick 2-parter for Dave. First part is if we strip out the benefit in the gross margin we saw from favorable mix and from advertising less promotions, it looks like you still haven't recouped everything that you lost in the first quarter of last year. At what point will you be able to recoup everything that you lost in the gross margin? Or is it just going to be structurally lower? And your commentary around share repurchases indicated that you're not going to do it for this year. What happens if there's a V-shape recovery or the business continues to perform very well? Under what conditions would you resume the share repurchases?
David Denton:
Yes. Michael, listen, it's our expectation that we would recover by the end of the year our gross margin to the baseline rate that we talked about. That was our prior guidance. And we're largely working on that day in and day out. I'd say there's a combined team between really merchandise and finance focused against that effort. And I'm actually really pleased with the progress we made, and we continue to push forward. So I feel like we're in really good stead there. We're kind of making the right investments to improve our performance.
And then secondly, from a share repurchase perspective, listen, we'll wait and see. I think the good news is, at the moment, our cash flow was very robust and really strong. We've shored up our balance sheet from a liquidity perspective. Let's just kind of watch and see just given the dynamic nature of this market and see where we stand. And we'll watch it carefully as we go through the balance of this year.
Operator:
Our next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
I wanted to focus a little bit on SG&A. Obviously, very good leverage in the quarter. You discussed some incremental costs, obviously, but you had some offsets. I'm just wondering if you can elaborate on some of those positive offsets in the quarter. How sustainable are those as you look into the second quarter? And then just regarding the $320 million of incremental cost, how should we be thinking about that bucket as well?
Marvin Ellison:
So Seth, I'll take the first part, and then I hand it over to Joe McFarland. I think that the key to our ability to have the leverage performance was the new scheduling and labor management system. Timing is everything, and our associates have been incredibly heroic during this time. But the ability to make sure we could look at the demands of the business by location, by department of the store to schedule effectively was in large parts.
I'll let Joe McFarland talk about what we were able to benefit from the labor scheduling system, in addition to some other expense-related initiatives that they drove in operation.
Joseph McFarland:
Yes. Thanks, Seth. This is Joe. So as we've been working on our 60-40, and again, that is to shift our labor productivity from tasking to selling, we are well on our way in our 60-40 transition. And so if you think about things that Marvin mentioned, the customer-centric schedule, we were able to really dial in our associate staffing based on departments that were lifting, reallocate labor in the areas of the store that were suffering. And also the smartphones, the ability for the associates to be able to sustain 150% comps in dot-com in the month of April and 80% for the quarter would not have been doable had we not done things, like our pick app, in the smartphone applications that really allow the associates to set up curbside delivery.
And so, Seth, there are a number of things throughout the quarter, the operational initiatives that we continue to stay focused on, our centralized receiving. So a lot of things allowed us to gain that leverage.
David Denton:
Yes. And Seth, I'll just add, give a shout-out to all the ops team to really be very focused and really drive a lot of efficiencies this quarter. However, there will be additional cost that we will incur as the new operating model goes forward. We incurred cleaning -- incremental cost for cleaning. We're put in social distancing ambassadors in our stores to manage the queues and flow-through from a traffic perspective. So some of those costs, which we incurred about $35 million in the first quarter, are probably ongoing for the balance of this year.
Seth Sigman:
And what about the $275 million, how much of that is ongoing past the first quarter?
Marvin Ellison:
So Seth, I mean, our goal is to take care of our associates. I mean we're really proud that in Q1, we invested roughly $340 million in our associates and our customers and communities. We're going to continue to make sure that we take care of our associates as this pandemic continues to drive a unique environment in our stores. Like anything else, it's difficult for us to project when that's going to be. But as an example, we paid out $80 million in special payments in the month of March, $2 wage increase for hourly associates in the month of April, another $80-plus million in special payments for the month of May. Joe talked about the Winning Together payment that we're going to make over and above the target for the month of June. And so we've looked at the needs of our associate, and we'll make the appropriate decision based on what we think is in their best interest.
Seth Sigman:
Okay. Just to follow up here on that May quarter to date trend, are you seeing the composition of growth change at all between DIY and Pro? And are you seeing a pickup in some of those weaker installation heavy categories, like kitchen and bath? Any signs that those are starting to improve more as the restrictions are easing here?
Marvin Ellison:
So I'll take the first one and let Joe talk about the install piece. The short answer is yes. DIY remains very, very strong. Pro is improving. And remember what I said, because our Pro is that smaller pickup truck Pro, the desk Pro tends to be less impacted by macroeconomic factors. And so desk Pro was healthy, but they're getting even more healthy as the weeks and days progresses throughout the year. And as I mentioned, in states that are reopening, we see strength in our business, but we also see strength in these urban store locations. Remember, I mentioned in the first quarter, our remote stores dramatically outperformed urban stores by almost 650 basis points. We're starting to see those urban markets start to improve as well. And so as Dave mentioned, there's a broad geographic positive double-digit performance that we're seeing.
And Joe can talk a little bit about the install piece.
Joseph McFarland:
Yes. So from the install piece, Marvin mentioned that our install heavy related categories for the quarter were significantly down, as referenced in our negative comps in kitchen and bath. As we have progressed through the quarter and looked week by week, we have a really robust dashboard that we look at that includes things like future leads. And so on the exterior installation projects, we're really seeing that business come back very, very quickly. So we're very pleased there. We are making progress on the interior projects, but that will be slow, and that will be tempered as our consumers feel more and more comfortable allowing our Pros in their home, our installers in their home.
Operator:
Our next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I have a follow-up for Dave and then on strategy, Marvin, I had one on that. Dave, just the $340 million that you did -- or $320 million on COVID, is any of that accrual that's something that, basically, you might get paid out later this year, like extra vacation? Or was that basically cost in the quarter? And then Martin, a follow-up.
David Denton:
It's largely cost in the quarter. There's always some accruals based on when things actually get paid. But largely, this is expenses that are incurred in Q1.
Gregory Melich:
Perfect. And you would -- and it sounds like you're comfortable if the leverage ratio falls from 2.7 down to 2. If results are strong, you want us to be more conservative on the balance sheet.
David Denton:
That's correct. If you look at our leverage ratio as we sit today, we're probably a little bit over 2.8 at this point in time. But if you net the cash that we have on our balance sheet, we're well below that. And I think just given the unprecedented environment we're operating, we're just going to be conservative here for a while until we kind of see how this plays out for the balance of the year.
Gregory Melich:
Makes total sense. And Marvin, you're talking about the digital surge and also how it's happening by geography and by even customer. Could you give us some more about the changes and improvements you're making in the multichannel experience and just any metrics around the customers that are using it that might be new or now behaving differently or more frequently since they use Lowes.com?
Marvin Ellison:
Well, what I can tell you, Greg, is that we're just pleased that the work that we put into stabilizing and modernizing Lowes.com is starting to pay dividends. As we mentioned in the last couple of calls back last year, the entire dot-com site was on a decade-old platform. And so we're in the process of transitioning that to Google Cloud, will be complete this quarter, but that allowed us to take on the demand. And what we're seeing is that customers simply want to shop the way that they choose to. And in the past, we couldn't accommodate that. Joe mentioned in his prepared comments, when we start to get request from customers for curbside, we put that up and going in 3 days. I mean this time last year, it would've been impossible to do that because we didn't have the infrastructure.
Bill Boltz and the merchant team has also done a really nice job of adding additional SKUs, and I'll let Bill talk about some of the work the merchants have done that has allowed us to drive the dot-com business and some of the future work that we have in place to drive dot-com for the balance of the year.
William Boltz:
Yes. This is Bill. So just a lot of work from the online team as well as the core merchants to get relevant SKUs online, relevant categories of product, in addition to being able to support the operation work that goes on inside the store. But along that, as I mentioned in my opening comments, the capabilities that the team is continuing to work on to enhance delivery operations, to schedule deliveries, to be able to shift from many of our locations, all of that work continuing to go and to be put in place through the balance of the year. So just lots of improvement that will continue to go on Lowes.com.
Marvin Ellison:
And Greg, the other point I make, I mean, I would say, roughly 90% of our dot-com sales are fulfilled or picked up at a store. And for us, that's significant because anytime the customer can pick it up at a store, that helps us to defer the cost of operating that platform. The good news is Lowes.com will only get better for the balance of the year. And as I mentioned, we're triple-digit growth in April. We're triple-digit growth month-to-date, and we can sustain that. And we're having improved functionality for the customer each and every week, and that's something that we're excited about the future.
Operator:
Our next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things. First of all, in terms of online, the pickup in store, fulfilled at store, I know you said that fulfilled from the store, but how much of this is getting delivered in the mail? And how much of it is getting picked up at the store? Can you just give us what that number was in the quarter?
Joseph McFarland:
Yes. So Greg, it's Joe. So just over 60% of our orders are picked up in store, and then the incremental is fulfilled primarily through store.
Eric Bosshard:
Okay. And then secondly, in terms of the promotion and merchandising strategy for 2Q, I guess, a question for Bill. The strategy around promotions and events for Memorial Day and Fourth of July, how are you planning on that? And then curious as you look back to how you manage the Spring Black Friday, the reduced effort to drive traffic, did you end up seeing -- or how material was the negative impact on sales from that and then bridge that to how you think about Memorial Day and July 4 as well?
Marvin Ellison:
Eric, this is Marvin. I'll take the Spring Black Friday, and I'll let Bill talk about Memorial Day and Q2. So when we look at Spring Black Friday, we received minimal incremental sales benefit from the event. Due to the distribution process of print media, we were unsuccessful in pulling the tap from distribution. But when we look at all other forms of media, all other traffic driving mechanisms for the event was pulled. So from that, the sales were minimal. And let me make sure, just for the broad audience, I define how we look at print media. Print is the least effective marketing medium that we have, and total sales contribution generated by print for Lowe's is 0.7%. So I know there was a lot of discussion that Spring Black Friday was a benefit to us in the quarter. But as I said, it was incrementally minimal at best.
In addition to that, as you know, we closed for Easter. And we were forecasting Easter to be a plus-$200 million day. And when Dave Denton, Joe McFarland, Bill Boltz and I sat down and made that decision to close, we had no idea at that time how we would make the sales up. But we felt like it was in the best interest of our associates and their families to give them a day off, and we would just take the financial hit, for lack of a better term, for that decision. But we felt like that it was simply culturally the right thing to do. So when we take then close for Easter, when we take full in all other traffic driving mechanisms for Spring Black Friday, both events turned into a negative environment from a sales perspective for us. So that kind of summarizes Easter and Spring Black Friday. And looking in the rearview mirror, I'll let Bill talk about Q2.
William Boltz:
Yes. Eric, in regards to the pricing strategy, as we've shared with you before, our intention has always been to change the pricing strategy at Lowe's and get to be more of an everyday competitive price program. And so that work really started a year ago. It continues into 2020. So as we look at Memorial Day, Memorial Day is going to be very consistent to how we operated in Q1. And as we get into the back half of Q2, with July 4 and Father's Day, we'll get, again, trying to implement the pieces and the place, the pricing strategy, more of a normal cadence from being relevant for dad and being relevant for the holiday on July 4. So that's how we're going to approach the quarter.
Marvin Ellison:
And Eric, the last point I'll make, and I think Dave will close the comment is, I mean, at the end of the day, we want to be a value-oriented retailer. But we don't want to be promotional. I think that's what just a point that Bill has said from his very first day here. So you may not see us using traffic driving media to get incremental footsteps in the store in this unique environment that we're operating in, but when the customers come in, we want them to see a value on the shelf because if there is a time that you ever needed a value for customers, this is one of those times. But we will be very cognizant and conscious of not driving traffic in an environment where that may put people at risk. And that's something that we're going to balance really well.
David Denton:
Yes. And to Marvin's point, obviously, we -- our stores, there's a lot of value in our stores, the items that we sell. And if you just look in the rearview mirror, you look at the number of items that we promoted this year versus the number of items that we sold on promotion last year, we're down about 24%.
Operator:
Our next question comes from the line of Kate McShane with Goldman Sachs.
Katharine McShane:
I just wondered, with regards to customer acquisition, do you have an idea of how any newly acquired customers broke down between DIY and Pro during the first quarter? And have you seen repeat purchasing from these customers?
Marvin Ellison:
Kate, this is Marvin. That's a really good question. What I will tell you is that this was such a unique quarter, and we were so focused on, first and foremost, making sure that we were looking into the health and safety of our associates and our customers. That is not a dataset that we spend a ton of time looking at. Candidly, as I said in my prepared comments, the moment we started to address the challenges of COVID-19 for our associates and customers, we became less focused on the financial performance of the company, and we became more focused on trying to provide the essential products that our customers and communities needed. I'm sure we can get that data, and we can probably share. I'm sure Investor Relations team can get it for you, but we were just so focused on just trying to run this business, serve our customers, serve our communities and keep our associates safe. But there are a lot of datasets we didn't pay a lot of attention to this quarter.
Katharine McShane:
Okay. And just as a follow-up and unrelated. I realize comps are very, very strong, but are you still seeing the stronger trends in the best -- the better and best categories versus the good categories? And have there any been -- any signs of trade-down by the Pro?
Marvin Ellison:
No. Average ticket remains strong. We have seen no trade-down. Our customer segment has been surprisingly resilient. And as I stated earlier, customers have rediscovered Lowe's. We know that for a fact. But again, patterns have been strong. They've been very consistent. And we're continuing, as you can imagine, to track it on a day-by-day, hour-by-hour basis, so we can make the necessary adjustment.
Operator:
Our final question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So 2 margin questions. First, Dave, on the gross margin, up 150 year-over-year. You think about the lower promotions and the mix benefit, how did the underlying expansion play out relative to your plan? And then in an environment, hypothetically, where the category goes flat or, let's say, down low single digits in the back half of the year because the recession lingers longer, how do you think about SG&A dollar growth or payroll deleverage in that sort of environment given the strong flexibility that you've shown over the past 18 months?
David Denton:
Sure. So I'll take gross margin. I'll flip to Joe to talk a bit about SG&A. I think, obviously, from a gross margin perspective, is my -- in my prepared comments, we made really nice progress. I think maybe the best way to look at it is in February. So when we entered the year, we were actively running our playbook. We had work between finance and merchandising to improve our cost complement, to partner more deeply with vendors, to manage our promotional cadence more effectively. And I think we're largely hitting in -- hitting our plan, if not, probably a little bit in advance of our plan as we went into February. Obviously, we got turbocharged a bit from a gross margin expansion perspective due to COVID in the back half of the quarter, but I feel like the underlying elements that we had put in place are driving really solid performance there. We still have work to do. We're not done. This is a marathon, not a sprint. But I think we have the right pieces together to play out and improve our margin performance, both in the short term but the long term.
And maybe I'll flip it to Joe to talk a bit about SG&A.
Joseph McFarland:
Yes. Thanks, Chris. So from an SG&A standpoint, the team did a really nice job in Q1, obviously, as Dave had mentioned. And as we look forward, it would be continued strong sales. We have a rule of thumb based on sales outperformance and payroll leverage. But in addition, the hard work that the ops team has done, putting new engineered labor standards in, the labor engine that the team built, the mix between ticket and transactions, and we're very confident in our ability to continue to leverage on SG&A.
David Denton:
Great. Thank you very much for calling in today and talking about Lowe's. Please stay safe and healthy.
Operator:
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.
Operator:
Good morning, everyone. And welcome to the Lowe's Companies' Fourth Quarter 2019 Earnings Conference Call. This call is being recorded. [Operator Instructions] Also, supplemental reference materials 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. These supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Good morning, everyone. In 2019, we made significant progress in transforming our company. While we're only 1 year into a multiyear transformation, we're confident that we're on the right path to capitalize on solid demand in a healthy home improvement market and generate long-term profitable growth.
I'll now take a moment to discuss our fourth quarter results. For the quarter, total company comp sales grew 2.5%. Our U.S. home improvement comps were a positive 2.6%. Our U.S. monthly comps were a negative 0.7% in November, positive 6.2% in December and a positive 2.1% in January. However, when you normalize for Black Friday holiday shift from 2018, our U.S. monthly comps were relatively balanced with growth of positive 2.8% in November, positive 2.9% in December and positive 2.1% in January.
While our monthly comps are relatively balanced, Q4 sales were softer than our expectations. This stems from 3 factors:
First, we did not optimize our marketing execution to align with the compressed holiday season. Our November holiday marketing activity was concentrated closer to Black Friday. And as a result, we didn't fully capitalize on demand for appliances and other key holiday categories earlier in the month.
Second, in Q4, we were lapping the exit of our Project Specialist Interior, or PSI, program in the prior year, which pressured install sales growth more than we anticipated during the quarter. And finally, as we discussed, Lowes.com is still under construction. As customers increasingly utilize online shopping options for convenience and efficiency in the shorter holiday selling season, Lowes.com lagged market growth, delivering comp growth of approximately 3% for the quarter. Let me remind you, at the beginning of 2019, Lowes.com was sitting on a decade-old platform. And although we're in the process of replatforming the entire site to Google Cloud, that work will not be completed until Q2. The good news is for Lowes.com, we know exactly what our issues are, and we have temporarily slowed our dot-com growth to resolve those issues. We recruited a very experienced and talented team, and we have a detailed project road map to modernize our website. We expect to see a trajectory change in this business in the second half of 2020, which we are very excited about. While our e-commerce business is under repair, I'm very pleased with the strength and productivity of our brick-and-mortar stores. There are very few large retailers in America delivering a 2.6% comparable almost exclusively from their brick-and-mortar stores. This underscores the sales productivity improvement of our physical stores and our opportunity to unlock additional growth when Lowes.com sales accelerate. One of the key strategic steps to improving Lowes.com is the transformation of our supply chain. Consequently, we're also investing $1.7 billion in our supply chain over a 5-year period. And in 2019, we opened 3 new bulk distribution facilities and 4 new cross-dock terminals. I look forward to updating you on our ongoing improvements of Lowes.com and our supply chain on future calls. Let me now take a moment and discuss the drivers of our sales growth in the fourth quarter. Our focus on pro continues to be a catalyst for our U.S. sales growth, with our pro comps outpacing DIY in the fourth quarter. Our commitment to implementing retail fundamentals in 2019 has paid dividends in our pro business. We're seeing compounding benefits from our investments in job lot quantities, department supervisors and our improved in-store experience. These investments not only drove improved trends in pro comp sales, they also drove a 400 basis point improvement in pro customer service scores in the fourth quarter. As Joe will detail, in 2020, we are transitioning to a more strategic investment for our pro customers, such as designated loyalty in CRM programs to advance the pro experience and drive future growth with this critical customer. Our success focusing on retail fundamentals is also evident as we again drove strong sales performance in merchandising departments that have historically underperformed. Bill will add additional insight on our merchandising performance shortly. From a geographic perspective, we saw consistent growth across the business, with all 3 U.S. divisions and 14 of 15 U.S. geographic regions generating positive comps. And during the fourth quarter, regions that outperformed the total company comps were Atlanta, Baltimore, Dallas, Houston, Nashville and St. Louis. And once again, the West was our top-performing geographic division. Turning to Canada. In the fourth quarter, we posted comp sales that were slightly negative in local currency. As we outlined on our third quarter earnings call, we're making foundational changes to improve execution and deliver long-term improved profitability in Canada. The initiatives we laid out as part of our strategic reassessment remain on track, including closing 34 underperforming stores, rationalizing SKUs to present a more coordinated assortment to the customer across our banners, reorganizing our corporate support structure across Canada to more efficiently serve our stores and migrating Canada to a U.S. IT platform to eliminate inefficiencies and unnecessary technology duplication. We've also implemented key leadership changes in Canada. Last month, Tony Hurst was appointed President of Lowe's Canada. Tony is a strong and accomplished leader with more than 25 years of retail and home improvement leadership experience. And during the fourth quarter, we also appointed Chris West as our Senior Vice President of Merchandising in Canada. Chris has over 20 years of experience in retail merchandising and is excited to return home to Montréal. We remain confident in the long-term potential of our Canadian business, and I know that Tony and Chris are the right people to lead Lowe's Canada into this exciting new chapter for our customers and associates. Despite pressure from lower-than-expected comparable sales growth in the fourth quarter, we delivered adjusted diluted earnings per share of $0.94, which exceeded expectations, supported by improved gross margin trends, enhanced process execution and strong expense management.
Turning to 2020. We're pleased to enter the year from a position of strength as we look to build upon the strong foundation we established in 2019. We expect to capitalize on a supportive macroeconomic environment by executing on our 4 strategic areas of focus:
driving merchandising excellence, transforming our supply chain, delivering operational efficiency and intensifying customer engagement by focusing on the pro. Our improved Lowes.com platform will allow these 4 strategic areas of focus to create a true omnichannel ecosystem for Lowe's so we can efficiently serve our customers any way they choose to shop. And our intense focus on retail fundamentals, combined with improving systems and technology, will continue to pay dividends across the business in 2020.
And in closing, I'd like to take a moment to thank our associates for their hard work and commitment to serving our customers and our communities. I spent quite a bit of my time in stores, and our associates continue to demonstrate that they are the cornerstone of our current and future success. We're looking forward to a great 2020. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 2.6% in the fourth quarter. We are especially pleased with these results when you consider that our Q4 comp sales were driven almost exclusively by our brick-and-mortar locations. We continued to see strong customer demand, and our stores executed very well, delivering a strong Black Friday event. However, as Marvin indicated, our November marketing cadence didn't fully capture expected sales early in the compressed holiday period.
Turning to our merchandising department performance for the quarter. We delivered above-average comps in appliances, decor, hardware, lawn and garden, lumber and building materials, millwork, paint and tools. We continue to be pleased with our paint business as it outperformed the company average again this quarter. As we continue to grow our paint business, we will continue to work closely with our suppliers to introduce an improved pro paint offering to better serve the repair/remodelers who need paint to complete a larger project, such as a kitchen or bathroom remodel. After previously performing below the company average for years, in Q4, decor performed above the company average for the third consecutive quarter with double-digit comp growth, supported by strength in home decor, blinds and shades and home organization. In Q4, our millwork business remained strong and outperformed the company average, driven by our strength in doors and windows along with our garage door opener program, where we are the only retailer to carry the top 3 brands of garage door openers in Chamberlain, Genie and CRAFTSMAN. The traction that we've built in these departments is a clear indication that the implementation of our retail fundamentals has been effective, and we look forward to taking this momentum into 2020. In tools, we are still seeing a strong customer response to our CRAFTSMAN offering. We continue to leverage this iconic brand in our home center channel exclusivity to drive market share gains within key tool categories. We also continue to gain traction within our key programs with our exclusive DEWALT 12-volt compact line of power tools, which delivers more power in a smaller and lightweight tool. We are also proud to announce an extension to our DEWALT power tool program with the launch of the new 20V MAX XR power tools with the power detect system in the first quarter, another home center channel exclusive. These tools are optimized to deliver more power than their predecessors, giving pros better performance to complete their jobs. In addition, we'll also continue to leverage new and innovative products from Bosch, Lufkin, Spyder, Metabo HPT and Kobalt to provide customers with an outstanding lineup of tool options. As Marvin mentioned, in appliances, despite performance below our expectations in November, we drove comps above the company average in the quarter, leveraging our position as the leading appliance retailer in the U.S. with our best-in-class appliance offerings, along with great values and special buys. We also delivered comps above the company average in lawn and garden with double-digit comps in live goods, fertilizer and landscape products, benefiting from an improved in-stock position and warmer-than-average temperatures. And lastly, we posted comps above the company average in lumber and building materials, supported by strong pro comps and warmer weather. Looking ahead, we are very excited about our plans and entered the year with a strong foundation in our stores. Our Merchandising Service Teams, or MSTs, have improved our merchandising reset execution and day-to-day bay and endcap maintenance at the store level, delivering a better shopping experience for our customer and taking time-consuming tasks off the shoulders of our red vest associates. We plan to build on this strength by adding approximately 7,000 additional vendor-funded MSTs to our stores in the first half of 2020. We'll also leverage our field merchandising team to drive customized assortments at the store level and improve our space productivity. In Q4, we made improvements to our store environment, optimizing our layout on a critically important seasonal pad at the front of our stores. This reset activity opens up additional square footage of selling space, which we'll use for additional seasonal selling areas in flex space in this strategic location to improve our sales velocity. Our upcoming spring sets will ensure that products typically used together to complete a project are now located in the same aisle to make it easier for the customer to efficiently shop their whole project. Also in the first half of the year, we'll complete the rollout of our new signage and way-finding package. This will provide all of our stores with an updated signage and way-finding for the first time in over 15 years. In our pilot stores, customer surveys showed that this new package improve the customer experience, make it easier and faster for customers to locate products. We have a number of exciting brand introductions in 2020. We are one of the first retailers to introduce the new Weber SmokeFire Pellet Grill. Weber's pellet grill is their initial entry into this fast-growing category and is built to let grill users discover what's possible with pellet grilling. And we are proud to partner with Weber to introduce this exciting new product. Within our seasonal and outdoor living business, we are excited to build on our strength in outdoor power equipment with the introduction of Honda outdoor power products. After many years, we are extremely excited to be able to offer this brand as part of the Lowe's outdoor power equipment assortment. The categories will be available both in-store and on Lowes.com and will include walk-behind lawnmowers, generators, snow blowers, tillers, pumps and trimmers for both residential and commercial projects. In addition to adding Honda, we will also be adding the Ariens brand of zero-turn mowers to our outdoor power lineup, which currently includes John Deere, Husqvarna and CRAFTSMAN. These 2 new brands further strengthen Lowe's position as the #1 destination for outdoor power equipment in the U.S. We are also excited to continue our national home center rollout of YETI, a leader in coolers, equipment and drinkware. Our expanded product offering highlights our commitment to providing our customers with relevant, innovative, best-in-class products. I look forward to sharing additional brand introduction news with you throughout the year. And in closing, we are very pleased with the progress we've made against our strategic objective of delivering merchandising excellence. We entered 2020 in a position superior to last year, and we're excited to take our positive momentum into the all-important spring season. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. In 2019, we focused on improving our customer service, investing in our in-stock position, driving efficiency in our store operations and advancing our pro service model. Our strategic initiatives not only drove top line growth but also positioned us for success in 2020 and beyond.
We are pleased that this quarter marked our fourth straight quarter of improved customer service scores combined with payroll leverage. This is evidence of our strong commitment to operational efficiency and focus on the customer. We continue to be pleased with our associate engagement as we undertake changes to better serve customers. For example, our annual employee engagement survey showed strength versus retail benchmarks in multiple key engagement measures. As a result of the improved internal and external brand reputation of the company, we have also been very pleased with our ability to recruit seasonal employees for spring. We are ahead of our target in recruiting efforts, which is a testament to our position as a preferred employer. In the third quarter of 2019, we completed the national rollout of our new customer-centric scheduling system. Our new labor scheduling system allows us to provide better department coverage and customer service while ensuring that we're using our payroll efficiently. We have also layered on scheduling effectiveness tools that measure schedule efficiency all the way down to the store and department level. These advancements allow us to align our payroll hours with peak customer traffic and customize that allocation at the store and department level. For example, under previous system, a DIY-heavy store in Dayton, Ohio had the same payroll scheduling framework as a pro-heavy store in Brooklyn. Our customer-centric scheduling system now allocates more associate hours to the weekend in the Dayton, Ohio store while allocating more hours to pro-centric departments on weekdays in Brooklyn, allowing us to provide better customer service while driving payroll efficiency. As a reminder, in early 2019, we deployed new mobile devices to our store associates called smartphones. Throughout the year, we added applications to the devices such as standardized performance scorecards; store-walk applications; and most recently, a new pricing application. This functionality made our associates more efficient and ultimately allowed them to spend more time interacting with customers. Our investments in store process and technology paid off in 2019, driving strong payroll leverage for the fourth quarter and the fiscal year, all while improving our customer service scores by 500 basis points year-to-date. This payroll leverage, combined with improved customer service scores, demonstrates our ability to reengineer our labor model while advancing the customer experience. We began 2019 with 60% of our payroll hours spent on tasking and 40% spent on service. We ended the year with 48% of payroll hours spent on tasking and 52% serving the customer. This represents a significant step forward in putting associate time back in front of the customers. These advancements will continue to deliver benefits in 2020, and we plan to build on these accomplishments to deliver additional improvements in customer service and drive more efficiency in our stores. In the first half of 2020, we will deploy a centralized return-to-vendor process, which will further reduce tasking, limit product damage and free up additional space in our stores. We will also roll out our new point-of-sale system in the first half of the year. Our previous point-of-sale systems were extremely outdated with an old green screen that was very difficult to navigate. Additionally, our associates had to toggle between multiple systems to sell product. For example, if an associate sold an appliance with home delivery and an extended protection plan, they previously had to interact with as many as 6 systems to complete that transaction. Our new point-of-sale system has a user-friendly touchscreen interface that will bring multiple systems together in one screen. This will greatly simplify the work of our cashiers, driving payroll efficiency by reducing training time and allowing for a much improved customer experience at checkout. In 2020, we plan to reinvest some of those savings from our process and technology efficiency in nearly 2,000 additional leadership roles in our stores. This includes 650 additional pro supervisors to drive incremental improvements in customers' experience. Moving to our pro business. As Marvin indicated, we were very pleased with our pro performance in Q4, as the pro continues to demonstrate their willingness to shop with Lowe's when we provide them with the right products and great service. In 2019, our pro strategy was primarily focused on improving retail fundamentals, such as job lot quantities, improved service levels, dedicated loaders, pro department supervisors and consistent volume pricing. In Q4, we continued this progress with the addition of dedicated point-of-sale terminals at our pro desk to allow for more convenient, fast service. Our commitment to retail basics drove strong pro comps and significant improvement in customer service scores in Q4. Although we're pleased with our pro performance in 2019, we are now transitioning from retail basics to more strategic initiatives for the pro. In the first half of 2020, we will launch our pro loyalty program nationally, integrated with a CRM program which will allow us to deploy more surgical, strategic marketing to the pro and expand our share of wallet through suggestive selling and improved account management. We are confident that our partnership with Salesforce.com will allow us to build a best-in-class platform to better serve our pros. All of these pro-centric initiatives reinforce the importance of the pro customer to Lowe's. We are encouraged by our 2019 successes and once again applaud our associates' commitment to our mission. We're excited about our future and focused on the work ahead to capture the opportunity in front of us. Thank you, and I'll now turn the call over to Dave.
David Denton:
Thanks, Joe, and good morning, everyone. Before reviewing the underlying operating performance of the business, I'd like to take a moment to discuss the previously announced restructuring of our Canadian operations and the associated fourth quarter financial impacts. During the quarter, we completed 28 store closures, with the remaining 6 planned closures completed earlier this month. Additionally, we completed the inventory rationalization activities in our remaining Canadian locations in support of our banner simplification strategies. As a result of the Canadian restructuring activities and the final closure of our remaining business in Mexico, we incurred pretax operating costs and charges of $185 million in the fourth quarter.
I'll now turn to a review of our operating performance, beginning with our strong capital allocation program. In fiscal 2019, we returned over $5.9 billion to our shareholders through a combination of both dividends and share repurchases. In the fourth quarter alone, we paid $423 million in dividends, and our dividend payout ratio currently stands at 36% over the trailing 4 quarters. We also repurchased approximately 5.7 million shares for $670 million through the open market, which brings us to nearly $4.3 billion in share repurchases for the year. We have approximately $9.7 billion remaining on our share repurchase authorization. And importantly, we continue to invest in our core business with capital expenditures of approximately $557 million in the fourth quarter and almost $1.5 billion for the full year. In 2019, we generated over $2.8 billion in free cash flow. Now turning to the income statement. In Q4, we generated GAAP diluted earnings per share of $0.66. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. In Q4, we delivered adjusted diluted earnings per share of $0.94, an increase of 17.5% compared to adjusted diluted earnings per share of last year. The strong performance exceeded expectations due in large part to improving gross margin trends and solid expense management. Sales for the fourth quarter increased 2.4% on a GAAP basis to over $16 billion. Consolidated comp sales were 2.5%, driven by an average ticket increase of 3%, partially offset by a transaction decrease of 0.5%. The decline in comp transactions was isolated to smaller-ticket purchases as warmer weather exerted pressure on small-ticket seasonal items, such as ice melt and pellet fuel. The comparison to our accelerated holiday clearance activity in the prior year also pressured transactions. When normalizing for these items, comp transactions were flat for the fourth quarter. U.S. comp sales growth was 2.6% for Q4. During the quarter, the net effect of cycling previous hurricanes was a drag of approximately 80 basis points on comp sales, while weather in the quarter provided a modest 20 basis points of benefit. We saw less impact from commodity deflation this quarter with a negative impact of approximately 15 basis points on comp sales. Adjusted gross margin for the fourth quarter was 31.9% of sales, an increase of 40 basis points from Q4 of last year. We are very pleased with the compounding benefits from the actions we've taken to improve our gross margin performance, including the implementation of a more dynamic and strategic pricing program, a pivot to more strategic and targeted promotions, greater vendor partnership for key promotional activities and continued aggressive product cost management. This quarter, we experienced approximately 55 basis points of total rate improvement offset by 15 basis points of pressure from product mix. Our rate improvement was driven by actions to improve gross margin, which drove approximately 105 basis points of benefit, which was partially offset by 25 basis points of pressure from supply chain cost and 25 basis points of pressure from inventory shrink. Adjusted SG&A for Q4 was 22.7% of sales, which levered 27 basis points, driven primarily by payroll leverage, which was partially offset by strategic investments in the business. Adjusted operating income increased 70 basis points to 7.2% of sales. The adjusted effective tax rate was 24.7% compared to 24.3% last year. At $13.2 billion, inventory increased $618 million or 4.9% versus the fourth quarter of LY, but decreased more than $1.8 billion versus Q1. The year-over-year increase was driven by strategic investments in the first half of the year to drive sales, such as CRAFTSMAN resets, increased presentation minimums and investments in job lot quantities for the pro. In the second half of the year, we invested in inventory to support an earlier spring load-in for the Southern markets and capture early seasonal demand for 2020. Looking ahead, I'd like to discuss our 2020 guidance and our business outlook. On providing the outlook today on an adjusted basis versus 2019, we expect that we will incur minor pretax operating costs and charges related to our Canadian restructuring into 2020. These charges are excluded from our adjusted 2020 business outlook. We expect that a constructive macroeconomic environment in the U.S. will continue to support our healthy growth in 2020. A strong consumer, low interest rates, a healthy housing sector and aging housing stock provide support for continued growth in home improvement spending. Turning to our financial guidance in 2020. We expect to drive strong sales through our brick-and-mortar locations. As we complete the foundational work to improve our e-commerce platform, we are planning for Lowes.com sales to steadily improve in the second half of the year, reaching high single-digit growth, which will provide modest contribution to sales growth. For 2020, we expect a total sales increase of approximately 2.5% to 3% driven by a comp sales increase of 3% to 3.5%. When considering the cadence of the year, we expect comp sales for the first half of the year to be slightly lower than the second half based on the anticipated timing of benefits from our strategic initiatives. Consolidated adjusted operating income is expected to increase approximately 8% to 12% in 2020 versus LY, with adjusted operating margins increasing approximately 50 to 70 basis points. For the year, adjusted depreciation and amortization is expected to deleverage approximately 10 basis points, driven primarily by increased investments in our store facilities and technology. We expect that gross margin and SG&A will provide equal contributions to adjusted operating margin expansion for the year. However, in Q1, we expect gross margin improvement versus the prior year to be elevated as we cycle the first cost pressure we experienced in Q1 of '19. We also expect that adjusted SG&A margin will be essentially flat in Q1 as we cycle over benefits from lease assignments and terminations in the prior year. We anticipate similar levels of adjusted operating margin expansion for the first and second halves of the year. Furthermore, we expect that the Lowe's U.S. operations will drive solid operating income performance, while the Canadian business will continue to mute overall operating profit performance throughout 2020. The effective tax rate and adjusted effective tax rate are expected to be approximately 24.5%. Additionally, our guidance assumes approximately $5 billion in share repurchases throughout 2020 and a targeted leverage ratio of 2.75x. Now with solid growth of approximately 8% to 12% in adjusted operating income, coupled with our $5 billion share repurchase program, we expect adjusted diluted earnings per share will grow approximately 12% to 16% to $6.45 to $6.65 per share. Strong sales and expanding margins are expected to generate $6.5 billion of cash flow from operations. We expect modest working capital benefits of approximately $300 million. Our plan in 2020 assumes our inventory level remain elevated as we implement enhanced tools to drive long-term inventory productivity. In the short term, we are focused on ensuring we have appropriate in-stock levels to support our pro and DIY customers. We are planning for capital expenditures of approximately $1.6 billion in 2020, and we will continue to look for investment areas to enhance the business over the long term. We estimate that free cash flow will be approximately $4.9 billion. In closing, we remain excited about the future of our business and its ability to deliver significant shareholder value over the long term. With that, we're now ready for questions.
Operator:
[Operator Instructions]
Our first question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I guess 2 areas I'd love to learn some more about. One, Dave, if you think about the margin outlook for this year, I want to make sure I got that right, Canada will continue to mute OI all through 2020. Is that on a year-over-year basis? Or is that on an absolute dollar basis that is still pressuring profitability?
David Denton:
On an absolute basis.
Gregory Melich:
On absolute basis. So year-over-year, though, it could still help -- the restructuring actions could make it better than last year?
David Denton:
Yes. It is our expectation that Canada will get a little better next year in 2020.
Gregory Melich:
For the whole company. Got it. And then maybe a little bit more on the dot-com rollout and sort of the timing and expected lift from that. Could you give us a little more detail on what you really expect to get from a customer standpoint once we're up to Google Cloud in terms of the number of SKUs that will be on offer or how it'll help you run the integrated business with BOPIS? Just a little bit more about what will change once it's up and running in the second quarter to help us understand that acceleration you expect.
Marvin Ellison:
Greg, this is Marvin. So we're excited about the work on Lowes.com. But as we noted in the prepared comments, the 3% growth underperformed any large brick-and-mortar retailer trying to create an omnichannel environment. So as we replatform the entire site to Google Cloud, that will happen in the Q2 time period. We'll have additional phases and additional initiatives being added throughout the year so there is no one big grand unveil. There will be phases of improvements throughout the year. But we're estimating, in Q3 we'll start to see benefits and the customers will begin to become aware of the improved functionality.
Let me give you a perspective of what we're doing over the course of this time frame. We're going to decouple freight from product costs. Today, we still have a competitive disadvantage that our retails look artificially inflated because many of them have freight included. We're changing that. We're going to be able to expand our online assortment. Today, it takes, in some cases, weeks and months to add drop-ship SKUs on our site because it's very manageable. And so we're creating a more digital process to do that. We'll have that ready in the second half of the year. Today, we don't have the ability to shop by collection. As an example, if you're purchasing patio furniture, it's a very cumbersome process, where a customer will have to shop on one screen for their table, they have to toggle to another screen for the umbrella, another screen for the chair. It is not very customer-friendly. We'll be able to get that done in this first part or the second half of the year. And believe it or not, with our market-leading position in appliances, it's still difficult to schedule a delivery date with the precision that most customers are accustomed to. And so we'll have that up and going by the second half. So those are just fundamental things in addition to one-click checkout, in addition to dynamic home page, in addition to navigation and search functionality that's more modernized. And so the reason why we're optimistic that this platform is going to be accretive starting in the second half is because we can look at the project time line and see all these things coming online over the course of the year.
Operator:
Our next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
I guess just given the most difficult comparison of the year coming up here in the first quarter, how are you thinking about Q1 in the context of that 3%, 3.5% full year guidance? And if you could just help us with some of the drivers that you think will help navigate these difficult compares here in the spring. Obviously, lapping a lot of inventory growth, much better in-stock last year versus the prior year. Just help us think about first quarter.
David Denton:
Yes. So this is Dave. So maybe I'll kick it off, and then Marvin will pick up here. Just as you know, we don't really guide specifically to the quarter just -- particularly in the first half of the year given the -- when the weather breaks from a spring perspective. I will say, if you look at first half versus second half, I would expect that the first half from a comp perspective to be slightly lower than the second half of the year as our strategic initiatives begin to take hold through the balance of the year and really start to pay off in the second half of 2020.
Marvin Ellison:
So Seth, relative to what will be our sales drivers, we have a very robust list of merchandising and pro initiatives that will be incremental. And we have initiatives that we will get full year benefit for things like the Merchandise Service Teams and field margins. So I'm going to hand it over to Bill to highlight some of the key merchandising initiatives that we believe will drive incremental sales in Q1, then I'll let Joe touch on some of the additional initiatives in pro. So Bill?
William Boltz:
Yes. I think in addition to the MST team and the field merchant team, we also have the first full year of our merchants being in the seat, which is a big deal for us. And then as I said in my prepared remarks, we're very excited about introducing Honda outdoor power, bringing in the Ariens line of zero-turn. We've got the first full year of CRAFTSMAN. If you think about that, we didn't finish the CRAFTSMAN rollout until midyear of 2019.
We've got a bunch of new products that we're introducing in our private brands in Kobalt and allen + roth. I touched on the new pro stuff coming out of DEWALT, the new products from Weber, YETI. We've got new fastener brands with FastenMaster and GRK. We've got Miracle-Gro, a live goods product that we're introducing in our live goods program. And then you think about all the changes that we've made in-store in 2019 that we're going to have in place for full year, our endcap strategy completely changed in 2019 as did our off-shelf strategy. We implemented a cross-merchandising program that rolled out in the fourth quarter of last year. We finished Phase 1 of our refresh work, and we've just tackled some really valuable retail space up in the front of the store that we'll be able to execute and use for the spring season. And as Marvin touched on with Lowes.com, albeit early and a lot of things going on, we now have the ability to ship battery-powered products. We have the ability to ship oversized products. We have easier checkout and navigation experience. We've got a more enhanced home page. So there's a ton of things that are in front of us that we've got that lay out what's going to happen in 2020.
Joseph McFarland:
And look, we're also really excited about 2020 in our pro business. If you think about what Marvin mentioned in the prepared remarks as well as I did, 2019 was all about fundamentals. It was on staffing. It was on services. As we move into 2020, we're now going to lap the investments that we made in 2019, as we made these investments to pro customers, it'll take them some time to start to catch on. And as we continue to see the pro business get better and better, but that was all on fundamentals in '19.
We've been testing our new pro loyalty platform, the pro customers' overwhelming excitement about the benefits they're going to have from there. As we think about personalized offers, as we think about being able to track spending, as we think about business management tools for the pro, none of that was ever available. The -- our "support program exclusive for pros." So really excited about all the things we're rolling out from a pro standpoint. In 2020, we'll continue to capture market share and gain traction.
Marvin Ellison:
So Seth, just in conclusion on Q1, we have a lot of confidence in the growth of the business based on these specific initiatives that we have in place and how we built our business plans from the bottom-up for really the first time based on the expectations of these initiatives. We just have to go out and execute, and that's the expectation going into 2020.
Operator:
Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Scot Ciccarelli. So system upgrades always sound like a great idea and provide a lot more speed and flexibility. However, making the changes themselves are often cumbersome and filled with risks. So especially given, let's call it, some of the issues you guys faced in the first quarter of 2019, how do you make sure you guys don't kind of stub your toe as you implement all these different system upgrades?
Marvin Ellison:
Okay. Thanks. A fair question. And the thing that we've tried not to do is set aggressive financial targets based on the implementation or delivery of a system. And so if you think about the list of things that you just heard from Joe and Bill on where we believe we're going to gain our sales benefit in Q1 and the first half of the year, there was no system dependencies listed. We have some big system things coming, and I can give you a list of those. But other than what we're expecting from e-commerce, there's really no big dependency on systems.
And look, this is a big business. It's a complicated business. But we are just very pleased that we have a group of leaders that have been in their roles for a full calendar year, to Bill's point, and that creates more continuity than we've had here in a while. So always a risk, but we think the risk is muted because we don't have high dependencies.
David Denton:
And Scot, this is Dave. I'll just add a couple of things. One is we're rolling out these systems in waves. So we're putting them in not in a big bang but over time, number one. And number two, we have a very robust piloting and testing program such that we're out in the field, either here in the corporate office or out in the stores, running them in a certain market or location to make sure that the functionality is adequate before we roll it out completely to the store environment.
Scot Ciccarelli:
That's really helpful. And then just a quick -- hopefully, a quick follow-up here. Payables inventory has been down a little bit for the last couple of quarters here. Does that start to stabilize as we roll into 2020, Dave?
David Denton:
Yes. I would expect that our inventories are going to stabilize through 2020. We do think, over time, we have the opportunity to reduce inventories in a major way. However, we're still building the systems and processes to be able to do that in a very systemic fashion. So think about 2020 as a point in time where we will be stable, making sure that we have the right inventory in the stores to support job lot quantities for the pro and support our in-stock environment, but not a big year which will yield performance from an inventory reduction perspective.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
So there was an execution mishap in the first quarter of last year. There was an execution mishap in the fourth quarter. Marvin, you've been involved in some very sizable retailers. Is Lowe's just more prone to these types of execution issues? And at what point in the transformation can we expect to see more consistent and sustainable execution? And then I have a follow-up.
Marvin Ellison:
Mike, I think it's a fair question. Look, in any large business, you're going to have execution risks. But for us, coming out of Q4, it's really more about understanding the competitive marketplace and having the agility to react to it. And when you have limited system capabilities, it really creates agility limitations. And what I mean by that is when we came to the conclusion for marketing spend that we were not where we needed to be relative to the quarter, we just didn't have the sophistication or the agility to pivot as quickly as we needed to.
That is more related to internal capabilities than execution issues. Look, there are always going to be execution issues no matter how good you are as a business. What I can tell you is 1 year into this multiyear transformation, I feel great about this team. I feel great about what we've accomplished. I feel great about 2019. And we have a significant amount of confidence going into 2020. But yes, there will always be execution risk. We'll always hold ourselves to a high standard, but I feel really good about how we executed throughout the quarter, even though it wasn't perfection.
Michael Lasser:
That's very helpful. And part of the question comes from the fact that you will be lapping some big inventory buildup in the first quarter, which could create some noise as you have to lap that. So the view is that execution will improve. Is that fair?
Marvin Ellison:
No. It's absolutely fair. And look, I'll go back to a couple of comments that's already been stated. First, the value of having leaders in their position for a full year seeing every seasonal cycle is critically important in merchandising, in store operations, in finance and in supply chain, so -- and we have that, and clarity of what we're trying to get accomplished and having just better tools and resources available. So we feel really good about our execution. If you think about for a second, we're able to roll out an entire new scheduling and labor management system. We're able to leverage expenses, improve service, improve our margin rate coming off of a tough Q1 throughout the year. So we think our execution really picked up significantly throughout the year, and we think we'll carry that momentum into 2020.
Michael Lasser:
And a quick follow-up for Dave. It looks like your gross margin guidance for 2020 is pointing to a 32 spot 3% gross margin at the midpoint, which would suggest you won't recoup everything that you lost in the first half of 2019. Why wouldn't you get it all back, particularly in light of what seems to be some steady gross margin progress in the fourth quarter?
David Denton:
Yes. Really excellent question. As I said in my prepared remarks, we expect a 50 to 70 basis point expansion in OI in 2020 with an equal contribution both from gross margin and SG&A leverage. And if you look at that, we expect that during 2020, we will achieve rate neutrality versus our rebase line level on a like-for-like product gross margin level. We will then incur some additional pressure from both supply chain and shrink. So those are the -- that's what's kind of dragging us down a little bit as we cycle into 2020, and we're working to offset those longer term. But I feel really good about the progress we're making in 2020. We're getting back to that neutrality level. Now we're trying to cycle over those investment areas.
Operator:
Our next question comes from the line of Chuck Grom with Gordon Haskett.
Charles Grom:
A lot of good things going on with pro. Just wondering if you could just update where you are, penetration at this point in time and where you think it could go over the next couple of years.
Marvin Ellison:
So Chuck, this is Marvin. Our penetration hasn't materially changed from what we called out earlier in '19, and we'll call it between 20% and 25%. We have intentionally not set a penetration target because we believe setting an artificial target could lead us to be focused on something other than what's in the best interest of the customer. What we're trying to do is be a very customer-centric organization in how we think.
Now Joe outlined in his prepared comments some key things that we're doing relative to pro loyalty in CRM. Do we have an expectation that we're going to see our pro penetration pick up in 2020? Absolutely. We haven't set a target, but we do have expectations on what we're going to be able to generate from new customers, average ticket, growth, frequency of visits because we're going to know this customer intimately based on having real data and not based on intuition. So that's a long-winded way of saying penetration is about the same and we are not setting targets, but we have an expectation we're going to grow the business in 2020.
Joseph McFarland:
And I think it's important to just realize, 2019, we focused on all of the kind of basics. And so as we roll into 2020, as I mentioned pro loyalty, we have also focused on our pro outside sales with strategic partnerships. We have the MSH business that has been under construction, that we're pleased with what's happening there. And so I think you'll get a much cleaner picture as we roll forward in 2020 on what an actual penetration is.
Charles Grom:
Okay. That's great. And then on the Merchandise Service Teams that you've installed in 2019, is there any metric you could provide about the productivity improvement that you've seen when you layer in those MSTs? And I think just to clarify, I think you said you're adding 7,000 in the first half of '20. Just a perspective of how many you have in place today would be great.
William Boltz:
Yes. Chuck, this is Bill. So the big role for our MST team is to improve the level of bay service inside of our stores. And so in addition to that, they also assist with project work. With the additional folks that we're adding in 2020, it's really about improving our service level and then being able to also tackle a number of the projects that we have to do. So we're excited about being able to grow this team. And we continue to thank our vendor partners for their participation. And it allows us to provide a better level of service, be more ready. So we're already excited about where that's going.
Operator:
Our next question comes from the line of Eric Bosshard with Cleveland Research Company.
Eric Bosshard:
Two things or a question and a follow-up. The 2.5% brick-and-mortar comp in 4Q, you've invested the last 4 or 5 quarters in improving the in-store experience. When you look at that number relative to your peer, curious how you'd characterize it. It seems a bit underwhelming. And I guess the core question is, what is limiting the core brick-and-mortar growth in the business? And what do you do in '20 to materially improve it? Or is this as good as it gets?
Marvin Ellison:
Eric, this is Marvin. Candidly, we're not spending our time looking at anything other than the customer and our internal execution. So for us, when we look at year-over-year improvement and we look at improvement in our store execution, we believe we're making progress. So if you think about it for a second, a lot of home improvement transactions begin online. They may not consummate a lot, but they begin online. So on one hand, it is a true omnichannel environment where research and also product education happens online, and then it drives traffic to the store. If you have limitations online, not only does it hurt your dot-com sales, it actually hurts your brick-and-mortar sales because it limits the amount of traffic, where people will show up after having quality, efficient research and decide to buy.
So we think it's part and parcel that Lowes.com has to improve. And when that improves, it lifts the entire company from an e-commerce standpoint, from an omnichannel standpoint and from a brick-and-mortar perspective. But if you think about the things that Bill talked about with the fact that we just changed out our entire endcap strategy, we just created an entire off-shelf program, we just cleared up a seasonal space upfront for the first time that's going to be consistent. In every store, we can actually set spring. We can set events. We can set holiday gift centers. So all of these things are about creating space productivity in the stores. In addition to that, I'll just let Bill walk through some of the other key drivers of spring and some of the things that we've invested in that we think will continue to create better brick-and-mortar sales.
William Boltz:
Yes. The other -- I think another big part that we've invested in is around the training for our associates in the store. And so between Joe and myself, we've put together just a lot of product knowledge training for our teams supported by our vendors, but really wanting to make sure that we can raise the level inside the aisle, inside the store. I touched on in my earlier comments about all of the different product launches that are coming, all of the different capabilities that are coming from Lowes.com and a couple of them that came on board in the fall of last year. I touched on the cross-merchandising program. We didn't have one until late last year, and so that's going to get a full year of that rollout. And then we've got field merchants on the ground inside of our regions to help us refine these assortments as we continue to work on improving our productivity.
And then as I just touched on with the MST team, being able to expand those folks allows us to speed up how we service the bays inside the store and how we get more things done. So we're excited.
Marvin Ellison:
Look -- and Eric, it's a really -- it's a fair question. And the only other comment I'll make is the importance of the pro business. In home improvement, if you don't have a healthy pro business, you really become the victim of weather patterns. You become the victim of a lot of different things that drive normal retail traffic patterns. But irrespective of the weather outside, pros have to work. And so a really robust pro business creates store-based productivity that continues to really benefit you throughout different weather patterns in times of year. And so one of the reasons why we've been so invested in pro is it goes directly to your question. So we can create better productivity in our brick-and-mortar stores and have more sustained growth in our productivity. So work in progress. We're 1 year into this multiyear transformation. I'm very pleased with where we are.
Eric Bosshard:
And then a follow-up, 2 important categories. Just quickly love some perspective on the relative trend performance versus 3Q or the first 3 quarters of the year. In flooring, I know that you've invested and gone through reset activity. I'm curious if you've seen comp improvement as a result of that. And then also appliances, did that take a notable step-down in growth relative to where the prior trend had been based on how things shook out in 4Q?
William Boltz:
So Eric, it's Bill. So on the appliance side, we continue to outpace the store. We're continuing to leverage our #1 position. Pleased with how our appliance performance had demonstrated all year long. And then we look at flooring, we've made a lot of investments in flooring. We're seeing continued growth in luxury vinyl plank. We're starting to see lines -- signs of growth now in our soft flooring business, which had lagged for years. We're seeing growth in new products. So anything that was new was introduced like in decorative wall tile, laminate, anything that's water-resistant, all of those trending very well.
And then we'll continue to refine that category. It's important for us to be able to get that shopper into our store and drive that portion of our business. So we're going to continue to tweak it.
Operator:
Our final question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Are you -- can you quantify -- are you trying to quantify some of these holiday marketing, appliances, some of the lapping of the PSI to get back to what you think you would have comped? I realize it's imprecise. And it sounds like, Marvin, you still weren't pleased with the outcome, but wanted to clarify that.
Marvin Ellison:
Simeon, what we know is we had an internal forecast as all businesses will have going to any season, where we had an internal plan. And Bill's point about appliance, although we're pleased with the comp in appliance relative to the company comp, it underperformed our internal forecast. And when you look at the data, that all came out of early November. Because as you know, there are a couple of big event periods during the year in appliances and November happens to be one of the largest. And the compressed holiday season and how the customers shop, we just didn't have the agility in our marketing strategy to take advantage of it.
So we know what we left on the table. We're not stating that externally. But what we can say is if we would have met expectations in the categories we laid out, we would have been at or above what we had forecasted from a top line standpoint. So we can definitely see how and why we did not hit the internal number. But even with that, we're pleased with the fact that we're able to leverage expenses and SG&A, and we're able to manage the business much better. I remember not too far in the distant past, if Lowe's didn't beat their top line, there's no way they're going to hit their bottom line performance. And we did all of that and still leveraged customer service across pro and DIY, so we did it the right way.
Simeon Gutman:
And the short follow-up is inventories. You've worked them down since the spike in the beginning of the year, as you've told us you would. Now we're in a better position, but let me just paint the other side of it. Hey, do you have the right inventory, the right level of purchasing, newness, where you want to be for the spring?
David Denton:
Yes. I think from a spring perspective, very much so. I think as we think about the full year, we'll continue to invest in strategic categories to enhance our business primarily in the pro space. At the same time, keeping our inventory levels relatively constant throughout 2020.
Operator:
Thank you. We have reached the end of our question-and-answer session and the conclusion of today's call. Thank you all for your participation. You may now disconnect your lines. And have a wonderful day.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' Third Quarter 2019 Earnings Conference Call. This call is being recorded. [Operator Instructions] Also, supplemental reference materials 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 material 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. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Good morning, everyone. For the quarter, total company comp sales grew 2.2%. Our U.S. home improvement comp was 3% despite low single-digit online growth and higher-than-expected lumber deflation. We saw consistent growth across the business, with all 3 U.S. divisions and all 15 U.S. geographic regions generating positive comps for the second consecutive quarter. These results reflect our continued progress on our transformation plan. 4 of our top 5 performing geographic regions were in the Western division, driven by strength in Pro, appliances, outdoor project category, improved in-stocks and customer service. And in addition to the West, geographic regions that outperformed the total company comp in the quarter were Nashville, Boston, Tampa and Houston. Commodity deflation exerted approximately 95 basis points of pressure on comp sales in the quarter. However, unit growth in impacted categories remained strong.
Let me now take a moment and discuss what drove our success in Q3. Let's start with Pro. Our full focus on the pro continues to be a catalyst for our U.S. sales growth. And during the quarter, we continued to receive very positive customer feedback from pros experiencing firsthand what is new and different at Lowe's, and we're pleased with the pros' willingness to grow their business with us. Our Pro comps significantly outpaced DIY in the third quarter, and the pro customer is responding very positively to our investments in job-lot quantities, department supervisors and our improved in-store experience. The result of these investments in Pro not only delivered positive sales growth, they are also reflected in a 700 basis point improvement in our Pro customer service scores in the third quarter. Despite this early success, we're focused on the work ahead to better serve this very important customer. And later in the call, Joe will detail some of the strategic investments we have planned for the pro customer in Q4 and in 2020. In addition to the pro, our success focusing on retail fundamentals is also evident as we again drove strong sales performance in merchandising departments that have historically underperformed. In total, 8 merchandising departments delivered positive comp performance above the company average, and Bill will add additional color on our merchandising performance shortly. Turning to Canada. In the third quarter, we posted negative comp sales below our expectations, which exerted significant pressure on our total company comp. In the third quarter, we initiated a more detailed strategic review of our Canadian business, inclusive of leadership changes, with a focus on improving execution and profitability. As such, we plan to take the following steps beginning in Q4 to improve our long-term results in Canada. We're closing 34 underperforming stores and expect to substantially complete that process in Q4. Given that the Canadian business is operating 5 banners with multiple legacy systems, we're undertaking a banner simplification process to reduce operational complexity and drive back-office synergies. As part of simplifying operations, we plan to rationalize SKUs across the simplified banners to present a more coordinated assortment to our customers. Implementing a simplified banner strategy will allow us to gain efficiencies in marketing, supply chain and merchandising. We're also reorganizing our corporate support structure across Canada to more efficiently serve our stores. And we plan to migrate Canada to the U.S. IT platform to eliminate inefficiencies and unnecessary technology duplication. We're committed to the Canadian market and we're taking decisive actions to improve Canadian operations and provide a better customer experience while improving profitability through margin improvements and SG&A reduction. Dave will take you through the anticipated financial impacts of these actions in a moment. Despite pressure from lower-than-expected comparable sales growth in Canada, we delivered adjusted diluted earnings per share of $1.41 for the quarter, which exceeded our expectations, supported by improved merchandise category management, enhanced process execution and expense leverage. Later in the call, Dave will outline the steps we took in the third quarter to continue to improve our profitability. During the third quarter, Lowes.com delivered comp growth of approximately 3%. And as we noted last quarter, our e-commerce business is under repair and we are addressing legacy issues with the platform. Our first step in improving our online business is creating stability. To that end, we're working diligently to improve the foundation of Lowes.com by replatforming the entire site to Google Cloud from a decade-old platform. This work is critical to improve the stability of our ecosystem and increase our agility. We expect to have the entire Lowes.com site on the cloud in the first half of 2020. With a modernized stable architecture in place, we have the ability to provide our customers with basic online functionality and address legacy e-commerce capability gaps. Let me give you 4 examples of things we're fixing while we're temporarily slowing our dot-com growth. First, we're taking steps to separate freight from product cost to improve our price perception versus our competition. Second, we are improving our systems and processes to allow us to quickly add SKUs and drop-ship vendors to more rapidly expand our online assortment. These enhancements will reduce onboarding time from months to days. Third, we're building capabilities to ship certain SKUs requiring special handling, which will allow us to sell basic home improvement items like lithium-ion batteries, cleaning supplies and fire extinguishers online. Fourth, we'll improve the customer experience on our website, including a dynamic home page, simplified search and navigation, the ability to schedule their product delivery and one-click checkout. We know how to repair all of these capability gaps, and we have a detailed road map, combined with an exceptionally talented team with deep omnichannel experience. It will simply take time and proper sequencing. We expect to see our Lowes.com growth rate start to accelerate in the back half of 2020. In the meantime, I am very pleased that we can deliver a 3% U.S. comp in the third quarter with virtually no benefit from Lowes.com. This only speaks to the upside sales benefit we have in upcoming quarters when the e-commerce business is repaired. Transforming our supply chain will also support acceleration of our growth as we look to build a true omnichannel ecosystem. We're investing $1.7 billion to transform our supply chain over the next 5 years. Part of this transformation can be reflected in our opening of 2 new bulk distribution centers and 3 cross-dock terminals this year. This infrastructure improvement will be key to Lowe's transitioning from a store-based home delivery model to a market-based model. We believe our future is bright at Lowe's. And as we enter the fourth quarter, we expect to deliver strong top line performance. We plan to capitalize on robust consumer project demand and excitement for the holiday season with strong holiday event execution while driving margin improvement and operational efficiency. Before I close, I'd like to take a moment to thank our associates for their continued hard work and commitment to the company. The best days of my week are when I'm out visiting stores. In doing these visits, I continue to be proud of the men and women that represent our company on a daily basis. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. We posted U.S. comparable sales growth of 3% in the third quarter as we continued to capitalize on robust customer demand, which drove strong traffic to our stores, along with improved in-store execution, which helped to convert that traffic into sales. We also had terrific execution over Labor Day, which drove record sales within our best-in-class appliance offering during the event.
Turning to our merchandising department performance. We delivered above-average comps in appliances, decor, hardware, lawn and garden, millwork, paint, rough plumbing, electrical and tools. Lumber and building materials comps were positive but below the company average. Paint, which had been a serial underperformer for us, outperformed the company average again this quarter. As we continue to refine our paint business, we'll continue to work closely with our suppliers to introduce an improved Pro paint offering to better serve the repair/remodelers who need paint to complete a larger project, such as a kitchen or bathroom remodel. Previously, our decor department had performed below the company average for 12 of the last 13 quarters. However, in Q3, for the second consecutive quarter, decor performed above the company average with mid-single-digit comp growth led by strong double-digit comps in blinds and shades. Millwork is another merchandising department which had historically underperformed. In Q3, for the second consecutive quarter, millwork performed above the company average. Our improved comp performance in these departments is a clear indication that the implementation of our retail fundamentals is gaining traction. For the quarter, we also continued to drive strong comps in areas of historical strength for Lowe's. Tools led the merchandising department growth with a continued strong customer response to our CRAFTSMAN reset. We are proud to be the exclusive destination in the home center channel for this iconic brand, which continues to drive market share gains within key tool categories. We also continue to drive sales with our key programs, such as DEWALT, the #1 power tool brand in the industry. And during the quarter, we launched an exclusive line of DEWALT 12-volt compact tools, which focus on delivering more power in a smaller and lighter-weight tool. In addition, we introduced new and innovative products from Bosch, Spyder and Metabo HPT as we continue to introduce new and innovative products in our exclusive Kobalt line of tools. In appliances, we delivered solid mid-single-digit comps and further increased our market share with record sales during Labor Day, and drove high single-digit comps in refrigerators and freezers with great values and special buys. We also posted above-average comps in hardware, with double-digit growth coming from our fastener categories, supported by investments in job-lot quantities and the full rollout of GRK, Power Pro One and FastenMaster, which drove Pro demand. Lastly, we again delivered comps above the company average in lawn and garden, with double-digit comps in live goods and landscape products benefiting from an improved in-stock position and the extended growing season. Within our seasonal and outdoor living business, we're excited about the announcement of our national home center launch with YETI, a leader in coolers, equipment and drinkware. The YETI brand, along with the expanded product offering, highlights our commitment to providing our customers with relevant, innovative, best-in-class products. As part of our ongoing effort to further drive merchandising productivity, we are continuing to implement a category management process and are taking aggressive steps to improve our cross-merchandising efforts and adjacencies in our stores. We are optimizing our store layout to ensure that products typically used together to complete a project are located in the same aisle to make it easier for the customer to efficiently shop their whole project. Looking ahead to Q4, we are very excited about our plans for the upcoming holiday season, driven by strong Black Friday and Cyber Monday events, along with a compelling tool gift center. We will continue to highlight our best-in-class appliance offerings and showcase strong values and special buys in the most sought-after brands and home improvement products this holiday season with exciting values such as select Buy 1, Get 1 deals across DEWALT, Kobalt, Bosch and CRAFTSMAN and the opportunity to receive a Lowe's gift card when buying 2 or more select major appliances. We'll showcase great gift ideas across the store, including great values for both the DIY and Pro customer. We're also excited to be one of the first retailers to introduce the new Weber SmokeFire Pellet Grill on Lowes.com as part of the preorder product launch on Cyber Monday. Weber's Pellet Grill is their initial entry into this fast-growing category and is built to let grill users discover what's possible with pellet grilling. We are proud to partner with Weber to introduce this exciting new product. This Black Friday, we plan to leverage our NFL partnership, turning holiday shopping into a chance to win the experience of a lifetime at Super Bowl LIV. As the official home improvement sponsor of the NFL, this year on Black Friday, each U.S. Lowe's store is offering its first 300 in-store customers the chance to enter to win 2 tickets to Super Bowl LIV in Miami. As we look to close out the year strong, we remain focused on retail fundamentals and driving sales and margin productivity by continuing our focus on the pro, leveraging the strong customer response to CRAFTSMAN, enhancing our space productivity improvements and expanding our brand message with our exclusive NFL partnership. Overall, we see significant upside from the initiatives that are underway, and we are confident that we are building the foundation to provide home improvement solutions that will continue to drive sales and grow our market share. Thank you. And now I'll turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. Our initiatives to improve in-stock levels and provide a better customer service experience, along with our advances in serving the pro customer, contributed to our strong U.S. execution in the quarter. We continue to build upon the actions we've taken throughout the year to further improve associate engagement and simplify our store operations and saw compounding benefits from our work to date.
Earlier this year, we deployed new mobile devices for our store associates called smartphones. The smartphone empowers our associates by giving them access to real-time data without having to step off the sales floor to access a terminal. Throughout the year, we've added functionality to the devices such as standard performance scorecards and the store walk application to drive a more efficient strategic store review process. These applications allow our store managers to optimize our store performance by evaluating productivity by department and by associate. In the third quarter, we continued to add new applications to our smart devices. During the quarter, we added a new pricing application that allows associates to update prices in the aisles and standardizes and simplifies the price update process such that any associate in our store can do it. The pricing application has already driven efficiencies of over 36,000 associate hours per week for the company. We'll complement this pricing application with new mobile printers, which will allow associates to print new price labels in the aisle, creating a complete mobile pricing solution. In this test, the mobile printing process has driven an additional 2 hours of efficiency per store per day, which will equate to efficiency of over 24,000 associate hours per week for the company. We plan to roll out mobile printing to the company in the first quarter of 2020. Our smart devices are a significant step towards driving operational productivity in our stores and allowing our associates to spend more time with the customer and less time on tasking. Near the end of the quarter, we completed the national rollout of our new customer-centric scheduling system, which better predicts customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic. Our new labor scheduling system allows us to provide better department coverage and customer service while ensuring that we're using our labor hours efficiently and reducing payroll expense. We also expanded our new one-task team to over 1,000 stores in the quarter. This initiative shifts task work from our selling associates to one centralized team that is responsible for completing non-selling tasks during evenings and overnight hours. This centralized team will drive more consistent tasking execution, streamline noncustomer-facing payroll and allow for improved cross-training programs. Our investments in store process and technology paid off in the third quarter. This is evidenced by our ability to leverage store payroll expense again this quarter while driving an increase of 500 basis points in our overall customer service scores. We will continue to deliver on our commitment to improve both store efficiency and customer experience, and we are very pleased with the results we are seeing so far. In fact, a recent Newsweek survey measuring customer service in home improvement recognized Lowe's as #1 among big-box home improvement retailers. This is one more example of the way our customers are recognizing our improved commitment to customer service in our stores. Now moving on to our Pro business. As Marvin indicated, we were very pleased with our Pro performance in Q3 and the customer's willingness to grow their business with us despite a noticeable increase in competitive promotions. As I've discussed on previous calls this year, our Pro strategy has been focused primarily on improving retail fundamentals for this very important customer. We have demonstrated a consistent focus on winning the pro by executing on basic fundamentals like job-lot quantities, improved service levels, dedicated loaders, Pro department supervisors and consistent volume pricing. Our commitment to retail fundamentals and continued focus drove significant improvement in the Pro customer service scores and Pro comps, which significantly outperformed DIY comps. Once again, this quarter, we invited customers in to see our improved experience with another successful pro appreciation event.
Although we are pleased with Pro performance in Q3, we are now transitioning from retail fundamentals to more strategic initiatives. Our goal is simple:
We want to deepen our relationship and continue to grow our sales with this very important customer. In keeping with this more strategic approach, this quarter, we launched a pilot for our Pro loyalty program. Our early results have exceeded our expectations in our test markets. We plan to launch our Pro loyalty program nationally in the first half of 2020, integrate it with the CRM program, which will allow us to deploy more surgical, strategic marketing to the pro and grow our share of wallet through improved account management and suggestive selling. I look forward to updating you on our Pro loyalty launch on future calls.
In the fourth quarter, we plan to improve the in-store pro experience with the rollout of dedicated point-of-sale terminals at the Pro desk to allow for more convenient, faster service. Believe it or not, today, most of our stores have no way for a pro to purchase product at our Pro desk. We will solve this problem in Q4. We're also very excited for our first dedicated Black November event for the pro, with compelling offers to drive pro traffic. All of these pro-related initiatives reinforce the renewed importance of the pro customer at Lowe's. Thank you. And I will now turn the call over to Dave.
David Denton:
Thank you, Joe, and good morning, everyone. Before I review the underlying operating performance of the business, let me briefly discuss the pretax charges taken during the quarter, and importantly, our go-forward expectations related to the Canadian business. As Marvin outlined, we are taking decisive actions to set our Canadian business up for both long-term growth and improved profitability. As part of our strategic review, we evaluated certain assets for impairment, which resulted in $53 million of noncash pretax charges in the third quarter.
In the fourth quarter, we plan to substantially complete the closing of 34 stores, liquidating the inventory in those locations and rationalizing the inventory in our remaining Canadian locations to support our banner simplification strategy. As a result of these actions, we expect to incur additional pretax operating costs and charges of between $175 million to $225 million in Q4 related to the Canadian restructuring. These charges will consist of inventory liquidation, accelerated depreciation and amortization, severance and other costs. These anticipated Q4 financial impacts are reflected in our 2019 GAAP business outlook and are excluded from our 2019 adjusted business outlook. I'll now turn to a review of our ongoing capital allocation program. In the first 9 months of 2019, we generated approximately $3.2 billion in free cash flow. And through a combination of both dividends and share repurchases, we've returned over $4.8 billion to our shareholders. In the third quarter alone, we paid $428 million in dividends, and our dividend payout ratio currently stands at 36% over the trailing 4 quarters. In Q3, we entered into a $397 million accelerated share repurchase agreement, retiring approximately 3.6 million shares. We also repurchased an additional 4.1 million shares in the open market for $438 million. This brings our year-to-date share repurchases to $3.6 billion with a plan to repurchase $4 billion for the year. We have approximately $10.3 billion remaining on our current share repurchase authorization. And we continue to invest in our core business with a focus on developing capabilities designed to drive long-term shareholder value. In Q3, we had capital expenditures of just over $400 million. Now turning to the income statement. During Q3, we generated GAAP diluted earnings per share of $1.36. Now my comments from this point forward will be on a comparable non-GAAP basis where applicable. In Q3, we delivered adjusted diluted earnings per share of $1.41, an increase of 36% compared to adjusted diluted earnings per share of last year. This solid performance exceeded expectations, in large part due to improving gross margin trends, strong expense management and a favorable tax rate. Sales for the third quarter decreased 0.2% to $17.4 billion as comparable sales growth was offset by the impact of previous store closures and the exit of Orchard Supply Hardware. Total average ticket grew 3.6% to $78.71. This was partially offset by a 3.7% decline in total transactions. Consolidated comp sales were 2.2% driven by an average ticket increase of 2.4%, partially offset by a slight comp transaction decrease of 0.1%. In the U.S., U.S. comp sales growth was 3% driven by an average ticket increase of 2.7% and a comp transaction increase of 0.2%. Now looking at monthly trends. Total comps were 2.8% in August, 2% in September and 2% in October. Additionally, monthly comps for our U.S. business were 3.6% in August, 2.7% in September and 2.7% in October. Adjusted gross margin for the third quarter was 32.4% of sales, an increase of 153 basis points from Q3 of last year and 94 basis points better than Q1. The improvement since the first quarter reflect the benefits from the actions we've taken, including retail price adjustments that had minimal impact to units, a pivot to more strategic and targeted promotions, greater vendor partnership for key promotional activities and a continued aggressive product cost management. We're very pleased with the progress we've made to improve our gross margin performance. The actions we've implemented are gaining traction, but there is additional work to be done in this important area for the balance of this year. This quarter, we experienced approximately 90 basis points of rate improvement. The positive impact of cycling our inventory rationalization event from last year was partially offset by 40 basis points of tariff pressure. As expected, we also experienced approximately 20 basis points of pressure from supply chain cost. We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery cost. Inventory shrink exerted approximately 20 basis points of negative pressure on gross margin for the quarter. And finally, product mix shifts had a 35 basis points positive impact on gross margin in Q3. Adjusted SG&A for Q3 was 21.4% of sales, which levered 53 basis points. We drove approximately 40 basis points of leverage in payroll in the quarter and approximately 10 basis points of leverage through improved advertising efficiencies. Adjusted operating income increased 215 basis points to 9.3% of sales. The effective tax rate was 24% compared to 21.8% last year. At $13.7 billion, inventory increased $1.4 billion or 10.9% versus the third quarter of last year but is down $1.3 billion versus Q1. This increase was driven by strategic investments in the first half of the year to drive sales, such as an earlier seasonal load-in, the CRAFTSMAN resets, increased presentation minimums and investments in job-lot quantities for the pro. Throughout 2020, we will refine our in-stock expectations and begin to strategically reduce inventories in certain areas while protecting our in-stock position, sales and gross margin. Now before I close, let me address our 2019 business outlook. As we've stated previously and as our analysis supports, the underlying macroeconomic fundamentals in the U.S. remain supportive as the solid pace of job growth, accelerating wage increases and home price appreciation continue to be tailwinds for our industry. We are maintaining our sales guidance for 2019 and expect a total sales increase of approximately 2% for the year. Comp sales are expected to increase approximately 3%. Given our strong financial performance in Q3 and our solid outlook for the remainder of this year, we are raising our 2019 adjusted operating margin and adjusted EPS guidance. We now expect adjusted diluted earnings per share of $5.63 to $5.70 per share, and we expect adjusted operating margin to increase 40 to 60 basis points versus last year. This revised outlook includes approximately $20 million to $30 million of incremental investments in our existing store environment. This $0.02 to $0.03 EPS investment will allow us to accelerate key reset projects during the fourth quarter to improve sales and space productivity over the long term without disrupting the stores during the critical spring season. Our business outlook also includes the impact of both wave 3 and wave 4 tariffs. The effective tax rate and adjusted effective tax rates are still expected to be approximately 24%. And we are forecasting operating cash flows of approximately $4.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio remains at 2.75x, and our guidance assumes that we will complete approximately $4 billion in share repurchases for this year. In closing, we remain excited about the future of the company and its ability to deliver significant shareholder value over the long term. Operator, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk about the gross margin? Obviously, some nice rate upside there. How much did the pricing pressures that you saw earlier in the year impact the third quarter gross margin? It doesn't seem like it did besides the tariffs. And then how are you thinking about Q4 for gross margin? I think previously, you said flat. And I think the big question that we get from investors is longer term, how do you think about getting back to that high 32%, maybe 33% rate, especially as you lap through the pricing pressures in '20?
Marvin Ellison:
Chris, this is Marvin. I'll take the first part, then I'll let Dave and Bill add any additional color to your additional questions. Look, we feel really good about margin improvement. We talk a lot about the issues that impacted Q1, and we went through a lot of detail after Q1, providing the steps we were taking to kind of recover margin and just to create better visibility and better processes. That's been a cross-functional effort, and we actually are pleased with the results, but there's a lot more work to do.
One of the key things that we're going to be launching before the end of this year is a new price management system. This will be for the very first time at Lowe's to have a consolidated depository of one view of all things cost, retail pricing and the impact of those changes. And that's going to be something we're going to put in place later this year. So we feel good about the trajectory. But I'll just remind you, as we think about out-years and we think about operating income, our real focus is going to be around trying to keep margin relatively flat and creating SG&A benefit in the future. And that's going to be the driver of our operating income growth in out-years. I'll let Dave provide more color to that, and Bill, any additional insight as well.
David Denton:
Yes. I think, as Marvin indicated, obviously, it's been a team sport here of working between -- cross-functionally between finance and merchandising, making sure that, one, we understand the cost complement of the products that we're buying; two, that we're analyzing those effectively and kind of put -- and I'll say, working with our vendors to maximize the performance from either a value engineering perspective or from a cost complement perspective to drive our costs lower over time.
Collectively, we've also been partnering with our vendors very aggressively to make sure that we can develop win-win scenarios that both drive the top line but also improve our margin performance in the near term. And then finally, I think one thing that's really come to life is, really, within the stores, we've made some very significant enhancements from a technology perspective at point of sale, which will allow us to be more effective in the promotions that we offer at point of sale, thus, improving our margin rate on those items.
William Boltz:
Yes. I think, Dave, the only thing I would add to that is that in addition to that, I mentioned in my opening remarks around merchandising adjacencies and putting products together. The cross-merchandising program that Joe and I rolled out at the latter part of Q3 is now up and running in all of our stores. And that certainly helps, in addition to the promotional planning process that we put in place starting with Q2. That really puts more focused offers out there in front of the customer and less of these category-wide-type offers that we have run historically.
Christopher Horvers:
And so then as a follow-up, do you still expect, I think, gross margin rate flattish to the 31.5% last year? And then can you also talk about, on the e-commerce front, is that a transaction growth headwind? Because transactions did -- were up in the U.S., but it was sort of an easy compare. So any thoughts there as well.
Marvin Ellison:
Yes. So on the dot-com question, Chris, the short answer is yes. It did have a negative impact to overall transactions. We were very transparent last quarter that we have this business under repair.
The good news is we have a very talented, very experienced team that have solved these problems before. It just takes time and sequencing. But in the short run, it did put some pressure on our transactions. We feel really good about our performance in our U.S. stores. And as I've noted in my prepared comments, I mean, we drove a 3% U.S. comp with no benefit from dot-com. If you just take a 15% to 20% dot-com growth for us, that puts that comp number north of 4% in the U.S. So we noted that benefit is coming in the future. But in the short run, we're going to kind of muscle through it. But we have a really good road map and a good plan in place, and we think that we'll be able to get this business growing again in the second half of next year. I'll let Dave talk about the margin rate.
David Denton:
Yes. And Chris, obviously, our objective is to recover from our gross margin downdraft in Q1. And I think we're making really nice progress against that. It's not our expectation that we could fully recover that here in 2019, but it's our expectation over the longer term to recover that downdraft that we experienced in Q1 and get back to a more stable environment in the long term.
Operator:
Our next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
So you're modeling sequential improvement in the comps in the fourth quarter. Can you discuss the puts and the takes into that forecast? And then related, the EPS, it's a little bit below -- the implied is a little below The Street. Can you clarify, is that the incremental store investment? And how does it compare to some of the underlying results of the business for the fourth quarter?
Marvin Ellison:
So Simeon, this is Marvin. I'll take the question regarding Q4. So as we've said, I mean, we feel really good about the overall business trends in the U.S. We feel great about our internal execution. Dave talked about the macro backdrop is solid. We look at discretionary purchases, things like average ticket above $500 was over 4% growth for us in the quarter. Consumer project demand is strong and there's excitement relative to the holiday season.
So what I'm going to do is let Bill just provide a couple of key highlights on the merchandising side that gives us confidence in Q4. I'll let Joe also cover a couple of things in the store that also provides us with a degree of confidence we're going to be able to achieve our targeted sales number. Bill?
William Boltz:
Yes. I think the piece for us for Q4 is the team has now had a full year to plan for Q4. So we've demonstrated throughout the entire year categories that have changed their trajectory from where they were a year ago, being able to plan for trim-a-tree and to be able to plan for the gift center and to be able to plan for these Pro deals that we've put out there for Black November, are all different from what we did a year ago. And we're seeing that pay off as it relates to change in direction in some of these key Pro-related businesses as well as DIY business.
Joseph McFarland:
Right. And then from a store standpoint, we're really excited about what's happening with -- inside of our Pro business as we continue into Q4. We're excited about the Pro loyalty launch we have [ coming ]. We're excited that as we continue to invite our pro customers in, that we're enjoying more share of their wallet, improved store execution, store layout. And I think we feel really confident in what we're doing for Q4.
David Denton:
Yes. And then, Simeon, just from a guide perspective, let me just kind of step back and just walk you -- what we've done. We've essentially taken the bottom of the range up $0.13 and the midpoint up $0.07 from a year perspective. Keep in mind that, that includes $0.02 to $0.03 that we're investing in Q4 to improve our performance from a long-term perspective. I think this is a really constructive investment that we're making that we identified late in the quarter, that we're incrementally investing in our store environment, both for the long term, but at the same time, managing the near-term financial objectives that we have as a company.
Simeon Gutman:
Okay. My follow-up is for Marvin. You've been in the seat now for over a year. Some ups, some downs. It seems like the skeletons should be out of the closet by now. You still have a few things, executing in stores, labor scheduling. It sounds like there's new Pro systems. So is that a fair statement? And did anything in your mind change about the potential margin upside? How do you think about it and the pace of margin over the next few years?
Marvin Ellison:
No. Look, I think when I look back at our initial assessment of the business, I would say the only thing that we probably underestimated the level of complexity was the e-commerce business. When we did our analyst and investor conference last December, we did not have our new online president onboard. So although we've spent a lot of time dissecting the business across multiple channels, the e-commerce business was still a little bit of a mystery for us, and that mystery unveiled itself during the holiday season when we had all the issues. And we've been digging ever since then.
So there's been ups and downs, but we were very clear that this is a transformation. I mean we didn't make any bones about the fact that this is a company that had great potential, but it had been underinvestment in supply chain, IT and also leadership development. So if I had to take a snapshot of how I feel about where we are, I think we are right on track where we hope to be. And that is taking into account there have been a lot of uncertainties in the marketplace. Like tariffs is one that we did not anticipate that we've been managing as best we can. Overall, I feel great. I think that we have identified most of the "surprises" because we spent a lot of time really digging deep into the areas of the business that carry the most financial risk and the most financial benefit. And we feel like we've got a really good plan heading into the fourth quarter and 2020.
Operator:
Our next question comes from the line of Karen Short with Barclays.
Karen Short:
I was actually wondering if you could give a little bit more color on how the dot-com business impacted the U.S. comp. And then, I guess, looking to Q4, wondering if you could give a little color on how the total comp will be impacted by Canada because, obviously, these closed stores will be less -- you won't even have that headwind on the U.S. comp versus the total comp. So any color on both those would be great.
Marvin Ellison:
So look, I'll take -- Karen, I'll take the dot-com question. I'll let Dave take Canada. So if you think about the impact of dot-com to our business, it was basically a neutral impact. We grew dot-com by 3% for the quarter. We grew U.S. sales by 3%. So there was really no benefit.
I would argue that there's not a brick-and-mortar retailer in the U.S. that is our size that had such limited growth in the dot-com business. Most U.S. retailers that announced their comp growth for the quarter, typically, will have a dot-com number that starts with a 20% growth, which is typical in this day and age. We're not there yet, but we know how to get there. And we're trying to take the right steps to fix the root cause of the issue. It's not difficult to grow dot-com sales. It's difficult to do it correctly, meaning -- and make money. And so rather than having a bunch of nonproductive promotions and other couponing events, we shut that down. And we basically said, how do we structure this business in the right way. We have a really good road map in place. I wanted to be really transparent in my prepared comments just to highlight some of the fundamental things we currently don't have in place that we will have in place in the second half of next year. But I see that as a glass half full. Again, our store productivity is strong. Anytime you can deliver 3% comp off the total benefit of your brick-and-mortar stores in this day and age is a very positive sign. But getting our dot-com and our omnichannel business going is a huge priority, and we think we can get that going as we enter into 2020. Now I'll let Dave talk about Canada.
David Denton:
Yes. Karen, as it relates to stores that will be closed in Canada, they will be considered non-comp. So they will not affect the comp cadence for Q4 for the company.
And then I also just want to clarify. As you look at Q3, the $53 million noncash charge that we took is exclusively within SG&A within our GAAP numbers.
Karen Short:
Okay. And then just a follow-up. In terms of other initiatives as we look to 2020, obviously, you talked about the price management system in 4Q. But can you give us an update on some other big initiatives that we should be watching for in early 2020? I think the POS upgrade is still going to be happening. But just so that we can track anything that may -- we may need to be on the outlook for if there are any risks on execution.
Marvin Ellison:
Yes. So let me -- I'll talk about one, and I'll let Joe give you some thoughts on some really exciting initiatives in Pro. And I know Bill has a couple of really nice merchandising initiatives we're excited about. But when we think about our supply chain transformation, I mentioned in my comments that we have a $1.7 billion investment over 5 years we're committing to supply chain. And that is to totally transform our supply chain from a distribution network designed to get product from suppliers to stores, from suppliers to distribution centers, et cetera, to be more of an omnichannel center that's going to allow us to go from store-based delivery to market-based delivery. We're opening 2 new bulk distribution centers this year and 3 cross-dock terminals, which is really the foundational steps to helping us to build out the supply chain transformation. This will be significant for us because it's going to take enormous pressure off the stores from being a hub for all things delivery, but it's also going to give us the ability to deliver to customers' homes and pro's job sites with the same efficiency that we deliver to a store. That is something we are going to be constantly rolling out throughout the year, and we're excited about that.
And relative to the price management system. We'll get that system in place by the end of this year. But then next year, in the first half, we're going to integrate into that system, the Boomerang Retail Analytics will be combined with that price management system. That's going to give us, for the first time, machine learning and AI kind of functionality around pricing and around scraping so that we can be a lot more dynamic. And the only other initiative I'll mention is that in the first half of next year, we should be fully on Google Cloud with our e-commerce platform. And again, we're moving from a decade-old platform to cloud, which is something that's going to give us much more agility. And I'll let Joe and Bill add any additional color.
Joseph McFarland:
Great. So we've talked a lot in the past about our Pro focus and really throughout all of 2019. We've really focused on the retail fundamentals, which we've talked about, things like Pro staffing, things like dedicated loaders, job-lot quantities, et cetera. And so we feel in 2019, we have largely made a great impact there.
As we move forward into next year, we're really excited about, number one, for the Pro loyalty test that we launched in 3 markets in the third quarter. The pros' reaction to the Pro loyalty has really exceeded all expectations we've had for it. And we continue to listen to the pros. We continue to make adjustments. That's why we're in test mode. And we're excited that we'll fully roll out Pro loyalty nationwide in the first half of 2020. In addition, things like tool rental, we feel really good about testing the waters there. In the Pro business, that pro continues to give us more share of their wallet. And so really exciting in the pro space. I'll let Bill talk about some of the merchandising.
William Boltz:
Yes. And just to close on the merchandising side, in addition to the cross-merchandising work that we're wrapping up and we wrapped up in Q3, we'll finish up at the end of Q4 in January, February and the [ wave-binding ] signage rollout in our stores, which allows the customer to navigate our stores easier. We'll also finish the refresh work that we started early last year, which will allow us to bring product categories and departments together to make it easier for the customer to shop and to give us the kind of holding power on our end caps and in our departments that we need, bringing product categories together. So really excited about all the work that the merchants have done to make our stores easier to shop.
Operator:
Our next question comes from the line of Steve Forbes with Guggenheim Securities.
Steven Forbes:
I wanted to focus on payroll leverage, right, given the commentary around the completion of the labor scheduling system rollout. So maybe just remind us, I guess, how that phased in throughout the year, right? How many regions were live, I guess, in the first half relative to the end of the third quarter? And then maybe discuss the expectations regarding payroll leverage in the fourth quarter and into 2020, right? Because I think it would seem to appear, right, there's sort of a chance or a potential, right, for payroll leverage to at least remain at the current run rate as we look out to 2020. So would just like to get your sort of thoughts and updates on that.
Marvin Ellison:
So Steve, this is Marvin. I'll kick it off, and then I'll let Joe provide some additional insight. I think as you look at the out-years, it's just a very basic philosophy. And what we're trying to do is we're trying to shift payroll from a task to service in the stores. Our first analysis when Joe arrived and started to look at the business is that we had a vast majority of our payroll in the store was doing something other than serving customers or driving sales. And so Joe's team built out a 3-year kind of project plan to shift that to be a more service-oriented store environment, and the way you do that is with technology.
And so what you're going to see in the out-years is the investment in technology, a reduction in total hours but an addition of selling hours. And that's one of the reasons why Joe gave this really interesting statistic that in third quarter, we leveraged payroll, but we improved service across all categories:
Pro, do-it-yourself customers in all types of surveys, internal and external. And that gives us really good comfortable feeling that the technology implementations are working and that we're putting the payroll in the right location.
So that's the out-years. I'll let Joe kind of talk about what we've done so far this year.
Joseph McFarland:
Yes. I'll give you a quick snapshot just for the third quarter. And I mentioned some of things in my prepared remarks. As Marvin said, when we first arrived and evaluated the percent of payroll being spent on service versus task, it was completely inverted. So we've assembled a terrific team in our store operations group. We're ahead of schedule as far as moving the needle to more rebalance with customer-facing versus tasking.
And so just in the third quarter alone, we talked about the new scheduling system. So I'll remind you, the first quarter of this year, we rolled out to one region, the customer-centric schedules to make sure we listened to the associates, validated the customers and to make sure that the changes we were making were beneficial. In the second quarter, we launched that to 3 additional regions across our Northern division, more seasonal. We wanted to kind of pressure test our spring and our hiring. And so in the third quarter, we have successfully rolled this out to every region. 100% of the stores in the U.S. are on customer-centric scheduling as of the first day of the fourth quarter. In addition, in the third quarter, we took action on things like our one-task team. We expanded the one-task team, centralizing tasks in just over 1,000 stores. In addition, we took action on things like our in-store assembler moving to third-party outsourcing, our janitor, our new pricing apps. So there's a laundry list of initiatives that we continue to execute against that, and at the end of the day, making sure that we're doing the things that the customers expect and notice and that the associates appreciate.
Steven Forbes:
But maybe just a quick follow-up for Dave, right, modeling purposes here. If you can, right, provide a little more detail around the breakdown of that $175 million to $225 million of cost into the various buckets. I don't know if you can split it between gross margin and SG&A at least, or the 3 buckets that you mentioned.
David Denton:
Yes. Listen, I will come back at the end of the year and end of the quarter and give a detailed reconciliation of that so you'll be able to have that from a modeling perspective. Keep in mind that all of this was non-GAAP.
But I would look at this as -- certainly within Q4, I would say, over 50% of those costs are due to inventory liquidation. And therefore, they would hit within the gross margin level versus the remainder kind of at the SG&A level. It's probably the best way to think about it.
Operator:
Your next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
I wanted to follow up on the cadence of the quarter and whether there were any seasonal elements to call out. Obviously, you were lapping hurricanes. I don't know if the extended season was a good guy and offset that. I also think there was a shift in the start of Black Friday. So anything you would call out there, and in general, how you feel about exiting the quarter?
David Denton:
Yes. This is Dave. Yes. Listen, we feel very solid about our plans for Q4 from a sales perspective. There was a little bit of, I guess, weather benefit as we cycled into Q3, probably in the neighborhood of 50 basis points. We also did run Black Friday week one week earlier. So that had a very nominal, probably 10 basis point impact on us.
So as you cycle into Q4, that would give you some confidence that as we cycle into Q4, the sales improvement, from a comparison perspective, looks pretty good.
Seth Sigman:
Okay. And then just in terms of the restructuring in Canada. Can you just help us better understand what wasn't working there? And then if there's a way to quantify by the drag that Canada has had on margins this year or over the course of a 12-month period, just so we could sort of understand the opportunity into next year, I think that would be helpful.
David Denton:
Well, maybe I'll start. Just as you can well imagine, just given the performance that we've articulated over the first 3 quarters of this year, the Canadian business from a top line perspective has struggled. It's fair to also understand and model that it is performing from an operating profit perspective below the company average. So it certainly is dragging us down, and certainly dragging us down more if you were to include the charges. So even without the charges, our -- the performance is lower than the company average.
With that, I'll turn it to Marvin.
Marvin Ellison:
Yes. So look, Seth, the only thing I will add is we have great associates in Canada. We just gave them a very complex business model that inhibited their ability to serve customers well. We're operating 5 banners, all with legacy systems, all with different back-end systems. And our initial integration process was wholly complex. It made it very difficult to create synergies from a marketing, merchandising, sourcing perspective and even in IT systems infrastructure.
So part of what we're doing here, in addition to closing underperforming stores, is ensure that we are just simplifying the businesses model so we can give the customers a great experience and give our associates a more simplified operational process to manage. And we think the decisions that we announced today is going to put us in a really good position to do just that. So we look forward to coming back in our February call to provide some degree of color around 2020 and our expectation in Canada and how we think these restructuring actions that we announced today is going to really put us in a position for long-term growth.
Operator:
Our next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I had 2 questions. I just wanted to follow up on the progress on gross margin. I understand it's improved sequentially from the first quarter. But Dave, I want to make sure I get the numbers right. If last year, the re-baselined gross margin was 32.9%, and this year, we're sort of down 40 or 50 bps on a like-for-like once you add back last year's inventory charge, are we thinking about that right?
David Denton:
Yes. So maybe I'll give you just kind of a few numbers to help you model this out. If you look at our gross margin performance, we're -- have improvements of about 150-some-odd basis points. We're overlapping the clearance event from last year, which gives kind of a tailwind, if you will, of about 170 basis points. We did have pressure from both tariff at 40 basis points, supply chain at 20 and shrink at 20. So if you think about it, we have a 90 basis point improvement just in gross margin rate. Then you add on top of that improvements from a product mix perspective.
Gregory Melich:
Got it. That's super helpful. And then maybe just a follow-up on Canada a bit. If we think about the charges in total, the $250 million, what do you guys expect the payback for that to be? Do we get that back in terms of profit in the next 12 months? Does it take 3 years? How quick do these changes really take effect in the business?
David Denton:
Well, obviously, these changes are going to take effect pretty quickly. But the way we've modeled this is clearly over a multiple-year period, at which we looked at the cash flows of the business and the net present value of that. So obviously, this is a tough decision to make, but is the right decision to make economically, and we look at that over a multiyear period.
Gregory Melich:
And last and just transitioning to the business a bit. I want to make sure I got the guidance right on the comp. Understanding that the Canadian stores come out of the comp. If I use the full year guide where it is, the fourth quarter comp should accelerate to about 4% -- or 3.5% or 4% to make up. Am I missing something there or that's the sort of trend that you're seeing so far into November?
David Denton:
No. Your math is correct.
Gregory Melich:
And are we in November running at that kind of rate?
David Denton:
Listen, we are about to approach one of our biggest weeks in the year, quite frankly, as we enter into Black Friday. So it's probably a little too early to comment on the quarter. I will say that we feel very strong about the programs we have in place and the things that we're executing at store level to drive our performance.
Operator:
Our next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
So if we triangulate your progress in a couple of ways, one, looking at the U.S.-only stacks on a 2-, 3-, 4-year basis, they did decelerate from the second quarter to the third quarter. And if we look at the spread, U.S.-only business compared to your biggest competitor, it did reverse this quarter, recognizing that a big piece of that is the performance of the respective dot-com businesses. Why do you think on those measures the business did take a bit of a step back this quarter versus last quarter?
Marvin Ellison:
Michael, it's a fair question. My only answer is that we feel really good about our U.S. business. And to be quite honest, we don't spend a ton of time thinking about our performance versus -- our competitor versus our performance versus our internal expectations. And relative to our expectations, we were where we thought we should be based on business investments based over year-over-year overlaps.
I mean, remember, Q3 last year was a really interesting quarter. We took a lot of actions around store closures, inventory liquidations. And so the year-over-year compares are really tricky. And so we appropriately planned the business for Q3 at a certain level. And in the U.S., we feel really good about exactly where we landed. And as we mentioned, we actually exceeded our expectations relative to operating income. So we feel good about the business. We feel good about our trends. And we have a repair plan to fix dot-com. We're not trying to rush a quick fix. We're going to fix it foundationally. And we think that's going to give us long-term growth potential, and we feel good about the steps we've taken to end the year strong as well.
Michael Lasser:
And my follow-up, Marvin, is in the prepared remarks, there was a comment that customers will -- the pro customers' willingness to grow their business with us despite a noticeable increase in competitive promotion. So can you provide more detail on that? Who and where are you seeing those higher promotions from? And is there a case where as Lowe's becomes more successful and as Lowe's become -- makes more progress, the overall environment is just going to become more promotional, more competitive because of that success?
Marvin Ellison:
No. Look, I think we are very well prepared for a more competitive marketplace. The comments were specifically driven based on a -- one of our large competitors getting really aggressive discounting, large projects going through a bid-room process. This is invisible to the general public. But for large customers with purchases over a certain volume threshold, you can submit that for additional discount from a commodity pricing perspective. And there was more discounting in that area over a consistent period of time than I've seen in my 14 years in this business.
It is neither here nor there. We just continue to compete. And we want to just run our strategy, which is something that we're going to continue to do. But we want to highlight that, that competitive cadence dramatically changed in Q3, and we're going to be prepared to see what happens in Q4.
Operator:
Our final question comes from the line of Zack Fadem with Wells Fargo.
Zachary Fadem:
Could you talk about your Black Friday and Cyber Monday offering, specifically online? And just given the re-platforming on the site, should we expect a temporary acceleration in dot-com sales for the seasonal uptick in demand around the holiday? Or do you expect similar growth versus Q3?
Marvin Ellison:
So look, I'll give you some comments on dot-com. I'll let Bill just give you some of the really exciting deals we have. For dot-com, I mean, we had a pretty underwhelming performance last holiday season, and so we are expecting to have better performance within that holiday period, but that holiday period does not define the entire quarter. We don't have an expectation that we're going to see dramatic dot-com growth in Q4 relative to what we've seen in the last 2 quarters. However, we do expect to have more stability and better performance during the Black Friday period.
The only caveat to that is we gave a lot of product away online last year. We're not going to give it away this year. We had a lot of site-wide promotions that didn't make any sense, didn't provide any value to the customers. Well, it gave a lot of value to the customers, no value to the shareholders and to the company from a profit perspective. So we're going to be appropriately aggressive online, but we're going to be aggressive with the standpoint of running a really good business model, but we're not expecting robust dot-com growth in Q4, no different than what we've seen in the last couple of quarters. And I'll let Bill highlight some of the exciting things we're going to be selling in the stores.
William Boltz:
Yes. So we're super excited about what's going on for Black Friday. But as you know, it starts with really Black November, and so we're able to do a number of deals and special values out there for the pro that ran for Black November. We kicked off the appliance event for Black November. And then with the team having roughly a year to be able to plan this year's Black Friday, we've got just some super doorbusters for Black Friday day. We've got, as I said in my prepared remarks, a chance for lucky customers to win a trip to the Super Bowl. And so we've got just a lot of excitement that's going to drive folks to the Lowe's door on Friday. So we're excited about what we're doing.
Zachary Fadem:
Got it. And then on the repair and remodel overall environment, curious to hear your thoughts on the latest round of data points, particularly with existing home sales improving. And curious how you think about just overall category demand and whether you have any expectation of improvement as we enter 2020.
Marvin Ellison:
So look, Zack, we feel great about the macro. All of the macro indicators that are important for our business are pointed in the right direction
Operator:
We have reached the end of our question-and-answer session and the conclusion of today's call. Thank you for your participation. You may now disconnect your lines, and have a wonderful day.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' Second Quarter 2019 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 will be used as a reference document following the call. During the call, management will be using certain non-GAAP financial measures. The supplemental reference materials 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. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Thank you, Regina. Good morning. Total company comp sales grew 2.3% in the second quarter. Our U.S. home improvement comps were a positive 3.2%, exceeding expectations despite lumber deflation and unfavorable weather. In fact, we saw broad-based growth across all 15 geographic regions, generating positive comps. Three of our top 4 performing regions were in the Western division. In addition to the Western regions, we also had great performance across the following regions that outperformed the total company comps
Weather was particularly challenging early in the quarter, exerting approximately 195 basis points of top line pressure in the month of May. And as weather improved, we saw broad-based sequential improvement in U.S. comps of a positive 0.7% in May, positive 4.2% in June and positive 4.7% in July. Commodity deflation exerted approximately 110 basis points of pressure to comp sales in the quarter. However, unit growth in impacted departments such as lumber and building materials remained strong. For the quarter, comparable transactions grew at a positive 0.3%, and average ticket grew at a positive 2%. We executed very well during key holiday events and converted strong foot traffic into sales. Once again, Pro comps significantly outpaced DIY during the quarter. And our strong Pro performance was particularly driven by investments in job-lot quantities coupled with our improved service model. As Joe will detail, we continue to make progress to better serve our Pros, and we receive very favorable feedback on our improved in-store experience with our customer service scores increasing 900 basis points. Overall performance in the quarter demonstrated continued momentum executing our retail fundamentals framework. And with the initiatives we've put in place, we continue to make steady, deliberate progress to better serve customers, position our business for long-term success and improve our results in categories that have historically underperformed. Bill will discuss some of those categories in a moment. On lowes.com, we posted comp growth of approximately 4% in the second quarter. There are a couple of key items that contributed to this underperformance. First, we intentionally slowed the number of new SKUs that we added in the quarter while we addressed systems and process issues that negatively impacted our stores' productivity. These systems and process issues were resolved in early Q3. Second, we took steps to improve the quality of our online business by eliminating certain programs, which were unsustainable from a profit perspective. In taking these steps, we knew that we would stun our short-term growth. However, we took the necessary actions to position ourselves to grow our online business for long-term sustainable success. In addition to solving these process and systems issues, we're taking aggressive steps to improve the technology foundation of lowes.com. We'll replatform the entire site to Google Cloud. At the beginning of this year, our dot-com site was on a decade-old platform. So we expect to have the entire site on the cloud in the first quarter, which will improve our agility as we redesign the customer experience from search and navigation to checkout.
Omnichannel is a tremendous growth opportunity for Lowe's. And we have a very detailed transformation plan to modernize our platform and dramatically grow lowes.com sales in the future. Our goal is simple:
we want to serve customers any way they desire to shop. And we look forward to updating you on our progress on future calls. In fact, our commitment to having a world-class technology team is reflected in our announcement to open a new global technology center for 2,000 additional technology professionals in Charlotte. Construction of this new facility began this month with plans to open the center in 2021. The global technology center underscores our commitment to recruiting world-class talent and becoming a best-in-class omnichannel retailer. But in the meantime, we're utilizing a temporary space in downtown Charlotte for the technology professionals that will ultimately be based in our new global technology center.
In Canada, we posted negative comp sales for the quarter. Our negative comps was driven in large part by our ongoing RONA integration. After a strategic reassessment of the Canadian business, we decided to make adjustments to the original long-term integration strategy. Although we remain confident in the long-term potential of this business, this shift in strategy has temporarily slowed growth. But once again, we're sacrificing short-term growth to position ourselves for long-term success. And I look forward to providing you with additional updates on future calls. Diluted earnings per share were $2.14 for the quarter, and adjusted diluted earnings per share were $2.15, supported by solid top line growth and expense leverage. Now I want to take a moment to provide an update on the progress to deliver gross margin improvement in 2019. The improvement since the first quarter reflects the immediate benefits from the actions that we've taken. In fact, we realized compounding benefits as we moved through the second quarter with marked improvement in gross margin for the second half of the quarter as compared to the first half. Our second quarter performance, coupled with actions still to come, give me confidence that we're on the right path to sequential gross margin improvement in the third and fourth quarters. Although we're pleased with the progress we made in Q2 to recover gross margin dollars, we have additional work to do to modernize our systems and our pricing tools. Therefore, over the next 12 months, we'll be focused on 2 major initiatives to deliver this modernization. Our first initiative is focused on the deployment of our new price management system, which will allow us to better systemically analyze, prioritize and implement retail pricing actions. This new system will create a single repository of pricing to provide better visibility for the merchants to understand the impact of our pricing decisions. This new price management system will be in place by the end of the year and will get us to competitive parity with most retailers. Our second initiative is focused on fully integrating our acquisition of the Boomerang Retail Analytics platform. Integrating this platform will allow us to incorporate Boomerang's technology into our core retail business; bolster strategic, data-driven pricing; and also allow us to make better merchandising decisions across the business from an assortment perspective. This retail analytics platform will be fully integrated with our price management system during the first half of 2020 and will provide us with a best-in-class pricing analytics system. We're confident in our strategic initiatives as we enter the back half of the year. And we expect to continue our strong top line performance while delivering margin improvement. And we'll also begin to manage down our inventory to more sustainable levels. So now allow me to take a moment to discuss inventory in more detail. This year, we invest in inventory to support efforts such earlier seasonal load-ins, CRAFTSMAN resets, increased presentation minimums and job-lot quantities for Pros. These strategic investments in inventory helped us to deliver improved sales performance in Q1 and in Q2. And although our inventory has increased year-over-year, we have very minimal seasonal inventory, which limits our risk of unplanned markdowns. In the back half of the year, we'll refine our in-stock expectations and begin to reduce inventory in certain categories. One key initiative tied to our supply chain transformation strategy is the rollout of predictable delivery to all stores. This more predictable product model will enable us to lower safety stock across many SKUs. In addition, we'll execute a list of strategic initiatives in the back half of the year that will allow us to strategically manage down inventory while protecting our in-stock position and our margin. Though we made great strides and we're pleased with our second quarter results, we're not taking victory laps. We have a lot of work to do, and we're fully committed to driving top line growth, improving our gross margin while intensifying our commitment to expense management. We're very excited about the upside potential of our company, and we believe we're on the right path to generate long-term profitable growth. And last, I want to take a moment to thank our associates for their hard work, dedication and commitment to each other and commitment to serving customers. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. We are pleased with our second quarter performance as we capitalize on the continued spring demand and strong event execution. We posted a U.S. comparable sales growth of 3.2%, exceeding our expectation. On a 2-year stack, U.S. comp sales accelerated from 4.7% in Q1 to 8.5% in Q2. During the quarter, we leveraged our successful Memorial Day, Father's Day and July 4 events, taking advantage of the seasonal project demand. And we also drove traffic with our compelling values, relevant assortments and our continued shift into digital marketing channels.
We were well prepared for our holiday events with excellent coordination and alignment between store operations, supply chain and our marketing teams. Our success in driving spring sales was supported by the improved service model in our stores and better in-stock execution. Joe will share more of that in a moment on how well our associates delivered in the aisle. Our continued focus on retail fundamentals drove strong performance in areas of [ historical ] strength and, more importantly, helped deliver improved performance in categories which have historically underperformed. In fact, we had 7 departments perform above the company average in the quarter. For example, we began the implementation of our retail fundamentals framework in the paint department 2 quarters ago. Prior to that implementation, paint had delivered comps below the company average for 10 consecutive quarters. This quarter, because of an improved service model, a better in-stock position along with compelling offers, paint led the merchandising department growth with the strength coming from both interior and exterior paint products, all of that being done despite some weather pressure early in the quarter. This marks the first time in 10 years that paint has led the merchandising department comp growth. We will continue to invest in this important area given that paint is a traffic-driving category and that painting is the #1 DIY project. We are working closely with our suppliers to roll out an improved Pro paint offering, and we see a significant opportunity to drive an increased Pro penetration in paint, all of this by better serving the repair/remodelers who need paint to complete a larger project such as a kitchen or bathroom remodel. Prior to our implementation of retail fundamentals, our decor department had performed below the company average for 12 of the last 13 quarters. In Q2, we drove mid-single-digit comps in decor with double-digit comps coming in blinds and shades. The improved performance was largely driven by job-lot quantity investments and our improved product offerings in both our private and national brands. Millwork is another merchandising department that had historically underperformed. In 11 of the past 12 quarters, millwork had posted comps below the company average. This quarter, with a heightened focus on the Pro, an improved in-stock position, a refreshed department, an investment in job-lot quantities and some new product introductions, millwork delivered comps above the company average. For the quarter, we also continued to achieve strong comps in areas of historical strength for Lowe's. In tools, we delivered strong mid-single-digit comps and continue to see market share gains as a result of our CRAFTSMAN resets. The strength in CRAFTSMAN came from categories such as power tools, tool storage and mechanics tools. We're excited to now have completed the CRAFTSMAN resets this quarter, and we're proud to be the exclusive destination in the home center channel for this iconic brand. During the quarter, we also leveraged key programs such as DEWALT, the #1 power tool brand in the industry, along with the introductions of other new and innovative products from Bosch, Spyder and Metabo HPT, all to help drive strong comps in tools. Within our appliance department, we drove solid mid-single-digit comps, building on our leading market share position with our top brands and breadth of assortment. In hardware, we posted solid mid-single-digit comps with strength coming from our framing hardware and our fastening categories. The investment we made in job-lot quantities and new product introductions helped deliver the results in these 2 categories to support the Pro demand in hardware. And lastly, we again delivered above-average comps and saw market share gains in seasonal and outdoor living, led by double-digit comps in pressure washers as well as riding lawn mowers where we continue to leverage the top 3 brands in riding equipment with John Deere, Husqvarna and CRAFTSMAN. We continue to be pleased with the results that we are seeing from our new merchandising service teams or MST. These teams are supported by our vendors, and they are responsible for day-to-day bay maintenance, the resets in our stores, setting and maintaining our endcaps and executing our off-shelf displays. The MST teams are a critical component to improving our merchandising reset execution at the store level as they continue to take tasking activities off the shoulders of our selling associates so that they can be freed up to dedicate more time to serving our customers. The early results of our MST program are positive, and these teams have shown a reduction in out-of-stocks, an improved sales productivity and an increase in bays serviced per hour. Now as we look ahead to Q3, we remain focused on our retail fundamentals and driving profitable sales with our upcoming Labor Day and fall harvest events; leveraging additional target events throughout the quarter that will take advantage of the fall micro seasons; continuing to drive the strength of the traffic power of CRAFTSMAN; building on the responsibilities of our field merchandising team who will be instrumental in driving the localization in our stores along with executing our seasonal transitions; continuing to focus on the Pro categories as we continue to capitalize on our investments and our focus on this important customer segment. And lastly, we look forward to leveraging our new NFL partnership, including introducing new exclusive products and events that will help drive a strong connection with both the DIY and our Pro customer. As I've shared on previous calls, we are in the process of implementing our category management strategy. This cohesive strategy is going to be critical to driving merchandising productivity by ensuring that we are allocating our resources to the areas of greatest opportunity. The merchandising team is committed to aggressively driving top line sales while growing gross margin dollars. Thank you, and now I'd like to turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. Our commitment to improving in-stocks and customer service, along with intensifying our commitment to the Pro customer, were integral to our strong event execution and comp growth in the second quarter. I'm pleased with the accumulating benefits we've seen from actions we took in the first quarter to further improve associate engagement and drive store simplification.
We recently deployed the new mobile devices for our store associates we call SMART phones. The acronym SMART represents our customer service velocity. Our new SMART phones are designed to reduced tasking hours by providing real-time data without ever stepping off the sales floor. In the second quarter, we added our standardized performance scorecard to the SMART phones. We also deployed store-walk application to allow for a more efficient, strategic store review process. These applications allow our store managers to drill down and evaluate productivity by department and by associate to manage our store more strategically. These new mobile devices are an example of how we can leverage modern technology to make significant advancements in the capabilities we make available to our associates. Putting the new mobile devices in the hands of our managers and supervisors is a significant step towards revolutionizing how we deliver sales and operational productivity in our stores. Our investment in over 600 assistant store managers and 5,500 department supervisors paid dividends in Q2. On average, we've added 120 customer-facing hours per store per week while still leveraging store payroll. Because of this investment, we are able to provide better departmental coverage and expertise as well as coaching for our associates and delivering excellent customer service. With the addition of department supervisors, we ensure that we have proper coverage for strategic areas of focus such as Pro and paint. It is no coincidence that both Pro and paint were 2 top-performing areas for the second quarter. All said, our commitment to improving both store efficiency and customer experience drove a 600 basis point increase in overall Q2 customer service scores. As Marvin indicated, we are very pleased with our Pro business performance in Q2 with Pro comps significantly outpacing DIY. We're also pleased with the Pro customers' willingness to grow their business with us. We continue to leverage our investments in job-lot quantities and product presentation in key areas such as the Pro canopy and endcaps; improved store-level service, including dedicated loaders and preferred parking under the canopy to ensure we can get our Pro customers in and out faster and staffing our Pro desk with dedicated associates working a consistent schedule; dedicated department supervisors for Pro areas; a consistent volume pricing message; and our redesign field structure with 15 new regional Pro directors and experienced leaders to focus our in-store and outside Pro sales. We're already seeing great results from this team with double-digit comps this quarter. We also continue to leverage key brands to grow our Pro business, such as Little Giant Ladder Systems, Lithonia commercial lighting, along with Bosch, Metabo HPT and DEWALT. And our merchant teams continue to work to add more key Pro items to our assortments, including the new exclusive DEWALT 12-volt cordless XTREME brushless platform launching this quarter. We're proud to be the destination for this platform offering extreme power in a compact lightweight design that allows Pros to work more efficiently in tight spaces. We are seeing positive results from our actions with increased Pro customer service scores. Once again, this quarter, we invited customers in to see our improved environment with another very successful Pro appreciation event, which allow us to grow our Pro accounts. In fact, we opened over 35,000 new Pro accounts in the quarter. Although we are pleased with the Pro performance in Q2, we're in the early stages of our transformation. Therefore, we're pursuing additional opportunities to deepen our relationship with the Pro, including our upcoming Pro paint test in select markets focused on improving our staffing and training model to better serve the needs of this key customer. We have additional initiatives on our Pro road map, and I look forward to keeping you updated on future calls. As we look to the back half of the year, we'll work to improve staffing and better leverage our payroll spend with the national rollout of our new customer-centric labor scheduling system. We have deployed this system in 4 geographic regions, and we'll complete the rollout to our remaining 11 regions by the end of the fiscal year. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic to provide better department coverage and customer service while ensuring that we're using our labor hours efficiently and reducing payroll expense. This new system will replace our current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. We're also deploying a new one-task team to shift task work from our selling associates to one centralized team that will be responsible for completing non-selling tasks during evenings and overnight hours. The centralized team will drive more consistent execution of tasking, streamline noncustomer-facing payroll and allow for cross-training. Though we are pleased with the changes we've made and excited about the results we're seeing, we are very focused on the hard work ahead to drive further improvements and transform Lowe's into one of the most operationally efficient retailers in the world. Thank you, and I'll now turn the call over to Dave.
David Denton:
Thank you, Joe, and good morning to everyone. I'll begin this morning, as I often do, with a brief review of our capital allocation program.
In the first 6 months of 2019, we generated $3.1 billion in free cash flow. And through a combination of both dividends and share repurchases, we've returned over $3.5 billion to our shareholders. In the second quarter alone, we paid $382 million in dividends, and our dividend payout ratio currently stands at 37% over the trailing 4 quarters. Now given the dislocation of our stock price coming out of Q1, we ramped up our share repurchase activity and bought back nearly $2 billion of our stock at an average price of approximately $100. Early in Q2, we entered into a $990 million accelerated share repurchase agreement, retiring 9.9 million shares. And additionally, we repurchased 9.7 million shares in the open market for $974 million. This brings our year-to-date share repurchases to $2.8 billion with a plan to repurchase $4 billion for the year. We also have approximately $11.2 billion remaining on our current share repurchase authorization. We continue to invest in our core business with a focus on high-return programs designed to drive long-term shareholder value. In Q2, we had capital expenditures of $321 million. Now turning to the income statement. We generated GAAP diluted earnings per share of $2.14. On a comparable basis, we delivered adjusted diluted earnings per share of $2.15, an increase of 3.9% compared to adjusted diluted earnings per share of last year. Sales for the second quarter increased 0.5% to $21 billion supported by total average ticket growth of 3.2% to $77.97. This was partially offset by a 2.7% decline in total transactions. On a comp sales basis, we were up 2.3% driven by a comp transaction increase of 0.3% and an average ticket increase of 2%. Our U.S. comp was 3.2% for Q2. Looking at monthly trends. Total comps were negative 0.3% in May, positive 3.4% in June and positive 4% in July. Additionally, monthly comps for our U.S. business were a positive 0.7% in May, positive 4.2% in June and positive 4.7% in July. Gross margin for the second quarter was 32.1% of sales, a decrease of 85 basis points from Q2 of LY but 65 basis points better than Q1. The improvement since the first quarter reflects immediate benefits from the actions we've taken, including retail price adjustments that had minimal impact to units, a pivot to more strategic and targeted promotions and greater vendor support for key promotional activities. We are very pleased with the progress we've made to improve our gross margin performance. The actions we've implemented are gaining traction, but there is additional work to be done in this important area for the balance of the year. This quarter, we experienced approximately 50 basis points of rate pressure. As expected, we experienced approximately 15 basis points of pressure from supply chain costs. We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery costs. Product mix shifts and inventory shrink each had an approximately 10 basis point negative impact on gross margins during the quarter. SG&A for Q2 was 19.3% of sales, which levered 170 basis points. It's worth noting that in the last year's second quarter, we recorded a noncash charge of $230 million related to the strategic reassessment of Orchard Supply Hardware. This resulted in approximately 110 basis points of leverage this year. We drove approximately 50 basis points of leverage in retail operating salaries in the quarter and approximately 15 basis points of leverage through improved advertising efficiencies. Operating income increased 98 basis points to 11.34% of sales. The effective tax rate was 24.2% compared to 24.4% to LY. At $13.7 billion, inventory increased $1.8 billion or 15.5% versus the second quarter last year but is down $1.3 billion versus Q1. As Marvin indicated, this increase was driven by strategic investments in the first half of the year to drive sales such as an earlier seasonal load-in, CRAFTSMAN reset, increased presentation minimums and investments in job-lot quantities for the Pros. In the back half of the year, we will refine our in-stock expectations and begin to strategically reduce inventories in certain areas while protecting our in-stock position as well as sales and margin. Before I close, let me address our 2019 business outlook. The underlying macroeconomic fundamentals in the U.S. remain, supportive as demonstrated by the solid pace of job growth. The home improvement sector should continue to benefit from several factors, including strengthening wage growth, gains in household formation and rising home prices that encourage homeowners to engage in discretionary projects. Additionally, the aging U.S. housing base is driving ongoing maintenance and repair spending across the nation. And despite our strong financial performance in Q2, which exceeded our own expectations, and the solid underlining economic outlook for the remainder of 2019, we've elected to maintain our current 2019 business outlook. We are still recovering from disappointing first quarter margin performance, but we have assembled a very talented management team, and we are aggressively implementing initiatives to improve our business. Therefore, we feel it prudent to maintain this intense focus on retail fundamentals throughout the remainder of this year. And as we've said many times, we are in the early days of our transformation. We expect a total sales increase of approximately 2% for the year driven by comp sales increase of approximately 3%. We expect an adjusted operating margin increase of 20 to 50 basis points. The effective tax rate is expected to be approximately 24%, and we now expect adjusted diluted earnings per share of $5.45 to $5.65. We shared previously that our business outlook includes the wave of 3B tariffs. We have evaluated wave 4A and have concluded that we can manage through the limited impact in the second quarter of this year within our existing guidance range. We are forecasting operating cash flows of approximately $4.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio stands at 2.75x, and our guidance assumes that we complete approximately $4 billion in share repurchases for this year. So in closing, we remain extremely excited about the future of the company and its ability to deliver significant shareholder value over the long term. So with that, we're now ready to take questions.
Operator:
[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
First question on, Dave, your comments on the guidance and your decision not to raise it. So I appreciate your comments on being prudent because there's a lot of uncertainty, and the turnaround is in the early stages. But is there anything in any area or any initiative in particular that causes -- gives you that pause or any area of the P&L in your guidance where you see more risk versus other areas?
David Denton:
No. Listen, we're really extremely pleased with the progress coming out of Q2. We are very confident in our outlook for the balance of the year. Keep in mind, as I said in my prepared remarks, we've worked -- we've committed ourselves to retail fundamentals and improving our financial performance as we cycle into the back half of the year. But as you know, we've launched many broad, cross-functional efforts touching almost all areas of our core business, thus creating a little bit of a fluid environment in our business model.
Having said that, we feel very confident in where we stand today and our outlook for the balance of the year. So there's nothing on the horizon that we see that is disappointing news coming forward from that perspective.
Marvin Ellison:
This is Marvin. The only additional comments that I'll make, Bill outlined in his prepared comments some of the key initiatives for the third quarter and the back half of the year. We have a lot of confidence in our strategy. Q1 was a disappointment, and we're still candidly digging out of that. But as we look forward, I mean we're very confident in our ability to drive the business. We just think it's prudent to just focus on retail fundamental execution to give this still relatively new team time to continue to get our arms around every aspect of the business, and then we'll evaluate guidance as we continue to progress through this quarter and beyond that.
Christopher Horvers:
Understood. And then just a question on the margin front. So SG&A dollars are down in the first half of the year. And if you look at it on a per-foot basis, it's up about 0.5% year-to-date with 2Q better than 1Q. So how are you thinking about SG&A as we proceed through the year and lap the store closures? Should the SG&A dollars be down in 3Q and then up modestly in the fourth quarter on a year-over-year basis as you get through the store closures in 4Q?
David Denton:
Yes. Let me just take it first half, second half. I think we continue to make really nice progress from an SG&A perspective. I think the second half, we won't leverage near as much in the second half driven by the fact that many of our initiatives from a project perspective are continuing to ramp into the back half of the year. And so you'll see those expenses show up back half of the year.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Wanted to ask about gross margin. If we look back, I think the right base on a rebase basis is around 33% for this business before some of the onetime issues occurred. Is there any reason that you shouldn't recoup and get back to those levels? And you mentioned this modernization. Do you need the modernization to recoup what you lost in Q1? Or does this enable you to even get past that 33% level over time?
David Denton:
Yes. This is Dave. Maybe I'll start. Clearly, if you look at the long-term algorithm of our business model, as we said, to get to our 12% operating margin over time is that we would think about gross margin being substantially flat, if you will, over time. And there's -- I don't think there's anything on the horizon that we see in our business model that would change that expectation. Clearly, as we go through the years to come, we need to do 2 things. We need to increase our performance from a sales perspective, thus leveraging SG&A and flowing through a higher profit margin through that algorithm and through that approach. So I don't think there's anything from a margin perspective that gives us pause at this point.
Marvin Ellison:
And Simeon, the only thing I'll add -- this is Marvin, is -- from technology dependencies, we don't have high dependencies on technology, specifically for the back half of this year. But I talked in a little bit of detail about our price management system and leveraging the retail analytics platform that we acquired from Boomerang. And we're going to have a new price management system in position in the fourth quarter. That would give us a competitive parity. And now candidly, we're quite a bit behind what a modern large retailer would be from the ability to leverage pricing and to have agility pricing in local markets in-store and online. We're going to give Bill and team just better visibility in a single repository, which, believe it or not, this company has never had.
Within the first half of next year, we're going to merge the price management tool with the retail analytics platform that we acquired. And we think that is going to unlock the ability to meet the expectations that Dave laid out. And that is relatively flat gross margin -- our operating income story is going to really be about flat gross margin and driving continued SG&A leverage by implementing technology and taking task out and putting more labor on the floor to serve customers. And so that is going to be more of an ongoing year-over-year process.
Simeon Gutman:
And then for my follow-up, I'll stay on the same topic. I mean there are some big events you're going to be lapping first in the third quarter with the write-down and then next year's first quarter. Is there any reason today that you see that you couldn't recoup then what you -- what was lost in the write-down that should have been a onetime event? Is there any reason we don't get back that amount coming in the third quarter, and then through the first quarter, a lot of the issues from this prior year's first quarter should be resolved?
David Denton:
Well, clearly, that's within our plan. So our guidance assumes that we're going to lap that in the back half of the year. And as we -- you look at the continued performance of our business both from a sales perspective and a margin perspective, we're actively managing up against that. So there's no doubt that we're going to sequentially continue to make progress from a margin perspective for the balance of the year.
Operator:
Your next question comes from the line of Zack Fadem with Wells Fargo.
Zachary Fadem:
So Marvin, you called out strong execution on holiday events. Curious if you could talk a little more about what you're doing differently there, both in terms of just the execution and merchandising assortment but also the traffic-driving initiatives like the paint promotions that you ran and how that's impacting your take rate.
Marvin Ellison:
So Zack, I'll take the first part of it, and I'll let Bill add some additional color. When you look at the home improvement business, the one thing that we brought from a strategic standpoint is the importance of the event execution because you have certain DIY customers that will traditionally shop with you about 4 times a year. So it's really important that you start the year really effectively. And in the past, Lowe's has kicked off these Spring Black Friday-type events, and they've been out of stock, had some degree of service issues. And so you disappoint customers, and those customers just don't come back for that second, third and fourth shopping occasion later in the year. So we've put an enormous emphasis on great execution, product load-in, in-stock great value for Spring Black Friday, understanding that customers who may have been disenfranchised by shopping at Lowe's in the past would come in to shop with us because the values were compelling. But the goal was to create such a great service experience that they would come back on that second, third and fourth occasion this year.
And so what we believe we're seeing in Q2 is we're seeing that second shopping occasion because of a great event execution and Spring Black Friday that led to continual execution in Father's Day, in Fourth of July, et cetera, et cetera. And so it starts with great product and great value. It starts with a compelling marketing message, and then the stores have to take it from there to turn that foot traffic into sales. And so we've done a really nice job of that, and it's been a collective team effort. So I'll let Bill talk about what some of the values were that drove our success and kind of what we're going to be leaning into as we think about the rest of this fall.
William Boltz:
Yes. I think just to add to Marvin's comments, a couple of other things. The investment that we made propping up our MST team as well as our field merchant teams certainly started to take hold in Q2. And we're able to pull a lot of this event recovery and event execution off of the shoulders of our selling associates and really recover faster inside the stores. And that was a big difference this year versus last year. And then the marketing teams and the merchant teams did just a -- I thought, a superb job of coming with just great values that would drive traffic into the store and drive the basket.
And your comment around paint was -- we know that that's a traffic-driving category. We know it's the #1 DIY project. And by being able to strategically look at our overall promotional strategy inside the store, we're able to do something disruptive in paint that drove some unprecedented traffic into that category for Q2. So we're excited about what's happened. We're excited about where -- the learning we've received, it'll help aid certainly as we go into the back half of the year and more importantly into 2020.
Zachary Fadem:
Got it. And then on some of the merchandising efforts, you're a year removed from the SKU rationalization. Could you talk about the success of that initiative, whether the replacement SKUs had been more productive from a volume or margin perspective? And then with your inventory up over 15% in Q2, how should we think about the timing potential for further inventory rationalization initiatives ahead?
Marvin Ellison:
So Zack, it was less inventory rationalization and more the removal of nonproductive inventories. And so it sounds like a nuance, but this is a little different because the steps we took the second half of last year was to basically just identify all the aged inventory that had been sitting and not turning and just take aggressive action to exit it from the business. We didn't, in many cases, go back in and replace it with more productive SKUs. We just tried to create better presentation of our most productive SKUs. So what Bill is in the process of doing now is identifying what we describe as slow-turning SKUs. And as we stabilize e-commerce, what really efficient retailers are doing, they're taking the slow-moving SKUs off the shelf in their brick-and-mortar locations and putting it online. It's easier to have it in a handful of parcel fulfillment centers than have it in 1,700 stores. So that work is just beginning for us.
But as we think about inventory and as I said in my prepared comments, we made a strategic decision to invest. If you take a look back at Lowe's historically, Lowe's had one of the worst in-stock positions of any major retailer. And to be quite candid, it was actually worse than what we anticipated when we started to take actions to get in-stock. So as we think about kind of the time frame around kind of getting our inventory more -- what I'll describe as rebalanced, we're going to have some supply chain initiatives that are going to be happening right now. I mentioned predictable delivery. That's really important for us because we were so out-of-stock and our delivery and supply chain process was so inefficient that we had excessive amounts of safety stock in stores just to compensate for late and slow deliveries. Now that our supply chain has become much more efficient, this more predictable delivery will allow us to reduce safety stock so we'll have more frequent flow of product. That doesn't sound like a big deal, but in our environment, it's going to be a big deal, and that's going to be one of the most significant initiatives that we're going to take to get our inventory rebalanced. And we think this is going to be a multi-quarter initiative. We'll be updating externally more at the end of this quarter. But we're going to see how our process goes this quarter, and then we'll have a better perspective on when we think we'll be in a position that we'll be most comfortable. And the only caveat to that would be we are committed to staying in-stock, we're committed to driving sales, and we're committed to protecting margins. So we're not going to swing this pendulum from one digit to the other. And so it's all about finding balance. But we feel comfortable that the quality of our inventory is really good. We have a small amount of seasonal inventory, so we don't have risk of taking excessive markdowns. So we feel like we have time on our side to get this in order.
William Boltz:
The only thing I would add is that the merchant teams now getting their feet on the ground, as they've all come together, along with our planning and replenishment teams on the supply chain side, SKU rationalization is an ongoing effort, right? It goes on all the time. So that's part of the rhythm of what they do, always looking at making sure you've got the most productive stuff inside the store. So...
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
It seems like you went to a deeper level of promotion on the paint category than the industry has seen in the past. So how does that inform your view on what you might do in other categories? Would you try the same strategy in other products?
Marvin Ellison:
No. Mike, it's a fair question. So let me just kind of take a step back and just give you kind of a broad view of the strategic approach that we're taking. One of the first observations that Bill made to me upon arriving is that we have too many category-wide promotional events. And so it is our intent and expectation that we will become less promotional, not more promotional. What we're trying to do with our promotions is to be more strategic and make them more event-based, more -- be less high/low, so that's something we're going to slowly wind ourselves out of and be more event-based.
Having said that, we're going to strategically choose categories that we believe are cart starters, project starters and that drive traffic. But when we lean into something like paint, we're going to be pulling back from other areas. So the net effect will be less promotions but more effective promotions. And so paint was the first attempt at that. We are very pleased with the results. Obviously, for competitive purposes, we're not going to telegraph what our next strategic move will be. But philosophically, I think the message is we're going to lean into certain categories that we think provide a broader strategic gain. We'll pull back from others, and we're going to be more SKU-focused on promotions than overall category. And that's going to allow us to drive price perception, to drive value perception but do it while protecting margin more effectively. And Bill, I don't know if you have anything to add to that.
William Boltz:
No. I think just it was also an area where we looked at a lot of disruption a year ago when we came in, and we had struggled really through the balance of the second half of last year to try to get paint stabilized. So really, 2019 gave us an opportunity to try to do something different, and that was an opportunity that we had to be able to mix it up a little bit.
Michael Lasser:
And I have one follow-up in 2 parts on that. So if you're going to pursue a similar strategy in other categories, do you see the risk? Or is there a risk of potential ripple effects across the industry as others might be forced to follow suit? And then as part of that, are you using some of the pricing actions that you're taking, as you described in the first quarter, to use that as a source of funding to go out and make some of these investments in promotional activities within certain categories?
Marvin Ellison:
Yes. Michael, we think, again, the net effect is going to be fewer promotions and more targeted promotions. So we don't see this as a risk. I mean as a matter of fact, we see it as a benefit because it's going to create an even more rational promotional atmosphere than what we have right now. We think we have a relatively rational sector from a promotion standpoint. We're in the process of redefining how we go to market. Anytime you have lost market share and lost relevance over a 5- to 7-year period, like Lowe's had done prior to 2019, you can't just run the same play over and over again and expect that you're going to get a different result.
And so we believe one of the reasons why, in Q1 and Q2, we've grown sales and taken share is because we've taken a more strategic approach to how we go to market. Having said that, we have no intentions on being more promotional. We have no intentions on doing anything that's going to ratchet up the promotional environment. This is an environment that competitors do special buys all the time, and a special buy is not really described as a promotion. It's described as taking advantage of a specific category on a specific event period. And so you'll see us do a lot of those different things, but we have no intention on being more promotional. We want to be less promotional, less high/low but a lot more strategic.
Operator:
Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Do you guys have any -- we talked about supply chain and inventory and some of the changes happening there, Marvin. Are there any examples of categories where you've been able to pull back on the amount of inventory in a category without it actually adversely impacting your comp growth?
Marvin Ellison:
Well, Scot, I would say that we try to test and learn in everything that we do. And so I would say that from this whole predictable delivery process that we're rolling out, part of that has been in cooperations with the stores and with supply chain. So because of that, we have taken a few items. We'll not -- for competitive purposes, we're not going to kind of lay everything out there. But the short answer is yes, we have. And as we roll predictable delivery out to the entire company, we're evaluating safety stock levels by SKU by store so that we can understand what level of safety stock will be required for us to maintain the proper in-stock position, the proper presentation minimum while driving sales. And then that ties to the frequency required from the supply chain. So this whole predictable delivery model is in large part driven by tests with the operations team on how effective we can do this while still hitting our financial targets.
Scot Ciccarelli:
And just to clarify, I mean you've made some, let's call it, adverse comments previously on some of the legacy systems that the current team kind of inherited. Do you have the analytics in-house to be able to make sure you're not adversely impacting your comp growth when you make some of those inventory changes on the delivery side?
Marvin Ellison:
Yes. That's why testing and learning, Scot, is the way you do it. I mean -- and that's just really the environment that we've put in place. We're not going to roll anything out chain-wide that we're not going to test it first. So the short answer is we have the analytics. We have the process design. And anytime we roll something chain-wide, you can be assured that we are pretty confident of what the outcome is going to be.
Operator:
Your next question comes from the line of Laura Champine with Loop Capital.
Laura Champine:
I'm just wondering if you can help quantify all the comments that you've made on your inventory management and the changes you expect to make. So by the end of this year, would we still be likely to see inventories up, call it, high single digits or because you need to reset levels to keep your in-stocks in good shape? Or should we start to see inventories growing in line with sales growth?
David Denton:
This is Dave. I don't think you're going to see much movement in inventory levels this year. I do think we'll -- as we indicated earlier, we're going to strategically rationalize inventory in certain areas. That -- this is probably a multiyear journey as we make sure that we have the right analytics in place, we have the right supply chain in place, and we've really thought through by category what's the right assortment. And that's a multiple-quarter, multiple-year journey to get us back to that, I'll say, the optimal level of inventory.
Marvin Ellison:
And the only thing I'll add to that is to reinforce points that I've made a couple of times this morning. We have very minimal seasonal inventory, so we don't have markdown risk of excessive inventory that we just have to work out of the system in a certain time frame. The good news about the home improvement sector is when you load in job-lot quantities in Pro-related categories, these are year-round SKUs. And when you look at presentation minimums, if you're doing it on core SKUs, you have limited markdown risk.
Having said that, we're still going to be working quarter-over-quarter to make sure that we are getting our inventory more in line with our rate of sales. We will learn a lot in the next 2 quarters, and we'll have a much more efficient and clear point of view as we head into 2020 for sure.
David Denton:
And I think also, as Marvin and I said, listen, it's really important, we're going to be focused on our in-stock levels, we're going to make sure that we're supporting our sales plan, and we're going to be supporting our margin plan. So we have all 3 of those kind of working in tandem, and we don't want to harm our business. We got to make it more efficient over time, but right now, those things are -- those 3 elements are pretty important to us.
Operator:
Your next question comes from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
Nice quarter. So first question, this one, I guess, bigger picture. On the Pro, you've discussed the success you're having lately with the Pro. We talked a lot here about better in-stocks, which is obviously an effort that would help both Pro as well as DIY. But Marvin, as you look out maybe further, to continue to really better serve this professional customer, where are some of the next initiatives we should be thinking about that Lowe's will undertake?
Marvin Ellison:
Brian, it's a good question. I'll take the first part then I'll hand it off to Joe. He's spent quite a bit of time on this. So let me first take a step back and give a more strategic overview of why Pro is important. I think one of the strategic missteps over the last 7 years here is not really understanding what the Pro customer does to the overall productivity of the business. I mean our stores operate with a -- in some cases, fixed expenses and variable expenses. And so as you drive more productivity through those boxes, it just creates and unlocks a lot of value. And so as we lean into Pro, our strategic rationale for this was how you take a box that has a certain amount of expenses allocated to it and exponentially increase volume, which makes it more productive.
And so we're pretty confident that our sales momentum over the last 2 quarters, our improvement in transactions and our improvement in sales per square foot in large part is driven by Pro. So the strategic rationale for Pro is traffic, transaction, sales per square foot productivity and just unlocking more value in every location. And so based on that, I mean we're committed to it. So I'll let Joe kind of provide kind of some -- what's on the horizon that we think will allow us to continue to build on this very important customer.
Joseph McFarland:
Look, Brian, thanks for the question. So the first phase of our journey to win the Pro business was setting up the proper retail fundamentals, which we've been discussing, and we largely feel we're completed with that in the first half of the year. As we look out in our Pro road map, we have a lot of initiatives that are coming. And when you think about having that foundation in place, we can now lean into better Pro marketing, focused on things like customer acquisition, driving awareness of what's different at Lowe's, the future focus, key segments, national accounts, our outside sales team, integration of MSH, better jobsite delivery. We have a laundry list of improvements that we'll continue to make for the Pro customer, and we're very, very encouraged by what we're seeing across the total store from a Pro standpoint.
Brian Nagel:
That's helpful. And then my follow-up question, shifting gears a bit. I just want to discuss again gross margin and maybe more for -- I guess, for Dave. But Q1, you had the inventory, the systems-type issue, and you articulated clearly that you isolated that impact on your gross margin. So what I'm wondering is, what was that in Q2? And how should we think about that specific impact as it mitigates through the back half of '19?
And then second to that, it seems -- and just looking through results today, it seems as though you're correcting those problems that emerged in Q1 quicker than you initially expected. So a, is that fair? And then b, why is that happening?
David Denton:
Yes. So listen, I think we have a fairly comprehensive plan to improve our margin performance. And I would say that if I just kind of tick down some of the things that we've done, you can get a sense for the progress we are making. First and foremost, we kind of really did an evaluation on our price complement across the categories, and we've adjusted price. At the same time, we've gone through and enhanced our point-of-sale system such that we're eliminating unnecessarily -- unnecessary discounting that is kind of, I'll say, leaking at point of sale. As the team spoke kind of many times throughout this morning, we've really leaned into the kind of more targeted, efficient promotions. And as you can imagine, given -- coming out of Q1, we couldn't touch all the promotions early in the quarter. We -- they were kind of already locked and loaded. So the changes that we made to address the promotional calendar largely happened in the back half of the quarter given the lead time. And then finally, we're working with our vendors and making sure that we're managing cost and making sure that we're getting the right support for all the efforts that we're doing within our stores. That's probably the long pole in the tent to get done for the balance of the year.
All of those factors are things that we're managing through the balance of the year. Clearly, when you change price, this is the quickest to respond from a P&L perspective. So I think what you've seen is that -- the effect of that happened more rapidly in Q2. We're going to probably lean more aggressively on some of the other actions to improve our performance in the back half of this year. So that's the -- that's why you're going to see that progression in -- both in Q3 and Q4 as we cycle into the back half.
Marvin Ellison:
And Brian, this is Marvin. The only additional comments, I mean we -- it was a lot of work, and I just have a ton of admiration for the merchant team, finance team, store operations team that really worked very hard to accelerate the recovery. But as I outlined in my prepared comments, I mean we have 2 initiatives coming for the -- over the next 12 months that are going to be critically important. The rollout of our price management system in Q4, it's going to be just critically important for us to just get to competitive parity. And then as we integrate this retail analytics platform from Boomerang, it's going to really take us from trailing almost every major retailer to being at a best-in-class level on pricing analytics.
And I think you're very aware that one of the most significant levers that any retailer our size has at its disposal around margin improvement is strategic pricing actions. And we learned a lot about strategic pricing in Q2, and we did it kind of the hard way. And as our systems continue to get better, it's going to make us a lot more agile. And so we have a lot of confidence in the future that we can continue to drive more sequential margin improvement from Q1 and just continue to get this whole platform stabilized.
Operator:
.
Our final question will come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things. First of all, the follow-on within gross margin. Dave, I'm curious what we should be expecting in the back half for gross margin. Obviously, 2Q was notably better than you had thought. Is that progress sustainable? Excluding the impact of the markdowns in 3Q, can we get all the way back to flat gross margin on a comparable basis in 3Q? How should we be thinking about that?
David Denton:
Yes. I think you should expect a sequential improvement in the second half jumping off to where we are in Q2. I don't think you're going to have a full recovery by the balance -- by the end of the year. Just I think mathematically, that's tough to deliver at this point.
Eric Bosshard:
Okay. And then secondly, the step-down in online, I assume was more precipitous than you had expected. But if you could characterize that and then also characterize the pace and timing of the road back in growing the online piece of the business.
Marvin Ellison:
Yes. Eric, so I think when we look at online, it was definitely below our plan. But as I mentioned, we made a strategic decision that we were going to slow it down primarily by not adding additional SKUs. But here's a broader point to that I'd like for everyone to consider. So we delivered the 3.2% comparative sales in the U.S. with a 4% online growth. And so to me, that just screams upside opportunity because we know how to fix the online business. We've hired an outstanding President of Online in Mike Amend. And Seemantini, our CIO, has a depth of online experience from her time at Target. So we have the right people in position to get this fixed, and we have a very detailed transformation plan.
So although we are disappointed with the results, it was part of a strategic decision to slow it down short term, to make sure that we could get some issues corrected. We had just some fundamental process issues, i.e., if you added a new SKU online, every store has to go through a manual process as though that SKU is being added to the shelf. And that was a priority project for every store because if they didn't flag it in the store, print a label and go through the same manual process as though they would literally add it to the shelf, you couldn't add it online. As rudimentary as that sounds, that was the process, and we were able to get that fixed in the early part of Q3. And there were other just really prehistoric processes like that, that really hindered our ability to add additional SKUs. And so the way we look at online is that we think for the balance of this year, we're going to have modest growth, but we're going to be working very aggressively on the replatforming to Google Cloud and a lot of other foundational functionality to just improve search, checkout, navigation, et cetera. And we believe as we get into 2020, you're going to start to see this business begin to grow at the rate that we expect it to. And we see nothing but upside potential. Just as a reminder, online is, give or take, 5% of our total sales, and it grew at 4%, and we still delivered 3.2% comp. So we know that we have upside potential for the business by getting our arms around this business, and we have the people that can do it.
William Boltz:
And Eric, the only thing -- this is Bill. The only thing I would add to Marvin's comments is that we're just in the early stages of getting the online merchants integrated with the core merchants. And so as that starts to gain traction and we get some of these legacy systems issues fixed, then the acceleration in the SKU expansion certainly starts to happen and we start to be able to really gain some traction on the online space. So there's a lot of good things in front of us for dot-com.
Operator:
I'll now turn the conference back over for any closing remarks.
Marvin Ellison:
No. Well, thank you for your interest in Lowe's, and we look forward to updating you on our next quarterly earnings call.
Operator:
Ladies and gentlemen, this will conclude today's call. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' First Quarter 2019 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 their 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. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz , Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Thank you, Regina. Good morning, everyone. Our first quarter comp performance is a true indication that our focus on retail fundamentals is gaining traction. Despite solid top line results, our gross margin performance in Q1 highlights that we still have work to do as we continue our transformation. We've taken the necessary short- and long-term actions to improve our gross margins, which I'll discuss in more detail in a moment, but first, let me highlight what drove our sales performance in Q1 specific to our commitment to improving in-stock and customer service, coupled with our focus on winning the pro are keys to our improved sales performance.
For Q1, we delivered total company comps of 3.5%, and our U.S. home improvement comps grew 4.2% for the quarter. While it was challenging earlier in the quarter, given that we experienced the second wettest February on record. In fact, unfavorable weather exerted 315 basis points of top line pressure in February. As Lowe's improved, we saw broad-based sequential improvement with comps of a negative 1.4% in February, positive 3.5% in March and positive 7.2% in April. We drove increased traffic to stores and to Lowes.com and generated a more balanced top line growth with increasing transactions by 2.2% and increasing average ticket by 1.3%. We delivered positive comps in 10 of 13 merchandising departments, including double-digit comps in seasonal and outdoor living and high single-digit comps in lawn and garden. We drove positive comps in all geographic regions with the exception of Tampa and Houston, which faced tough prior year comparisons of Hurricanes Irma and Harvey. For Q1, some of our best-performing geographic regions were Atlanta, Charlotte, Los Angeles, Nashville, New York Metro, Pittsburgh, Philadelphia and Richmond. Our pro comps significantly outperformed DIY, and we see early evidence that our strategic initiatives with this very important customer are gaining traction. And Joe McFarland will add additional color to our pro performance later in the call. For Lowes.com, we posted comp growth of 16% for the quarter. Although we're still not where we like to be with our online business, I'm pleased with the progress our new leaders are making to improve the infrastructure of this very important channel. In Canada, we posted negative comps for the quarter as the weaker Canadian housing market exerted pressure on the business. Adjusted diluted earnings per share were $1.22 for the quarter, and a convergence of factors led to gross margin pressure in the quarter. Some of these challenges are a reflection of the tools and process limitations I've discussed on previous calls. But what's important is that we have our arms around the issues and have plans to improve gross margin over the course of the year. But allow me to take a moment to outline the factors that led to our Q1 gross margin shortfall. First, we recognized inventory first in, first out. So cost increases that were agreed to by merchants in 2018 are now flowing through the P&L as we turn inventory, the majority of these cost increases that were accepted in 2018 without any corresponding offset to gross margin pressure. Second, as we are preparing and we're preparing for the business' seasonal year, we undertook unprecedented levels of change in our merchandising organization. Over the past 6 months, we replaced 2 of our 3 merchandising senior vice presidents and we replaced 11 of our 13 merchandising vice presidents. This level change was necessary to ensure that we have the best talent in position to plot our strategy for the second half of the year, spring of 2020 and to fuel our future growth. However, as we transitioned from legacy merchants to new merchants, there was much more disruption in Q1 than we anticipated, and this disruption was primarily driven by a lack of visibility in our pricing ecosystem. Our new merchants simply did not have clear line of sight to the cost increases that were accepted by prior merchants as we transitioned. Based on the really limited systems visibility, we could not quickly analyze and offset these cost increases with appropriate pricing action. Our challenge with pricing tools and processes aren't new to Lowe's. However, we did not anticipate the impact of fully communicated cost increases, significant organization changes with 11 new merchandising VPs and legacy ineffective pricing tools and processes. Now let me take a moment and outline the decisive actions we're taking to improve our gross margin for the balance of 2019. First, our CIO, Seemantini, is leading an effort to implement changes to our pricing and point-of-sale systems. With these changes, we will streamline who can affect costs and pricing changes and sequence those pricing actions to prioritize those that have the greatest impact to gross margin. We'll also have better visibility for the merchants to understand the impact of all pricing actions without having to view multiple systems and numerous reports. We're establishing a more efficient process to systemically analyze, prioritize and implement pricing actions to offset cost pressure. Second, our recent acquisition of Boomerang's retail analytics platform, a leading pricing analytics practice, is a significant step forward towards modernizing our approach to pricing by digitizing our business processes and increasing our agility. This acquisition reflects our commitment to modernizing our systems and reinforces our philosophy to buy-versus-build capabilities if that approach is more advantageous for the company. And finally, as our merchant leaders accrue more time in their roles, they have better view of the categories and assessment plans, and stability in any organization is important, and now we have that stability for the balance of 2019 in our merchandising organization. With enhanced visibility, the merchants are better able to offset cost pressure with adjusting prices within their portfolio of products. In addition, we're building improved pricing analytics to help offset future cost pressure and protect gross margin and impact the top line sales. It's important to mention that we believe our pricing issues hurt top line sales as well as gross margin in Q1. By not taking pricing action on our inelastic SKUs to offset cost increases, we simply decremented top and bottom line at point-of-sale, which we believe negatively impacted sales. As I've discussed on previous calls, this is a multiyear transformation, and we're in the Phase 1 of a 3-phase process. However, our first quarter results clearly reflect 2 things. First, our 4.2% comp in the U.S. clearly illustrates that customers are responding to our changes and our approach to retail fundamentals is working. From my experience, there are 3 things you hope to see during the early stages of a transformation. You want to see positive customer transactions. You want to grow average ticket while reducing expense and improving efficiencies to leverage SG&A. We saw all 3 in Q1, which gives us confidence that we're taking the right strategic steps. Our first quarter also reflects that as we encounter systems and process limitations during this transformation, we now have the experience and the internal expertise to address the issues and minimize the impact on future periods. The issues that impacted Lowe's gross margin in Q1 have been identified and are being addressed with process changes and system adjustments. Consequently, we expect to deliver improved gross margin performance over the balance of the year. We made a lot of progress, but our transformation is clearly ongoing. Our first quarter comp and our improved sales for productivity, driven in large part by the pro customer, gives us confidence that our strategy is working. And we're committed to making the investments and taking the actions necessary to address legacy issues and position Lowe's for sustainable long-term sales and profit growth. My most enjoyable time as CEO is the weekly visits I spend in the stores. Our associates have demonstrated to me their passion for our customer and for this great company. So before I close, I would like to thank them for their hard work and their commitment to serving the customers and serving our communities. And with that, I'll turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. As Marvin shared with you, we capitalized on spring demand in the first quarter, posting U.S. comparable sales growth of 4.2%. We transitioned into the spring season more efficiently. We began setting our stores from south to north 3 weeks earlier than last year, and we adjusted our store inventory load-in to 60% versus 35% last year. These actions ensured that we were ready for the spring season and positioned us to have adequate seasonal inventory on hand to capture that spring demand.
Our teams also significantly improved sales for productivity through better use of end caps and a redefined strategy for off-shelf side stacks. We leveraged our spring Black Friday event to take advantage of seasonal project demand with strong messaging and attractive offers, more personalized marketing and a continued shift into digital and localized marketing channels. And as Joe will share with you in a moment, our associates delivered very well in the aisles and executed a very successful event. Our success in driving strong spring sales was supported by the improved service model in our stores and a better in-stock execution. For the quarter, we achieved double-digit comps in seasonal and outdoor living, led by double-digit comps in outdoor power equipment, where we continue to leverage the top 3 brands in riding equipment with John Deere, Husqvarna and CRAFSTMAN. We also drove double-digit comps in grills through our offers from Weber and Char-Broil, the top 2 brands in outdoor grilling. In addition to seasonal and outdoor living, we also delivered high single-digit comps in lawn and garden, with the strength in our lawn care and landscape products through the power of the Scott's brand, and in live goods with our nationwide body plant offers, along with the extension of our Monrovia plant program, a home center exclusive. In the first quarter, we also saw strength in our tools and our appliance businesses. We have posted above-average comps and tools as the CRAFSTMAN reset continues to drive strength in categories like tool storage and mechanics tools. We're excited to be able to complete the CRAFTSMAN tools reset by the end of the second quarter, and we look forward to introducing the brand into additional categories in the second half of the year. The CRAFTSMAN brand, along with our proprietary Kobalt brand, continues to drive traffic, and they both create a loyalty-building opportunity for us. We are proud to be able to offer both brands and with the exclusive destination of the home center channel for the CRAFTSMAN brand. We also drove above-average comps in appliances as we continue to leverage our leading market share position through our top brands, our breadth of assortment and our strong events. Though paint performed below the company average, the category still delivered positive comps even with the significant weather pressure early in the quarter. Our intense focus on our retail fundamentals, while leveraging our exclusive partnership with Sherwin-Williams, has allowed us to continue to drive progress in this category. And as Marvin indicated, we are in the early stages of implementing change, which did create some disruption in Q1. However, I'm very pleased with the talent and the deep retail experience we've been able to recruit and to infuse throughout our merchandising organization. Our new leaders are now firmly established in their roles, and we expect this leadership stability to drive sustainable improvement for the balance of 2019 and beyond. We are encouraged by the early results that we are seeing from our new merchandising service team. These teams are supported by our vendors, and they are responsible for the day-to-day bay maintenance and resets in our stores, along with setting and maintaining end caps and help executing off-shelf displays. The MST teams are a critical component to improving our merchandising reset execution at store level as they take these important and time-consuming tasks off the shoulders of our red vest associates, so that they can be freed up to serve our customers. The early results of our MST program show reductions in out of stocks and improved sales productivity and an increase in bay service per hour. The MSTs also provided critical support during our successful spring Black Friday event as well as for our CRAFTSMAN outdoor power equipment and tools reset. As Marvin stated, we were very pleased with our pro business in Q1, and we are focused and leveraged on our improved in-stock position along with our key brands to drive additional sales with this very important customer. As an example, in the first quarter, we announced that Little Giant Ladder Systems, a leader in safety and innovation, has chosen Lowe's as their exclusive home center partner. Our teams continue to work to add more key programs to our assortments as well as leveraging our existing partnerships with brands such as Dewalt, the #1 power tool brand in the industry, and the new and innovative products we have from Bosch and Metabo HPT that are all focused on saving the pro both time and money. In the first quarter, we also took steps to driving merchandising productivity and localization through the investment and rollout of our field merchandising teams. The teams are now in place, and we expect to see the continued benefits from their work with our merchants and our stores in the second half of 2019. As we look ahead to Q2, we remain focused on carrying our momentum forward. We expect to drive sales and traffic with our compelling Memorial Day, Father's Day and July 4 events, the power of CRAFTSMAN as we complete the rollout of our CRAFTSMAN tool program and our pro categories as we continue to capitalize on our job lot quality investments and are focused on this very important customer segment. We also remain focused on driving improved growth on Lowes.com as we work to increase our online assortments, continue to improve the shopping experience and work to ship slower-moving SKUs out of our stores and on to our website to improve inventory productivity. We are excited about the opportunities that are ahead of us, and we're working very hard to position Lowe's for the future and to capitalize on the strong demand in the healthy segment. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. As Marvin indicated, our commitment to improving in-stocks and customer service, along with our focus on winning the pro, were keys to our improved sales performance in the first quarter.
To improve associate engagement, we rolled out smart model, a new customer service model which guides the way we hire, train, evaluate and coach our associates. This program models with a great experience that actually looks like and drives behaviors that deliver the kind of experience that customers want. It includes a comprehensive tool kit, training program and mobile devices, which are designed to provide our associates with the tools they need to deliver outstanding customer service. In the first quarter alone, we trained over 280,000 associates on smart customer service. And we also rolled out approximately 88,000 smart mobile devices to our stores. Associates are no longer required to leave the sales floor to log into a terminal to determine the price, availability or order status of an item. The new smart device reduced tasking hours by providing associates with real-time data without ever stepping off the sales floor. For example, the smart devices have functionality to process bottom line pick up in store orders. This new functionality takes us from a 12-step, paper-based process to an average of 2 digital scans. In the first quarter, 60% of our online purchases were picked up in our stores, which reinforces the power of our omnichannel model. The rollout of smart devices and the systematic improvements in buy online, pick up in store represents a significant advancement in the partnership between our stores and IT, and are really terrific early examples of what we can accomplish as an organization when we are focused in the line. To further improve the customer experience, in the first quarter, we replaced a series of nonfacing customer positions with over 6,000 assistant store managers and department supervisors. These customer-facing store leadership roles are focused on providing better departmental coverage and expertise as well as coaching our associates in delivering excellent service. Previously, for example, a single department supervisor was tasked with covering the lawn and garden, rough plumbing and electrical and paint department simultaneously, which simply isn't manageable. With the addition of department supervisors, we're ensuring that we have the proper coverage for strategic areas of focus such as paint. To that end, one of the incremental supervisors is dedicated to the pro department. As we have discussed, the pro customer is a key focus for us in 2019. In the first quarter, we were very pleased with our sales and customer service improvements in pro. This improvement was driven by executing 5 key steps. First, we addressed our out-of-stock issues and poor inventory presentation with a commitment to improving our job lot quantities and our product presentation under the pro canopy and on our end caps. Second, we improved our store level service to ensure we can get our pro customers in and out faster. This included adding dedicated loaders and establishing preferred parking under the canopy. Remember, for the pros, time is money. Next, we staffed our pro desks with dedicated associates, working a consistent schedule, and we added department supervisors to all pro areas of our store. We redesigned our field structure, adding 15 new regional pro managers, and recruited experienced leaders to focus on our in-store and outside pro sales. Then finally, we worked with Bill and the merchandising team to communicate a consistent volume pricing message and improved our product presentation in the area. After we felt comfortable with the execution of these 5 steps, we invited customers then to share our improved environment with a very successful and nationally marketed pro appreciation event, which allowed us to grow our pro accounts. In fact, we opened over 40,000 new pro accounts in the first quarter. We also leveraged our exclusive partnership with the NFL. We ran pro-focused national advertising during the NFL draft. This was an extension of our do it right for less campaign, reinforcing that Lowe's offers the job site delivery and job lot quantities pros need as well as designated pro supervisors equipped to help our customers. Although we are pleased that our first quarter pro comp significantly outperformed our DIY comp, we are still in the early stages of our transformation with this customer. I look forward to discussing additional initiatives for the pro in upcoming calls. In closing, to improve staffing and further leverage our payroll spend, in the second quarter, we'll continue the rollout of our new customer-centric labor scheduling system. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic, providing better department coverage and customer service while ensuring that we're using our labor hours efficiently and reducing our overall payroll expense. This new system will replace our current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. We'll have this new system fully rolled out in the second half of this year. Though we are in the beginning stages of change, we are excited about the early results we're seeing and committed to the work ahead to fully capitalize on the healthy demand in our sector. Thank you, and I will now turn the call over to Dave.
David Denton:
Thanks, Joe. Good morning, everyone. Let me begin this morning with just a few housekeeping notes.
First, as disclosed in our press release, this quarter, we adopted the new lease accounting standard using a prospective transition approach. The adoption of the standard resulted in an increase in lease-related assets of $3.6 billion and an increase in lease-related liabilities of $3.9 billion. The difference between the increases in lease-related assets and liabilities, net of deferred tax impact, was reported as an adjustment to beginning retained earnings. The standard had no impact on our debt covenant compliance under our current agreements. Second, as also described in our press release, in the first quarter, we realized a tax benefit in connection with our previously announced decision to exit our Mexico operations. We had originally planned to sell the operating business. However, in the first quarter, after an extensive market evaluation, we decided to instead sell the assets of this business. That decision resulted in an $82 million tax benefit, which offset $12 million of pretax operating costs for the Mexico operations within the quarter. With that, I'll turn to a review of our operating performance starting with our capital allocation program. In the first quarter, we generated over $1.9 billion in free cash. And through a combination of both dividends and share repurchases, we've returned over 60% of this cash to our shareholders. In the first quarter alone, we paid $385 million in dividends, and our dividend payout ratio currently stands at 37%. We also entered into a $350 million accelerated share repurchase agreement retiring approximately 3.2 million shares and repurchased approximately 4.4 million shares for $468 million throughout -- through the open market. So in total, we've repurchased $818 million of our stock at an average price of $107.60. We have approximately $13.1 billion remaining on our share repurchase authorization. In April, we issued $3 billion of unsecured bonds. The issue was consistent of 10- and 30-year notes with a weighted average interest rate of 4.1%. The proceeds of this issuance were used to refinance current year maturities and other general corporate purposes. And we continue to invest in our core business with capital expenditures of approximately $205 million in the first quarter. Now looking at the income statement. We generated GAAP diluted earnings per share of $1.31 per share compared to $1.19 in the first quarter of last year, an increase of 10.1%. On a comparable basis, excluding the $82 million tax benefit and $12 million of pretax operating costs to Mexico, adjusted diluted earnings per share was $1.22, an increase of 2.5% compared to LY. As Marvin indicated, though we are very pleased with our sales performance, we experienced significant gross margin contraction, which resulted in lower-than-expected earnings per share in the quarter, which I'll discuss in more detail in just a moment. Sales for the first quarter increased 2.2% to $17.7 billion, supported by total average ticket growth of 2.9% to $77.19, partially offset by a slight decline in total transactions. Comp sales were 3.5%, driven by a comp transaction increase of 2.2% and an average ticket increase of 1.3%. Our U.S. comps was 4.2% for Q1. So looking at monthly trends, total comps were negative 1.4% in February, positive 3.5% in March and positive 7.2% in April. Additionally, monthly comps for our U.S. business were negative 0.9% in February, a positive 4% March and a positive 8% in April. Now if you were to adjust for the impact of commodity deflation along with weather in February, our U.S. comps would have been approximately 5.7% for the quarter. Gross margin for first quarter was 31.5% of sales, a decrease of 165 basis points compared to Q1 of last year. We experienced approximately 90 basis points of pressure from the challenges with our pricing ecosystem that Marvin discussed earlier. The tools and process issues have been identified and are being addressed to mitigate this pressure going forward. As expected, we also experienced approximately 40 basis points of pressure from supply chain costs as we added new facilities to the network that are still ramping up to full capacity, coupled with ongoing increases in transportation costs and customer deliveries. Product mix shift had approximately 30 basis points of negative impact on gross margins also in the quarter. SG&A for Q1 was 21.8% of sales, which levered 89 basis points. We drove 80 basis points of leverage in retail operating salaries and 17 basis points of leverage through improved advertising efficiency. We also had 34 basis points of leverage from lease assignments and terminations associated with last year's store closing activities. These items were partially offset by deleverage in incentive compensation and employee insurance. Operating income decreased 45 basis points to 7.99% of sales. The effective tax rate was 16.6% compared to 24.3% last year. This significant improvement year-over-year is primarily due to the favorable tax benefit associated with the change in approach to exiting our Mexico operations. On a comparable basis, our adjusted effective tax rate was 22.9%. At $15 billion, inventory increased $1.8 billion or 13.8% versus the first quarter of LY. This is largely driven by inventory to support anticipated seasonal demand, adjusted presentation minimums and investments in job lot quantities. Albeit a significant increase in inventory, these are important strategic investments to drive sales performance in the coming months. Now before I close, let me address our 2019 business outlook, which has been updated to reflect our gross margin miss to plan in the first quarter and to adjust the remainder of the year for the expected timing and impact of our corrective actions. For 2019, we still expect a total sales increase of approximately 2% for the year, driven by a comp sales increase of approximately 3%. However, we now expect adjusted operating margin to increase 20 to 50 basis points. The effective tax rate is expected to be approximately 24%, and so we now expect adjusted diluted earnings per share of $5.45 to $5.65. We are now forecasting operating cash flow of approximately $4.5 billion as a result of our lower operating margin expectations and an increase in inventory versus our plan. CapEx is still expected to be approximately $1.6 billion, and this is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio remains at 2.75x. So with that, our guidance now assumes approximately $4 billion in share repurchases for the year. Now as Marvin mentioned, we're early in our transformation, but we now have a management team in place with the expertise required to tackle the opportunities ahead of us. With the sales momentum we gained throughout the first quarter, we remain extremely excited about the future of our business, and we're focused on taking the necessary actions to both improve our performance and drive long-term shareholder value. And with that, we're now ready to take questions.
Operator:
[Operator Instructions] Our first question comes from the line of Michael Baker with Deutsche Bank.
Our next question will come from the line of Scott Mushkin with Wolfe Research.
Siddharth Dandekar:
This is Sid on for Scott. You mentioned 90 basis points of gross margin contraction from the pricing system issue. It sounds like some of these things like the FIFO inventory and the merchandising issues, they were probably -- you had some insight to that coming into the quarter? Just trying to understand how much of that was expected versus completely unexpected.
Marvin Ellison:
I'll take the first part of that. It was primarily unexpected. As I mentioned, we see and view our inventories first in, first out, and we had cost increases that were taken in 2018 with no offsetting steps to protect gross margin, which obviously was not a great decision. Because of the limitations within our system and the transition of our merchandising team, we literally had no visibility to those cost increases until the inventory that was increased in costs started to hit the P&L as it layered and sold through with inventory turns. So our legacy systems really gave our merchants and our finance team limited visibility to these changes until it literally hit the P&L. So we did not have an expectation this was going to happen.
The good news is that we've upgraded our systems to provide better visibility to costs and retail pricing actions. We now have the ability to prioritize which pricing actions to take. And as Dave mentioned, we've taken mitigative steps and actions to address this. Where we have made the changes, some pricing actions, we feel good about the year-over-year performance in our gross margin. We're just continuing to work through the issue. And again, it was not something we planned coming into the quarter.
Siddharth Dandekar:
All right. And then just one follow-up for Dave. It looks like the 6x rent calculation that you had in your leverage ratio target prior to this new standard was understating the operating lease adjustment, which is now actually on the balance sheet. So given you ended 1Q with the leverage so close to your target, are you foreseeing any modification of the target going forward, some wiggle room in your capital allocation strategy for the year?
David Denton:
Sid, I think if you look at that number, it changed only modestly. So I think that our estimates were pretty spot on from that perspective. And we do not anticipate change in our cap structure of 2.75x based on that adjustment.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley
Simeon Gutman:
So just to clarify, this GM weakness, this was not driven by promotion. This was bad systems. There was some execution. And by the logic you provided on the call, where you didn't get higher prices on inelastic items, you didn't mention elastic goods. Because by that logic, if you didn't push higher prices on elastic goods, why is that different from being promotional or even discounting?
Marvin Ellison:
So this is Marvin. I'll take your question. From a promotional cadence, it was consistent with last year. So this was not driven by increased promotions. As a matter of fact, we believe strongly that not only did this dilute gross margin, but it also diluted sales. So our pricing architecture, we look at it head, core, tail. Head items are items that are price-sensitive, most often scraped by our competitors, where we have to be price-competitive. And so we're going to be competitive on those head items. Typically, what happens, if you receive a cost increase, you're not going to increase your retails of your head items because it makes you nonprice-competitive. So that does not happen. Instead, what you do is you find items that are inelastic within that same assortment, and you make the adjustments there. We didn't make any adjustments, nor did we promote lower prices. So we just basically decremented margin at point-of-sale and we decremented top line at point-of-sale as well. Our promotional cadence was the same. We desire to be less promotional, not more promotional. And again, our promotional strategy was a lot different from last year in terms of days, offers or inventory.
Simeon Gutman:
Got it, okay. I guess my follow-up then is separating out the actual execution from these -- from fixing this from the accounting. So it seems like you're making changes now. If not, a lot of those are being made or have been made. How does that flow? Why -- does it take time? I guess, it flows through the rest of the year? Or we should be -- should we recoup this by the time we get to the end of 2019? Or is this a 2020 recoup?
Marvin Ellison:
So I'll take the first part of that, and I'll let Dave provide any additional context. So as I discussed and Dave mentioned, this was worth about 90 basis points. And again, each of [ them ] has visibility, we didn't know this was going to start hitting the P&L. To be quite candid, some of these cost increases were taken 40 or 50 weeks ago and without any mitigating actions I mentioned to offset gross margin. So as we work through making these adjustments, where we have implemented pricing action to gross margin [indiscernible] versus last year, which is [indiscernible]. If we're taking additional taking strategic pricing actions that [indiscernible] impacted 2019, we're confident it's working. We typically are taking the time to analyze the results to make sure that we understand the full benefit to '19. And because of that, we felt it prudent to update the guidance because this is an ongoing effort. So that's the operational execution side of it.
And the good news is the partnership between finance, merchandising, led by IT, we have significantly better visibility to all pricing actions, to cost increases. We have now one team responsible for approving and managing our cost and retail increases. We also have a very basic retail philosophy. That is if you accept the cost increase, you need to take mitigating steps to offset gross margin. That's not unique in retail, but it was unique to Lowe's until Q1. So we now have our arms around this, and that's the operational execution side of it. And I'll let Dave speak to any of the accounting side.
David Denton:
Yes. So maybe I'd like to step back and give a little color on our guidance and kind of lay it out as we cycled into Q1. As we look very near term from a Q1 sales performance, we continue to see that consistent with our expectations. And our gross margin trends, as we cycle into Q2, are materially consistent with what we've seen in Q1. However, as Marvin indicated, in the areas we have taken pricing actions, we have began -- we have just begun to see some improvement performance versus trend and versus OI. And our guidance reflects the fact that we still need to implement more actions. And quite honestly, we need more time to make sure that we analyze and fully understand the net effect of all the changes that we are currently implementing. So you're going to see this improvement bleed also into Q2, but importantly into 3 and 4. And I think we won't see major trends inflection in Q2 as much as we'll see in 3 and 4 as we bleed this inventory, these pricing actions through our system, as we're currently doing as we speak.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Can you give us more specifics on what categories the price increases that you experienced are in? And why can you not remediate or address this issue until the second half of the year? Why can't you just peak price increases on those inelastic goods right now?
Marvin Ellison:
So, Mike, I'll take the first part of that, and I'll let Bill jump in if he has any additional color. It is rather widespread because some of the categories that these actions were taken in. Quite candidly, we're trying to understand the logic of the cost increases across multiple categories. The good news is we now have visibility to what they were, and we're putting the processes in place to go back and correct those issues. As you can appreciate, Michael, we're in a very competitive environment. And so we just can't go out arbitrarily and raise prices. There's a degree of analysis required to make sure that we are raising prices in categories that are, in fact, inelastic. And so as we lay out our head, core, tail, head being the key price-sensitive categories, the tail being the least price-sensitive categories, we have to be very diligent to make sure that we just don't go across the entire business and just arbitrarily raise prices because then you're going to have a negative impact on top line. So as Dave mentioned, we are doing this in a very structured, very surgical way, and the good news is that the action we're taking is working. But we're analyzing it as we go to ensure that we're making the right decisions for the business. And that's all ongoing. And so we just thought it was prudent to adjust guidance based on the ongoing efforts with the expectation and the confidence that we're going to get this done, and we're going to be successful. And the good news is we think this will benefit us, not only for the balance of 2019. We're going to solve a problem that's been a legacy issue here for a while, and that issue will be behind us. And I'll let Bill talk about any other pricing concerns in the work that he and his team are doing to make sure that we continue to work with our suppliers to ensure that we are competitive from a cost perspective.
William Boltz:
Yes. I think just a couple of things to add. This is -- and when you start to take it on, when it's across a number of categories that's across, it's what I refer to as real pick and shovel work. And so it's a SKU-by-SKU review. You have to look at it at the assortment level as well so that we don't screw up the assortment philosophy of what a merchant's trying to do. So all of that is being done. And where we -- as both Dave and Marvin have mentioned, where we have been able to do some of that in the last few weeks, we have seen improvement happen.
In addition to that, as I've shared with you on the other calls, we're in the early stages of rolling out category management into the organization. So you want to be able to do this in conjunction with the category management philosophy, where you've got the intent of each of these product categories, so that the philosophy falls into, and that it can be built into the financial planning as you move into 2020. So we're rolling into that second phase of category management in the back half of the year where we start to apply it into each one of those product categories. You take this work, you've got to roll it in together so that we don't do something stupid. So that's what we're working on.
Marvin Ellison:
And Mike, I think it's worth me noting that we're looking at this short, medium to long term. So short term, we've improved visibility for the merchants on all pricing actions. We've eliminated the need to look at numerous systems, multiple reports to get basic pricing and cost information. We now have one team in place to manage cost and price. We now have the ability to prioritize which pricing actions we take to have the greatest impact on gross margin. Believe it or not, in Q1, we couldn't do that. We have a really simple philosophy that's pretty consistent in retail. And that is if you take a cost increase for any reason, you've got to offset that within the portfolio with actions to protect gross margin. All of these things sound basic, but these things didn't exist in Q1. So that's short term.
By Q4, Seemantini, our Chief Information Officer, is implementing a new price management system. It's going to be rolling out. It's cloud-based. It's agile. It's going to enhance the visibility for the entire merchant and finance team on pricing. It's going to be a single repository for pricing for Lowe's, something we currently don't have. And that's going to -- that is being developed as we speak. This would get us to parity. Then the acquisition of Boomerang's retail analytics platform in 2020, we're going to integrate that to this new price management system. This is going to give us a best-in-class system on both price intelligence and price management. And this is another example that this is a multiyear transformation. So we've got short-term actions that we're taking right now. We've got actions later this year that's going to get us to parity with a pricing management system in 2020. We believe with the acquisition of Boomerang's retail analytics platform, we're going to have a best-in-class pricing system. And that's the cadence that we'll follow.
Michael Lasser:
That's helpful. Two more quick questions. Given that this surprised you, do you think, Marvin, that you might have underestimated some of the depths of the challenges that the business is under? And as a result, it's either going to take longer to achieve the longer-term margin expectations that you set for the longer-term margin expectations you might -- you're supposed to achieve? And then on the quarter, your sales performance has improved. How much of the incremental inventory that you added attributed to the better sales performance this quarter?
Marvin Ellison:
So Mike, it's a fair question. We still feel good about the outlook we gave at the Analyst and Investor Conference this past December. There's a lot of work to do, and my team knows that one of my favorite comments is that all of the easy jobs are filled. So when we came here to take this on, we knew we're working for a great company with an outstanding balance sheet, but a comp that has underperformed this sector for a significant amount of time. If Q1 proved anything, it proved that this team can drive sales. And so we're pleased with our sales performance, and we're not going to decelerate our aggressive approach to driving sales. But when we think about what drives our sales and what we think allowed us to be successful in Q1, we think it's about getting in stock, about the investment and job lot quantities, about the improvements in customer service, about the space productivity that the MST team is helping to drive and the focus that Joe talked about in pro. We're in the early stages with pro. We understand that there are other things that we will do. We have a great platform in MSH that we are going to be talking about later this year. We have some initiatives we're working on with same-day job site delivery. We've got this wonderful unique pilot with FedEx on the same-day delivery bot that is going to change and revolutionize how you get product to pro customers. And so we have a long-term view, but we're just really pleased that the fundamentals that we've put in place for our business are paying dividends in Q1. And we think that's going to continue for the balance of the year. We simply have to get our arms around these issues.
And the last point I'll make is, are we going to have surprises? I'm sure we will. But when I look around the table at the men and women that are on this leadership team, we have people who have the experience, the talent and the expertise to solve these issues. And as devastating as the margin impact was in Q1 with these unanticipated, fully thought out cost increases, the team rallied, got our arms around it, and we're going to be able to resolve this as the year progresses.
Operator:
Your next question comes from the line of Zach Fadem with Wells Fargo.
Zachary Fadem:
So online sales up 16%, a nice acceleration versus late 2018. Curious if you could speak to some of the drivers here. Anything new you're doing with respect to the website or online ads? Any category callouts? And then second part, as your online sales accelerate, could you speak to the margin impact? And any thoughts on mitigating the fulfillment drag there?
Marvin Ellison:
So Zach, I'll take the first part, and I'll let Bill Boltz give you some specific information. As I mentioned in my prepared comments, I mean, 16% is improvement. And I am really pleased with the new leadership. We have an entirely new leadership team focused on our online business. We have a CIO who has a deep understanding of the online space. And so there's a great partnership happening right now, and there's a lot of what I call infrastructure and foundational work being done. One of the key things that we're in the middle of doing is taking this platform from a mainframe platform to cloud-based. And that's going to be significantly important to us because it's going to give us much more agility, and we can create a lot more dynamic responses to our customers. So I'll let Bill talk about what drove the business in Q1, but we think we're only at the early stages of what's going to be a tremendous business platform for us over the next couple of years.
William Boltz:
Yes. So a couple other comments to make in regards to online. I think I'm certainly pleased with the growth over Q4 of '18. But as we think about big changes that we're making, we're now putting an organization in place that's dedicated and focused on this part of the business. So with that, it means online merchants, online merchants tied into the product categories and merchandising departments within our core merchandising groups, so that we can pull the strategies through on Lowes.com. The team's also in the process of working through foundation stability that Marvin mentioned to make sure that our site operates the way we need it to operate. We're also working on enhanced content with all of our supplier partners, and we're ramping up the amount of SKUs and assortments that we carry on Lowes.com. So a lot of work going on there. In addition, the direct fulfillment center that we opened outside of Nashville a year ago, working with the supply chain team to be able to leverage that. And so we're in the early innings of that, but we're ramping up SKUs into that facility, which allows that pressure to come off of our stores, where they have been the fulfillment arm in the past, all of that making it easier for our customers to shop on Lowes.com. So we've got a lot of things that are in the works, a lot of things that have been done and a lot of things still to do to improve our performance there. And there's nothing but upside for Lowes.com.
Zachary Fadem:
Got it. And then one for David. On the change in EBIT outlook, I just want to confirm that the 50, 60 basis point change or so, entirely at the gross margin line, and then whether you'd expect the impacts to be felt throughout the year or if this is more of a -- more concentrated in Q1, Q2 with improvement in the back half?
David Denton:
Yes. The vast majority of the impact will affect the gross margin line. I would expect us, our performance to get better later as we're -- as we said earlier, as we're taking action at the moment, that will bleed into our performance as we cycle through the year. So I think it'll be disproportionately affecting Q2 and -- versus 3 and 4.
Zachary Fadem:
So do you expect gross -- or, I'm sorry, EBIT margins to be positive in the back half of the year?
David Denton:
Yes. We don't really guide to that level of specificity.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan
Christopher Horvers:
Can you talk a little bit about your business outside of seasonal? Obviously did a lot of work to front-load inventory, improved processes and drive in-stocks. Can you talk about the improvement in the rest of the business, particularly as we look into the back half of the year and the seasonal really fades? How are you thinking about the improvement that you're seeing in the back half? And then more broadly, tough compare in Q2, easier compare in back half, how are you thinking about cadence, especially in light of your comments that you should be able to accelerate demand because you didn't capture price inelasticity?
Marvin Ellison:
Chris, I'll take the first part of this, and I'm going to let Joe McFarland talk a little bit about pros. Because as we look at Q2, when you separate the business from seasonal, we think the key to really driving the sales in Q1 was in the pro customer. We mentioned that pro significantly outperformed DIY for the quarter. And the thing that the pro customer does for us, it drives sales force space productivity because the pro shops the entire store. So when Bill talked about the power of MST and improvements in in-stock, that impacts the pro across the entire store. But I think the pro is really the key for us, was a key in Q1, will be the key for the balance of the year. And I'll let Joe just talk about some of the successes we saw and some of the things that we have planned moving forward.
Joseph McFarland:
All right. Great. Thanks, Marvin. So as Marvin mentioned, we were very pleased with the acceleration of the pro business throughout the entire quarter. And as we mentioned, Phase 1 was really the retail fundamentals. And we really got our arms around the retail fundamentals in pro. I mentioned in my prepared remarks the supervisor, the dedicated staffing, the loaders, the job lot quantities. And so as you think about that we continue to see acceleration into Q2 in this pro business, and feeling that we now have a foundation in place, that we have the basics for the pro done as we accelerate that through the back half of the year with things like pro loyalty, things that will help us capture a much larger share of the pros' wallet, you'll see that come to life through brands, through advertising and through service in the store. So we remain very, very pleased with the progress.
David Denton:
I also think it's important to add that we had positive comps in 10 of 13 merchandising departments. And we saw growth beyond the seasonal categories, in categories like -- merchandising departments like millwork, like flooring, some of these areas that we've discussed in the past that have struggled, that we saw positive growth on. So I'm real pleased. Again, as I said in my comments, positive comps in paint, right, where we have struggled all year last year. And so that trajectory is on the right path. So we're excited about what's going on there.
Marvin Ellison:
We will take one more question, please.
Operator:
Your final question will come from the line of Brian Nagel with Oppenheimer
Brian Nagel:
So I apologize if this first one's a bit repetitive. But Marvin, I just want to go back and look at the release data in your comments. The -- you had the 4.2% domestic comp, a nice improving trajectory through the quarter. You laid out, in the prepared comments, that, that, would have been markedly higher had it not been for weather. And then we had the issue on gross margin with the corrective actions you take. Am I hearing you correctly that those really are distinct events, meaning that the corrective actions that impacted gross margins did not contribute to the sales showing in the quarter?
Marvin Ellison:
Brian, it did not. If anything, they hurt sales. Because our gross margin was negatively impacted, because we had cost increases that were taken in 2018 with no mitigating steps to offset gross margin. Our system visibility was so limited that merchants that took position in 2018 later in the year, and in some cases in 2019, had no visibility that these cost increases had even been accepted. And because of the first-in, first-out nature of our inventory and the layering impact of our inventory, we just start to recognize the cost until we turned the inventory in those items where we have, except the cost increases, started to flow through the stores and started to flow through transaction. So we had no visibility to it. And so it was a discrete kind of issue of cost increases, no steps to offset it. So as we look at it, we have, again, a pricing architecture of head, core, tail. And if we receive a cost increase and we accept it, what Bill will do is he'll work with the finance team supporting him, and they will take steps to find offsetting retail increases in nonprice-sensitive categories, i.e. tail items. Those items will then offset cost increases that you take, that you cannot affect retail in competitively priced items. We didn't do any of that. So in essence, we took cost increases, and we took no actions to raise retail. And because of that, we've decremented our gross margin, and we decremented our top line sales. So it is the worst of both situations. Now we're going back, as I mentioned and Dave have mentioned, and we're taking very specific actions to address those issues. And we're taking pricing actions, and we've been taking those actions for the past weeks. And where we've taken those actions, and those products are flowing through the stores and turning, we're seeing our gross margin improve on the items where we've taken the pricing action. We're still working through it. And so what we're trying to do is analyze the actions we're taking, making sure that we're not negatively impacting sales, and that we're solving the problem we're intended to solve. And that's taking time, and that's why we want to be prudent and update our guidance based on the analysis that's currently underway.
Brian Nagel:
Got it. That's helpful. And then this is a follow-up, a quick follow-up I had. In the monthly comp cadence you gave us, you -- the domestic comp in the month of April was 8%. Recognizing it's early here in fiscal Q2, but any commentary how sales have tracked here into May or into Q2?
Marvin Ellison:
Well, what I will say is they're as expected. We have some big events, including this weekend, coming up. We feel like our in-stock position is as good as it's ever been. We feel like our staffing levels are as good as they have ever been, and we feel like that our stores are set and we are signed and we are marketing for success. As frustrated as we are by the gross margin performance and the poor decisions made and the limited system visibility on cost increases, we're correcting that. But we want to be crystal clear that we are aggressively going after sales. And we believe that the success that we have in Q1 will carry over into the balance of the year because it was driven by in-stock improvement, service improvement, improved space productivity and driving the pro sales. And we think we can maintain that in Q2 and for the balance of the year.
Brian Nagel:
Let me -- if I could ask just one more, kind of a big open-ended question. But given the comments here about identifying this inventory flow issue -- I'm just going to say inventory flow issue, I mean, is that -- we're being surprised by it? Has that allowed you to now look elsewhere for other potential surprises if that makes sense? I mean, this issue popped up. Could your team now say, "Well, this issue popped up. Something else might pop up, but we're looking into that?"
Marvin Ellison:
The short answer is yes. We have taken aggressive steps -- let me rephrase that, more aggressive steps to make sure we analyze, review and do systemic reviews of every single thing we can imagine so not to have another unexpected event like we experienced in Q1. And we're going to continue to be laser-focused on that. And the good news is we have people around the table with deep experience and deep expertise. The good news is we changed a lot of merchants, which was disrupted. We accept that, but we did it on purpose. Because we wanted to have the right merchant leaders sitting in position through spring of '19, so they could help us plot our strategy for fall, for spring of 2020 and beyond. And we have merchants with deep experience. We've got merchants with 30, 40 years of category experience now sitting in these vice president roles. And so they are helping us identify additional issues, but they have the skill set to solve them. And we now have the technical expertise in-house to get the right systemic solutions. And so, yes, we're doubling our efforts, making sure that we limit the number of surprises that will get us in the future.
Operator:
Ladies and gentlemen, this will conclude today's call. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2018 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. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Thank you, Regina. Good morning, everyone. Overall, we are pleased with the progress we're making in our business, and most of the intense work over the past 6 months to transform our company has been in preparation for an improved spring season and fiscal 2019. Therefore, we're encouraged by the customers' response to our assortment and service changes in Q4, and with the results we're seeing in early spring categories. This progress was evident in the improvement we saw in the paint category in the fourth quarter. As a reminder, for the past 10 consecutive quarters, paint has delivered comps below the company average. Our intense focus on retail fundamentals in this ever -- area while leveraging our exclusive partnership with Sherwin-Williams allowed us to exceed our expectations in paint during the fourth quarter and transition this business to comp above the company average.
While paint is only one category, it is the first area of the business where we implemented our retail fundamentals framework of improved staffing and in-stocks while remediating issues from previous resets. We believe this renewed focus on retail fundamentals across multiple categories will pay dividends for our entire business in 2019. Now allow me to take a few moments to update you on our quarterly results and provide you with thoughts on fiscal 2019. For the fourth quarter, we delivered comparable sales growth of 1.7% and our U.S. comps improved by 2.4%, delivering a positive 5.8% comp in January. We're also very pleased with the comp progression, which we believe further reinforces that our retail fundamental focus was in place and doing well in the quarter. In the U.S., we delivered comps in 11 of 14 geographic regions, and our Tampa and Houston markets faced tough comparisons from Hurricane Irma and Harvey. In the U.S., we delivered comps -- positive comps in 8 of 11 product categories, and great offers in tools and hardware delivered a comp above the average, supported by strong customer response in CRAFTSMAN products, which gained market share across every category. In addition to paint, we also achieved above-average comp performance in lawn and garden, appliances and lumber and building materials. We delivered online comp growth of 11% for the quarter. And while traffic to our website was strong, we were unable to fully capitalize on the traffic due to system challenges, such as the outages we experienced on Black Friday weekend. These challenges are a reminder of the upside opportunity we have in our online business. However, coming out of the holiday season, it was obvious that we needed to redirect our online strategy and our focus. Therefore, in January, we made a leadership change, hiring Mike Amend as our new President of Online Business. Mike is someone with extensive knowledge and expertise in the home improvement omnichannel space, and we're confident that Mike will work with our new Chief Information Officer, Seemantini, to lead an aggressive transformation of Lowes.com in 2019. In Canada, we posted negative comp sales for the quarter as a weaker Canadian housing market, combined with ongoing integration of RONA, exerted pressure on the business. We also recorded a $952 million noncash pretax goodwill impairment charge associated with our Canadian operations. We anticipate weakness in the Canadian housing market, which is exerting pressure on our outlook for that business over the near term. However, we remain confident in our market position in Canada and of the long-term potential of this business. We reported diluted loss per share of $1.03 for the quarter, but our adjusted diluted earnings per share were $0.80, an increase of 8.1% for the same period a year ago.
Now as we transition in 2019, we remain true to our mission of delivering the right home improvement products with the best service and value across every channel and community that we serve. And we'll achieve this mission by winning in 4 key areas:
driving merchandising excellence, transforming our supply chain, delivering operational efficiency and intensifying customer engagement.
Note that our strategic focus hasn't changed, but we've modified the title of our second focus area since our Analyst and Investor Conference from omnichannel to supply chain transformation. This better describes the initiatives beneath it, including fulfillment and delivery optimization. In fact, all 4 key areas deliver a better omnichannel experience for our customers. Now allow me to take a few moments to discuss 2019 in more detail. The U.S. home improvement industry should continue to benefit from several factors, including income growth, lower federal tax rates, gains on household formation and continued home price appreciation. This growth is further supported by an aging housing stock. As home prices are increasing, consumers are staying in their homes longer and because of their improved financial position, they are investing in their homes. All of these factors drive investments in home improvement projects. To capitalize on this supportive macroenvironment, we will continue to improve our execution and focus on retail fundamentals. And to be transparent, we are an executive team with high expectations and we visit stores on a weekly basis. We're still seeing pockets of inconsistent execution. However, through the inconsistency, we're beginning to see improvements in key areas. So let me take a moment to share with you 5 areas where we were pleased to see signs of progress in our business. First, we're delivering better customer service. Customer satisfaction scores have improved for both DIY and Pro customers. Second, our Merchandise Service Teams, or MST, pilots showed positive results. Third, we're seeing improvement in performance versus expectations in key categories. In addition to the improvement we saw in paint, we're also leveraging our improved reset process to better position us for the spring selling season. Fourth, we continue to see strong customer response to CRAFTSMAN, with market share gains in each CRAFTSMAN category since introducing the brand. We're also very excited about the product launch of CRAFTSMAN outdoor power equipment this spring. And fifth, we're seeing positive results in our Pro business, driven in part from our investment in job-lot quantities. Although things are far from perfect and we still have work to do to transform the company, these 5 areas of progress give us confidence in our business outlook for 2019. They also demonstrate that we are focused on the right initiatives to achieve our long-term targets.
Before I close, I'd like to thank our over 300,000 associates for embracing change and for their renewed competitive spirit and for their commitment to our most important initiative:
serving the customer.
With that, let me turn the call over to Bill.
William Boltz:
Thanks, Marvin, and good morning, everyone. We see a great opportunity ahead of us to capture more share in the home improvement market with a strong retail brand, great products, a compelling new marketing campaign and impactful new partnerships, all of which will drive customers to our stores and our website. We are very excited about our new partnership as the official home improvement retail sponsor of the National Football League. This exclusive multiyear sponsorship grants Lowe's the ability to market on a national and local level throughout the year, which will allow us to deepen our relationships with both the Pro and our DIY customers. We are also working to deliver an outstanding customer experience in our stores and on our website. Today, Joe McFarland and I will provide you with an update on our progress.
As Marvin indicated, we are in the early stages of change. And while there are still pockets of inconsistency in our system, transformative action is underway and we are beginning to see signs of improvement. For example, we are seeing positive signs from our Merchandising Service Team, or MST, pilot. These teams are funded by our vendors, and they add an average of 8 full-time employees per store. These teams are responsible for the day-to-day maintenance of the bay presentations in our stores, responsible for setting and maintaining end caps and helping execute off-shelf displays. The MST teams are critical to improving our execution at store level as they take these [ time- ] consuming tasks off the shoulders of our Red Vest associates so that they can be freed up to serve customers. Early results of our MST pilot show reduction in out-of-stocks, improved sales productivity and an increase in bays serviced per hour. We expect to complete the staffing of our MST teams and roll the program out nationwide in the first quarter of 2019. As we have discussed before, the Pro customer will be a key focus for us in 2019. This is why, as Marvin mentioned, we took steps in the fourth quarter to improve our inventory position for the Pro by investing in job-lot quantities, an area that has historically been underfunded. We must ensure that we have inventory depth at the store level to meet the Pro customer needs and enable the presentation impact on our top-selling items. In the fourth quarter, we piloted job-lot quantities for select SKUs in select test markets, and we saw an increase in both Pro comps and Pro sales penetration. Following this successful pilot, we are now expanding our investment in job-lot quantities, and we are rolling out nationwide in the first quarter. We are also leveraging our improved reset process to better position us for the spring selling season. We are transitioning into the season more efficiently, and we are setting our stores earlier, all of this to ensure that we have sufficient seasonal inventory on hand and that we are positioned to capture the spring demand when the season breaks. We are pleased with early results in the south and deep south, where we are seeing strong comps in our seasonal and lawn and garden categories. Another area of excitement for spring is the continued rollout of CRAFTSMAN. Our data shows us that approximately 60% of customer -- CRAFTSMAN customers were not previously a Lowe's customer. So from tools to outdoor power equipment, from the garage to the garden, CRAFTSMAN is a traffic-driving, loyalty-building opportunity for us. And we are very proud to be the exclusive destination in the home center channel for this iconic brand. We have gained market share in each CRAFTSMAN category since introducing the brand, and we are excited to add CRAFTSMAN outdoor power equipment as part of our spring offering. Throughout this spring, we will also continue the roll out of mechanics' tools, hand tools, power tools and tool storage across the chain. In addition, for the first time this spring, Lowe's will have the top 3 brands in riding equipment with John Deere, Husqvarna and CRAFTSMAN. In addition to our assortment in outdoor power equipment, we expect to drive sales this spring with compelling events like Spring Black Friday; exciting product offerings such as the extension of our Monrovia plant program, a home center exclusive in lawn and garden; and expanded offerings from Weber and Char-Broil, the top 2 brands in outdoor grilling. In fact, earlier this month at our store managers' meeting, the merchants led every store manager in the company through a product walk, displaying for them all of the new and innovative products that they could expect to see for the upcoming season. This event was well received and has built an increased excitement for the spring season. In the first quarter, we will also drive merchandising productivity through the rollout of our field merchandising teams. These teams will focus on meeting the needs of the customers at market level, delivering localized and relevant product assortments, helping to drive customer engagement and improving sales per square foot and inventory productivity in our stores. We will also dramatically increase our online assortment in 2019 as we work to shift slower-moving SKUs out of our stores and onto our website to improve inventory turns. We are excited about the opportunities that are ahead of us, and we're working very hard to position Lowe's for the future and to capitalize on the strong demand in a healthy sector. Thank you, and I'll now turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. I'd like to discuss the steps we are taking to improve customer service, in-stock and better optimize our labor spend. The first step to improve customer service is to streamline communication and tasks at the store level. Therefore, in the fourth quarter, we moved to a simplified weekly playbook that focuses the teams on top priorities, key metrics and critical deliverables. Since then, we've seen a significant increase in on-time task completion in the stores as our associates are now more focused on activities that drive sales and improve customer service. In addition, we instituted a regular pack-down process within our stores to ensure that we're consistently filling our shelves with the product we already have. Since that launch, we've seen in-stocks improve by 15%. To assist with our supply chain replenishment algorithms and keeping pace with sales demand, we gave our store managers limited autonomy to reorder appropriate quantities of low-risk, high-velocity SKUs to improve in-stocks on key items.
To improve our focus on customer service, we eliminated sales forecasting activities during the busiest hours of the day so our associates can focus solely on selling and providing excellent service. As a result, we've seen an increase in sales productivity and customer satisfaction scores. In the first quarter, we'll improve associate engagement by rolling out the smart model, a new customer service model which will guide the way we hire, train, evaluate and coach associates. This program models what a great experience actually looks like and drives behaviors that deliver the kind of experience that customers want. The Smart program is a comprehensive toolkit, including a training program and mobile devices, which are designed to provide our associates with the tools they need to deliver outstanding customer service. In the first quarter, we will train all associates in the company on smart customer service, and we'll complement this training by rolling out smart mobile devices to our stores. No longer will associates be required to leave the sales floor to log into a terminal to determine the price, rate of sales, on-hand quantities or order status of an item. The new smart device will provide associates with real-time data at their fingertips without ever stepping off the sales floor or losing engagement with the customer. Also, in order to improve staffing and better leverage our payroll spend, in the first half, we'll roll out our new labor scheduling system. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic, providing better department coverage and customer service while also ensuring that we're using our labor hours efficiently and reducing payroll expense. This new system will replace the current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. To further improve the customer experience, in the first quarter, we are replacing a series of non-customer-facing positions with over 600 assistant store managers and over 5,000 department supervisors. These customer-facing department supervisor roles will focus on providing better departmental coverage and expertise as well as coaching our associates and delivering excellent service. One of these supervisors will be dedicated to the Pro department. To improve the Pro customer experience, we're also reallocating resources to add dedicated loaders so that the Pro customer can consistently rely on us to help them load the bulky product they need. These new resources in Pro will allow us to take full advantage of the job-lot quantity investment that Marvin and Bill mentioned earlier and build on the momentum created in January when Pro comps were high single digit. Though we're in the beginning stages of change, we're excited by the early results we are seeing and committed to the work ahead to fully capitalize on the healthy demand in our sector. Thank you. And I will now turn the call over to Dave.
David Denton:
Thanks, Joe, and good morning, everyone. Let me begin this morning with a few housekeeping notes and a review of the major charges that we incurred during the quarter. First, as a reminder, in the first quarter of fiscal 2018, we adopted the new revenue recognition accounting standard. The primary impact was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales. The adoption of this program had no meaningful impact on operating income and no impact on comparable sales. Secondly, this quarter, we changed our accounting policy for shipping and handling costs. Costs related to the delivery of products from the company to the customers are now included in cost of sales versus SG&A and D&A. This reclassification resulted in a decrease in gross margin of $289 million in the fourth quarter, and prior periods have been restated. Again, this accounting policy change had no impact on operating income. Third, as described in the press release and consistent with our plan to reposition Lowe's for long-term success, we incurred $625 million of pretax charges related to our strategic reassessment. And finally, during Q4, we recorded a $952 million noncash pretax goodwill impairment charge associated with our Canadian operation. Given the softening outlook for the Canadian housing market, we determined that the book value of this business exceeded its fair value. This write-down essentially eliminates all goodwill associated with our Canadian operations.
I'll now turn to review of our operating performance, starting with our capital allocation program. In fiscal 2018, we generated over $5 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned nearly 90% of this cash to our shareholders. In the fourth quarter alone, we paid $387 million in dividends, and our dividend payout ratio currently stands at 35%. In November of this year, we entered into a $270 million accelerated share repurchase agreement, retiring approximately 2.9 million shares. We also repurchased approximately 2.8 million shares for $259 (sic) [ $259 million ] through the open market. So in total, we repurchased $529 million of our stock at an average price of $92.25. We have approximately $14 billion remaining on our share repurchase authorization. And importantly, we continue to invest in our core business with capital expenditures of approximately $328 million in the fourth quarter and nearly $1.2 billion for the year. Now looking at the income statement. We generated a diluted loss per share of $1.03 compared to diluted earnings per share of $0.67 in the fourth quarter of LY. On a comparable basis, excluding the $1.6 billion in pretax charges we recognized in the fourth quarter, adjusted diluted earnings per share was $0.80, an 8.1% increase over last year's adjusted diluted earnings per share. Despite slightly softer sales in the quarter due to the weaker Canadian macroeconomic environment, the $0.80 of adjusted diluted earnings per share was in line with our expectations as we effectively managed expenses and drove store payroll leverage. Sales for the fourth quarter increased 1% to $15.6 billion, supported by total average ticket growth of 4.6% to $76.96, partially offset by a 3.6% decline in total transactions. Comp sales were 1.7%, driven by an average ticket increase of 2.3%, partially offset by a transaction decline of 0.6%. Our U.S. home improvement comp was 2.4% for Q4. While comp transactions declined for the quarter, we drove sequential improvements throughout the quarter, with comp transactions down 2.1% in November, down 0.8% in December and positive 1.6% in January. During the quarter, the net effect of cycling the hurricane season was an approximate 80 basis point drag on comp sales. Headwinds from Hurricanes Harvey and Irma were partially offset by demand from Florence and Michael. Now looking at monthly trends. Total comps were 0.3% in November, 0.8% in December and 4.8% in January. Additionally, monthly comps for our U.S. home improvement business were 0.9% in November, 1.4% in December and 5.8% in January. Now my comments from this point forward will be on a comparable non-GAAP basis. Adjusted gross margin for the fourth quarter was 31.5% of sales, a decrease of 56 basis points from Q4 of last year. The adoption of the new revenue recognition standard provided a 110 basis point benefit to gross margin. We experienced 55 basis points of pressure from substitute items that were offered over Black Friday weekend due to inventory shortages on advertised SKUs as well as an accelerated clearance activity for holiday inventory in order to better position us for the spring selling season. We are raising the bar on serving our customers. Therefore, these 2 actions were necessary to mitigate inefficient planning leading into the holiday season. We also experienced 45 basis points of pressure from supply chain costs as we added new facilities to the network that are still ramping up to full capacity, coupled with ongoing increases in transportation cost and increases in customer deliveries. Tariffs exerted 25 basis points of pressure on gross margin, and other product cost increases exerted 15 basis points of additional pressure. We are working diligently to mitigate the pressure from tariffs through our portfolio approach. We are acting with caution and deep analytical rigor given the unprecedented size and scale of potential changes to allow us to measure the unit impact before proceeding. And finally, product mix shift had a 25 basis point negative impact on gross margins for the quarter. Adjusted SG&A for Q4 was 23% of sales, which delevered 77 basis points. Adoption, again, of the new revenue recognition standard resulted in 108 basis points of SG&A deleverage. This was partially offset by leverage from operational expense management. Adjusted operating income decreased 106 basis points to 6.4% of sales. The adjusted effective tax rate was 24.3% compared to 31 point -- 39.1% of LY -- versus LY. The significant improvement is largely the result of the tax reform. At $12.6 billion, inventory increased $1.2 billion or 10.3% versus the fourth quarter of LY. This was largely driven by earlier spring buys, the anticipation of additional CRAFTSMAN resets and our investments in job-lot quantities. These are important strategic investments to drive sales performance in the coming months. Looking ahead, I'd like to discuss our 2019 business outlook, which remains essentially unchanged from what we shared at our end of December Analyst and Investor Conference. I'm providing the outlook today on an adjusted basis versus 2018. However, we have also provided a schedule on our Investor Relations website that takes this one step further and re-baselines 2018 by quarter, removing all operational impacts associated with our strategic reassessment. Also, as disclosed in our press release, for fiscal 2019, we will adopt a new lease accounting standard using a prospective transition approach. We estimate adoption of this standard will result in an increase in lease-related assets of between $3.2 billion and $3.6 billion and an increase in lease-related liabilities of $3.5 billion to $3.9 billion. The difference between the increases in total assets and liabilities will be recorded as an adjustment to beginning retained earnings in fiscal 2019. The standard will have no impact on our debt covenant compliance under our current agreements. In 2019, we expect a total sales increase of approximately 2% for the year, driven by a comp sales increase of approximately 3%. We expect adjusted operating margin increase of 85 to 95 basis points. The primary driver of operating margin expansion beyond sales growth is expected to come from SG&A leverage. Store labor productivity as well as reductions in advertising costs from more effective and targeted marketing programs will be the major contributors. The effective tax rate is expected to be approximately 24%, and we expect adjusted diluted earnings per share of $6 to $6.10 a share. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $4.9 billion for 2019. And our guidance assumes approximately $6 billion to $7.5 billion in share repurchases for the year. We remain extremely excited about the future of our business and are focused on taking the necessary actions to drive returns and long-term shareholder value. So with that, operator, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk about the improvement in January? Obviously, you called that out in the press release and on the call. It's a small month. So was curious, have you seen it in particular categories? Was it driven by particular regions? How did it look in DIY and Pro? And was there any of the clearance activity that you saw pressure gross margin provided a benefit to the January comp?
Marvin Ellison:
Chris, this is Marvin. Overall, we saw improvement in both Pro and DIY. And really, the sequential comp improvement was driven by quite a few factors. First, we saw transaction growth in Pro and DIY. And I think David's comments on the progression of transactions throughout the quarter reflected that. We also saw significant comp improvement in the Pro business. We think that is based on the investments in job-lot quantity, the supervision and staffing improvements, basic things like loading and just the broader service operation that we put in place. We also feel very good about the early set to spring. I think Bill mentioned it in his comments, and so did I, where we actually had stores this time last year that in the seasonal area, they were still managing through clearance holiday product. And so the simple fact that we were able to get what would be relevant spring product in some of these warmer weather markets paid a big dividend. In addition to that, we talked about the CRAFTSMAN response by the customer was also important. I'll let Bill add any additional color, but the good news for us is it was widespread. It was not either DIY or Pro. It was both. It was transaction-driven. It was driven across multiple categories, and the Pro business improvement also drove the kind of correlated improvement in building materials and tools and categories like that. Bill, anything you want to add to that?
William Boltz:
You hit on most of it. I think the comments that were made in your earlier response around paint was another one where we saw the improvement there, both for DIY and for the Pro. In addition to the deep south and the south, as I said in my prepared remarks, where just by setting these stores earlier and getting ready for spring earlier, we saw payback come from that. So we're encouraged by the early signs in that.
Marvin Ellison:
And Chris, the only caveat I'll provide is we're not declaring victory. We have a lot of work to do. There's still areas of the business that I mentioned that we are still seeing pockets of inconsistency. But we believe that the whole retail fundamentals focus that we all talk about is paying dividends the longer we are able to embed it in our merchandising philosophy and our operational processes. And that's why we believe we sequentially improved throughout the entire Q4 period.
Christopher Horvers:
And then as a follow-up, Dave, as you look forward, can you talk a little bit about the cadence around the quarters or the halves? Anything on the comp and the margin structure? And as you look forward, do you think the inventory's clean such that, and the stores are close, so do you think that the gross margin pressures from clearance are behind us and the accounting charges as well?
David Denton:
Yes. So maybe keep that -- a couple of questions in there. First, from a comp perspective, as I think about 2019 as it's shaping up, I would think about that as somewhat balanced first half and second half, maybe with a slight bias a bit to the back half of the year. The first half, I think we're very nicely positioned for seasonal. And I think the season will drive our performance a bit in the first half as we implement our initiatives. The second half driven more specifically related to our initiatives beginning to take hold or beginning to see some progress financially from those programs. And so I think that's the way to think it about as the year shapes up. I do think, largely, our inventory liquidation work is behind us. As a retailer, we are always in this business. We always look at nonproductive inventory, so we will continue to focus on that. But we don't see any major program from that perspective going forward.
Operator:
Your next question comes from the line of Simeon Gutman from Morgan Stanley.
Simeon Gutman:
My first question is on 2019 guidance. I think it was mentioned that the guidance is essentially unchanged. Can you just help us bridge -- I think at the Investor Day, it was 30 basis points of pro forma adjusted margin improvement. Can you bridge that versus the guide and maybe the base that you're guiding off of today? Is that effectively unchanged?
David Denton:
Yes. So think about this in 2 ways. One, when we gave guidance at our Analyst and Investor Conference, we baselined it off of a rebaseline assuming a midpoint of our Q4 guidance range. Now that Q4 is done, we kind of came in closer to the high end of that guidance range. So we're -- so that's really the major change. Secondly, when I provided our guidance, during my prepared remarks, I referenced back to our adjusted 2018 numbers not our rebaseline numbers. So if you step back and you do the compare to rebaseline numbers versus our adjusted, that would bridge that gap. So our -- essentially, our 2019 outlook has not changed as we sit here today.
Simeon Gutman:
Okay. And my follow-up is on the Q4 gross margin. You mentioned the drivers. Can you remind us or can you share with us how much of it was unexpected versus your plan? And then if you look at the entire margin expansion guidance for 2019, that 30 basis points or so or the adjusted one that you're talking about, if you end up doing better than that, besides sales, which I would think is the more obvious lever, is there an opportunity to beat on margin? And I'm just trying to gauge the sensitivity within each of these lines, whether it's gross margin or SG&A, and determine if there is high degree of any or not.
David Denton:
So I guess, I'll take the first piece, as what was, I'll say, somewhat unexpected in gross margin as we cycled into Q4. I don't think we fully anticipated the impact of both the substitute items on Black Friday and the requirements to do that, although it's the right thing to do from a customer perspective. And then secondly, we made, during the quarter, a proactive change to our plan to liquidate seasonal more aggressively and earlier to get ourselves better positioned from a spring perspective as we cycled into 2019. So those were probably not completely expected, but we actively manage that from our standpoint.
Marvin Ellison:
Simeon, this is Marvin. So the broader comment that I will make is we put a very new merchant team in place. And Bill Boltz didn't really get in the seat until basically mid-August. And so as you know, planning for spring is well underway prior to that time frame. So it was a real accelerated process to understand where we were entering spring set dates and the like. And to David's point, there is a traditional process that I'm accustomed to and Joe and Bill are accustomed to heading into the holiday period with big ad items, that is to go through the ads and make sure that you have a degree of in-stock. And what we found out is that we didn't. And that was a traditional problem that we've had here at Lowe's. And so rather than to disappoint customers, again, we decided to take the aggressive approach that we're going to substitute it, knowing that it would have margin impact. But as David stated, it's the right thing for the customer. In addition to that, as I mentioned, it was not uncommon going into week 3, 4 and 5 for Lowe's to be still managing through holiday markdowns in lieu of driving spring categories. And so obviously, we decided to take advantage of our Merchandise Service Teams and to reset these areas. And we're pleased with what we're seeing in areas where the sun is actually coming out. And those things exerted pressure. Bill and his team have good plans in place. We have a lot of new leaders running big businesses. And we think the guidance that Dave outlined for margin is something that we'll be able to deliver upon.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
Can you give us a sense for how your promotional posture is going to be in 2019? It seems like this clearance activity is taking a little bit longer than what you expected and is not only that going to extend into the upcoming year, but will you also be more aggressive to reengage customers with your store?
Marvin Ellison:
Michael, we don't see any material changes to our promotional cadence in '19 versus the prior years. We think we have a great brand. We're excited about products that we're bringing to market. And we think that that's going to allow us to get the traffic and do a much better job of converting that traffic.
Michael Lasser:
Okay. Then I want to follow up on the outlook for 2019 because you did embed income tax rate that's 100 basis points below what you had previously expected. So what prompted that change? And how did that flow through the rest of the model?
David Denton:
Yes. Clearly, we are constantly looking at our income tax status. And I think we should -- we're just continuing to tweak that as we look at our expectations for 2019. So nothing dramatic there.
Operator:
Your next question comes from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
First question I have, Marvin, you discussed a lot of what's happened in the stores and obviously, some initial positive results. How should we think about, with all -- with what you're doing in the stores, initiatives in the stores, how far into this process are you? And then also, is there a way to look at -- particularly with the sales acceleration, comp sales acceleration through fiscal Q4, is there a way with that data to sort of, say, isolate areas where you have touched versus areas you haven't so we could see evidence of the progress you're making in the stores with some of the initiatives?
Marvin Ellison:
No. That's a good question. I would say putting a measuring stick to how far we are, we still have a lot of work to do. I mean, if you took a poll in this room with me, Joe and Bill, who spent quite a bit of our life in home improvement, we would tell you that we're going to be a lot better this spring, but we're not going to be nearly as good as we would like to be, just because we all really started with Lowe's late in the summer, and it just didn't give us the proper time to make the necessary adjustments to the categories we wanted to impact, the buys we'd like to make and the supplier relationships that we would like to formulate. Having said that, we're very proud of the work of the teams. And we're very proud of the change management acceptance that we've seen in stores, on the merchandising side and the supply chain, really across the whole organization. But we have a ways to go to be the great company that we know we can be. And as we think about the business we've touched, I'm going to let Bill provide a little more specifics. But I highlighted paint, and we highlighted paint because one of the first areas that were obvious, from a retail fundamental standpoint that was not working, was the paint department. We had poor staffing. We were totally out-of-stock. We had no accessories. We had no philosophy on attachment selling. And we were not leveraging this great supplier partner in Sherwin-Williams to the degree that we felt that we could. And so we immediately addressed that, and we feel great about the progress that we're making. And we felt like that the progress was more of a microcosm of kind of what could be for other categories that we're now touching. But I'll let Bill talk about some of the other categories that we're going to be focused on going about this year to try to get the same level of improvement.
William Boltz:
Yes. So I think a couple of things. First of all, just to kind of finish the comment around paint, there's a number of things that are happening, even though we're in the early stages. We've -- between Joe and myself, we've worked on staffing, right? We made a lot of changes in our paint department last year, but we never addressed the staffing model. So now the staffing model is being addressed. We've addressed supervision for the paint department. We took an in-stock focus. So between Don Frieson's team, the store team and my team, we took a look at what's needed for the Pro and for the DIY. And that includes job-lot quantities in products like 5-gallon paint. Training, we put a whole new paint department in front of our customer last year, we didn't do any training. So now we're going through training all of our associates. We're leveraging the relationship, as Marvin touched on, with Sherwin-Williams. These guys know the Pro business better than anybody else. And so as our partner, how do we leverage that relationship in order to make sure that collectively, we're addressing that Pro painter in the way that we need to. From a marketing perspective, we've got a whole new marketing campaign coming out this spring. We're very excited about that and the work that the team's done, in addition to pricing and loyalty programs that we're testing to be able to put it out there for the Pro painter. And then as I touched on already in the seasonal categories, the work that we're quickly able to do at the latter part of last year between the store team, the supply chain team and the merchant teams, to look at spring, to look at load-ins, to look at the prep needed in order to be ready for spring when the season breaks, was all efforts that we had to quickly get behind in order to make that happen. So again, early stages. But as I said, we're seeing pockets of where it's working. And so that gives us little bit of encouragement in regards to the stuff that we're focused on is working. Yet, as Marvin said, we've got areas inside the store that are a longer putt for us that we've got to get out -- further out on, and we'll see some of those improvements coming to us in the back half of this year because it's going to take longer for us to get cleaned up and to get addressed.
Joseph McFarland:
Brian, one other thing, as you think about the -- where we're at from this recovery we've been talking about, new department supervisors in place, that just happening in January. I talked about the smart training that rolls out in Q1, the mobile devices rolling out in Q1. We're early stages in Pro job-lot quantities. So we feel good about where we're at today and feel really good about the plans we have moving forward.
Brian Nagel:
That's helpful. Just may be a real quick follow-up. You obviously called out January and the 5.8% comp there. Any commentary on how the business has tracked here in February?
Marvin Ellison:
Well, I think the simple answer would be, minus obvious weather challenges, we're pleased with what we're seeing. I mean, February is always an interesting month in home improvement because it's not a high-volume month and weather is very unpredictable. But as we mentioned, we've gone into stores, and we set spring early. And I'll just give you one anecdote. I was in a store recently, and the store was performing really well from a comp perspective. And then we have a 21-year manager that's in the building, so I pulled him aside and wanted to get his assessment of how does he feel about spring versus last year? And we were standing in the area with the new CRAFTSMAN outdoor power equipment and with the new grill assortment. And he basically said to me, "Marvin, this time last year, we would have been surrounded by clearance holiday," he said. So that's how I feel about the business. We're selling product that's relevant to the customer. And so that's what we're seeing, Brian. So none of the things we're doing is outrageously strategic. It's retail fundamentals, setting product in the time frame that customers would like to buy it, having great brands, improving service, having product available. But the key for us for February is just the timing, meaning having the product in the store, online when customers are interested in buying it. And so where the sun is shining and we can get the good points of view on category performance, we're feeling good that we're headed in the right direction.
Operator:
Your next question comes from the line of Scot Ciccarelli from RBC.
Scot Ciccarelli:
Scot Ciccarelli. Given the improvement that you saw in the Pro sales specifically in January, I guess I'm wondering how are you guys generally thinking about Pro trends for '19 as you add job-lot quantities and some of the other changes that you're making. That's number one. And number two, related to that, do you have any feel for whether the improvement was more from bringing new customers into the Lowe's ecosystem? Or is that just a greater share of wallet from existing customers? Or is it just too early to tell?
Marvin Ellison:
So Scot, I'll give a high-level answer to Pro, and if Joe believes there's any other specifics, he can jump in. But we think our Pro business improved, and our actual Pro comp in the month of January outperformed the total company comp. So Pro really had a strong close to the quarter. But when we look at it fundamentally, it's just some basic things. It is getting the job-lot quantities in the stores. And as both Joe and Bill mentioned, we're not yet complete, but we should have all stores with the job-lot quantity investments by the end of this quarter. It's doing basic things like adding dedicated loaders to every store. Joe mentioned the fact that we put Pro department supervisors in position. For a business this important, we did not even have a supervisor overlooking the area. We've invested in equipment, just basic things like lift trucks and carts that were not even in the area, in addition to fundamental things like easy accessibility to parking. So, we believe we're simply servicing an existing customer better, and we're becoming a second, if not a first option for customers that literally stopped shopping us because we didn't have adequate inventory levels. We have high expectations for Pro, but we have a lot of work to do. We are, by no means, checking the box that we kind of solved this very important customer's issues. But we think that we have a good plan forward, and so we're going to continue to execute on that. I don't know, Joe, if you have anything you want to add?
Joseph McFarland:
The only thing I'd add is we brought in a few -- 2 new leaders for our Pro business that have depth of experience servicing the Pro of both inside the store as well as outside sales. So we've been focused on both. And focused on attracting new customers, but also focused on serving the customers and getting the larger share of wallet. So as Marvin said, we're early stages in Pro, but we feel very, very good about the focus that we have.
Marvin Ellison:
And Scot, the other thing that I'd close with is it's too early to determine if it's new customers, existing customers, we're looking at all that data, as you can imagine. But our philosophy is very basic here. We want to improve our overall service and engagement with our DIY customers, but we want to have a more intentional focus on the Pro because we know that a more intentional focus on the Pro will improve transactions, it will improve ticket, and it will improve overall productivity from a sales per square foot perspective. And so it's a balanced approach, serving both of those very important customer segments.
Operator:
Your next question comes from the line of Steve Forbes with Guggenheim Securities.
Steven Forbes:
I wanted to start with the adjusted EBIT margin guidance for '19, right? You mentioned leverage within the SG&A. But can you give some color around the outlook for gross margin, specifically as it relates to a bunch of the headwinds, right, you called out impacting you in the fourth quarter? How should we think about those impacting you in '19?
David Denton:
Yes. So Scot -- or Steve, this is Dave. I would look at gross margin, think about that as essentially flat for the year, for the most part. We're going to get operational leverage really through SG&A as we focus on both store productivity, but importantly, as we focus on advertising effectiveness. And I feel like that much of what we had occur in Q4 of '18 is kind of behind us, and baked into our plan going forward is essentially that flat outlook.
Steven Forbes:
And just a quick follow-up regarding the capital deployment plans for the year. Any color, right, regarding the anticipated timing of the activity or share repurchase activity and how much you planned to fund via just the free cash flow profile of the business versus incremental debt as we fine-tune the models here?
David Denton:
I can't give you too much on that. I -- we're taking obviously a very cautious approach to this, making sure that we understand both the macro environment and, specifically, the credit markets as we approach 2019 from a capital plan. I think that the best assumption that you should use from a modeling perspective as you think about share repurchase, it's more or less equal throughout the year. Obviously, that will ebb and flow based on how we actually go to market, but that's probably a good starting point for you.
Operator:
Your next question comes from the line of Eric Bosshard from Cleveland Research.
Eric Bosshard:
Two things. First of all, in terms of online, curious for your outlook in terms of when the results there start to improve. Seems like the execution at the stores is better, but online continues to lag. So I'm curious for the outlook for progress there. And then also, if you could explain within that, changing your strategic focus, which may be a nuance, but from omnichannel to supply chain. And then secondly, if there's any quantification of the benefit in January, if it was material, of clearancing holiday out earlier.
Marvin Ellison:
So Eric, I'll take the first part of the online question, and I'll let Bill give some color to online. And I'll let David jump in on the question regarding clearance. With -- first and foremost, we know a modern-day retailer has to be an omnichannel retailer. And for us, the classic example of our shortcomings was evident on Black Friday weekend where we had our failures from a system and service perspective. And so we made the decision to just go out and recruit someone who had a specific background in this to just kind of supercharge our focus and have a much more aggressive approach. And that's Mike Amend. Mike Amend joined us in January, as I mentioned in my prepared comments, and he's going to work with Seemantini, our new Chief Financial Officer, who actually ran the e-commerce business for Target. And they're putting together an aggressive plan that's going to allow us to get very focused on creating a true omnichannel experience for Lowe's. And so the good news for us is that we have 2 leaders in position, one with deep home improvement experience from an e-commerce perspective and another with broad experience on the e-commerce world that's going to allow us to really have a more aggressive focus. And the fact that it's reporting into merchandising is critical because we want the merchants to have a broad view, not a store view or an online view, but an omni view. So I'll let Bill talk a little bit about kind of his additional thoughts on what the expectations are in that business for 2019 and beyond.
William Boltz:
Yes. Thanks, Marvin. So a couple of things. First of all, we're not sitting still in online. So as we've strengthened the leadership team on the merchandising side for online underneath Mike, realigning those folks so that they're tied to the core merchandising teams so that we can pull through those strategies. But we're really looking at it focused on 3 separate areas. So from a customer's perspective, making sure that it's easier to shop, easier to navigate and that we have more products available on Lowes.com. And then for our associates, it's building out the muscle in the endless aisle inside of our stores. So utilizing Lowes.com as a tool in their toolbox and getting that rigor as we work through the smart training that Joe was talking about. It's about being able to leverage Lowes.com as a solution for our customers inside of our stores. And then the third part of it is our vendor partners, right? Being able to get the SKU additions online, the product availability, making sure that we're forecasting and building out the rigor around those businesses just like we do inside of our store, improving the A+ content and then improving our drop-ship ability and fulfillment availability that we have on Lowes.com. So that's what we're focused on. We've got a lot of work to do. We know that we've had some struggles there, but I think we're very confident with the leadership team that we have in place there that we'll see significant progress in our Lowes.com business in 2019.
Marvin Ellison:
And before I hand to David, there's just one other data point. Even with some of our challenges, today, 60% of our online orders are picked up in the store. And so that -- so our customers are begging us to get this right. And we have some short-term and long-term plans that we think will make a true difference in this business. And we're pleased with the leaders we have in position, pleased with the oversight and strategic direction that Bill is providing. And we are looking forward to coming back in subsequent earnings calls to update the investor community on kind of the progress we make. I'll let Dave talk about clearance.
David Denton:
Eric, your last comment around the clearance affecting January. Clearance did not drive any material influence, or had very immaterial influence on sales in January, so that's not a driver of our performance in the month.
Operator:
Our final question will come from the line of Peter Benedict with Baird.
Peter Benedict:
So I'll start with a question just around supply chain transformation, Marvin, that you called out, kind of that second strategic focus. Any -- give us a sense of where you are today. Any milestones we should think about in terms of where you want to be 12, 24 months from now with respect to fulfillment and delivery? That's my first question.
Marvin Ellison:
Well, Peter, I would say where are they? We talked about it at the Analyst and Investor Conference that we just opened our first direct fulfillment center. And that's a milestone for us because, believe it or not, we were shipping parcel online product from our first distribution center out of Wilkesboro. And it's very manageable, not very efficient or effective, and we've transitioned from that to something that's much more state-of-the-art, with plans to open a second facility on the West Coast. What we're also focused on this year is transitioning a lot of the deliveries that take place in the store today, primarily appliances and other big bulk items, into a bulk distribution cross-dock strategy that takes enormous pressure off the stores from a delivery perspective and it centralizes it and it will allow us to aggregate bulk deliveries to the customers' homes more effectively. At 30,000 feet, Lowe's has a supply chain that does a very good job of supplying product to the store. But in modern retailing, your supply chain must have the same ability to deliver a product to the consumer's home and to the job site. And so in essence, what we're developing is a network of distribution centers and systems that will allow us to do store, job site and to the customer's home. And that's what we will start to build out this year. And that's really the short- and the long-term plan.
Peter Benedict:
Okay. That's helpful. And my follow-up would be basically related to how you guys are working with your vendors as you execute all the stuff you've been talking about. You talked about having them pay for the MST efforts. Are there any other -- just give us a sense for how maybe you're working differently with vendors today than maybe Lowe's has in the last few years. And what's been the response as you've been asking these folks for more?
William Boltz:
So I'll take that. First of all, we're being way more transparent with our vendor partners, making sure that they understand what we're focused on. And then we've had some history of being inconsistent with them. So for us, it's about being able to deliver on what we're working on together and being very transparent and making sure that the teams are communicating to them frequently and often. Marvin and I have made ourselves available for those strategic meetings where necessary to help pull those messages through. But we value our vendor partners. They're doing a great job. We've thrown a lot at them just as we've thrown a lot of change in our organization, and they've responded very favorably. So we're -- just like what we talked about with paint, that's a real good example of how that communication and that response has helped pull through that performance improvement in our paint business because we're collectively working together.
Marvin Ellison:
And Peter, the only 2 comments I will add is number one, our vendor partners are eager and willing to work with us. They want to win, and they want Lowe's to win because we are true partners in each of our entities' success. And secondly, it's a ton of value to have Bill Boltz here as someone who was a vendor to Lowe's. So not only does Bill bring very specific and a deep understanding of home improvement product and category knowledge, he also brings a perspective of a former supplier working with Lowe's to help us understand how it feels to be in that position. And so we have work to do, but as Bill noted, we've made ourselves available. We've had quite a few strategic meetings. We've had some very positive and very impactful discussions. And we think it's going to bear more fruit in the long run than it has thus far.
Operator:
Ladies and gentlemen, this will conclude today's conference. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2018 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. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Thank you, Regina. Good morning, everyone. As reflected in our earnings released earlier today, the strategic reassessment of our business continued in the third quarter. Our top priority this quarter was taking the necessary steps to build a sustainable foundation to position Lowe's for long-term success by exiting underperforming stores of noncore businesses. This will allow us to intensify our focus on our core retail business.
As part of the strategic reassessment, we've made the decision to close 20 U.S. stores and 27 stores in Canada as well as 4 other Canadian locations. We also intend to exit our retail operations in Mexico and our Alacrity Renovation Services and Iris Smart Home businesses. These were difficult decisions to make, and we believe we can deliver the greatest return to our shareholders while focusing our attention on running outstanding retail businesses in U.S. and Canada. These actions send a clear message that we'll no longer pursue ventures that dilute our return on capital. Instead, we're committed to a more effective capital allocation process that will deliver better returns to our shareholders. I'm pleased to announce that we have substantially completed our strategic reassessment of the business, and now we can shift our attention to improving execution in our retail stores and online. And of course, we'll continue to evaluate all elements of our portfolio annually. Now let me comment on our performance in the third quarter. We delivered comparable sales growth of 1.5%, driven by a 2.3% increase in average ticket, partially offset by a 1% decline in transactions. Our U.S. home improvement comp grew at 2%, with positive comps in 11 of 14 geographic regions. And as expected, the Tampa and Houston markets had the weakest comparable sales in the quarter due to tough prior year comparisons from Hurricanes Harvey and Irma. We also posted 12% comp growth on Lowes.com.
Diluted earnings per share were $0.78 for the quarter and adjusted diluted earnings per share were $1.04, a decrease of 1% for the same period a year ago. Our third quarter results reflect many of the themes we discussed on our second quarter call. First, while we drove strong traffic to our stores and website, out-of-stocks continue to pressure sales. Second, our inefficient reset process continue to create disruption in our stores and contributed to out-of-stocks. In fact, all of our categories with negative comps:
millwork, paint, fashion fixtures and flooring were pressured by poorly executed resets. Third, our store processes are too complex, our labor management system is primitive and our associates are burdened with too many tasks. These distractions are preventing our associates from spending adequate time with the customer to provide assistance. And fourth, our project specialist and installed sales business is too complicated, which prevents us from delivering an outstanding customer experience, and it pressures our sales.
The good news is I'm pleased with the strategic initiatives the leadership team designed in Q3 to address these chronic issues. You'll hear more about these plans later in the call. As I said earlier, our priority in the third quarter was building the sustainable foundation for long-term success and part of the foundation for long-term success was identifying a world-class Chief Information Officer. And earlier this month, we're pleased to name Seemantini Godbole as our new Chief Information Officer. Seemantini is an accomplished retail executive with more than 25 years of global technology expertise and a proven track record of transforming IT and digital platforms. This is the final addition to our executive leadership team, and I'm confident in her ability to help us modernize our IT and omnichannel systems. Also, during the third quarter, our new leadership team assessed our functional areas, upgraded talent, conducted deeper dives in their business areas and the team was committed to identifying the root causes of our sales per square foot challenges, merchandising reset issues, our chronic out-of-stock and our low job-lot quantity issues. But rather than implementing quick fixes to address these chronic and long-standing issues in the third quarter, we developed plans to drive sustainable improvement. And this is reflective of our commitment of building a foundation of sustainable long-term success. In a moment, Bill Boltz, our Executive Vice President of Merchandising; and Joe McFarland, our Executive Vice President of Stores, will walk you through a detailed review of the third quarter results and outline improvements they are making in merchandising and store operations as well as their plans for the fourth quarter. I'm also pleased to welcome Dave Denton to the call. As we previously announced in August, Dave has been appointed our Chief Financial Officer. And while today is his first official day with the company, he's spent the past several weeks meeting with our executive leadership team and will share his views on the business as well. Now turning to the macroeconomic environment. Although interest rates have ticked up and housing turnover has been pressured, the home improvement backdrop remains strong, driven by robust real residential investment, home price appreciation, which continues to encourage homeowners to engage in discretionary projects. The average age of the home in the U.S. is 40 years, which creates an attractive opportunity for our project categories that support maintenance and repair. Consumer confidence continues to hover at high levels as consumers remain upbeat about their employment and income prospects, suggestions that we will continue to see solid gains in consumer spending, supported by stronger real disposable personal income growth. And looking ahead, our future is bright. We operate in a fragmented $900 billion marketplace and we have a unique opportunity to fix some long-standing chronic issues that will improve our performance and increase our market share. And as we look at our Q3 results specifically, our top line underperformance, both in stores and online, we see the issue as poor execution, not a macro concern. And as I mentioned earlier, we're not chasing short-term fixes, but we have every expectation that our actions and initiatives will begin to drive improvements in our business as we enter 2019. I look forward to sharing more details on our long-term strategic plans at our Analyst and Investor Conference on December 12. And now before I close, I'd like to thank our associates for their hard work and dedication to serving customers. Our systems and our processes don't make it easy for our associates. Nevertheless, I'm incredibly proud of the way they support customers, each other and the communities in which they live and work. This is evident in their response to Hurricanes Florence and Michael this quarter. We've already hosted 27 hurricane-relief events and served 15,000 hot meals. We've delivered 18,000 disaster relief buckets for impacted communities. And this afternoon, our associates will serve 50,000 people Thanksgiving meals in hurricane-impacted areas of North Carolina and Florida. I'd also like to send our thoughts and prayers to all the individuals and the communities being impacted by the California wildfires. We're using one of our closed Orchard Supply Hardware locations for emergency relief and the warehouse donated supplies for the community. This is the most devastating wildfire in California history and we will do all we can to support our associates and the communities impacted by this horrific event. Now with that, I'll turn the call over to Bill Boltz.
William Boltz:
Thanks, Marvin, and good morning, everyone. Today marks my 99th day with Lowe's, and I'm pleased to be here to discuss the performance of the merchandising team. As Marvin shared with you, we posted comparable sales growth of 2% in U.S. home improvement this quarter. The favorable macro environment, combined with great values and events, drove traffic to our stores and website, but the continued challenges with out-of-stocks, poor reset execution and assortment issues in certain categories put pressure on our ability to turn those visits into transactions.
Let me take a moment to discuss some of the positives from the third quarter. 7 out of 11 merchandising departments had positive comps in the quarter. Seasonal and outdoor living, appliances, lawn and garden, kitchens and rough plumbing and electrical all delivered comps above the company average. Seasonal and outdoor living led the way with high single-digit comps, driven by double-digit comps in grills and lawnmowers. Along with the increased demand driven by the inventory rationalization activity, in addition, we also delivered on the response for hurricane-related products such as generators, air conditioners and dehumidifiers. Our lawn and garden comps were the result of capitalizing on the extended growing season, along with our fall preparation activity in our grass seed, fall fertilizer, live goods and watering programs. For the ninth quarter in a row, we drove above-average comps in appliances as we continue to leverage our omnichannel offering through our leading brands, our breadth of assortment and strong Labor Day and Columbus Day events. Our kitchen department also posted above-average comps, with strength in organization and shelving as well as cabinets and countertops. And we also had solid performance in our core Pro product groups within rough plumbing and electrical. We continue to be excited about the effectiveness of our new destination brands attracting Pro customers, as was evidenced by the double-digit comps in SharkBite plumbing fittings and our strong growth in water heaters, driven by the professional brand of A. O. Smith. Also during the quarter, we completed the rollout of 2 key programs into our stores with Zoeller pumps and MAPEI tile setting material. We also launched new exclusive Pro cordless power tools from both Bosch and Metabo HPT that brings the power of a corded tool to the job site through the ease and convenience of cordless. We continue to see robust consumer demand, bolstered by a strong home improvement sector. As Marvin noted, during the third quarter, we took steps to begin to strengthen our merchandising focus on our retail basics. We've added industry experts to the team as part of building out a world-class merchandising organization. In addition, as many of you know, in the third quarter, we also undertook an aggressive inventory clearance process that was focused on eliminating slow-moving or underperforming SKUs and ultimately reducing the clutter in our stores. With that process complete, we have now begun reinvesting those dollars into improving in-stock on our best-selling SKUs and focusing on job-lot quantities for the Pro customer. Although the inventory clearance activity and the subsequent reinvestment will allow for strategic benefits in the future, the discounted sales cannibalized other merchandising categories during the quarter. Within merchandising, we are streamlining our decision-making processes. We are investing in faster-moving SKUs, and we are shifting the mindset from managing to an inventory dollar amount to managing to an inventory turnover goal, which, for example, will allow us to have sufficient inventory on hand before the season breaks and have the stores set and ready for our customer. Now let me discuss some of the opportunities from the third quarter. Our underperforming categories were largely impacted by out-of-stocks, stemming from poor reset execution, all of which had recovery dates that were pushed back, and therefore, the planned improvements were not realized in the quarter. Millwork was pressured by supply and reset challenges in categories such as window blinds, resulting from a difficult product transition. Out-of-stocks and limited job-lot inventory in core product categories, including both interior and entry doors, also exerted pressure on the comp. We expect to see improvements in these areas in the early part of 2019. Our paint business was impacted by brand transitions, along with supply disruption as we transition into our exclusive partnership with Sherwin-Williams. Going forward, we're working with our supplier to improve our inventory position, and we expect to see improvement in this area by year-end. Our fashion fixtures department was negatively impacted by reset challenges in light bulbs and commercial lighting, where supply availability and a shortage of third-party labor to perform the resets led to out-of-stocks and reset delays. We expect to make continued progress in our reset completion and in-stock improvements throughout the fourth quarter. Finally, the underperformance in our flooring business continued and was driven by reset disruption in hard surface and an assortment that is still overly focused on soft flooring as we continue to see consumers shift to the ease in innovations that are available in vinyl plank flooring. Going forward, our new assortments will better reflect this trend with the expansion of our exclusive SMARTCORE vinyl plank products. Our updates to these areas, which are in the early stages, will introduce new lower price points in laminate that will provide great values to both the Pro and DIY customer. These updates will also expand the off-shelf space and will introduce new looks and trends for tile, laminate and vinyl planks that will be assorted to the local market. Given the complexity of these activities, we expect to have solutions implemented in the latter half of 2019. Although we were not pleased with our execution or results in the third quarter, as Marvin mentioned, we have identified the root causes of the issues that negatively impacted our sales. We are focused on changing our results by enhancing our processes to address these issues, and we anticipate that we will see the improved execution in 2019. Now let me transition to the fourth quarter. We are excited about our continued rollout of CRAFTSMAN, including the individual mechanics tools, hand tools and power tools. Throughout the fourth quarter, we will showcase CRAFTSMAN on multiple end caps, highlighting exclusive products and offers, including 3 great values that are featured at $99. We are proud to be the exclusive destination in the home center channel for this iconic brand, offering some of the best hand tools, storage and outdoor power equipment products in the industry. We are also excited about our plans for an integrated omnichannel holiday experience that will be driven by a strong Black Friday, Cyber Monday and other key holiday events. We will continue to highlight our best-in-class appliances offering and showcase strong values focused around tools, holiday lighting, trees and decor, along with other great gift ideas from across the store.
In conclusion, as part of our refocus on merchandising basics, we have 5 key priorities:
one, we are simplifying our merchandising organization, and we are continuing to recruit talented, experienced leaders to enable faster decision-making and to ensure that we are optimizing our assortments across all channels. Two, we're implementing a localized assortment strategy with the development, rollout and support of a field-based merchandising team. Three, we are taking steps to rebuild our reset process by reducing our reliance on third-party labor. With that, we are redesigning our internal reset process with the implementation and rollout of our new merchandising service team or what we refer to as MST. Four, we are changing our end cap and off-shelf strategy to showcase great values and innovation that drive traffic and that ultimately improve the overall sales productivity of this valuable real estate in our stores. And five, we will continue to strengthen our merchandising presentations by adding key brands to our assortments and by investing in both job-lot and presentation quantities within our best-selling SKUs.
All of this is designed to drastically improve the experience for our Pro customers. All 5 of these initiatives were launched at the end of the third quarter, and we'll be laser-focused on the rollout plans and execution as we move into 2019. I look forward to discussing these 5 priorities in more detail at our December 12 Analyst and Investor Conference. We are excited about the opportunity ahead of us, and we are working very hard to position Lowe's for the future and to capitalize on the strong demand in a healthy sector. Our changes will take time, but we have a detailed plan in place to allow us to make steady progress with near- and long-term wins. Thank you, and now I'll turn the call over to Joe.
Joseph McFarland:
Thanks, Bill, and good morning, everyone. Like Bill, I, too, have celebrated my 99th day with Lowe's, and I'm very excited to share with you the steps we are taking to improve store operations.
When I joined the company, it struck me that some of the basic and foundational elements of operations were not in place. As an example, there are engineered standards for in-store processes like unloading a truck, flowing product from receiving to the sales floor or stocking the shelf to drive in-stocks, and labor scheduling systems were antiquated and ineffective, leading to payroll inefficiency and detracting from customer service. Other than cost of goods sold, payroll is the largest expense for the company and we have limited ineffective tools to track, allocate or monitor coverage. In addition to payroll inefficiency, stores were inundated with communications and reports with no prioritization. This lack of payroll efficiency, combined with nonexisting communication standards, led to process breakdowns like excessive out-of-stocks and a poor customer experience. Although these process challenges hindered our execution in the third quarter, I've encountered these types of issues before and have put solutions in place to solve them. Therefore, in the third quarter, we established an operations team with home improvement experts, took initial steps to simplify our focus and developed processes and procedures to address all identified issues. As part of simplifying operations, we're focusing the teams on key priorities and metrics while removing distractions and non-value-added tasks. To improve customer service, we've recently eliminated sales forecasting activities during the busiest hours of the day so that our associates can focus solely on selling and providing excellent service. This process eliminates competing demands and provides a clear, concise and consistent approach to deliver a repeatable and reliable customer experience across all stores. Earlier this month, we also significantly reduced the volume of communications and reports going to our stores. Previously, corporate and field associates communicated directly with the stores, bypassing the formal gatekeeping process and leading to information overload, conflicting messages and inconsistent execution. To focus our teams on the most essential initiatives and allow them to spend more time with customers, we funneled all store communications through a single portal to establish clear weekly priorities and held the stores accountable for executing against these priorities. To drive efficiency, we've also streamlined the reams of reports and metrics sent to our stores and instead focus the teams on analyzing and improving their customer service scores. To address the overly complex project specialist and installed sales business that Marvin mentioned, we recruited an experienced industry leader to the team in the third quarter. Through his leadership, we are taking steps to simplify and redesign how we engage customers and grow sales in this very important business. I look forward to sharing more details with you at our December 12 Analyst and Investor Meeting. In addition to simplifying our focus in stores, we developed a comprehensive in-stock process, including standardized procedures for efficiently moving product from receiving to the sales floor and rolled it out to U.S. stores in November. We expect that we'll begin to see measurable improvement in our in-stocks as we head into 2019. As we work to improve our customer engagement, we continue to invest in our military appreciation program. During the World Series and over Veterans Day weekend, we were in a television spot featuring our veteran associates, thanking all veterans for their service while building awareness of our 10% off discount for active duty and retired military. As a Marine veteran who served in both the Gulf War and Desert Storm, I'm proud of the fact that our military discount will provide over $1 billion in savings for our veterans this year. This is unprecedented in retail and I'm proud to work for a company that stands with our veterans.
To recap. As part of our store operations focused on retail fundamentals, we have 5 key priorities:
One, we have developed and are rolling out engineered standards for all in-store operational activities. Two, we are taking steps to simplify communications and reporting sent to our stores. Three, we are rolling out a consistent and comprehensive strategy to improve our inventory in-stock execution. Four, we're developing a new payroll allocation system to deliver a better customer experience while driving payroll efficiencies. Finally, we are establishing clearer priorities to ensure that customer service is top of mind for our associates in the stores. This includes giving our district managers and store managers the autonomy to adjust assortments in their stores to meet the local demands of their customers. We are a big believer in the power of entrepreneurial spirit in the home improvement retail. We know there is still more work ahead to fully capitalize on the healthy demand in our sector, and we believe we have the plans and expertise in place to win in today's retail environment.
The good news is I have not encountered any issues or business problems in my last 99 days at Lowe's that I have not experienced before. Therefore, I'm confident in our ability to develop a world-class operational focus. Thank you, and I will now turn the call over to Dave Denton.
David Denton:
Thank you, Joe, and good morning, everyone. I'm excited to be with you today. And while I know many of you from my past, I look forward to working with all of you as we position Lowe's for long-term financial success. While today is technically my first official day as CFO, over the past several weeks, I've spent a great deal of time immersing myself in the business. I've engaged with both the executive leadership team as well as the finance team here at the company. I've had the opportunity to both review and participate in the ongoing strategic planning efforts, and I strongly believe that the company is taking the necessary actions to be well positioned for success at both the near and long term. I've grown to appreciate the strong fundamentals of the home improvement market, driven by robust real residential investment and home price appreciation, and yet I've seen the existing challenges facing the Lowe's business. I've come away from the past few weeks with tremendous excitement about the future and believe we can create significant long-term value for all stakeholders, including both shareholders, customers and associates.
This morning, I'll spend a few minutes reviewing the company's financial performance in the third quarter and provide an overview of our expectations for the balance of this year. As a reminder, in the first quarter of this year, we adopted the new revenue recognition accounting standard. And as a result, we reclassified certain items within operating income, the most significant of which was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales. The adoption of the standard had no meaningful impact on operating income and no impact on comparable sales. Also, it was adopted on a modified retrospective basis so the prior year has not been adjusted.
Also, before I review the underlying operating performance of the business, let me briefly discuss the pretax charges taken during the quarter. As described in the press release this morning, our strategic reassessment has resulted in $280 million of pretax charges. These charges were incurred to reposition Lowe's with the objective of improving the company's financial returns and to allow the organization to focus on the key drivers of long-term value creation. Specifically, these charges include:
$123 million associated with our decision to close all Orchard Supply Hardware locations; $121 million related to our decision to close certain underperforming stores in the U.S. and Canada, along with a few other Canadian locations; $22 million related to our decision to exit retail operations in Mexico; and $14 million related to our decision to exit Alacrity Renovation Services and the Iris Smart Home business.
The $280 million in pretax charges can be classified into a few major expense categories. These include approximately $130 million of long-lived asset impairments; $15 million in lease obligations; $103 million in accelerated depreciation and amortization; and $32 million in severance obligations. And given the nature of these expenses, we estimated that the net future cash outflows will be approximately $50 million. I'll now turn to a review of our operating performance for the quarter, starting with our capital allocation program. In the first 9 months of 2018, we generated nearly $6 billion in free cash. And through a combination of both dividends and share repurchases, we've returned approximately 60% of this cash to shareholders. In the third quarter alone, we paid $390 million in dividends, and our dividend payout ratio currently stands at 35% over the trailing 4 quarters. In August of this year, we entered into a $310 million accelerated share repurchase agreement, which settled in the quarter, retiring approximately 2.8 million shares. We also repurchased approximately 2.9 million shares for $310 million in the open market. So in total, we repurchased $620 million of our stock in the quarter. This brings our year-to-date share repurchases to $2.5 billion through the end of Q3, with a plan to reduce -- to repurchase $3 billion for the year. We have approximately $4.5 billion remaining on our share repurchase authorization. And importantly, we continue to invest in our core business with capital expenditures of approximately $300 million in the third quarter and nearly $850 million year-to-date. We are very deliberately managing our capital expenditures, focusing on investing in areas that both stabilize our business and generate healthy long-term returns. Now looking at the income statement. We generated GAAP diluted earnings per share of $0.78 compared to $1.05 in the third quarter of LY. On a comparable basis, excluding the $280 million in pretax charges associated with our strategic reassessment, adjusted diluted earnings per share was $1.04 a share, a 1% decrease over last year's earnings per share. Despite softer sales in the quarter than anticipated, the $1.04 of adjusted earnings per share beat our expectation. The better-than-planned performance was a result of a lower effective tax rate and better margin performance from our inventory rationalization activities. Sales for the third quarter increased 3.8% to $17.4 billion, supported by an average ticket growth of 4.5% to $75.89, partially offset by a roughly 1% decline in total transaction. Adoption of the new revenue recognition standard provided 143 basis points benefit to sales growth. Comp sales were 1.5%, driven by an average ticket increase of 2.3%, partially offset by a transaction decline of about 1%. And as the team has shared, we continue to see strong traffic growth from the third quarter. However, challenges with inventory out-of-stocks, poor reset execution and assortment concerns in certain categories pressured our ability to turn those visits into transactions. During the quarter, the net effect of cycling the hurricane season was approximately 100 basis point drag on comp sales. Headwinds from Hurricanes Harvey and Irma were partially offset by demands from Florence and Michael. Our inventory rationalization efforts in the quarter provided an approximately 15 basis points benefit to comp sales. Looking at monthly trends. Comps were 4% in August, 0.7% in September and essentially flat in October. Excluding the estimated net negative impact of hurricanes and adjusted for the estimated pull-forward impact of our inventory rationalization efforts, our monthly comps were 3.7% in August, 1.9% in September and 1.7% in October. Gross margin for the third quarter was 32.5% of sales, a decrease of 157 basis points from Q3 of LY. Again, adoption of the new revenue recognition standard provided 107 basis point benefit to gross margin. Our efforts to aggressively rationalize inventory and to eliminate slow-moving or underperforming SKUs negatively impacted gross margin by 180 basis points. This effort was an important step in better positioning the company's inventory to foster long-term sales growth and ROIC improvement. We also experienced 35 basis points of additional pressure from reset-related clearance activity and 25 basis points from clearance activity from the wind-down of our Orchard Supply Hardware operation. Finally, product mix shift had a 10 basis point negative impact on gross margin in the quarter. SG&A for the quarter was 24.5% of sales, which delevered 180 basis points. Again, adoption of the new revenue recognition standard resulted in 118 basis point of SG&A deleverage. Additionally, pretax charges in the quarter related to our strategic reassessment drove 105 basis points of deleverage as well. These items were partially offset by 20 basis points of leverage due to incentive compensation and 15 basis points of leverage from a favorable employee insurance adjustment. Depreciation and amortization for the quarter was $433 million, which delevered 36 basis points, again, primarily as a result of the accelerated depreciation related to the exit of Orchard Supply Hardware. Operating income decreased 373 basis points to 5.5% of sales. Our effective tax rate was 21.8% compared to 37.1% LY. This significant improvement is largely the result of tax reform as well as a few other discrete items that were recorded in the quarter. Quickly let me highlight a few items related to the balance sheet. Inventory at $12.4 billion, decreased $28 million or 0.2% versus the third quarter of last year, again, primarily the result of our inventory rationalization activity. Inventory turnover was 3.84x, a decrease of 10 basis points versus Q3 of LY. And at the end of the third quarter, lease-adjusted debt to EBITDAR was 2.29x. And our return on invested capital was 19%. Looking ahead, I'd like to address several updates that we've made to the Lowe's business outlook. As Marvin shared, the home improvement backdrop remains strong, driven again by robust real residential investment and home price appreciation, which continues to encourage homeowners to engage in discretionary projects. But as you well know, 2018 continues to be somewhat of a rebalancing year for Lowe's as we are refocusing the organization to both enhance returns and drive shareholder value. As a result of our strategic reassessment of the business and the ongoing execution challenges, we have updated our expectations for the balance of this year. We now expect a total sales increase of approximately 4% for the year, driven by comp sales increase of approximately 2.5%. We anticipate opening 8 stores. On a GAAP basis, we expect an operating margin decline of 240 to 255 basis points. This includes charges of 135 to 150 basis points associated with our strategic reassessment of the business. As a reminder, we incurred $230 million of pretax charges in the second quarter, $280 million in the third quarter and expect an additional $460 million to $580 million in the fourth quarter. Keep in mind that the amounts, the nature and the timing of any additional charges associated with the exit of our retail operations in Mexico will depend on the plan executed, and therefore, have not been reflected in our business outlook. The effective tax rate is expected to be approximately 24%. And for the year, on a GAAP basis, we now expect diluted earnings per share of $4.08 to $4.24 per share. Excluding the impact of the charges associated with our strategic reassessment, adjusted diluted earnings per share is now expected to be $5.08 to $5.13 a share. We are now forecasting cash flows from operations of approximately $6.7 billion and capital expenditures of approximately $1.2 billion. This is expected to result in free cash flow of approximately $5.5 billion for 2018. And our guidance assumes approximately $3 billion in share repurchases for the year. Again, we remain excited about the future of our business, and we're focused on taking the necessary actions to drive returns and shareholder value. And with that, we'll now open it up for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Michael Lasser with UBS.
Michael Lasser:
If we look at your performance relative to your large competitor or relative to the category, clearly, it's a step back this quarter. Now I don't think anyone thought it was going to be easy, but Marvin, when can we expect to see some progress from Lowe's by narrowing these gaps to your competition?
Marvin Ellison:
Okay. Michael, I think for us, and I stated this in the prepared comments, we're really focused on creating a sustainable foundation in the third quarter. And we made a conscious effort not to chase short-term fixes or short-term results. In any quarter, retailers could make decisions on promotional cadence and special buys and those types kind of tactical things. We stayed away from all of those types of decisions because I wanted to give the team the appropriate time to really get to the root cause. And that's why I think it's appropriate to know that both Bill Boltz and Joe McFarland are celebrating their 99th day with the company today. So although we made great strides in our kind of reassessment of the business, we have a lot of really new executives. Having said that, we have an expectation that we're going to see the business improve going into 2019, but we're also expecting some short-term improvements in the business just based on all of the actions that the team has taken and some of the initiatives put in place in the third quarter. I mean, some very fundamental things that we're looking at that we think will deliver some short-term results will be just the simple improvement in customer service. And Joe talked about how removing tasks and designating service versus task time, those things are important. Bill talked about bringing some level of productivity to our end caps. Our end caps in the past have been used for billboards, not real sales productivity. So we think just that simple transition will add some value. The improvements we made in the supply chain and how we now have better coordination between supply chain and stores will improve our in-stocks and we'll see incremental improvement. So to answer your question specifically, we were not chasing short-term results in the quarter. And if there's an expectation that some of these chronic, long-standing issues can be fixed in a couple months, that's really unrealistic. And rather than trying to chase quick fixes, we want to fix it at the root and we think we're doing that. And that's why we believe that going into '19, you'll see this company start to have sustainable improvement month-over-month, quarter-over-quarter.
Michael Lasser:
And Marvin, as you head into 2019, what chance that any sort of gains you make with the self-help and addressing some of the execution issues are simply just offset by what will probably be a tougher industry environment next year? And how are you preparing for that?
Marvin Ellison:
Well, I think for us, the great thing about our business is that we're in a $900 billion fragmented home improvement marketplace. And if you combine us and our chief competitor, that's less than $200 billion in revenue. And so there is a lot of market share up for grabs. We have been very transparent on the issues that we are dealing with as a company. Most companies are not going to be as transparent. The reason why that's important is because when we fix these very long-standing, chronic issues, poor reset execution, out-of-stocks, assortments not being localized, poor customer service, no real focus on the Pro customer, irrespective of what could happen with our competitor or competitors, plural, we have market share opportunity just because we've been underperforming as an individual company in a massive marketplace where we have about 10% share. And so we're not as concerned with kind of what's happening in other places, not even in the macro because we feel really good about the macro environment for home improvement. This is really more about us understanding the steps we need to take to improve execution. And the team will lay out some very specific short- and long-term initiatives at our December 12 Analyst and Investor Conference.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk a little bit about the 180 basis point headwind from the inventory clearance and reconcile that to the sort of 15 basis point lift to sales from clearance? Is there any assumption in there on ticket cannibalization sort of stealing a more full-priced sale and thereby sort of diminishing the comp from that clearance activity?
Marvin Ellison:
Yes. Chris, the one reason why a retailer never desires to have a massive inventory liquidation process is because it really wreaks havoc on your numbers. But as Dave stated in his prepared comments, I mean, we believe that we saw some comp benefit early in the quarter from the inventory liquidation because it was being sold at a higher average ticket. As we've gotten to the month of October when we started to see the liquidation at its kind of most aggressive cadence, we believe that not only did it hurt average ticket, we think it cannibalized sale. So I remember as an anecdote being in the store and seeing a heater being clearanced in the month of October and I thought that was very odd. So after we followed up, I realized that, that was a heater from 2 seasons ago that had been trapped in the overhead because it had never been properly clearanced out. So if you think about that for a second, October is a time where we're really selling heating at a very high rate. But if you can trade down and get a unit that's roughly 60% to 70% off, it's going to cannibalize regular ticket items. And so we think it may have benefited us at the beginning of the quarter from a comp standpoint. But as the quarter progressed, specifically in October, we think it was a negative impact.
David Denton:
Chris, it's Dave. I think the good news is, while no company likes to liquidate inventory, we had about $500 million to liquidate. That's now largely behind us. So we're now positioned going into the back half of the quarter and into '19 kind of clean from that perspective. So I think we're well positioned to put the right inventory in the right locations to begin to improve performance.
Christopher Horvers:
Understood. I guess, I mean, just as a devil's advocate question, I mean, you talked about conversion issues at Lowe's. And so I guess, my question is, how do you necessarily know that, that sale would've been made if it weren't for that aggressive discount on the product?
Marvin Ellison:
Well, Chris, our conversion issues were less about the liquidation of inventory and more about just being out-of-stock. This is a very simple retail analysis. When customers walk into a brick-and-mortar location, they have an intention to either buy or to get some level of consultation on an item they're considering buying. And we're in the project business, so that happens quite often. But when we talk to our customers and ask the question what drove a decision not to buy when you physically showed up at a store, it is overwhelmingly that you were not in-stock. And so our conversion issues had nothing to do with the inventory liquidation. It had everything to do with the fact that we had 4 very problematic resets underway and we still have a significant number of out-of-stocks on our shelves. You can just simply walk our stores and see it with the naked eye. So as Joe McFarland mentioned, we put some operational processes in place that's going to help us to improve this, but out-of-stocks is also something you can't flip a switch on unless you're going to make some aggressive short-term decisions like air freighting in product or making some bad short-term decision. We chose not to do that, and we're actually fixing the reset process with an internal team that's going to own resets. We're having better coordination between supply chain and store operations, and we have a consistent in-stock process in the stores. And so conversion, for us, was driven almost exclusively by out-of-stocks. And so we're going to continue to just execute and improve in-stock, and we think our conversion will improve accordingly.
Christopher Horvers:
Understood. And then just one quick one for the model. How should we think about depreciation going forward?
David Denton:
I think it would be if you look at Q3, if you back up the charges that I indicated from the -- from my prepared remarks, it should be fairly consistent going forward. It will depend a little bit about what we do with Mexico and the ultimate disposition of that business.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Maybe I missed it, but did you quantify how much you think all the reset activity and the out-of-stocks hurt your comps in the quarter?
Marvin Ellison:
We did not.
Simeon Gutman:
Is -- do you have a guess? Or is it too difficult to gauge?
Marvin Ellison:
Simeon, I've learned that guessing is probably not a good thing to do on an earnings call. But technically, it is a little too difficult to gauge. We spent most of the time, quite candidly, trying to get to the root cause of why these issues exist. Bill Boltz and his team spent a lot of time understanding supply issues, supply coordination issues, third-party reset issues, just in-store planning. And so we feel really good about the fact that we've identified root causes. So we really focus our time and attention on now trying to put those plans in place to solve those issues. We'll have a much more detailed and specific overview of this on our December 12 Analyst and Investor Meeting because we felt it was important to make sure that we communicate externally how we're solving this because we spent time in the last 2 calls talking about it being a chronic issue. And now we want to spend time about the steps we're taking to correct it.
Simeon Gutman:
Okay. I guess, within that question, I think paint, right, this category has been affected for, I think, for 2 quarters in a row. I figured maybe you have some guesstimate around on that business. And then maybe a way to think about it is, can you tell us what the comps were in the categories that weren't affected? And then for the answer, I would exclude probably outdoor and seasonal, just given that there was probably some hurricane stuff noise in there. So if we look at traditional categories, you did mention some above average, some at company average, but maybe you can give a little more color on the categories that didn't have some type of reset activity.
Marvin Ellison:
Well, Simeon, I think, for me, the best way to answer your question is that we had 4 negative comping categories for the quarter. All 4 had reset interruption issues. And so that's probably the most effective way to answer the question. Where we did not have reset issues, we had positive comps. Where we had reset issues, we had negative comps. And so I think to me, that's the best explanation of the impact of poor reset execution on the business. I think anything beyond that will just be data that may not be useful.
Simeon Gutman:
Fair enough, okay. And my real follow-up is you mentioned to us, I think it was in September, that there were a couple of Pro brands that Lowe's didn't have and I forget -- you didn't name the brands. I don't know if you could share with us what it is, but is -- what's the visibility on that? And does that -- trying to get new brands, does that take a back seat now to you fixing some of the core operations of the business?
Marvin Ellison:
Well, I'll do 2 things. So first, we're always going to talk about the brands that we have and the brands that we're very proud to have, and I'll let Bill talk about some of those Pro brands. And I will just say for the record, the brands that we don't have that we desire to have, we're actively working to try to get them in our assortment. But we will just take the practice of only talking about the brands we have because those are the companies we want to highlight. And Bill, just talk a little bit some of the Pro brands that we feel really good about that performed well in the third quarter.
William Boltz:
Yes. So we're excited about what happened with water heaters and A. O. Smith. We're very excited about what happened with SharkBite. As I mentioned in my prepared remarks around the SharkBite plumbing fittings, we finished the rollout of Zoeller pumps. We finished the rollout of our tile setting material under MAPEI. We introduced new Pro cordless products under Bosch and Metabo HPT. And so as good merchants, we'll continue to evaluate assortments and look at where those opportunities are going forward and try to make sure that we're doing our best to offer the products and the brands that the customers want.
Operator:
Your next question comes from the line of Steve Forbes with Guggenheim.
Steven Forbes:
I wanted to start with the 5 key priorities you mentioned within the merchandising and store operational functions. Not to take too much from the Analyst Day, but can you briefly address sort of the anticipated timing of the completion of these initiatives? Is it a first half, second half '19? Just some general idea on the timing of the initiatives would be helpful.
Marvin Ellison:
So Steve, I'll hand it over to Bill and let him go first and ask him to keep it high level because, as you can imagine, we're still working on some of the really specific details of these. Although these initiatives were launched in the end of the third quarter, there are still some specific details we're working on. And I'll ask Joe to kind of appropriately stay a little high level on operations as well. So Bill can talk about those priorities for merchandising.
William Boltz:
Yes. So we're continuing to evaluate talent and to bring in experienced leaders. And so that will continue as we go into the early part of next year. We want to have that done, obviously, as quickly as possible and as we work through some of the merchandising opportunities. Some of those categories I called out in our prepared remarks that will take us longer. Some of those will take into the back half of '19 because of the complexity. The ones that we can get done sooner, we'll obviously implement it as early as we can in the early part of 2019. So we'll take them as they come and continue to work through them on an issue-by-issue basis.
Marvin Ellison:
Okay. Joe, you want to talk about throughput?
Joseph McFarland:
And so for store operations, what I would say is we have identified all of the challenges that we have, certain things like simple process for receiving trucks, customer service. We have already begun implementing those as we think about the new payroll allocation system. We've already taken initial steps. However, that will flow into 2019. And so I'd say we're well underway, that we have identified all the root causes, and we're excited to share more as we get together in December.
Steven Forbes:
Right. And then just a quick follow-up for Dave. You called out a bunch of the margin dynamics, right, during the quarter for gross margin. What about rising transportation cost and supply chain cost? Was that -- can you quantify that drag this quarter?
David Denton:
Yes. We've been watching that closely. Like all industry participants in the sector, transportation cost is a worry. I'd say that as we looked at our forecast for the balance of the year, we've included that in our guidance. I would say it's not a significant headwind at this point in time, but it's something we're watching closely as we cycle through the balance of this year and into next year.
Operator:
Your next question will come from the line of Zack Fadem with Wells Fargo.
Zachary Fadem:
With your strategic review coming to a head, Marvin, could you talk about how your findings compare to your expectations going in? I'm sure you had some ideas around what needed to change. So I'm curious if you could speak to areas within your business that are maybe functioning better than you expected. And then for those areas underperforming, how does the magnitude of change needed compare to what you initially thought?
Marvin Ellison:
Okay. Zack, what I've been most pleased with is really the people side of the business. As I said in my prepared comments, I mean, we don't make it easy on our associates. I mean, we spend a lot of capital as a company over the last 7 years, but we haven't necessarily spent a lot of capital on making the stores more efficient, making our supply chains modern and just creating an easier work environment for our associates. And so our associates have been resilient. And I've visited all of our geographic markets, including Canada and our MSH operation for Pro. And in every case, I just walk away just being encouraged by our associates. I've mentioned the engagement with the community, and we were serving 50,000 meals to date for Thanksgiving for communities affected by the hurricane. This is a kind of a thing that I had no real impact on. It was just happening when I got here. And so that's part of the associates loving the business and the culture. And I would say the decisions we've made rather quickly were around leadership structure and organization. I felt that we needed to bring in some core retail experts. What I've learned in my successes and failures in retail is that when you're solving problems, it is best to go out and find leaders who've kind of been there and done it before. And so that's why when I look around the table at Don Frieson in supply chain and Bill Boltz in merchandising and Joe McFarland in stores and Dave Denton as our CFO and Seemantini as our new Chief Information Officer, et cetera, et cetera, we've gone out and recruited world-class leaders who've kind of been there, done it before, and that's required. And so mostly I was disappointed in what I found, but I felt like the need to bring in experienced leaders so that we could solve these problems quickly. And also, I just want to make sure that we have a more disciplined capital allocation process. As I mentioned earlier, a lot of these strategic reassessment and closing underperforming stores, exiting noncore businesses, getting out of environments where we can't really be competitive because we can't get to scale like Mexico, is all a part of making sure we reallocate capital and invest in creating a great home improvement retail environment. And so that's kind of where we are and we'll continue to make the necessary changes. But we feel great about the future of this company. I mean, we can identify obvious shortcomings in what we're doing on a daily, weekly basis. We can look at where we're underperforming from a sales perspective and we could point exactly to what's causing it. And to me, that's very encouraging because we know how to fix it. And so we're going to continue to push forward.
Zachary Fadem:
Got it, Marvin. That's helpful. And I think a quick one for Dave. First of all, welcome aboard. And then on the store closings and the additional initiatives announced today, curious if you could speak to your approach to some of the cost savings coming out next year. And how do you think about just the process of redeploying and reinvesting those savings? And are there any of those savings that you would expect to drop to the bottom line next year?
David Denton:
Well, obviously, we're making these investments and these decisions to position the company for long-term financial success. There's no doubt about that. And I think the team is really focused against that very intensely. I do think that the savings that are going to be generated from these activities are partly going to be invested a little bit as we think about repositioning the company and some of the efforts you heard from both Joe and Bill today. But importantly, as we think about that future and the future growth and the returns on the business that we have today, this will largely fall to the bottom line and really enhance those returns over the next future periods.
Operator:
Our next question will come from the line of Greg Melich with MoffettNathanson.
Gregory Melich:
A couple questions. I just want to make sure I piece together the guidance and the inventory adjustments right. If I got it right, there's $320 million of inventory hit in the third quarter. And I think, Dave, you mentioned around $500 million over the course of the year. If we think about either of those numbers, it's sort of 60 to 90 bps of margin hit this year. Should we be thinking about that as the -- if there was 100 -- 135 to 140 bps of charges, right, mostly noncash, that really this year, EBIT margins are down 90, 100 bps, but that inventory is 60 to 90 of it and that's sort of a clean like-for-like slate into next year? Am I piecing it together right?
David Denton:
Well, a little bit. Let me just step back a minute. We had roughly $500 million of inventory to clear. We roughly cleared that at a 40% discount. So I think that's largely behind us. As we cycle into Q4, we're essentially clean from the inventory rationalization perspective. So don't think about a hangover into Q4. Think about that being complete in Q3.
Gregory Melich:
Got it. And so the -- if we took just the third quarter -- and that's now behind us and that what we saw in the gross margin, that $320 million to $330 million, is when we get to next year, that's -- that we're clean when we think about it as sort of a run rate of margin. Great. And then second and sort of bigger picture on just traffic and conversion. I think, Marvin, you mentioned that traffic was still positive, but we basically have transaction counts down. How do you measure what traffic really was versus that conversion? I mean, do you -- was it the store traffic was up 1%, but we were down -- transaction counts down 1% and that's the difference in terms of close rate?
Marvin Ellison:
Well, I think a couple of ways. Measuring traffic online is just pure data driven, so that's something we have 100% visibility to like any other e-commerce or brick-and-mortar companies with an e-commerce platform. So that's pretty straightforward. When we look at traffic in the stores, I mean, we have monitoring devices to measure traffic. Our environment is more difficult to measure conversion because we're a project business. And so we're going to shift our discussion from conversion to transactions. I think that is a better way to understand a year-over-year comparison of our business. So having said that, we still feel very good about traffic, both online and in-store base, and how we measure it. But we understand that we have challenges in driving transactions and/or conversion based on the traffic. When we look online, we know we have some issues with functionality that we're addressing. We also note we have issue with search and navigation and ease of checkout. If you look at our mobile app, you can see an app that desires to be much more robust and we're in the process of delivering on that. As we look in the store, I go back to my previous comments, we don't want to make this overly complicated. When a retailer is not delivering on the traffic that's walking in your store, there really are a couple of basic reasons why. Either you are priced incorrectly from what you advertised or you're out of stock. And we feel good about the consistency of our pricing. And all of our data tells us that we're out of stock. And that's why we put such a huge emphasis on addressing this issue. And so we understand the root cause. We understand how we got here, and now we're working to create a sustainable solution to fix it.
Operator:
Our final question will come from the line of Scot Ciccarelli with RBC.
Scot Ciccarelli:
I guess, this is a bigger picture view for a second as well. When you kind of look at your performance against Home Depot, the bulk of the sales gap on a per-store basis, Marvin, as we've talked about, is really on the Pro side. If you were to get the stores right where you want them, the in-stocks where you want them, I know this is an opinion, but over what kind of time frame do you think you would start to take market share back on the Pro side? And related to that, why would a Pro change who their incumbent product supplier is?
Marvin Ellison:
No, Scot, it's a fair question. So I'll speak specifically on the Pro customer. The Pro customer is a very important customer, but they are very, very simple customers. And this customer is looking for a couple of fundamental things. First, they're looking for a great price. They're looking for service that saves them time because time is money, and they're looking for the brands that they identify with. That's really it. They're pretty much agnostic on anything else. And so Lowe's has proven that you can have a dominant market share in Pro and lose it because at one point, Lowe's had dominant market share in Pro and they didn't maintain it because primarily of those 3 things I outlined were no longer competitive advantages. And so for us, we're going to make sure that we are competitively priced. That's something that Bill and his team are taking a lead on. We're going to make sure that we have great service because, again, time is money and servicing a Pro is not giving them product knowledge. It's about having job-lot quantities. It's about giving them the ability to buy and stage product. It's the ability to load, it's the ability to speak their language and to engage them at the Pro desk or engage them online. And now the third level is to go out and get the brands. And as Bill and I both mentioned, we're actively engaged in trying to fill our assortment with brands that we currently don't have. When you do those things, the Pro is totally agnostic to the channel in which they shop because it's all about those 3 things for them.
Scot Ciccarelli:
And do you think that if you kind of match apples-to-apples, the Pro would come to Lowe's instead of Home Depot or...
Marvin Ellison:
Well, I think the key is we spend very little time looking across the street. We are a customer-centric company. And what we believe is if we take care of the customer, everything else will take care of itself. And I'll just remind you that we operate in a $900 billion marketplace and so we don't care a whole lot about what's happening across the street because between Lowe's and our largest competitors, less than $200 billion in market share, which means there's more than $700 billion up for grabs in this really fragmented environment. And so for us, it's less about what's happening with a competitor, it's more about how we serve customers and how we go out and we take share in this fragmented marketplace that we're in.
Okay, thank you very much. And look, we appreciate your time and attention on the call, and we look forward to speaking with you again on our fourth quarter call, which will be Wednesday, February 27. Thanks, and have a very blessed Thanksgiving.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2018 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. Marvin Ellison, President and Chief Executive Officer; Mr. Mike McDermott, Chief Customer Officer; and Mr. Marshall Croom, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.
Marvin Ellison:
Thank you, Regina, and good morning, everyone. It's an honor to be here today as the President and CEO of Lowe's. But before I get started, I'd like to take a moment and acknowledge the many contributions of Robert Niblock through his 25 years of service, including 13 years as Chairman and CEO. Running a large public company is never easy, and Robert led Lowe's through some impressive periods of growth, doubling the size of the company and navigating through an important era of transformation in retail. I'd like to personally thank Robert for his service and his commitment to the hundreds of thousands of men and women who work for this great company.
Now let's turn to our second quarter results. We capitalized on a delayed spring demand to drive strong growth in seasonal businesses and achieved comp sales above the company average in lumber and building materials, appliances, rough plumbing and electrical and delivering a comparable sales growth of 5.2% overall. Our U.S. home improvement comp was 5.3%, with positive comps in all 14 geographic regions and 14 -- in 8 of our 11 product categories. And we drove an 18% comp growth in Lowes.com. Diluted earnings per share were $1.86 and adjusted diluted earnings per share were $2.07, an increase of 31.8% from the same period a year ago. But taking a step back, our second quarter results represent 3 broad themes. Theme number one, resilience. Despite significant organizational changes during the quarter, the associates and the leaders of this company remained focused and resilient. And I'd like to personally thank the more than 310,000 associates for their hard work and commitment. Theme number two, great marketplace. After spending almost 4 years in the apparel sector, it's obvious to me that the home improvement marketplace is among the most robust in retail, and we anticipate continued growth in the home improvement sector, where there is a strong demand for our products and services from a diverse group of customers motivated to invest in their homes. And the final theme is we have work to do. Despite delivering a 5.2% comp and $2.07 adjusted EPS for the second quarter, we have a lot of opportunity as a company. Specifically, we are significantly behind in our supply chain strategy, our in-store technology is dated, overall execution is impaired by complexity, we have a large number of out-of-stocks in our stores that must be addressed and we need to increase the rigor with which we evaluate capital investments. Although it's never good to be behind, our current position presents significant upside potential for Lowe's and for Lowe's shareholders. So the question is, how do you realize this potential? Over the past 12 weeks, we've hired some of the best leaders in retail to help us address these shortcomings, and I'm excited to see how great we can be as a company when we have these retail fundamentals corrected.
And although I've only been in position for several weeks, my opinions on the current state of the business have been formed by the following:
First, I've conducted detailed business reviews with all of our functional leaders. I've spent time with suppliers. I've engaged our customers around the country and conducted numerous town halls with our associates and visited stores in all 14 U.S. regions. My aggressive travel schedule has given me the opportunity to learn from those closest to the customer. In fact, my greatest learning thus far is just how outstanding our associates are. Our front-line teams find ways to serve our customers despite some of the competitive disadvantages we created for ourselves. And without question, our associates are our greatest asset, and we must give them better tools to compete.
Simply stated, at Lowe's, we desire to be a great omnichannel retailer. While we have the foundational elements of an omnichannel network, we need to better connect and align our systems and processes to create a truly integrated ecosystem. But fortunately, I've been down this road before and I have a clear understanding of the steps and processes required to build a world-class omnichannel environment. And in addition, to drive value for our customers and shareholders, we must simplify the business to produce better results and more consistent results. The company has unfortunately become distracted over the past few years. And specifically, we've taken initiatives that did not add value and were not core to our retail business. Spending time on these non-core initiatives shifted capital, people and attention away from being an operationally sound home improvement retailer. And these distractions also created a complex environment for our front-line associates. We recently took steps to simplify our organizational structure, and my experience has taught me that a simplified organizational structure is the first step to create operational excellence and allow for faster decision-making. We also made several important leadership appointments, and I'm pleased to welcome Bill Boltz as our Executive Vice President of Merchandising; Joe McFarland as our Executive Vice President of Stores; Don Frieson as our Executive Vice President of Supply Chain. And earlier today, we announced the addition of David Denton to the team as our new Chief Financial Officer. And David currently serves as the EVP and CFO of CVS Health, where he's held that position for over 8 years. We're very excited to welcome David to the Lowe's team. All of our new Executive Vice Presidents have a strong retail pedigree and proven track records of success. And combined, Bill and Joe bring over 50 years of home improvement experience, and Don and David will bring a deep technical knowledge from their related fields of supply chain and finance. All 4 leaders will be instrumental in helping us to establish the necessary building blocks to create a world-class omnichannel environment. And when you combine proven leadership with disciplined capital allocation, great things can happen. We're also working aggressively to fill our open Chief Information Officer position and expect to have a leader named in short order. In addition to implementing a new leadership structure, simplifying the business also means that we will shift our focus away from less-effective projects. As we announced this morning, we've initiated a strategic reassessment of the business, which has already led us to make a series of decisive moves to refocus our financial and intellectual capital on running a great retail business. First, we decided to exit our Orchard Supply Hardware operations to allow us to focus on our core home improvement business. We expect to close all 99 stores, which are located in California, Oregon and Florida, as well as one distribution facility, by the end of fiscal 2018. To ensure an orderly wind-down process, we plan to conduct store closing sales and have partnered with Hilco Merchant services to help manage the process to ensure a seamless experience for our customers. Closing stores is always difficult, and we'll take all possible steps to find positions for our displaced associates in nearby Lowe's stores. Second, we are eliminating approximately $500 million in planned capital projects for 2018. Specifically, we're eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates and did not meet our hurdle rate. Instead, we will reallocate that $500 million to our share repurchase program, and we believe this will deliver more value to our shareholders. Third, I've charged the new leadership team to develop an aggressive plan to rationalize our store inventory to remove clutter and reduce lower-performing inventory. This will enable us to invest and improve job lot quantities with Pro and increase our depth of inventory in our top 2,000 high-velocity SKUs. None of these actions are easy to take. However, they are the right decisions for our company and our shareholders. And this will allow us to position our core home improvement business for continued growth.
The company's strategic reassessment is ongoing, as we will evaluate the productivity of our real estate portfolio and our non-retail business investments. And going forward, our goal is simple:
We plan to deploy both human and capital resources to their highest and best use.
And finally, as we work to create more value for our shareholders, we must create a true expense reduction culture here at Lowe's. No longer will we throw payroll at each problem. Instead, we will rigorously scope out the issue and implement technology to improve our processes. This will ensure that we deliver better sustained expense discipline and more effective capital allocation that will drive improvements in our return on invested capital.
So to summarize, our short-term priorities at Lowe's are the following:
We'll simplify our organizational structure, recruit outstanding leaders, improve our reset execution, rationalize store inventory while improving our in-stock position, invest in high-velocity SKUs for our Pro and DIY customers, implement more rigor into our capital allocation process, intensify our customer engagement and develop a true expense reduction culture.
This is what I define as sharpening our focus on retail fundamentals. I look forward to sharing more details on our long-term strategic plans at our Analyst and Investor Conference on December 12. And with that, I'll turn the call over to Mike.
Michael McDermott:
Thanks, Marvin, and good morning, everyone. It has been a pleasure to serve Lowe's over the past 5 years. And though we have a lot of work to do, I believe the business has great potential for success going forward.
As Marvin shared with you, we capitalized on delayed spring demand in the second quarter, posting comparable sales growth of 5.2%. We drove increased traffic to our stores and Lowes.com and grew transactions 0.6% while increasing average ticket 4.5%. We leveraged holiday events designed to take advantage of seasonal project demand, with strong messaging, attractive offers, more personalized marketing and our continued shift into digital and localized marketing channels. We were positioned with seasonal inventory in place and staffing trained and ready to help customers complete their projects. In fact, we kicked off the quarter with significant outdoor recovery, driving comparable sales growth of 8.2% in May. For the quarter, we achieved double-digit comps in lawn and garden, driven by broad-based strength in lawn care, live goods and landscape products. We delivered high single-digit comps in seasonal and outdoor living, with double-digit comps in cooling, where we were pleased with the results of our transition to GE air-conditioning products. And we delivered double-digit comps in outdoor power equipment, driven largely by strength in battery-powered cordless products as well as double-digit comps in pressure washers following the introduction of CRAFTSMAN to the category. We drove market share gains across all major categories where we introduced CRAFTSMAN to our lineup. In the second quarter, we also saw continued strength in categories such as lumber and building materials, appliances and rough plumbing and electrical. We achieved high single-digit comps in appliances, as our omnichannel offering, together with leading brands, breadth of assortment, competitive pricing and service advantages, continued to propel our performance. Pro demand as well as inflation drove strong comps in rough plumbing and electrical and lumber and building materials. In order to continue growing our sales to Pro customers, we'll further strengthen our portfolio of Pro-focused brands. Today, we're proud to announce the introduction of MAPEI to all stores, the leading brand in tile-setting materials. And we're also excited to announce the addition of Zoeller, the #1 brand in pumps and a retail exclusive. Lowe's will be offering the full line of Zoeller products, including well, sump, submersible and utility pumps. As we look forward, we're focused on capitalizing on the opportunity presented by a strong home improvement sector. We'll work to sharpen our execution, as Marvin noted, by simplifying the business and focusing on core retail fundamentals, improving our in-stocks and reducing the time our associates spend on tasking so that they may focus more on serving our customers. We'll also streamline and simplify our reset process to improve our execution and reduce disruption for our stores. Reset challenges adversely impacted our performance in fashion fixtures, specifically light bulbs, and in paint, throughout the quarter. We're working diligently to address those issues. We'll also continue to make advancements in our supply chain, opening our first direct fulfillment center this fall to allow for expansion of our online product offering and more efficient delivery for our customers. And we're testing predictive delivery scheduling for our stores to allow them to better plan for shipment arrivals from our regional distribution centers. We're excited about our continued rollout of CRAFTSMAN in the second half, including individual mechanics and hand tools, power tools and fall outdoor power equipment. Given the strong response we've seen in category introductions thus far, we're thrilled to be the exclusive destination in the home center channel for this iconic brand, offering some of the best tools, storage and outdoor power equipment in the industry. We'll also leverage our expanded strategic partnership with Sherwin-Williams, one of the most recognized brands in paint, highly respected for quality products by both homeowners and pros. With this partnership, Lowe's is the only national home center to offer top-selling stain brands, Minwax, Cabot and Thompson's WaterSeal. Moving beyond the reset pressure we saw in Q2. In the second half of the year, we'll deliver a simplified line design that makes it easier for customers to select the right product for their painting needs, with exclusive HGTV Home by Sherwin-Williams and Valspar interior and exterior paints as well as the top paintbrush brand, Purdy. We're excited to bring customers more of the top brands they trust for their next paint or stain project. We're also rolling out a new paint desk experience, including an updated product selector display, as well as a simplified and streamlined service model to make it even easier for customers to work with an associate to find a color, pick a paint or stain, quickly have it mixed and begin their project. We're excited about the second half of the year. With great brand introductions, exciting marketing plans and events to drive traffic and a focus on core retail fundamentals, we will capitalize on strong demand in a healthy sector. Thank you for your interest in Lowe's, and I'll now turn the call over to Marshall.
Marshall Croom:
Thanks, Mike, and good morning, everyone. It has been a great experience for me to serve Lowe's for the past 21 years in many different capacities, and I'm excited to see what the future holds for this great company.
As a reminder, in the first quarter, we adopted the new revenue recognition accounting standard. And as a result, we reclassified certain items within operating income, the most significant of which was the reclassification of the profit sharing income associated with our proprietary credit program from SG&A to sales. The adoption of this standard had no impact on operating income and no impact on comparable sales. It was adopted on a modified retrospective basis, so the prior year has not been adjusted. Sales for the second quarter increased 7.1% to $20.9 billion, supported by a 1.3% increase in total transactions and total average ticket growth of 5.8% to $75.53. Adoption of the new revenue recognition standard provided a 74 basis points benefit to sales growth. Comp sales were 5.2%, driven by an average ticket increase of 4.5% and transaction growth of 0.6%. Looking at monthly trends, comps were 8.2% in May, 4.2% in June and 3% in July. As Mike indicated, we capitalized on delayed spring demand, leveraged our strength in appliances and drove strong comps in lumber and building materials and rough plumbing and electrical. Gross margin for the second quarter was 34.46% of sales, an increase of 25 basis points from Q2 of last year. Adoption of the new revenue recognition standard provided a 55 basis points benefit to gross margin. Product mix shifts negatively impact gross margin by 20 basis points, and higher transportation costs negatively impacted gross margin by 20 basis points. SG&A for the quarter was 22.45% of sales, which deleveraged 229 basis points. As Marvin noted, we performed a strategic reassessment of Orchard Supply Hardware during the quarter, which led to noncash charges of $230 million and a decision to exit the business. These noncash charges drove 110 basis points of SG&A deleverage. Adoption of the new revenue recognition standard resulted in 64 basis points of SG&A deleverage. And in last year's second quarter, we recorded a $96 million gain from the sale of our interest in the Australian joint venture. This resulted in 49 basis points of deleverage this year. And while increased demand from continued growth in appliances drove 16 basis points of deleverage in customer delivery costs, it was offset by 21 basis points of payroll leverage in the quarter. Depreciation and amortization for the quarter was $345 million, which was 1.65% of sales and leveraged 18 basis points. Operating income decreased 186 basis points to 10.36% of sales. Interest expense for the quarter was $153 million, which leveraged 7 basis points. Effective tax rate was 24.4% compared to 36.2% last year as a result of tax reform. Diluted earnings per share was $1.86 for the second quarter compared to $1.68 in the second quarter last year. Excluding the noncash charges as a result of the strategic reassessment of Orchard, adjusted diluted earnings per share was $2.07, a 31.8% increase over last year's adjusted earnings of $1.57. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $2.3 billion. Inventory at $11.9 billion increased $478 million or 4.2% versus the second quarter last year. Inventory turnover was 3.85x, a decrease of 15 basis points versus Q2 of last year. Moving on to the liability section of the balance sheet. Accounts payable of nearly $9 billion represented a $335 million or 3.9% increase over Q2 last year. At the end of the second quarter, lease-adjusted debt to EBITDAR was 2.23x and return on invested capital was 20%. Now looking at the statement of cash flows. Operating cash flow was nearly $5.8 billion and capital expenditures were $543 million, resulting in free cash flow of $5.2 billion. In the second quarter, we paid $338 million in dividends. And in May, we entered into a $550 million accelerated share repurchase agreement, which settled in the quarter for approximately 5.6 million shares. We also repurchased approximately 5.8 million shares or $550 million through the open market. In total, we repurchased $1.1 billion of stock in the quarter. We have approximately $5.1 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several updates we made to Lowe's business outlook. From a macroeconomic perspective, we maintain our positive outlook for the home improvement industry. We expect to see solid sector growth driven by gains in employment, which should boost disposable income and consumer spending. And we expect that housing will remain a positive driver as solid housing demand and continued home price appreciation supports home improvement spending. However, while we recovered approximately half of the seasonal miss in the second quarter, assortment issues in flooring, inventory out-of-stocks and reset disruption continue to exert pressure on sales growth. As a result, we now expect a total sales increase of approximately 4.5% for the year, driven primarily by a comp sales increase of approximately 3%. And we anticipate opening approximately 9 stores. As Marvin shared, we are developing plans to aggressively rationalize our store inventory to remove clutter and to allow for investments and job lot quantities for the Pro and overall depth of high-velocity SKUs. These actions may put up to 55 basis points of pressure on operating income in the second half of the year. Also, our business outlook reflects the $230 million noncash charges we incurred in the second quarter related to long-lived asset impairments and discontinued projects for Orchard as well as the expected $390 million to $475 million of additional charges expected in the second half of 2018 as a result of our decision to exit this business. On a GAAP basis, we now expect an operating margin decline of approximately 180 basis points. Effective tax rate is now expected to be approximately 25%. And for the year on a GAAP basis, we now expect diluted earnings per share of approximately $4.50 to $4.60. As Marvin mentioned, we lowered our capital forecast for the year by $500 million, eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates or didn't meet our hurdle rate. We are now forecasting cash flows from operations of approximately $7 billion and capital expenditures of approximately $1.2 billion. This is expected to result in estimated free cash flow of approximately $5.8 billion for 2018. Due to the lower capital expenditure forecast, our guidance now assumes approximately $3 billion in share repurchases for 2018. Regina, we're now ready for questions.
Operator:
[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So I have 2 questions. So first question, you spent a lot of time in the field. I want to get your thoughts on the opportunity to improve the Pro performance, as it appears that this is where the strength of the market is and Pro performance gap has widened. So you're attacking in-stocks first, but what's your other early diagnosis points of areas that you can see improvement and try to improved comp on the Pro side of the business?
Marvin Ellison:
Okay. Thanks, Chris. Pro is a huge opportunity for us. Today, we estimate roughly 30% of our overall sales penetration is from the Pro segment. If you think about the Pro for a second, they are a very important customer, but they have some very simplistic expectations on what it takes to get their business and it really starts first with service. I mean, we've heard oftentimes that Pros deem time as money, so they want to get in and out quickly. And so we'll invest more emphasis on simple things like loading, staffing the desks and making sure that we improve our delivery processes. Secondly, they just want to have the product there. And so I discussed in my prepared comments how we're not only rationalizing inventory, we're also investing in job lot quantities. That is primarily for our Pro customers. Pros need to be able to walk in to see a depth of inventory that they can complete their jobs, and we are very inconsistent in that today. The next thing that we have to do, and this is, Bill Boltz, our new EVP of Merchandising, is already working on this, is we need the brands. Pros resonate to certain brands. And so we're working to look at our assortment in our Pro building materials area and asking the question, what brand gaps do we have in the assortment that we need to attack? And that is already underway to try to make sure that we are responding to the feedback we receive on certain and specific brands that we need to add to the assortment. And the last thing that we feel really good about is credit and our relationship with Synchrony and how we've worked with them to create more of an emphasis around our Pro customer. So these are really the short-term priorities that we're going after. As you noted, it's a huge opportunity for us. We can impact this side of the business without distracting or disenfranchising our DIY customers on the garden, on the decor side and it's something that we're going to spend a lot of time on. And Joe McFarland, who is our new Executive Vice President of Stores, has a deep understanding of this segment, and we're excited about the short- and long-term potential.
Christopher Horvers:
Understood. And as a follow-up, you mentioned reviewing non-retail investments. I'm curious as to what they are exactly. And as you think about the long term here, you mentioned a culture of expense discipline. How do you think about the ability to drive operating margin expansion versus the need to invest in things like in-store technology, labor and supply chain?
Marvin Ellison:
I think from a non-retail investment, I mean, if you look across some of the decisions we made from a capital perspective over the course of the last 3 to 5 years, we dabbled in quite a few investments in non-retail type of formats and non-retail type of synergies and systems and services. And so without getting very specific, because it's still really early, we're just assessing everything. We're looking at our entire real estate portfolio and looking at every capital investment where we are spending the shareholders' money and asking the question, are we getting an appropriate return? And equally as important, is it consistent with our strategic long-term view of where we think Lowe's should be as a world-class omnichannel retailer? So I'm expecting that when we gather for our December Investor Conference, we're going to have much more specificity on kind of where we see the future going, where we will invest and investments we're going to kind of pare back. And I want to just wait until that time frame before I'm -- be more specific on kind of what opportunities or possibilities we're going to be shifting from. Relative to operating income, it really comes down to a couple of fundamental things. I mean, we need to generate more sales per square foot productivity in our stores. If you look at where we are in the past, we've been focused on our end caps. As an example, our end caps have been more leaning toward innovation than driving sales productivity. It's really not the merchants' fault. The merchants have simply been following the company's strategic plan. But what we're going to do is shift away from innovation -- if innovation is driving revenue. So we have to drive more improved sales per square foot productivity. While we're doing that, we have to be more disciplined on our SG&A. We have to be more disciplined on our investments of expense and capital. So I've mentioned in my prepared remarks that we're going to no longer throw payroll at problems. In the past, when we've had what we deemed conversion issues in the stores, we indiscriminately just added payroll to try to solve it without really identifying the root cause, and that is not how you run a business this size. So instead, we're going to be more prudent on getting to root cause, redefining process and not just thinking every solution is a solution we just kind of throw more headcount at it, because that's not sustainable. So improving productivity on our sales per square foot, being more diligent and disciplined around SG&A, making sure that we have more rigor in our capital allocation process, is going to improve our EBIT performance, operating profit and have more sustainable EPS growth.
Christopher Horvers:
So does that mean you think there's an expense reduction opportunity outside of driving the actual productivity in the business?
Marvin Ellison:
I would say there's more to come on that. We are spending a lot of time looking at our strategic process around where we invest and where we cut and how we can drive productivity in our stores. I mean, as a recollection, one of the things that I am significantly focused on is how we can drive improved productivity in our stores while continuing to leverage operating profit, and we can do both. We can improve service. We can improve productivity, and we can also create a more profitable environment. And that is a correlation of understanding more process discipline in addition to making the right investments. As one specific example, we have very few, if any, engineered standards in our stores. And what I mean by that is that typically for a retailer our size, there's very engineered processes on things like how you unload a truck and how you flow product from receiving to the sales floor to drive in-stock. We have no standards for that. It's a very random process, where our stores are kind of fending for themselves trying to make it happen. That is how you destroy productivity. And so if you simply go in and build engineered processes consistent across all types of stores and volumes, you can drive increased productivity without having any kind of a staff reduction action. It's just more about process efficiency. So we're going back right now to create engineered standards for everything we do, from unloading the truck to stocking the shelf to every other process, and we know that that's going to reap significant benefits.
Operator:
Our next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question is, given your experience, Marvin, in this segment, you used to compete a lot against Lowe's. Wondering at that time, how you thought about the productivity advantage that Home Depot had over Lowe's, whether it was real estate-driven, whether it was operating execution-driven? Any thoughts that you'd share from your time last in the segment of why Lowe's wasn't operating at the same level as Home Depot?
Marvin Ellison:
Well, Simeon, I can remember back in early 2000s, where it felt like that every quarter, we were getting beat pretty significantly by Lowe's with those same structural disadvantages that we currently have. So I think for us, it is less about looking at the competition and it's more about looking within and asking the questions, where can we be better? Now obviously, relative to our largest competitor, we have a disadvantage in real estate locations from a metro area, specifically the Northeast and the West Coast. However, we believe that if we can find just a better balance between serving our do-it-yourself customer and our Pro, that we can start to chip away at any competitive gaps that we have. Mike McDermott and I both mentioned in our prepared remarks about the challenges we face with our reset execution. That is an example of where I call it a self-inflicted strategic wound that we've done to ourselves, because, structurally, how we execute resets puts our team at a tremendous disadvantage. From a merchandise planning standpoint, that is kind of living in the merchandising side and actually, reset execution is in store operations. So you have 2 teams working on the same process, and that just creates inconsistency and communication problems. So there's process improvements that we'll make to fix areas like resets. In addition to that, we talk about our dot-com performance and how we delivered, drove an 18% comp. Within that number is a significant systems issue, where we tried to create better inventory visibility. And by doing that, we drove a significant number of order cancellations that had a dramatic impact on overall sales number of our dot-com business. That's another self-inflicted issue that created a lack of performance for us during the quarter. And I also mentioned the significant number of out-of-stocks that we're dealing with in our stores that we have to fix. And so as we look within and we ask the question where can we be better as a company to drive improved productivity, improved sales performance, improved operational leverage, we think that there are a lot of things that we can correct ourselves because there are certain structural disadvantages that we cannot overcome. But what we can overcome is poor execution, and that is where our focus will be. And we think as we improve within these areas, we're going to see that gap start to close, because we're going to be focused more within our own company versus looking across the street at our competitor.
Simeon Gutman:
Okay, that's fair. My follow-up, it's -- I respect that it's early days, but if you're willing to share your instinct, especially given your experience in this segment and now knowing both players, whether there is some type of underspending that had been taking place at Lowe's and whether there -- that necessitates some type of big catch-up in order to drive those results that you're talking about or if it's more on process than it is infrastructure.
Marvin Ellison:
Well, I don't think it's necessarily overspending as it was the strategic choices we made on what we spent money on. As we announced today, we're going to be moving away from our Orchard investment. And in retrospect, you can argue that, that may not have been the most prudent use of capital. And so I think it's less about total spending and more about the strategic rationale regarding the spend. And so what we're doing as a team now is we're taking a really hard look at capital spending and asking the question, where should we invest? And obviously, we're going to invest in supply chain. We have a very clear line of sight of exactly what we want our supply chain to look like. We recruited Don Frieson, who spent time at Walmart and Sam's Club, and he brings a wealth of knowledge, and so we'll make the right investments. And we feel very confident that we can create a modern supply chain over the short and long term. It's a iterative process that you can't do overnight. I mentioned we're looking for a new Chief Information Officer to help us understand how we continue to modernize our in-store technology. We have the capital to spend, and we have a pretty good line of sight of what we need to spend it on. And now we're going to bring a leader in that's going to build out a multiyear plan. And so I guess my short answer to the question is it's not a lack of spending, it's the prioritization of what we spend it on, and we're going to get focused on retail fundamentals. Now it doesn't mean that we're going to think short term. While we're fixing these fundamental issues like out-of-stocks and reset issues and customer engagement and being more specific around serving the Pro, we're going to be building out our supply chain, improving our IT infrastructure and also creating this omnichannel environment where we can deleverage these wonderful stores to be more in tune to serving customers the way that they want to serve, both in-store and online.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
The first question I have is, Marvin, how are you going to define success, especially in light of the fact that the company has grown earnings over the last few years and benefited from what's been a fairly healthy home improvement cycle that now looks like it's in the later stages?
Marvin Ellison:
Well, I think for us, I mean, like any large public company, we're going to define success in a couple of ways. First, we're going to look at are we gaining market share? I mean, we're going to be very purposeful around taking share in key categories. We're going to look at our financial performance. We look at our sales growth relative to our competitive set. We're going to look at our bottom line, how are we performing from an EBIT and an EPS perspective and are we continuing to deliver value for our shareholders. The thing that we're going to do, Michael, which is not a surprise, is that we're going to be really customer-focused. We have some very impressive competitors in this space, and we're not denying that, but we understand that we also have to be focused on our customers. And we can serve our customers at the highest possible level. We think that we're going to take market share. We think that we will see the proper levels of comp sales growth, and we'll drive that sales productivity that I mentioned and you'll see overall bottom line improvement. I mean, there are areas that we know we can do a much better job on relative to operating profit, which will be driven through more disciplined SG&A execution, overall operating expense but keenly focused on driving improved sales productivity in our stores, and we know that we can do that. And so those are kind of the basic fundamental things that we're going to look at, but it's going to be really more about are we serving our customers at a level that's driving loyalty and return visits.
Michael Lasser:
And my follow-up question is, can you frame the upside and the downside you're guiding for the back half of the year? Was there any thought to a new team coming in, let's provide a downside case or a really conservative outlook to provide breathing room for some of the changes that we're going to have to make, especially in light of the fact that there's already been some execution challenges that we're going to have to confront as we begin this journey?
Marvin Ellison:
Mike, I'll give you high-level -- my thoughts. I'll hand it to Marshall, who can provide you any more specific. But I think the simple answer is that we have a lot of moving pieces, as the earning release outlined, with our decision to liquidate Orchard and our decision to rationalize inventory. And also, we made, I think, a very prudent decision to take $500 million in CapEx and shift it to our share repurchase program. And so based on all of that, specifically Orchard and the inventory rationalization, I mean, we felt it was prudent to update our guidance. And we feel as though we were conservative, but we wanted to also make sure that we did not underperform what we believe the number should be for the second half of the year. And with that, I'll hand to Marshall, as he may provide some more specifics.
Marshall Croom:
Michael, when we started the year, we were guiding to 40 basis points of pressure on our operating margin. We've expanded that to 180 basis points, so that's 140 basis points. Again, to Marvin's point, are largely driven by Orchard, decision to exit that business, as well as the -- taking a hard look at our inventory rationalization process that we're getting underway. And so those 2 items combined drive that. But again, the right thing to do, so we can redeploy capital to invest it where necessary, but it's those 2 big pieces that are driving the operating margin pressure.
Michael Lasser:
And Marshall, just to confirm, those 2 pieces that are what we're seeing the difference between your old guidance and your new guidance? Or was there pressure factored into the operating profit margin above and beyond that, other factors as well?
Marshall Croom:
Those were the 2 key drivers. And again, taking a hard look at the inventory rationalization, felt that we needed to plan for an aggressive approach to that.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
I'm curious, Marvin, as you think about -- you are doing a good job of listing out the investments that are needed, the prioritization of what you're doing. But I'm curious, as you think about the resets and customer engagement and the Pro service and building out the supply chain and IT and also identifying the productivity opportunities, is your mindset and discipline to invest first in these areas to strengthen the future? Or is your discipline to self-fund these things along the way and measure out and meter out the implementation of these things? Which path are you more apt to go down?
Marvin Ellison:
Eric, I think it's a combination of both. The best way to describe it is I think we have to work very aggressively to address what I call a lack of retail fundamentals. I mean, just basic things like reset execution, in-stock improvement, sales productivity on end caps, addressing out-of-stocks and job lot quantities, having more engagement with customers and not overriding and taxing versus engaging customers and understanding how we serve our Pro via improved service and brands that they respond to. Concurrently, we'll be investing in a multiyear plan in supply chain. Concurrently, we'll be investing in a multiyear plan from an IT infrastructure improvement. And concurrently, we'll be building out our omnichannel investments in our stores so that we can continue to leverage our 2,300-plus physical locations with our digital platform. So I think it's a combination of address the retail fundamentals, because we think the short-term benefit is there. And again, you can't be a great retailer if you're not fundamentally sound, while making the strategic investments that will make us viable for the short term and the long term. And so it's a combination of all those things.
Eric Bosshard:
That's helpful. Secondly, curious in terms of the timing we should be expecting regarding payback on the sales line. You talked about the importance of considering sales growth and sales per square foot and even your market share performance. When is it reasonable to expect the efforts that you're making to start to change the performance in those areas?
Marvin Ellison:
Eric, what I would say to you is, as you can imagine, we're spending a lot of time getting our new leaders assimilated to the company. And the good news is both Joe McFarland and Bill Boltz bring a combined 50 years of home improvement experience, which I think is really important for us on the merchandising and the store side, but they have to get assimilated. Don Frieson brings over 18 years with Walmart and Sam's Club, but he needs to get assimilated. And we just announced David Denton this morning as our new Chief Financial Officer. And so when we come together at the Investor and Analyst Conference in December, it's my expectation that we're going to have a high degree of specificity around where we see the business going, not only for 2019, but over the course of the next 2 to 3 years, and we'll be able to lay out those strategic investments that we're going to make that's going to deliver upon that. And we're going to have probably a degree of detail that hopefully will give comfort to everyone that we thought through this in a very specific fashion. So I would kind of postpone answering that question more directly until we have a chance to get all these leaders assimilated and we can get together and lay out that all-inclusive strategic plan.
Operator:
Your next question comes from the line of Zach Fadem with Wells Fargo.
Zachary Fadem:
I'm curious if you could talk a little bit about your initial conversations with vendors and suppliers. Where do you think those relationships are today versus maybe what you expected? And where do you see the opportunities to improve these relationships, either via expansion or consolidation of your offerings where appropriate and any additional improvement efficiencies?
Marvin Ellison:
Well, Zach, the first thing is I want to just give Mike McDermott and his team a lot of credit. I mean, there are some just significant partnerships that they've created the last couple years that I think have long-term benefits. I mean, specifically if you think about being the exclusive big-box home center channel for CRAFTSMAN. I mean, what an iconic brand, and the brand is exceeding expectations of the team, and we're just getting started. And also with Sherwin-Williams, I mean, another iconic brand, and having the ability to have their products, whether it's Thompson's WaterSeal or Purdy brushes, in addition to their paint. I mean, this is something that we think we're just scratching the surface on the potential. So I would say, overall, I've been very pleased with my engagement with the suppliers I've had a chance to spend time with. Obviously, with Mike's transition and Bill Boltz coming onboard, we're going to be spending more time, not only with existing suppliers, but we'll be spending time with suppliers that we currently don't work with to see if there's a realistic possibility that we can add additional brands to the assortment that will resonate with our DIY and Pro customers. But I will say, overall, it's been very positive, and I think that they've been very encouraged by some of the changes that we've made, because they now know that we're getting back, refocused, on being a fundamentally sound home improvement retailer, which opens up the opportunity for them to drive more revenue within their own companies.
Zachary Fadem:
Got it. And also just to marry up your current outlook with the plans outlined at the beginning of the year. Marshall, you had called out about $140 million of tax reform reinvestment spending for things like labor, technology, some other items. To what extent are these investments still incorporated in the current outlook today? And is there any planned reallocation in that spend being contemplated?
Marshall Croom:
Zach, again, taking a look at the reduction of capital, there are expenses associated with those that's actually providing a little bit of offset in the back half of the year. But again, net-net, the incremental pressure of 140 basis points from our original guidance on operating margin.
Operator:
Your next question comes from the line of Steve Forbes with Guggenheim Securities.
Steven Forbes:
Maybe to start with the full year comp guidance. Are you assuming any flow-through benefit from your inventory rationalization efforts that you mentioned today in the back half or right from the remaining seasonal recapture? I think you mentioned on the call that you got about half of it back in the second quarter. And then on the top line guide for the back half in general, can you help us quantify what you think the out-of-stock impact is to the business today, sort of like the run rate of it?
Marvin Ellison:
So Steve, I'll take the out-of-stock question, and I will let Marshall take the remaining components of the question. Look, it's hard for us to determine the upside potential of the out-of-stocks. Having said that, having been in retail for over 30 years, I'm keenly aware that if we have increased traffic and improved in-stock, we should see some level of sales productivity from that. So we're optimistic that we're going to be able to drive sales improvement when we get our in-stock position improved. Now the reality is, is that you just can't flip a switch and have inventory in your stores on the shelves. We are going to be very prudent in how we exit out and rationalize inventory that we think needs to exit the assortment, but we're going to be equally as prudent on making sure that we are selective and surgical on what we bring in. And so it's really more about timing than anything. Once we get this process completed, we're very confident we'll see sales productivity. The question is, how quickly can we get it done? And that's the unopened question that I have that makes it very difficult to answer your question more precisely. So with that, I'll let Marshall take the rest of your question.
Marshall Croom:
Steve, just on the inventory rationalization efforts, again, in the back half -- and primarily, that's being driven in the third quarter. And we are anticipating about 55 basis points of operating margin pressure, again, just to allow for what we believe will be an aggressive approach to remove some of the clutter of inventory in the store and potentially effort to reinvest into job lots for the Pros and some higher-turning SKUs to drive future sales productivity as the company moves forward.
Steven Forbes:
And then just a quick follow-up. I think there was a $1 billion increase in the free cash flow guidance for the year, 2Q over 1Q. Half of that, obviously, is the $500 million reduction in planned CapEx for the year. Where is the other half coming from, the other $500 million? And then just touch on where you think inventory ends up being at the end of the year.
Marshall Croom:
So the question on where is the incremental $500 million of operating cash flow coming from, it's from the liquidation efforts of Orchard and actions we are anticipating taking in the third quarter with inventory rationalization. So that's really the 2 drivers to that piece. Was there another part to that question?
Zachary Fadem:
Just what do you think inventory is at the end of the year as far as the balance sheet line item or on a per store basis.
Marshall Croom:
Right now, we're looking at total inventory to be roughly flat for the year.
Operator:
Our final question will come from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
A couple of follow-up questions. First, just in terms of Orchard Supply, any more insight into that decision to exit that business and the historical financial contribution for that business? And then I'm just curious of your views on Canada, and RONA specifically, do you view that as core to the go-forward strategy?
Marvin Ellison:
Well, I would say Canada and RONA first has been a very positive benefit for the company. The good news is that the overall integration is happening well. The introduction of unique and different categories in RONA like appliances has been met with really strong response from the customers, and we feel very, very good about the Canadian business performance and again, that overall acquisition of RONA. And we think that it's exactly where we want it to be, if not exceeding expectations from the original pro forma. Relative to Orchard, I mean, as the old saying goes, hindsight is 20/20. But I just -- I think there were some strategic decisions made that if they had to be done over would be different. The good news is, is that 86% of the Orchard stores that are closing are within a 10-mile radius of a Lowe's store. And so we're very optimistic that any associate who's an Orchard associate that's looking for a home at Lowe's, we should be able to find them a position and we're going to prioritize those individuals. But the business was just not running well. And as we started to do the strategic assessment of where we want to invest our capital and where we wanted to be focused, it became really clear to me and to the leadership team that we want to be focused on our core retail business. And we could grow Orchard into the most dominant small-box specialty home improvement channel in America, and it would be very minimal positive impact from an EBIT, from an overall revenue standpoint, to the Lowe's business. And so the question is, do you continue to invest financial and intellectual capital in an initiative that will have a very small benefit to the shareholder? And we decided that we would not. And so we're going to take the intellectual and the financial capital that we would have been investing in that business and invest it in the core Lowe's business, and we think that's a better return for the shareholder.
Marshall Croom:
And Seth, I'll add just one other point, just as a frame of reference. Orchard for 2017 generated about $600 million in sales, and it was a negative $65 million in EBIT.
Seth Sigman:
Okay. That's helpful. My last follow-up is just around e-commerce and your assessment of the gap versus the competitors in the space. And I guess, in general, how are you thinking about investments required to address those gaps?
Marvin Ellison:
Well, the good news is a lot of the investments are underway, and we are building a very, very impressive team of experts that are coming in from a lot of different backgrounds and some of our very impressive competitors. I think our greatest opportunity is fundamentally making sure that our site is a lot more user-friendly, from a search, from a navigation, from a checkout. And there's a very specific road map that is being built and being executed to deliver on all of those things. And then the second big component is how do we more seamlessly connect our digital and our physical footprint together. The great news for us is that we're in a space of home improvement, where customers still like to come to the stores. They enjoy engaging our associates because they want some level of consultation on a purchase. In addition to that, we have products that are big, bulky and hard to ship. And having the ability to leverage our digital and our physical stores is important. The good news is if you look at our business today, roughly 60% of our e-commerce transactions were picked up in a store. That's incredibly powerful, even though we have significant list of opportunities that we are addressing. And so that's telling me that our customers is -- they're already resonating with our omnichannel philosophy and being able to connect digital and physical. We just need to make them more seamless. And so the investments required are really already underway. The road map is already built, and we're continuing to tweak it. But we see nothing but positive upside in the space.
So just a few closing remarks. I want to make sure that I just take a moment and thank both Marshall Croom and Mike McDermott for their love and commitment to this company. But more importantly, these gentlemen have been extremely professional and very, very helpful for me throughout this transition. And so I'll be eternally grateful for both of them for their support of me and this transition, their love and support of the associates of this company. And I wish them Godspeed and many blessings in the next chapter of their lives and careers. Thank you, and we look forward to speaking to you on our November 20 earnings call.
Operator:
Ladies and gentlemen, this concludes today's call. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' First Quarter 2018 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 McDermott, Chief Customer Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Richard Maltsbarger, Chief Operating Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. Before we discuss our first quarter results, I want to take a moment to talk about the leadership announcement we made yesterday.
As you know, in late March, I announced my plans to retire from Lowe's. Since that time, the board has been engaged in a thorough and comprehensive search to identify the right leader to take the reins. I'm pleased that the board has found that leader in Marvin Ellison. Effective July 2, Marvin will become President and CEO. Marvin is an experienced retail CEO and a 30-year industry veteran with expertise in complex omnichannel environments. He has a deep appreciation for Lowe's' culture, people and customers, which makes him the ideal person to serve as this great company's next leader, and I'm confident that this will be a smooth transition. As this is my last earnings call, I want to reiterate that it has been an honor to serve as Lowe's' Chairman, President and CEO. We're fortunate to have a strong leadership team who is passionate about helping people love where they live and creating enhanced value for shareholders. I'm confident in the company's prospects for growth and value creation under Marvin's leadership, and I look forward to following Lowe's' process for many years to come. With that, I will now turn to our results. In the first quarter, we experienced a delayed spring selling season due to prolonged, unfavorable weather across geographies that impacted outdoor categories. As a result, we delivered first quarter comparable sales growth of 0.6%, driven by a 4.3% increase in comp average ticket. However, spring has finally arrived, and comps in May are double-digit positive. Our U.S. home improvement comp in the first quarter was 0.5%, with positive comps in 6 of 14 regions, while 2 regions were essentially flat. We posted positive comps in 5 of 11 product categories, while 1 category was essentially flat. As you know, Lowe's has built a very strong seasonal business over the years, with approximately 35% of Q1 and 40% of Q2 sales historically driven by outdoor categories. With more rain and snow in the first quarter than we've seen in 12 years and the coldest April since 2007, outdoor products were certainly impacted. However, comps for indoor products were positive. Appliances led product category growth with another strong quarter of double-digit comps, supported by our integrated omnichannel experience. And we continue to strengthen our relationships with Pro customers, driving outperformance in rough plumbing and electrical, lumber and building materials, tools and hardware and millwork. We're pleased with our sales growth with Pro customers as we leverage the strong foundation we've built to drive comps above the company average. We continue to make investments to deepen our relationships and make it simpler for Pros to do business with us, including the expansion of our ProServices team. And we continue to see strong customer response in investments we've made to enhance our online shopping experience, which is reflected in our 20% online comp growth this quarter. Internationally, we delivered double-digit comps in Mexico, while comps in Canada were positive, both in local currency. We continue to make progress integrating RONA, and we believe the business is poised for continued growth from the rollout of appliances, a strong digital offering and ongoing store conversions and remodeling. However, comps in Canada were pressured by challenging weather conditions similar to those we experienced in the U.S. For the quarter, we delivered diluted earnings per share of $1.19, a 15.5% increase over last year's adjusted diluted earnings per share. Delivering on our commitment to return excess cash to shareholders, in the quarter, we paid $340 million in dividends and repurchased $750 million of stock under our share repurchase program. As I mentioned, spring has finally arrived, and we are encouraged by the strong sales momentum we're experiencing in the month of May. Spring is a first-half event, and I'm confident the Lowe's team is prepared to capitalize on increased demand with compelling offers and seasonal staffing and inventory in place to serve customers. And our entire leadership team and Board of Directors are actively working together to analyze our performance and business expectation and drive improvements in key areas, such as traffic conversion, inventory management and gross margin stabilization. Mike will speak to those efforts in a moment. Looking ahead to the rest of the year. We expect that solid macroeconomic fundamentals, such as strong employment and income gains, will sustain home improvement market expansion and that the home improvement industry is poised to grow its share of overall consumer spending. Housing is expected to remain a positive driver as demand in excess of supply drives home price appreciation. And we continue to see household formation improvement over the past year, which should persist amidst steady job gains. We'll continue to focus on and invest our resources in what is most relevant to engaging customers in the moments that matter and improving the capabilities our employees need to better serve customers. In doing so, we will strengthen our competitiveness, positioning us to continue capitalizing on home improvement demand. I would like to thank our more than 310,000 outstanding employees for their commitment to serving customers, serving their communities and fulfilling our purpose-driven mission to help people love where they live. Thanks again for your interest. And with that, let me turn the call over to Mike.
Michael McDermott:
Thanks, Robert, and good morning, everyone. We entered the season well positioned to capitalize on spring demand with compelling messaging, more personalized targeted content, strong assortments as well as inventory in place and seasonal staffing ready to help customers complete their projects. But a late spring, due to unfavorable weather across geographies, exerted approximately 300 basis points of pressure on comp sales. Weather had a disproportionate impact on seasonal categories, such as lawn and garden and seasonal and outdoor living. However, we drove positive comp growth for indoor products.
We achieved double-digit comps in appliances as we leverage our investments in customer experience, both in-store and online as well as our best-in-class selection of leading brands and our service advantages like next-day delivery, haul away and facilitation of repairs and maintenance. We also saw continued strength from the Pro customer with comps above the company average. Pro demand drove solid comps in rough plumbing and electrical, and we continue to be excited about the effectiveness of destination brands in attracting Pro customers. Pro strength also drove above-average comps in lumber and building materials, tools and hardware and millwork. In order to continue growing our Pro sales, we're investing to improve the Pro experience. We're building on our strength in the MRO space by leveraging our Maintenance Supply Headquarters business, having launched a streamlined product catalog this month with brands expansion to follow later this year. And we're investing in outside selling capabilities as well as improving job site delivery options. We continue to execute on our strategic priorities, including enhancing our digital presence. We drove comp growth of 20% on Lowes.com in the quarter, which now represents approximately 5% of sales. We'll continue to upgrade our online shopping experience with enhanced assortment informed by digital line reviews and optimized search capabilities to meet customers' evolving expectation. And as the do-it-for-me opportunity continues to grow, we're providing differentiated services, delivering complete home improvement project solutions through our in-home sales platform. We're connecting our omnichannel assets, making it even easier for customers to engage with our in-home project specialists and request services on Lowes.com, driving an increase in project [ activities ] this quarter. As noted on our February call, we're focused on strengthening our day-to-day execution. We're working diligently to improve traffic conversion by accelerating associate readiness and knowledge through our training programs and providing even more prescriptive scheduling to better align staffing to customer traffic, not only by department, but also around key marketing and promotional campaigns. We're also reengineering key processes. Project quoting, our paint service model and our pick up in store experience all improve our utilization of associate hours and provide a better customer experience. This quarter, we completed the first phase of our process to centralize project quotes, starting with flooring, allowing our sales associates to guide customers through their projects, focusing on education, project planning and product selection rather than spending their time on the administrative task of compiling a project quote. We also added functionality on Lowes.com to allow customers to request the flooring consultation online, which has the dual benefit of making the process easier for the customer while removing another administrative task from our selling associates. We recently rolled out our improved paint service model, separating tasking and selling activities. We cross-trained 17,000 associates to assist with mixing paint during peak selling periods, allowing our skilled paint associates to focus on providing project advice and color selection expertise. And we advanced our pick up in store experience with convenient reserved parking spaces, dedicated space in stores with clear signage to direct customers to the pickup location and optimized processes to ensure that product is staged and ready for pickup within 2 hours of an order being placed. We expect the new processes will drive greater efficiency in order fulfillment and improve our ability to meet the expectations of customers, allowing them to pick up product within 5 minutes of arrival. Central quoting, our paint service model and our pick up in store experiences are examples of actions we've taken within the quarter to improve our processes in stores and a snapshot of the more extensive process reengineering effort underway to improve store execution as we continue through 2018. We've identified additional opportunities as well. For example, in high-touch categories such as flooring, millwork and kitchens, we will improve installer responsiveness and lead times and integrate our systems to provide better visibility in the order status and improve communication to the customer. These opportunities in high-touch categories are additional ways to improve the experience and drive better conversion over time. As we work to better capitalize on traffic growth, our supply chain transformation efforts are also key to better serving customer expectation and improving conversion in the short and long term. We're focused on optimizing the flow of product through our supply chain to better connect customer needs with the products and services we offer and improving inventory management to ensure that we have the right product and a sellable position for the customer. For example, we're currently testing a way to improve the flow of product from our regional distribution centers to our stores, including more frequent, highly organized shipments of product to allow for greater efficiency in unloading trucks and stocking product on shelves. And given the increased demand for in-home delivery, we're piloting a segmented delivery network for appliances and other bulky product through a network of bulk distribution centers and cross-dock facilities. This segmented network will manage inventory at the market level, improving our working capital efficiency while also reducing damage as bulky product is handled less. And we'll manage deliveries more efficiently at the market level rather than at the store level. In the first quarter, we made progress in stabilizing gross margin. Throughout the year, we plan to expand our application of new pricing and promotion analytics tools to ensure that we're competitive on highly elastic, traffic-driving products while increasing profitability across less elastic items. And through our value-improvement efforts, we will continue to work closely with our vendors to reduce first costs. Looking forward to Q2. We're encouraged by the strong sales momentum we've seen as weather has improved. Given that spring is an event that spans the first half of the year, we're focused on capturing the increased demand that the season is now creating. We believe we're well prepared with seasonal staffing and inventory to serve incremental traffic. We look forward to our Memorial Day, Father's Day and July 4th events with exciting messages, compelling values, strategic brands and differentiated experiences all designed to capitalize on the excitement of the season. We're proud to welcome CRAFTSMAN into our outstanding portfolio of brands with mechanics tool sets, tool storage, garage organization, flashlights and pressure washers available just in time for Father's Day. Then, later this year, we'll expand our CRAFTSMAN offering to include individual mechanics and hand tools, power tools and select outdoor power equipment. We're honored to be the exclusive destination in the home center channel for this iconic brand, offering some of the best tools, storage and outdoor power equipment in the industry. Together, we're making it easier for customers to access the high-quality, durable tools and expert guidance they need to confidently tackle any home improvement project. We're also excited about our expanded partnership with Sherwin-Williams as we work together to deliver a simplified line design that makes it easier for customers to select the right product for their painting needs. Sherwin-Williams is now the exclusive national supplier to Lowe's U.S. retail outlet for interior and exterior paints, including the Valspar and HGTV Home brands. Under this expanded strategic partnership, Lowe's will become the only national home center to offer top-selling brands, Krylon, Minwax, Cabot and Thompson's WaterSeal as well as the top paintbrush brand, Purdy. In summary, we'll continue and improve our execution while accelerating the investments that will improve our ability to serve rapidly evolving customer expectations, strengthen our competitiveness and position Lowe's to capitalize on solid project demand now and into the future. Thank you for your interest, and I'll now turn the call over to Marshall.
Marshall Croom:
Thanks, Mike, and good morning, everyone. During the quarter, we adopted the new revenue recognition accounting standard, ASU 2014-09. As a result, we reclassified certain items within operating income, the most significant of which was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales.
The adoption of this standard had no impact on operating income and no impact on comparable sales. It was adopted on a modified retrospective basis, so the prior year has not been adjusted. Sales for the first quarter increased 3% to $17.4 billion, supported by total average ticket growth of 5.7% to $74.98. Total transaction count decreased 2.8%. Adoption of the new revenue recognition standard provided a 76 basis points benefit to sales growth. Comp sales were 0.6%, driven by an average ticket increase of 4.3%, offset by a transaction decline of 3.7%. Looking at monthly trends. Comps were 0.6% in February, 1.1% in March and 0.1% in April. As Mike indicated, prolonged unfavorable weather across geographies delayed the spring selling season and negatively impacted comp sales in the quarter by approximately 300 basis points. Gross margin for the quarter was 34.63% of sales, an increase of 23 basis points from the first quarter of last year. Adoption of the new revenue recognition standard provided a 58 basis points benefit to gross margin. As we've grown our share in appliances, gross margin has been impacted from both the mix and rate perspective. We were also lapping competitive actions taken a year ago, which were partially offset by benefits from Value Improvement as well as positive results from our pricing optimization efforts. And lastly, our transportation costs shrank and inflation negatively impacted gross margin in the quarter. SG&A for the quarter was 24.12% of sales, which deleveraged 113 basis points. Adoption of the new revenue recognition standard resulted in 66 basis points of the deleverage. While our spring seasonal hiring was a success, lower-than-planned sales drove 32 basis points of payroll deleverage. And increased demand from continued growth in appliances drove 18 basis points of deleverage in customer delivery costs. Depreciation and amortization for the quarter was $360 million, which was 2.07% of sales and leveraged 9 basis points. Operating income declined 81 basis points to 8.44% of sales. Interest expense for the quarter was $160 million, which leveraged 4 basis points. The effective tax rate for the quarter was 24.3% compared to 35.5% last year as a result of tax reform. Diluted earnings per share was $1.19 for the first quarter, a 15.5% increase over last year's adjusted diluted earnings per share of $1.03. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $1.6 billion. Inventory at $13.2 billion increased $950 million or 7.8% versus the first quarter of last year, which was primarily driven by investments in key categories, such as appliances, flooring and tools as well as investments across Pro categories. Inventory turnover was 3.8x, a decrease of 20 basis points versus the first quarter last year. Moving on to the liability section of the balance sheet. Accounts payable of $10.1 billion represented $199 million or 2% increase over first quarter last year. And at the end of the first quarter, lease adjusted debt-to-EBITDAR was 2.23x. Return on invested capital was 19.4%. Now looking at the statement of cash flows. Operating cash flow was $3.4 billion, and capital expenditures were $224 million, resulting in free cash flow of $3.2 billion. In the first quarter, we paid $340 million in dividends and we repurchased approximately 8.7 million shares of stock for $750 million. We have approximately $6.2 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in our Lowe's business outlook. As Robert and Mike indicated, spring is a first half event. We expect to recover the majority of our first quarter sales miss over the next 2 quarters, and believe we are prepared with the seasonal staffing and inventory to serve increased traffic. As a result, the only adjustment to our guidance stems from the adoption of the new revenue recognition accounting standard. So for 2018, we expect this change to positively impact sales by approximately 1% and negatively impact operating margin by approximately 10 basis points. It does not affect operating income or comp sales. We now expect a total sales increase of approximately 5%, driven primarily by comp sales increase of 3.5%. We anticipate opening approximately 10 stores. As a result of the new accounting standard, we now expect gross margin expansion of approximately 60 basis points for the year. And on a GAAP basis, we now expect an operating margin decline of approximately 40 basis points. Effective tax rate is expected to be 25.5%. For the year, on a GAAP basis, we reaffirm our diluted earnings per share guidance of approximately $5.40 to $5.50 for the year. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.7 billion. This is expected to result in an estimated free cash flow of approximately $4.8 billion for 2018. Our guidance assumes approximately $2.5 billion in share repurchases for 2018. Regina, we're now ready for questions.
Operator:
[Operator Instructions]
Our first question will come from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
Robert, best of luck to you. There's been a lot of talk in recent quarters about the opportunity to improve conversion in the store. And Mike, you discussed a number of initiatives to improve that today. As you sort of benchmark yourself versus others in the industry and other retailers, is there a way to frame the opportunity? And I guess, I'm more curious also, over time, is that something that's declined within the Lowe's store? And then we're just trying to understand the opportunity. And I guess related to that, at the core, what do you think the core issue is here? Is it in stock? Is it service? Is it assortment? Just any perspective on that, I think, would be helpful.
Richard Maltsbarger:
Sure. Absolutely, Seth. This is Richard, I'll actually take the question. To your question specifically, we have experienced a decline in close rate over the past year and we began to highlight that last year as part of our communications. And we certainly still have work to do. We've had early progress in the quarter, I'd like to talk to some of the elements that we've put into place and some of the actions that Mike and I and the rest of the leadership team have in place for the rest of the year. So first, in our call last quarter, we talked about a primary focus on associate readiness and development. Happy to say we came into the spring season the most ready for the season that we've been in recent memory, with both the associate staff and the readiness of their development under a program we call Red Vest Ready. The reality is that with the delayed spring, we didn't achieve all the benefit we expected from that early-season hiring. But thankfully, as the season has begun to spike over the past couple of weeks, we believe we've had the staff in place to take advantage, and it's helping to support the strong comps that we've experienced. The second area we're focusing on is reengineering key processes and activities, with a primary focus on being able to reallocate investments we make in nonselling labor to increase the percentage of that labor that can be on the floor serving the customer. A great example is what Mike covered with you in his earlier remarks where, during the quarter, we cross-trained approximately 17,000 associates, most of whom are nonselling associates, to be able to bring them to the floor during peak periods, such as intraday periods as well as key holidays like this weekend for Memorial Day to serve those customers by splitting the tasking behavior of mixing paint from a selling behavior of being in the aisle providing color expertise and project planning expertise to our customers where there are dedicated paint associates. Other activities that we've had under way include what Mike talked about in terms of tests of more prescriptive scheduling where, during the quarter, we executed several tests in select markets. Some of the benefits of those tests are now being rolled across the country as we set our staffing plans for Q2 and as we move through these holiday periods. However, as they've gotten into the first 100 days of their role, they didn't feel -- gotten the feedback from our store associates, been able to talk to many of our best customers. There are 2 additional areas in which Mike and I and the rest of the leadership team are taking action. The first is supply chain product flow, where we believe we've made the inventory investments necessary to have the depth and breadth in key categories like appliances and flooring and tools and hardware to serve both the Pro customer and our DIY customer. Our focus has now shifted to how do we optimize that flow to improve our service levels and to improve our in-stock percentages. As Mike noted, a key focus there is the movement of that good from our regional distribution center to our stores. The last area, as Mike noted, is he and I have led a deep dive into our high-touch selling categories during the quarter, with specific emphasis on flooring, millwork and kitchen, and identified ways in which we actually allow our selling associates to have more time in front of the customer. Central quoting is a great example of that. As Mike noted, the administrative burden passing to a central quoting team to allow our in-store project specialists to spend more time educating the customer, providing their project planning, helping them select their products and then turning over the finalization of the quote over to a team that specializes in doing this nonselling tasking activity. Ultimately, over time, Seth, it's going to take a combination of each of these different types of actions for us to improve conversion. We're confident from the early signs we've seen. We saw a great uptick in our customer satisfaction levels for in-store experience during Q1 and believe that we're on to the right set of work that we need to undertake to improve conversion over time.
Operator:
Your next question comes from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My question is around the comp trends by ticket. Your ticket under $50; comp down 4.1%. Is it possible to break that out, excluding the seasonal categories, so we can get a better sense of what the underlying trend is?
Michael McDermott:
Yes, the most significant impact to tickets under $50 could be tied to our lawn and garden and seasonal business. Certainly, weather had an impact on that performance. That's a significant transaction driver for us. And with our concentration of about 35% of our business in the first quarter, that was the primary driver there.
Marshall Croom:
Seth, one other point, if I could, just to add on to that is -- and we talked about the 300 basis points of pressure in the spring. A lot of it is impacting transactions as well for the seasonal items, which were spread across the lower buckets as well.
Seth Basham:
Got it. When you think about your conversion challenges, you're focusing, it seems, primarily, on converting within big-ticket categories. What do you feel about the smaller-ticket categories? Do you feel like you're well positioned there? Or are there challenges in smaller-ticket categories as well?
Michael McDermott:
I believe we're well positioned in smaller-ticket categories across a broad array of product categories in the business. Obviously, from a conversion perspective, we are focused on high-touch categories as we try and improve the customer experience from both inspiration all the way through to enjoyment. When I take a look at our overall value perception, our competitiveness, our product assortment, our balance of brands, I feel very good about the position we've got across the take-with categories.
Operator:
Our next question will come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
One of the initiatives you spoke to was gross margin stabilization. I'm wondering if you could expand a little bit on what you're seeing there and what you're trying to accomplish.
Michael McDermott:
Yes, as Marshall highlighted, gross margin increased by 23 basis points. Revenue recognition provided 58 basis points to that benefit. Obviously, we're lapping the competitive actions we took in 2017, partially offset by continued Value Improvement activity as we work closely with our vendor partners to deliver value in the marketplace and reduce first cost. I'm really excited about the positive momentum I'm seeing, particularly around the installation of improved competitive analytics and pricing optimization tools. As we widen our visibility of the market, it gives us the ability to effectively manage the trade-offs required to both remain competitive and stabilize gross margin. And we saw a meaningful, sequential improvement in gross margin from fourth quarter to first quarter, and we'll continue that work to deliver against our commitment.
Eric Bosshard:
And then one follow-up, if I could. Robert, I'm just curious, your thoughts as you pass the baton to Marvin, what might be different or what might be the same, if you have any thoughts or perspective you could provide us on that.
Robert Niblock:
Well, certainly, Eric, we're excited to have Marvin join the team. As you know, he's an experienced retail CEO, significant experience in the home improvement industry. So I think that's very exciting for us to have him join. I called Marvin this week and spoke to him and congratulated him on the role and welcomed him back to the home improvement industry and certainly told him that I'd be available for anything I can do to assist in a smooth and orderly transition. I think Marvin will be coming in and look and see, review our strategy, look at the plans we have in place, the initiatives that we're working on in areas, as you've seen on the call today, where we outlined opportunities for improvement. And I think he'll want to dive in and be able to add his thoughts to what the team's already working on to see how we can continue to make progress and take care of -- do a better job of taking care of customers' needs.
Operator:
Our next question will come from the line of Scot Ciccarelli with RBC.
Scot Ciccarelli:
I know you talked about the decline you've seen in close rates, and obviously, that's been a driver to your decline in transactions. But do you also have a feel for what's happened to your stores from a pure traffic perspective?
Michael McDermott:
Traffic continues to be positive for both our stores and Lowes.com. We continue to see positive yield from the start with Lowe's campaign, we're driving better awareness, great value perception, engagement and, ultimately, traffic. I think we're striking the right balance, the right allocation of digital and mass media. We're optimizing our spend and delivering targeted, personalized messages. So I think we're really connecting with the customer in a very positive macro environment. And we continue to engage customers with trusted brands, great values and promotions and a strong assortment. So a lot of things working for us on the traffic front right now.
Scot Ciccarelli:
Okay. And then hopefully, just a quickie for Marshall. On the monthly cadence you guys provided us, are there any calendar shifts we need to be aware of?
Marshall Croom:
For us, no. We're a 4-5-4 -- on a calendar 4-5-4 basis. So for us, there wasn't any meaningful shifts in the calendar for the first quarter.
Operator:
Your next question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
I want to talk about the guidance and the decision to hold it for the full year. I picked up from the prepared remarks, it sounds like you're going to -- you expect to make up the sales in the second quarter and it sounds like a little bit in the third. Is that the same in terms of profit flow-through? And is there any less investment that you're making in the year? Or is making the full year all predicated on just recouping some of the loss flow-through that occurred in the first quarter?
Marshall Croom:
Simeon, yes, we are anticipating recovering the majority of the sales miss in the first quarter. So that's what we're expecting to flow through in Q2 and Q3. So that's what we factored in to maintain our guidance. So again, the only other change that we made would have been for the revenue recognition accounting standard. But we believe we've got, again, the staffing, the inventory, the efforts to really -- how are we improving our customer experience, the shop-ability of the stores, the shop-able inventory, a lot of the associate investments that we're making to make them connected and confident within the stores. So we do anticipate leaning into the investments that we laid out on the call in February for 2018 as we're looking to really ramp up our strategic investments to help our associates to better improve customer engagement. So I think some of the spend that we have across services Pro supply chain transformation efforts are just examples of what we're continuing to invest in.
Robert Niblock:
Simeon, this is Robert. Also recognize, as we get through the balance of the year, we'll start to lap some of the marketing additional [ services ] we had up from last year as well as you're already seeing some of the early signs of the gross margin stabilization work that Mike and his team are doing. And certainly, that'll continue to make progress throughout the year. So you'll see a layering effect of those items on top of the recovery of the sales that were delayed from the first quarter.
Simeon Gutman:
Okay. So just to clarify, so no less rate of investment than what you planned. And I'm speaking to those -- the investments that were made in light of some of the tax savings. And then as far as just the improvement goes, it's cycling some things from last year as opposed to internal improvements that are beyond what you initially planned or that you're just running better than expected.
Marshall Croom:
I think, one, we're continuing to lean into the investments as planned for the year. Again, to Robert's point, there are certain things, competitive actions, the amp up in advertising, certain things that we ramped up beginning last year that we'll lap. But with some of the efforts under way, right now, I would just say that we're encouraged; but more to come as we get traction on some of the tests and the pilots that we've got underway. So we're comfortable with our guidance as is.
Simeon Gutman:
Okay. And maybe my follow-up. Any product categories that are maybe less weather sensitive where you outperformed or underperformed that are worth calling out?
Michael McDermott:
Yes. I would tell you that, Simeon, we continue to feel very good about our appliance business. Obviously, continued double-digit growth in that category. We're running something like 3x better than the industry and continuing to take share. I think we've got the best-in-class assortment and experience for our customers there. I also see some great, great progress in some Pro-related categories. Rough plumbing and electrical, for example. We continue to grow share. The water heater program with the new A. O. Smith brand continuing to gain momentum. Saw double-digit comp in electrical cable, thinking about a commodity that Pros would leverage as they do their work for customers. And expanded penetration with the plumbing and electrical Pro. Lumber and building materials, continued Pro growth there. Storm-related recovery demand and inflation is supporting some favorability in that space. And then positive improvement above the average in tools and hardware, the Pro being the biggest driver of that. So you start to hear the theme that the actions and investments that we're taking, and our associate engagement with the Pro is paying off. Key brands like Dewalt, Marshalltown, Norton abrasives, the recent launch of [ estoine ] striking tools, we really feel good that the double-digit comps in subcategories like tool storage and mechanics tools will continue to complement the launch of CRAFTSMAN. So they are the categories I'm feeling pretty good about and continuing to see great progress with our Pro customer base.
Operator:
Our next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
Best of luck, Robert. So if we allocate the 300 basis points of comp drag that you called out due to the weather all to your traffic, with your traffic down closer to, call it, 0.7%, you have a pretty easy comparison this quarter. So the 2-year traffic trend was noticeably degraded even on that basis, down 2.2% or so. Why would've the traffic gotten that much worse even adjusting for the weather? Was it -- was there more disruption this quarter? You would think that after a lot of focus you put on traffic and conversion, it would have gotten a little bit better.
Marshall Croom:
Yes. When you think of the 300 basis points impact from weather impacting lawn and garden, our seasonal categories, that's really what we were seeing is just reduced transactions in those categories. So again, positive comps in our indoor categories. So that's how we think about the 300 basis points impact. I think, as Richard highlighted, it's not just all weather. Just continued focus on opportunities within conversion. And again, highlighting the number of factors, the 5 points that Richard laid out, talked about associate readiness, et cetera, with the opportunities we have with execution within the stores.
Michael Lasser:
Outside of the weather, did conversion get worse this quarter from where it has been?
Richard Maltsbarger:
No, Michael. Outside of the weather, the pattern that we saw in the conversion challenges of last year has stabilized in the Q1 period. And now the intensity of focus is on working our way back to improvement.
Michael Lasser:
And then my follow-up question is -- yes, go ahead. Sorry.
Robert Niblock:
Michael, this is Robert. Just keep in mind, when we look at the 300 basis points drag, I also think about what we talked about, the strong seasonal business we've built. 35% in first quarter of our sales, 40% in the second quarter. So it does kind of have a disproportionate effect, given how tough the weather was this quarter.
Michael Lasser:
And then thinking about the double-digit comps that you've seen thus far in May, is that all traffic related? Are you seeing conversion already improve? And then you talked about it extending through the third quarter. So what makes you believe it's going to be all the way through the third quarter, given that you've already seen double-digit comp trend, May quarter-to-date?
Marshall Croom:
Michael, what we're seeing is balanced transactions and ticket through the first couple weeks of May. We take a look at our promotional alignment, our product assortment, the momentum that we've got in the business, we feel good that we'll recover a majority of that seasonal business loss as well as expand growth in indoor categories throughout second, third and fourth quarters. So a lot of optimism for us with the way the business is unfolding here in May.
Operator:
Our next question comes from the line of Greg Melich with MoffettNathanson.
Gregory Melich:
Just to maybe dig a little deeper on Pro and then make sure I've got the guidance right. It sounds like, given the categories and what you described, Mike, the Pro is probably up to 35% of sales in the quarter. Is that right? And if you think of what's working there, what do you think you're going to lean into to sort of drive that for the rest of the year? And then Marshall, I had a question on the guidance, a follow-up.
Richard Maltsbarger:
Okay. So I will say there, Greg, that we have had strong performance with the Pro but not yet ready to go beyond our 30% penetration number.
Gregory Melich:
Okay. So we'll stick with that. And then make sure I get the math right on this. And Robert, thanks for all the help over the years, and also please enjoy your retirement. I think it's important to say that here. The guidance now, given the shift in accounting, if EBIT dollars were down 6% in the first quarter but will still be up a little bit if I take the midpoint of your guidance for the year, is it fair to assume that EBIT dollars will be positive the last 3 quarters of the year? Or do you think it's really more of a back half, just given the way the cadence is flowing through, Marshall?
Marshall Croom:
Thanks, Greg. Again, we're looking to recover, again, the majority of the sales through that. Obviously, we'll have a flow-through impact so that's going to play out over Q2 and 3, that we have that as a recovery opportunity in the year. So that's how we were thinking about how we would recover sales and EBIT.
Gregory Melich:
So the EBIT dollars, just to focus on that, given the accounting change, that will flow through, it sounds like, whenever the sales come. And if it's the second quarter, it's the second quarter. But if it ends up being more the third, it will be then?
Marshall Croom:
Correct. And again, the accounting change does not impact comp sales or operating income.
Operator:
Our next question will come from the line of Elizabeth Suzuki with Bank of America Merrill Lynch.
Elizabeth Lane:
You mentioned that storm-related activity helped lumber. Can you call out any particular hurricane-related benefits or quantify that in any way?
Marshall Croom:
Yes, Elizabeth. It was about 100 basis points of benefit in the quarter from hurricane-related activity from what we experienced last year. Again, that was a step change from Q4 to Q1, I think, the benefit that we realized, and we expect that to step down again in Q2 and really would kind of dissipate over the back half of the year.
Elizabeth Lane:
Okay, that's really helpful. And can you just talk a little bit more about the categories that didn't have positive comps outside of sales in outdoor living and lawn and garden? So presumably, kitchen and flooring were probably comping negative. Can you just talk about what's going on in those categories?
Michael McDermott:
Sure, Elizabeth. Paint, I think, had a significant weather impact. If you think about exterior stains and exterior paint in the first quarter, weather certainty hurt us there. When you think about flooring and kitchen, as Richard highlighted, we got a lot of work under way to improve our conversion rate in those categories, not just through the selling experience, but also managing our installer base and reducing time in phase from the moment a customer makes a selection until the moment they receive an install. So they are the areas of most significant focus, and kitchens and flooring certainly had been impacted as high-touch categories.
Operator:
Our next question comes from the line of Chuck Grom with Gordon Haskett.
Charles Grom:
Just to clarify on your guidance that the change in the gross margin view for the year, I think you said up 60 basis points. That's entirely due to the rev rec change?
Marshall Croom:
Correct. In the first quarter, it was 58 basis points. So we were guiding to flat gross margin before the adoption of the revenue recognition standard. So yes.
Charles Grom:
Okay. And then just as a follow-up to that. I think you said, when you provided the guidance earlier in the year, that you expected the front half to be lower and the second half to be better. Is that still the case? I presume it does.
Marshall Croom:
Yes, that's still primarily the case. Again, lapping some of the actions that we took in kind of Qs 2 and 3 last year, in addition to improving stabilizing gross margin. And again, a good step change from Q4 to Q1. So again, more pressure on gross margin ex the revenue recognition standard, more pressure in the first half than back half, again, as we lap some of those actions.
Charles Grom:
Okay. And you guys are not going to restate last year, did you say that earlier?
Marshall Croom:
We adopted the modified retrospective methods, so that does not require you to restate that, highlighting the impact and basis points on sales, gross margin and SG&A.
Charles Grom:
Yes, okay. And then I think you touched on this a little bit earlier, but can you update us on the progress you've made with your product portfolio analysis in terms of [ elastic ] benefits that you've seen so far?
Michael McDermott:
So we continue to see positive improvement as it relates to moving more revenue under management of our new pricing optimization tools. So as I mentioned on prior calls, it does take time to code models to that strategic approach. And as we move those -- more and more of that revenue under management, we are optimistic about the results we're seeing and the benefits it's having to our gross margin.
Operator:
Your next question comes from the line of Daniel Binder with Jefferies.
Daniel Binder:
I was wondering if you could just talk a little bit about the growth on Lowes.com. Looks like it was a bit slower than where we were last year. Just to get your thoughts on that and what you think the key drivers are to accelerate it.
Michael McDermott:
Yes, this is Mike again. Look, we had another strong quarter with our digital properties, delivering a 20% comp. We continue to build out our capabilities to support the overall omnichannel experience. So remember, Lowes.com is not just about the business we do online but integrating those interactions for our customers throughout their home improvement journey. We saw traffic conversion and comps all continue to improve as we elevated our targeted marketing efforts to continue to drive traffic, optimizing our assortment through digital line reviews and certainly remain competitive from a pricing perspective, improving conversions. So as we get better usability, faster site speed, intuitive navigation with investments in new search capabilities, improved checkout that we've got planned for this year, expanded assortment, I think our dot-com business will continue to grow, and our digital capabilities will enhance the omnichannel experience. So we're in a good place.
Marshall Croom:
And Dan, this is Marshall. I'll just add to that. When we had the question about continued investment, digital platform and capabilities is certainly something that we continue to lean into and invest. We've got a new Chief Digital Officer onboard, who's been here about 4 months, Vikram Singh. So he's digging into our platform, and so we're looking forward to leaning into expanding our capabilities on that front. And we comped 27% on online last year, so 20% is on top of that. And our sales penetration is now about 5% of sales from an online standpoint. So certainly, it's part of a key element to our omnichannel strategy.
Daniel Binder:
And then as a follow-up. Adjusting for any weather impact there may have been on the Pro growth sales -- Pro sales growth, I should say, would you generally describe that growth rate as stable, accelerating, decelerating? I know it's above average, but just kind of trying to understand trend, if it's getting better or similar to where we've been.
Marshall Croom:
Daniel, it's a relatively similar pattern, and continued strong. We do believe, based off all the tracking that we have in the marketplace, that we continue to take share in that space.
Operator:
Our final question will come from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
Robert, all the best to you after all these many years. I'm going to start by talking briefly about February. So February did not seem to be a weather callout in terms of the impact the way March and April were. The February monthly number on a 1-year basis and 2-year basis still represent a bit of a step-down from where we've been. So was it really the last 2 months of the quarter that were light? Or was the first month difficult as well?
Marshall Croom:
Yes. I would just say that the bigger crunch that we had were March and April from a sales and transaction impact.
Robert Niblock:
Yes, if you look at certainly the volume, as you know, Matt, the business grows dramatically between February and by the time we get to the end of the quarter. So the impact from those higher-volume weeks is much more significant than it would be in a month like February.
Matthew Fassler:
Got you. Second question relates to expenses. You actually came in a bit below the number from a dollar perspective adjusted for the accounting changes and all that, so below our forecast there. And I know that you held on to the labor investment that you had made, the seasonal labor investment. Were there any other expenses that were deferred or shifted into later in the year? I know you gave a new operating margin guidance for the remainder of the year, but as we think about whether that SG&A cadence needs to be taken up a bit as the year progresses.
Marshall Croom:
No, we actually were pretty pleased with our results in the first quarter. So we had some productivity efforts that helped provide and offset even with the investment in labor. So we'll continue to keep that as a focus as we lean into the year. We're also -- we have productivity efforts on that front. And so while we have that as a focus, we're also keenly focused on sales productivity opportunities as we move forward.
Matthew Fassler:
And then finally, a bit more strategically, you talked about pricing analytics and your desire to roll them out as the year goes on and the impact that you hope that has for gross margin. What's your best sense today from your consumer surveys as to your price impression? And how responsive consumers are when you've been promotional and the elasticity that has emerged from that -- from those efforts?
Michael McDermott:
Matt, we look at value perception pretty regularly. And our value perception metrics continued to be consistent with where they've been since we took the competitive actions in the second quarter of 2017. We remain competitive. We see a rational environment right now as it relates to the competitive pricing front. We've got a wider view into more competitors with these new tools. And I really feel good about our position on the competitive front. So priority one is be competitive and deliver great value to our customers, and by doing that, we've got to make the right trade-offs to maintain gross margin. So that's our focus. And what we've seen so far are positive results.
Robert Niblock:
Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter 2018 results on Wednesday, August 22. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' Fourth Quarter 2017 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. Richard Maltsbarger, Chief Operating Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Mike McDermott, Chief Customer Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's.
Fiscal 2017 represented the highest sales in net earnings in our company's history. In the fourth quarter, we delivered comparable sales growth of 4.1%, exceeding our expectations, through compelling consumer messaging, strong holiday event performance and integrated omnichannel customer experiences. Our U.S. home improvement business delivered a 3.7% comp for the quarter with positive comps in 13 of 14 regions. From a product view, we posted positive comps in 9 of 11 product categories, while 1 category was essentially flat. Appliances led product category growth with another quarter of double-digit comps. We achieved above-average comps in tools and hardware, rough plumbing and electrical and lumber and building materials. Internationally, we delivered another strong quarter with high single-digit comps in Mexico and mid-single-digit comps in Canada, both in local currency. We've made significant progress integrating RONA, delivering double-digit online sales growth, rolling out appliances to approximately 100 locations, completing 5 RONA big-box conversions, driving strong growth in our affiliated dealer business and further optimizing shared supplier partnerships and procurement efforts. We're pleased with the strong momentum we built throughout the year culminating in RONA posting its highest comp in 13 years. We believe that we're well positioned for continued growth and remain on track to double operating profitability in Canada by 2021. For the quarter, we delivered adjusted diluted earnings per share of $0.74. Delivering on our commitment to return excess cash to shareholders in the quarter, we repurchased $133 million of stock under our share repurchase program and paid $341 million in dividends. And our Board of Directors recently authorized an incremental $5 billion of share repurchases, which further underscores our commitment. Turning now to our progress against our strategic priorities. I'm particularly proud of how we've grown sales with Pro customers by focusing on breadth and depth of inventory, our portfolio of brands, localized assortments and enhancing LowesForPros.com as evidenced by our Pro growth rate outpacing DIY for both the fourth quarter and the full year. The integration of Maintenance Supply Headquarters and Central Wholesalers remains on track and provides a compelling opportunity to improve and expand our ability to serve multi-family property management customers. On Lowes.com, we saw a strong customer response to our enhanced shopping experience and marketing efforts with comp growth of 28% for the quarter and 34% for the year. We continue to enhance our in-home selling program, providing customers the ability to now request services online. And we are centralizing our process for providing installation quotes, allowing for greater efficiency and a more consistent customer experience. Our project specialists represent a critical element in our omnichannel offering and a differentiated capability in capturing and serving project demand for the do-it-for-me or DIFM customer. Though we are pleased with the strategic milestones we achieved this year, we recognize that we still have an opportunity to improve execution to ensure greater success in the future. Richard will speak to our efforts to improve conversion, gross margin and inventory management in a moment. Looking ahead, the home improvement industry is expected to see solid growth supported by job and income gains, which should drive increases in both disposable income and consumer spending. And we expect continued housing tailwinds, including favorable trends in household formation despite near-term pressure on housing availability. In 2018, we plan to capitalize on the strong macroeconomic environment and see an opportunity to invest much of the incremental cash flow from corporate tax reform to accelerate our strategic priorities, including investments in our people. We're focusing our resources of what is most relevant to engaging customers in the moments that matter and improving the capabilities our employees need to serve customers. In 2018, we will focus on leveraging analytics to know the customer better, changing how we engage, expanding our fulfillment options, delivering compelling product experiences, growing sales with the Pro customer and differentiating with services. These strategic areas of focus and investment will be instrumental to further strengthening our competitiveness and enhancing our position as the omnichannel project authority. Richard will provide additional details on each of these focus areas in a moment. And of course, as we look at our results, along with the additional investments we're making, it warrants reevaluating our long-term targets. Marshall will address those in a moment. But let me be clear that our entire leadership team and board are focused on working together to continue to analyze our performance and business expectations, and we are moving forward with urgency to improve our results. Before I close, I would like to express my appreciation to our employees for their dedication to serving customers and living our purpose-driven mission to help people love where they live. We recently announced plans to expand our employee benefits and a onetime bonus of up to $1,000 for our more than 260,000 hourly employees in the U.S. Our employees are the foundation of our success, and we are investing in them to support our bright future and reward them for their unwavering commitment to serving customers in the communities where they live and work. It's their dedication that makes this company great. Thanks again for your interest, and with that, let me turn the call over to Richard.
Richard Maltsbarger:
Thanks, Robert. Good morning, everyone. As you just heard, we've achieved some important milestones this year and identified actions necessary to drive future success.
First, we refined our marketing strategy, successfully launching a new campaign, Start with Lowe's, which has captured mind share and improved measured campaign effectiveness. We've also continued our evolution from analog to digital marketing, delivering more personalized, targeted messages. And we've optimized our messaging content, driving critical improvements in value perception. Together with our incremental marketing investments, these improvements have increased awareness, leading to robust traffic growth. Second, we capitalized on customer excitement for the holiday season. We provided cohesive decorating solutions as well as compelling gift ideas across our product assortment, connecting our in-store display with digital assets such as Pinterest, Facebook, Instagram and YouTube and delivered a seamless shopping experience on Lowes.com. In fact, we drove double-digit comps in appliances, leveraging our investments in customer experience, both in-store and online as well as our best-in-class selection of leading brands and our services advantages of next-day delivery, haul away and facilitation of repairs and maintenance. As cold temperatures and winter storms hit, our never-out strategy ensured that we were in a strong position to serve demand for critical items customers needed. Combined, our strong holiday performance and never-out strategy drove above-average comps in tools and hardware and rough plumbing and electrical. We also continue to execute on our strategic priorities, driving comp growth of 28% on Lowes.com, the result of strong customer response to our enhanced online shopping experience. We have optimized functionality and display for touchscreen devices to support a better mobile experience, improve product content recommendations, refine search algorithms, improve click-to-chat capabilities and optimized our assortment, informed by digital line reviews. And we have releveraged our MyLowe's platform to drive brand loyalty and build deeper relationships with customers, important because MyLowe's members spend approximately 35% more on average than nonmembers. In 2017, we added more than 4.5 million new MyLowe's members, and we used the platform to simplify our military recognition program, allowing active duty personnel and veterans to register through MyLowe's and receive 10% off their purchases every day. However, not all the actions we took during the year delivered on expectations. While we were pleased with our traffic growth, we are actively working to improve conversion and gross margin while better managing inventory. Earlier in the year, we recognized the need to improve our sales floor coverage, especially during key weekend and holiday events. We made an investment in Q3 to bolster conversion rates, but did not realize the full value of this investment in the second half of 2017. We ultimately determined that while necessary, payroll actions alone will not deliver the conversion rates we expect. Therefore, we must accelerate associate readiness and knowledge through training programs and reengineer key processes in order to better serve customers. We must also stabilize gross margin by leveraging new pricing and promotion analytics tools to ensure that we are competitive on highly elastic traffic-driving products while driving profitability across less elastic items. And through our continuing Value Improvement efforts, work closely with our vendors to improve first cost. Finally, we've made the required inventory investments to support key categories such as appliances, flooring and tools as well as depth and breadth in critical Pro categories. Now we must drive greater working capital efficiency. We entered 2018 with a plan to address these challenges and accelerate the investments that will improve our execution and our ability to serve rapidly evolving customer expectations. As Robert outlined, there are 6 planks to this strategy. First, we are working to know customers and their homes on an even deeper level, understanding their plans and designing better solutions to help navigate their project journey. We're integrating our analytics capabilities, bringing together terabytes of customer data, connecting many different touch points throughout our omnichannel platform, supplementing that data with third-party information and leveraging our talented global workforce to translate this information into actionable insights. Second we're changing how we engage, connecting with customers and associates through relevant tools and messages. We'll deliver a more refined, personalized messages to customers through our enhanced marketing management platform that went live in Q4. And we'll better empower associates by deploying more user-friendly interfaces, beginning with our point-of-sale upgrade in Q1, which will allow our associates to better serve customers with a touch of a button. Later in the year, we'll significantly improve our associate connectivity, expanding the functionality of our in-store handheld devices to improve the efficiency of our order staging and management, daily tasking and inventory processes. Third, as customers demand an increasingly broad set fulfillment options, we're transforming our supply chain to better serve their needs and expectations. We're investing in a new direct fulfillment center, which we expect will be operational in the third quarter of 2018, allowing for the expansion of our online product offering and faster parcel shipping. We're also investing in delivery capacity to meet increased demand, and we're advancing our pick-up-in-store experience during Q1 to allow customers and our installation service providers to pick up product within 5 minutes of arrival. Fourth, we'll continue to deliver compelling product experiences to provide inspiration and personalized choice through a combination of strategic brands and differentiated in-store experiences. We previously announced the introduction of craftsmen in-store and online in the second half of 2018. Today, we're proud to announce our expanded partnership with Sherwin-Williams. Paint continues to be a top home improvement project, and we will partner closely with Sherwin-Williams to deliver a simplified line design to make it easier for customers to select the right product for their painting needs. Sherwin-Williams will now be the exclusive national supplier to Lowe's U.S. retail outlets for interior and exterior paints, including the Valspar and HGTV Home brands. Sherwin-Williams is one of the most recognized brands in paint, highly respected for quality products by both homeowners and Pros. Under this expanded strategic partnership, Lowe's will become the only U.S. national home center to offer top-selling stain brands, Minwax, Cabot and Thompson's WaterSeal as well as the top paintbrush brand, Purdy. We are excited to bring consumers more the top brands they trust for their next paint or stain project. We're also investing in our paint service model to improve the associate and customer experience across the entire paint project. We are rolling out a new paint desk experience in select stores beginning in the first quarter with plans for a nationwide rollout in the second half of 2018. The improved experience will include an updated product selector display as well as a simplified and streamlined service model to make it even easier for customers to work with their associate, to find the color, pick a paint or stain, quickly have it mixed and begin a project. Fifth, while our Pro penetration has grown over the last 5 years, we have further opportunity to continue growing sales to Pro customers and expanding our market share. To that end, we're investing to improve the Pro experience. We are building on our strength in the MRO space by optimizing our Maintenance Supply Headquarters business, launching a streamlined product catalog this spring, followed by branch expansion beginning later this year. We're also testing improved Pro job site delivery in select urban markets with an expectation of rolling out the best concept nationwide in the second half of the year. And in order to build a stronger generation of skilled trade professionals, we are launching our Track to the Trades program, a new workforce development initiative that provides innovative career alternatives and financial support for our employees as they pursue a skilled trade. Finally, as the DIFM opportunity continues to grow, we're providing a differentiated services offering, delivering complete home improvement project solutions through our in-home sales platform, which, we are proud to note, has grown to over $2 billion in sales annually. Across all project types, our installation services team completes approximately 60,000 in-home installations each week. And we continue to push forward in this space where we are currently testing the commercialization of Lowe's Vision Pro with our in-home project specialists, allowing customers to use augmented reality to visualize their kitchen or bath remodel and feel confident proceeding with their project. Through this and other work, we have earned recent recognition by Fast Company as the most innovative company in augmented and virtual reality. Together, these 6 planks build upon our strong foundation and further strengthen our competitiveness, positioning us to continue capitalizing on healthy project demand. Thank you for your interest in Lowe's, and I will now turn the call over to Marshall.
Marshall Croom:
Thanks, Richard, and good morning, everyone. Let me start by reminding you that last year's results included an extra week, which contributed approximately $950 million in sales. That extra week also caused the calendar shift this year, which had no impact on comp sales, but negatively impacted fourth quarter total sales growth by approximately $1 billion or 7%.
Sales for the fourth quarter were $15.5 billion, a decrease of 1.8% compared to last year's fourth quarter. Total transaction count decreased 7%, while total average ticket increased 5.2% to $73.44. Maintenance Supply Headquarters contributed 40 basis points of growth in the quarter, while new stores contributed 60 basis points. Comp sales were 4.1%, driven by an average ticket increase of 4.9%, partially offset by a transaction decline of 0.8%. Looking at our monthly trends. Comps were 1.1% in November, 7.7% in December and 3.4% in January. Hurricane recovery efforts in Texas and Florida aided fourth quarter comps, which offset the impact of cold temperatures and winter storms across the country in the latter part of the quarter as well as the comparison to Hurricane Matthew and Louisiana flooding last year. We estimate that the net benefit of weather in the quarter was approximately 65 basis points. For 2017, total sales were $68.6 billion and comp sales were 4%. Gross margin for the quarter was 33.73% of sales, a decrease of 68 basis points from the fourth quarter of last year. 2/3 of the decline was attributable to rate, while the balance was mix and shrink. As we've grown the market share in appliances, gross margin has been impacted from both a mix and rate perspective. We also continue to take competitive actions, which were partially offset by the benefits from Value Improvement as well as early results from pricing optimization efforts. SG&A for the quarter was 24.28% of sales, which deleveraged 29 basis points. In last year's fourth quarter, we recorded severance-related costs for organizational changes, which drove 53 basis points of leverage this quarter. In the fourth quarter of '17, we experienced 21 basis points of leverage related to employee insurance and 32 basis points of leverage related to incentive compensation due to low retainment levels versus last year. Offsetting these items were the onetime cash bonus for eligible hourly employees in the U.S, which resulted in 42 basis points of deleverage as well as 21 basis points of deleverage and delivery costs due to increased demand from continued growth in appliances. We also had 14 basis points of deleverage in advertising, primarily the result of our efforts to amplify our consumer messaging. And lastly, the 53rd week in the fourth quarter of 2016 drove approximately 65 basis points of deleverage this quarter. Depreciation and amortization for the quarter was $367 million or 2.37% of sales, flat to last year. Operating income declined 97 basis points to 7.08% of sales. The 53rd week in the fourth quarter of last year drove approximately 90 basis points of deleverage this quarter. Interest expense for the quarter was $154 million, which leveraged 3 basis points. Effective tax rate for the quarter was 41.3% compared to 40.3% last year. The higher rate this year was driven by tax reform. The change in our federal statutory rate triggered remeasurement of our deferred tax assets and liabilities, resulting in a charge in the fourth quarter. Earnings per share was $0.67 for the fourth quarter. The tax reform negatively impacted earnings per share by $0.02, while the onetime cash bonus reduced earnings per share by $0.05. Adjusted earnings per share was $0.74, a 14% decrease compared to last year's adjusted earnings per share of $0.86. Last year's extra week contributed approximately $0.08 to last year's quarter, which negatively impacted adjusted earnings per share growth this year by 9%. Our 2017 earnings per share was $4.09, while adjusted earnings per share was $4.39. Turning to the balance sheet. Cash and cash equivalents at the end of the quarter was $588 million. Inventory at $11.4 billion increased $935 million or 8.9% versus the fourth quarter of last year. This is primarily driven by investments in key categories, as Richard mentioned, such as appliances, flooring and tools as well as investments across Pro categories. And part of the increase is also attributable to the acquisition of MSH and new store growth. Inventory turnover was 3.9x, a decrease of 15 basis points over last year. The extra week in 2016 negatively impacted inventory turnover by approximately 6 basis points. Asset turnover increased 5 basis points to 1.9x. Accounts payable of $6.6 billion represented a $61 million or 0.9% decrease over fourth quarter of last year. At the end of the fourth quarter, lease adjusted debt-to-EBITDAR was 2.33x. Return on invested capital was 18.8%. Now looking at the statement of cash flows. We generated strong operating cash flow of nearly $5.1 billion and free cash flow of $3.9 billion. In the fourth quarter, we paid $341 million in dividends, and we repurchased approximately 1.7 million shares of stock for $133 million through the open market. For the year, we paid $1.3 billion in dividends and repurchased $3.1 billion of stock for the year. In January, our Board of Directors authorized a new $5 billion share repurchase program. The new program has no expiration date. Therefore, our combined purchasing power on the share repurchase program, we have a total authorization of approximately $6.9 billion. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert and Richard indicated, we've made meaningful progress this year against our strategic priorities. While we are pleased with the strategic milestones, we do recognize that we have an opportunity to improve execution to ensure greater success in the future. We are focused on improving conversion, gross margin and inventory management. In addition, customer expectations in retail landscape are rapidly evolving, and corporate tax reform provides incremental cash flow. As a result, we are accelerating our investments to enhance our ability to serve customers. We'll be taking the necessary actions to transform our supply chain, better empower our associates and continue to deliver compelling product experiences. In 2018, we expect a total sales increase of approximately 4%, driven primarily by comp sales increase of approximately 3.5%. We do anticipate opening approximately 10 stores. On a GAAP basis, we are expecting operating margin decline of approximately 30 basis points. While we expect flat gross margin for the year as we improve execution, incremental expenses associated with our strategic investments will pressure SG&A. Factoring in the benefits of tax reform, which are approximately $750 million in 2018, the effective tax rate is expected to be 25.5%. For the year, on a GAAP basis, we expect earnings per share of approximately $5.40 to $5.50. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.7 billion. This is expected to result in estimated free cash flow of approximately $4.8 billion for 2018, and our guidance assumes approximately $2.5 billion in share repurchases. As we look at our results, along with our decision to accelerate strategic investments, we are reevaluating our long-term targets. We plan to provide a full update on our business strategy and long-term outlook at our Analyst Investor Conference in December. Until that time, I'd like to share some parameters that we're applying as we reevaluate our long-term targets. First, the outlook for the home improvement industry over the next few years remains solid. As such, we continue to expect an average annual sales increase of at least 4%. Second, we expect operating margin to improve after 2018 even while we continue to invest in the business, and we are diligently working to improve productivity in order to provide greater confidence in the operating margin targets we plan to communicate in December. Finally, we remain committed to our current shareholder distribution target, returning approximately $14 billion to shareholders through 2019. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
So a couple of questions. First-off, with respect to the investment plan or the strategic plan you laid out on the call, how should we think about, as we go through 2018, the sort of, say, the investment -- the cadence of investments along those lines and the potential benefits in terms of sales and other metrics? How should those line up?
Marshall Croom:
Yes, I'll take the top line first. This is Marshall. Basically, as we think about our sales progression and comps, we would slightly expect sales to be higher in the first half of the year. As you recall, first quarter was our easiest comparison as we head into '18. So first half sales will be slightly higher than second half. As far as capital expenditures and expenses throughout the year, we'll be leaning that throughout the year. But we do expect, as we've managed to stabilize gross margin, that not only the capital investments but the expense associated with some of these initiatives will put pressure on SG&A.
Richard Maltsbarger:
And Brian, as noted during my comments, this is Richard, a few of the nationwide rollouts that we have such as the paint service experience as well as some enhancements to the digital tools in the hands of our associates are backloaded.
Brian Nagel:
Got it. And then the second question, more of just a follow-up. If you look at the cadence of the comps in the quarter, so clearly it was weak to start, weak to end, stronger in the middle. Is there something that explains that, basically that what we saw through the quarter?
Marshall Croom:
Yes, it's largely a function of the holiday sales that we experienced. So as we mentioned, we were pleased with appliance sales growth. A majority of our appliance sales are scheduled to be delivered, they're not take with. As a result, a lot of those sales over Black Friday and that holiday period were delivered in December, and it's not until they're delivered or customer takes possession that we recognize that revenue. So that created some lumpiness of the 1.1% comp in November to the 7.7% in December.
Brian Nagel:
Is there a way just to -- just that one piece, can we quantify the shift between those 2 months?
Marshall Croom:
Yes, Brian, there's another way to think about it. If you look at the comp progression, not including the impact of deferred sales, it was roughly kind of mid-3% comp in November and January and roughly mid-4% comp in December.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two questions for you. First of all, the 4Q margin I think was below the guidance you had given 90 days ago. So just curious if you could summarize again the moving pieces with the math. And then secondly, excited to hear about the incremental investments to grow the business in '18 and you talked about taking advantage of the tax savings, the $750 million. But wonder if you could just quantify the amount of incremental investment that you're making in 2018.
Michael McDermott:
Eric, this is Mike McDermott. I'll touch on the gross margin question. In the fourth quarter, we meaningfully exceeded our expectations in the appliance category, growing significant market share. As a result of that, that had an impact on both our mix and our rate from a margin perspective. The other thing we did, as you recall, in the second quarter of 2017, we focused on getting more competitive and improving our value perception to make sure that we could take advantage of the available market opportunity. Those actions continued in the fourth quarter, and yet were only partially offset by our Value Improvement initiatives working closely with our vendors on first cost and some early price optimization benefits as we're in early innings of rolling out analytics tools and capabilities to drive that optimization. As we look into the new year, I think we're in a solid competitive position. We continue to offset the impact of any competitive pricing actions through the rollout of those tools that I mentioned a moment ago. And we'll continue to work on Value Improvement with our vendors, ultimately delivering flat gross margin in 2018.
Marshall Croom:
Eric, this is Marshall. Just one other factor for fourth quarter gross margins. As we were going through our integration process with RONA, we did have some accounting harmonization that impacted gross margin in the quarter. So that was just another small factor for the pressure we experienced there. To your second question on the incremental capital that we plan to spend in 2018 as a result of tax reform, about 85% of that we will be investing in 2018. So we recognize this is an opportunity. And largely, where we're spending that, as you think about our capital expenditures going from roughly $1.1 billion in '17, $1.7 billion in '18, 45% of that $1.7 billion will be on the strategic initiatives. That's almost triple of what we spent in 2017. So again, the opportunity to lean into the omnichannel capabilities that we need to build to expand customer reach and relevancy and to further drive the 6 planks that Richard spoke to earlier.
Eric Bosshard:
Great. And then just one last question, if I could circle back with Mike McDermott. How do you think about the balance between the incremental promotional spending getting a bit more aggressive on price and effective and then the market share performance? And I know that looking at it relative to Home Depot is just one way to look at it, but how do you look at the incremental spend and then the market share performance?
Michael McDermott:
Eric, look, when I take a look at incremental spend, I look at both price as well as traffic. And we had some incredible performance as it relates to our efforts to improve our customer awareness as well as drive traffic and engagement through that awareness through optimizing our marketing spend and better balancing our digital and mass media approach, make sure we're engaging customers at the right time with the right content. As it relates to both promotional and pricing spend, we simply have to be competitive and that is our focus. The opportunity to continue to drive optimization is what we see ahead of us in 2018.
Robert Niblock:
Eric, this is Robert. I would just add on that. I think we're pleased with the work that Mike and his team have done from a promotion standpoint, the additional traffic it's driven, the consumer awareness, those types of things. As Richard and I both outlined, opportunity is to take that traffic and drive greater conversion. That's what Richard and his team were working on in some of the strategic investments that he talked about was for focusing on investing in our associates to make sure that they have all the tools, the training, the capability, we have the right coverage for daypart hours, those type of things to ensure that we're then converting that traffic into sales. So that's a big focus area that we're -- that Richard and his team are focused on as we head into 2018.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk about the appliance category? It sounds like you did extremely well in that category. Any further quantification of what double-digit growth is? Is that close to the 20 than to 10? And somewhat related to that, traffic was down in the fourth quarter. What do you think the drivers of the down traffic were?
Marshall Croom:
I'll just reinforce that we had double-digit comps in appliances and feel good that the combination of our messaging, our assortment, our brand partnerships and our product offering continue to resonate very, very well with customer. We are the leader in that space and continuing to drive leverage as a result of that leadership position with fantastic displays and great, engaged associates. So I continue to see runway in the appliance space as we lean into that market opportunity that exists.
Robert Niblock:
Chris, this is Robert. Just to clarify, it was not traffic that was down. It was transactions that were down. As I just indicated in my follow-up with Eric on earlier question, we're driving the traffic, it's the conversion of that into transactions. And as we mentioned, as Richard said in his comments, we put the labor there. We realized we've got to put more than just the labor there. So we've made the labor investments, now we need to make the incremental investments to ensure that we convert that traffic into transactions.
Christopher Horvers:
Understood. That's a great segue. So as you think about the labor model and the change that you've made, are you thinking about structurally changing sort of how you allocate labor, whether it's full-time versus part-time? The algorithms that you put in place with the new system last year, how is the overall labor strategy shift going forward?
Richard Maltsbarger:
This is Richard. The reality is over the last couple of weeks, I've had the opportunity to go into stores across 5 different states, speak directly with our associates, understand some of the challenges that are happening in our aisles every day. And the emphasis I would put on are a few areas. First and foremost, it's really the mix of our selling and tasking hours. How do we go about getting the work done in our stores every day to enable our Red Vest associates to be in front of the customer when it's time to serve? Second focus we have on, as Robert noted, is having the labor hours in the stores necessary, having associates ready through our training and our knowledge programs to be ready to serve is just as necessary. So reinvestments and actions that we are taking right now during spring hiring to bolster that area. Third, reengineering some of our key processes. As noted in my comments and Robert's, our pick-up-in-store experience, as an example, we have an upgraded experience both in the physical layout as well as in the staffing and training model going out in Q1 as well as to Robert's comment on centralized quoting, an opportunity to speed up our process by centralization and greater support for our in-store associates to allow them more time to serve the customers that are with them every day. And then finally, upgrading our digital management tools, giving a chance for our associates to get more productive with the hours that we invest in the tasking. So when you look across those investments, from the mix of tasking to selling, to our associate readiness, to reengineering key processes, to better empowering our associates with the right tools, those are some of the initial focus areas as we move into the year.
Operator:
Your next question comes from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My question is a follow-up on the conversion issue. If you could just give us a sense of how conversion trended through 2017 and how much of improvement you expect in 2018 and what the biggest driver of that is going to be, is it the training and knowledge programs or something else?
Richard Maltsbarger:
Absolutely. As I just noted, the challenges we've had for conversion have steadily been a challenge as we moved throughout the year. In fact, it really is an opportunity. As we have grown the traffic, we know that the customer is interested in our offer. There is the demand for what we're bringing to the marketplace. Really, the conversion challenge has grown as the traffic has grown. We have begun to address it in the steps that we had to take necessarily in the payroll action in the back half of the year. And now it is simply a matter of ensuring that our associates are more ready to field that traffic.
Seth Basham:
And a follow-up on that. In terms of the readiness, is the fact that you had a lot of employees that weren't quite qualified for their jobs, weren't trained for their jobs or in the wrong places?
Richard Maltsbarger:
The biggest focus that has come from my conversations with our teams in the field right now is greater role clarity and greater understanding of who's going to field, what particular aspects of the project cycle and being able to improve the execution of that.
Operator:
Your next question comes from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
I want to follow up on gross margin. So gross margin I think was down all 4 quarters of this year. And I know there's been some mix issues and Canada coming into the mix earlier on probably impacted that as well. But given the commitment to deliver a comp that's level with what you've been putting up in a pretty strong backdrop, and given the fact that Value Improvement has been part of the agenda for quite some time, why the confidence that with mix moving against you and with the desire to continue to hold or gain market share, at this moment the gross margin is -- can stabilize while you achieve everything else you're trying to get done here?
Michael McDermott:
Matt, this is Mike McDermott. Obviously, we have seen gross margin decline throughout 2017. Most of the actions we put in place started in the second quarter of '17. So we're going to have the ability to lap those activities. We've been working to optimize throughout the year to improve our promotional effectiveness and reduce our spend while continuing to drive traffic. We've seen pretty good results in the third and the fourth quarter there. And then we've got some new tools really focused on price and promotional optimization that give us the ability to offset any inflation impacts that we're experiencing, primarily in the lumber and building materials space, while at the same time, making sure that we remain competitive and minimize the spend to do so. Value Improvement is an ongoing initiative of us working closely with our vendor partners, make sure that we've got the most efficient and effective way to deliver value to our customers, moving from -- all the way through our supply chain to the prices and promotions that we offer to close the sale. So I think the combination of all of those activities give me confidence that we'll deliver flat gross margin in 2018.
Matthew Fassler:
And just a quick follow-up on that. Obviously, inventory has the potential to be a factor here. And inventory growing faster than a fairly healthy sales rate, I know it doesn't make it any easier to drive gross margin improvement. So can you talk about your expectations for inventory growth relative to sales growth over the course of the year and whether working that down will require any measures that would impact gross margin as well?
Richard Maltsbarger:
Absolutely, Matt. This is Richard. I'll talk about some of the actions we're taking to manage inventory and then allow Mike if he wants to weigh in further with any estimated impact. But as noted in our guidance, right, we are going to focus on the improvement of our inventory management. We believe we've made the investments in the inventory, in our system to support the strong sales growth we're seeing in categories such as appliances and tools, right? Now the onus is on me as I get into the role to continue working with our teams to understand what changes in the flow of our supply chain, what changes in the interactions between our supply chain and our stores and what changes in specifically having inventory in a shop-able position for customers when they come in to demand the purchase are necessary to continue to manage at roughly a flat to slightly up inventory that is less than our rate of sales growth during 2018.
Operator:
Your next question comes from the line of Mike Baker with Deutsche Bank.
Michael Baker:
Wondering if you could tell us how you measure traffic and conversion and share some trends on that metric over the year?
Richard Maltsbarger:
Yes, absolutely. Mike, this is Richard. We leverage video analytics in the tracking of movement of customers into our stores and measure that up against the transactions that we are able to execute through our registers and the rest of our activities with customers.
Michael Baker:
So can you share some metrics on that? So you're saying traffic was up. Frankly, we don't see it in the data that you provide in terms of the number of transactions. So again, if you could help give us confidence in that metric and then also what that would imply for conversion, how that has changed throughout the year?
Richard Maltsbarger:
Not at this time, Mike.
Michael Baker:
Okay. Then I'll ask just one more quick follow-up. Marshall, you talked about CapEx going from $1.1 billion to $1.7 billion. Then you said 45% of that is on initiatives. Is that 45% of the incremental $600 million or 45% of the total $1.7 billion?
Marshall Croom:
Yes, it's 45% of the total $1.5 billion (sic) [ 1.7 billion ]. The 85% was referenced to kind of the proportion of the tax reform benefits that we're going to see in 2018.
Michael Baker:
Understood. So if it's 45% of the total, and then that's up 3x versus last year, and so the incremental CapEx accounts for most of that 85% of the tax reform, I guess, then my question is, is there an SG&A component? Why would SG&A be down 30 basis points on a 3.5% to 4% comp or sales growth number where you'd otherwise expect that to be up with the typical leverage that you get?
Marshall Croom:
Yes, with a lot of these programs and our initiatives, there are expense components to deliver some of the strategic initiatives that we do have going on in 2018. So that's just noted pressure that we would expect in SG&A.
Michael Baker:
Above and beyond the investment in CapEx from the tax reform?
Marshall Croom:
CapEx component and in expense component.
Operator:
Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Are you -- have you made any changes in your terms with any of your vendors? I guess, I'm trying to understand the payable of the inventory ratio a little bit better.
Marshall Croom:
There is no significant change as part of this was just due to timing. Kind of comparing this year to last year, we're still looking at terms and where it makes sense to extend terms where we can. But it's all part of the balance that we have. With our Value Improvement process and ongoing vendor negotiations, we do expect to improve that in '18. But it was just really a matter of timing of some of the seasonal build and buy towards the end of the year.
Scot Ciccarelli:
So one of the things that I know that kind of gets negotiated between vendors and retailers is kind of pricing or gross margin targets, if you will, coupled with kind of payment terms. Is there any change in thought process regarding what is a more important aspect or metric to Lowe's?
Marshall Croom:
Not at this point in time. We'll always kind of factor in that net-net what we think is beneficial for us and beneficial for our ongoing relationships with the vendors.
Operator:
Your next question comes from the line of Gregory Melich with MoffettNathanson.
Gregory Melich:
I just had 2 questions. One was on the reinvestment of the tax savings, just to make sure I got that right. It sounds like there maybe 30 bps on the income statement, which would be about $200 million. And then a portion of the CapEx of that increase from $1.1 billion to $1.7 billion is because the tax reform has given you more money. But probably -- CapEx probably would have gone up at least several hundred million anyway. Is that a fair way to think about it?
Marshall Croom:
Yes. First and foremost, as we think about our capital allocation philosophy is to first invest strategically in the business to maintain RONA and improve and enhance the business. So that is always going to be the first pillar. So one is we're reflecting on where we were in the marketplace, the initiatives we need to get underway, this provided a good backdrop to be able to enhance and ramp and accelerate our capital investment as we lean into 2018.
Gregory Melich:
So it sounds like of that $600 million increase in CapEx this year, a portion of it, maybe half of it, was related to the tax reform, and you would have been doing a lot of these things anyway, you're just accelerating things that were coming. Is that fair?
Marshall Croom:
Correct. Accelerating, actually it was about 85% of the tax reform benefit that we're going to see in '18 that is helping fuel the incremental CapEx. But yes, we would have accelerated the CapEx spend to get after our strategic initiatives.
Gregory Melich:
Regardless. Perfect. So then the second question is on RONA. I think, Robert, you mentioned at the beginning that the integration is going well and doubling the profitability goal over the next 4 or 5 years is still there. Could you help us understand how much RONA improved or helped corporate margin last year in '17 and what is in your guidance for this year in '18 in terms of RONA improvement?
Robert Niblock:
Yes, like I said, things are going well at RONA. We're pleased with the performance from how it blends in from a margin standpoint, Marshall?
Marshall Croom:
Yes, we should be cycling from a gross margin standpoint as we anniversary the acquisition. We did have some -- just again some minor cleanup that put some pressure in the fourth quarter. But we are in a good trajectory to doubling the profitability of RONA -- or Canada by 2021.
Gregory Melich:
Got it. And then last, just to make sure I understand...
Richard Maltsbarger:
Greg, this is Richard. Not being too far removed from the old job yet. RONA was not a significant improvement operating margin in 2017 nor was it planned to be. However, 2018 is when we begin to see more significant movement on the operating margin.
Gregory Melich:
That's great to hear. And then last, is gross margins flat this year? And on the sales standpoint, you guys think the first half stronger, it sounds like the SG&A investments won't really build until the second or third quarter.
Marshall Croom:
It was just slightly higher in the first half. But from a capital expense standpoint, again, we are trying to accelerate our investments throughout the year.
Robert Niblock:
And part of the sales is because if you think about -- we didn't have a strong spring last year or. So being in cycling year, slightly weaker numbers.
Operator:
Our final question will come from the line of Michael Lasser with UBS.
Michael Lasser:
So arguably, you made some investments over the last several quarters in areas like labor and promotions. And they produced somewhat mixed results. Now you're accelerating investments in different areas. But how do you ensure that you produce a suitable return that will be attractive to your P&L as you accelerate those investments?
Robert Niblock:
See, I'll start, Michael. Certainly, you mentioned a couple of things, labor and promotions. I think if you look from the promotional aspect, I think we've been pleased with the investments we've made. As I said, driving the traffic, the brand awareness, those type of things. Certainly, as we mentioned, we have challenges from a conversion standpoint that we're working on. As Richard mentioned and he can further elaborate, we've made the investments in labor. Now it is going in and supplementing those investments that we've made with -- make sure we have the training, the tools, the other components that are necessary so that we have the associates in front of the customer when they are ready to buy. And Richard, I'll let you...
Richard Maltsbarger:
Michael, all I'd add to that is several of the things that we talked about, investing further into the back half of the year for nationwide rollouts. So we've had under test over the past several months or weeks to be able to get the early signs of success. And that really is the approach that we're going to take. A great example is the pickup in the store experience that's currently rolling out in Q1. We've actually had that and a team dedicated to that since last August, testing in a handful of stores, slowly going to a greater level of investment and iterating along the way to ensure that we're getting the maximum value out of the investment we're going to make prior to going to a nationwide rollout. In fact, the iteration that is going to currently rollout is the fourth iteration of that test already in the past 6 months in order to make sure that we're maximizing the return from all components, the physical space change, the training of the associates, the shift in the processes, the reengineering of how we do that and the dedicated labor before we decided to take it to a nationwide rollout during the latter part of March and April.
Michael Lasser:
And my follow-up -- yes, please.
Marshall Croom:
I'm going to pile on for more comment. I just want to make it clear that the leadership team is aligned and focused on areas that we highlighted on the call. You think about stabilizing gross margin, improving conversion, improving inventory management, along with getting after from the 6 strategic planks. So I think that's just something that I do want to reemphasize and that we are working with a sense of urgency along all of those fronts.
Michael Lasser:
My follow-up question is that I think we all appreciate your commentary you made around the longer-term guidance, and it was helpful. So if we assume kind of sales remain where they are, flattish gross margin, can you give us a little sense of the operating leverage in the business now with all the different changes that are going on and all the different changes that have taken place over the last few years? It's become harder to understand where the leverage point of the business is or in a normal run rate environment, how fast your expenses grow relative to the rate of your sales growth?
Marshall Croom:
Yes, at this point in time, we're giving the high level of sales growing at least 4% of the total shareholder distributions, sticking to the $14 billion there and then just really the improvement of operating margin from 2018 levels, we expect those to improve from where we're setting that target in '18. That being said, we do plan on updating longer-term guidance when we get to our December investor and analyst conference.
Robert Niblock:
And Michael, I would just add on to this. If you think about, one, the investments that we're making in the business. Two, some of the investments we made last year, as Richard has spoken, him and Mike are working together, diving into the investments we've made, trying to figure out how can we get better performance out of those and then ensuring as we're doing the test and learn before rollout, that they're working on as we head into 2018. Before we go out and commit to additional targets like that, when we get time for them to be able to continue to dive into the business, understand the opportunities for improvement and be in a position to really be prepared as we get to December to provide you guidance -- longer-term guidance that we think we'll have great confidence in. And so at this point, we just don't want to get ahead of ourselves.
Michael Lasser:
That makes sense. And if I could add ask maybe more qualitatively. Robert, are you looking at all these investments and then changes in the 6 pillars with a lens that you're looking to take the business to be more efficient and maybe produce more leverage over time as you do grow sales?
Robert Niblock:
Absolutely, yes. We know that certainly, we've got some investments we've got to make in this. We talked about the supply chain investments we're making. We know that as the business has continued to move, consumer expectations have had moved. And so we've got investments for making in our supply chain, some of those will pay dividends in 2018. Some of them will be further into the future. But yes, absolutely, that's what we want to do is making sure that as we're investing in the business, have the right people in front of the customer at the right time, supporting that with supply chain, supporting it with technology that we're getting greater leverage points to be able to drive improved operating margin in the future. That's what we're after, focused on diving into that in '18 so that we can be in a good point to provide you exactly how we're going to get after and how -- where it's going to be delivered when we get to our analyst conference in December.
Great. Thanks, Michael. As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2018 results on Wednesday, May 23. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' Third Quarter 2017 Earnings Conference Call. This call is being recorded. [Operator Instructions]
All 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 to the following 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 of the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements, as defined in the Private Security 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 Security 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. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Richard Maltsbarger, Chief Development Officer and President, International; and Mike McDermott, Chief Customer Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. This quarter, our teams were tested by the largest natural disaster response we've ever mounted, and I'm extremely proud of the way they met the challenge. Our merchant, vendor, logistics and storm teams worked together seamlessly to ensure customers had the right products to protect and repair their homes.
Following the storms, our operations team worked tirelessly to get our stores up and running quickly, and over 3,000 employees generously volunteered to serve our employee relief teams, providing additional support to customers in their time of need and giving employees impacted by the hurricanes a chance to focus on their own recovery efforts. Lowe's has also provided financial support, committing over $2.5 million in disaster relief through cash and product donations. And we continue to work closely with our nonprofit partners to provide both immediate and long-term support to impacted areas. I'd like to take a moment to thank our employees for their remarkable efforts to serve their communities, help customers and support their colleagues in the face of numerous natural disasters. Turning now to our third quarter results. We delivered comparable sales growth of 5.7%, driven by a 4.8% increase in comp average ticket and transaction growth of 0.9%. Hurricane-related sales contributed 140 basis points to comp growth. Our U.S. home improvement comp was 5.1%, with positive comps in all regions and all product categories. Lumber building materials led product category growth with double-digit comps, driven by Pro demand, hurricane prep and cleanup and inflation. Appliances also posted double-digit comps, supported by our best-in-class omnichannel offering, and we achieved above-average comps in rough plumbing and electrical. We are pleased with the progress we've made to enhance our product and service offerings for the Pro customer, delivering another quarter of comps above the company average. Our integration of Maintenance Supply Headquarters and Central Wholesalers remains on track, and we continue to be excited about opportunity these acquisitions provide to further expand our products and services to serve the multifamily housing industry. During the quarter, we also advanced the customer experience through our omnichannel assets, driving 33% online comp growth. We're seeing positive customer response to our evolving omnichannel capabilities intended to meet customers at every critical moment, whenever, wherever and however they choose to engage with us. In fact, we were recently recognized by Forbes Magazine as one of the top 10 most engaged companies. This distinction highlights our commitment to engage customers with a purpose, offer consistent experiences and put the customer at the center of everything we do. Internationally, we delivered strong performance, including high single-digit comps in Canada and double-digit comp growth in Mexico in local currency. We made further progress with the integration of RONA, continuing our rollout of appliances, converting our second RONA big-box store to a Lowe's-branded store and continue to drive growth with our e-commerce platform. We're excited with the momentum in the business and believe we are well positioned for continued success in Canada. We continue to focus on improving our profitability while investing in key capabilities to drive sales growth. For the quarter, we drove diluted earnings per share of $1.05, a 19.3% increase over last year's adjusted diluted earnings per share and in line with our expectation. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $500 million of stock under our repurchase program and paid $344 million in dividends. Turning to the economic landscape. The home improvement industry remains poised to see solid growth, with job and income gains supporting consumer spending. We believe that revolving credit usage will continue to supplement spending power generated by stronger incomes. Housing is also expected to remain a bright spot. Household formation improvement this year is encouraging, and home price appreciation should continue as housing demand outpaces supply, encouraging homeowners to engage in discretionary projects, in addition to ongoing maintenance and repair spending. And as we survey consumers, we continue to see favorable trends. Our third quarter Consumer Sentiment Survey highlighted that consumers have an increasingly positive view of the national economy and continue to view their personal financial situation favorably. Given that over half of homeowners believe their home values are increasing, intent to engage in discretionary home improvement projects remain strong. Reflecting on our third quarter results, we were pleased with our continued traffic growth, driven by optimized marketing messaging and the benefits provided by strategic investments in our integrated omnichannel experience. We look to further build upon our strong foundation by developing capabilities to anticipate and support customers' evolving needs and improve our operating discipline and execution, making productivity a core strength for Lowe's. We remain committed to balancing our promotional strategy with our price optimization efforts to improve profitability, and we will further leverage our new store leadership model, which provides better management accountability while optimizing our investments in customer-facing associate hours to fully capitalize on strong traffic trends and deliver an improved customer experience. Once again, I would like to thank our employees for their unwavering commitment to serving customers and their communities. The team faced challenging circumstances this quarter, and they delivered, demonstrating our purpose-driven mission to serve the communities in which we live and work. And finally, before I turn the call over to Rick, I want to take a moment to thank him for his innumerable contributions to Lowe's. As you know, we announced this morning that Rick will be retiring after 36 years with our company, the last 5 as our Chief Operating Officer. Rick has worked across every aspect of operations and has positively impacting Lowe's customers and employees. We wish him all the best in his retirement. Richard Maltsbarger, who currently serves as our Chief Development Officer and President, International, will succeed Rick upon his retirement in February. Richard is a proven leader with a keen understanding of our business and industry. He has been instrumental in the development and implementation of our strategy. Rick and Richard have a great working relationship, and I expect the transition will be seamless. And with that, I would like to turn the call over to Rick.
Rick Damron:
Thanks, Robert. It's been an honor to work besides you and our incredible Lowe's organization and management team through the various stages of my career. I'm thrilled that Richard will be stepping into this role, and I'm confident that he will further propel the company's operations and customer experience to new levels of growth and success. I look forward to working closely with Richard over the next few months to ensure a seamless transition and will be cheering Lowe's on from the sidelines in my retirement.
During the quarter, we drove increased traffic in-store and online with compelling messaging and integrated omnichannel experiences, capitalizing on a supportive macroeconomic backdrop and customers' continued desire to invest in their homes. We delivered a 5.7% comp, achieving positive comps in all regions and all product categories. We drove double-digit comps in appliances, posting our best appliance comp in 7 quarters, leveraging our investment in customer experience, both in-store and online; our service advantages of same or next-day delivery and haul away and facilitation of repairs and maintenance; our best-in-class selection of leading brands; and our strong and strategic relationships with partners such as Whirlpool that we proudly announced as one of our 2017 Vendor Partners of the Year. We also achieved double-digit comps in lumber and building materials and above-average comps in plumbing and electrical. Lumber and building materials benefited from robust Pro growth, inflation and strong hurricane-related demand for plywood, pressure-treated lumber, fencing, shingles, drywall and insulation. And as hurricanes Harvey and Irma drove demand, our teams sent over 11,000 truckloads of products to impacted areas, supporting both Pro and DIY customers as they prepared for the storms and work to repair their properties afterward.
For the Pro customer, we also added Account Executive ProServices, or AEPs, to the Texas and Florida markets to support incremental demand. Historically, most storms have 4 distinct phases:
first, preparation in advance of the storm; second, impact when the storm actually causes damage; third, cleanup; and fourth, recovery when repairs are made and damaged items are replaced. In the third quarter, we experienced preparation, impact and some initial cleanup from hurricanes Harvey and Irma. We expect hurricane recovery to begin in the fourth quarter and extend into 2018. Given that Harvey was more of a water event and Irma was more of a wind event, we expect that the magnitude of benefit and the recovery period for Houston will surpass that of Florida.
Rough plumbing and electrical performance this quarter is evidence of the power of destination brands as our revolving brand portfolio continued to capture Pro sales and drive above-average comps in the category. Our Pro business continues to thrive with comps 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. In addition to our outstanding portfolio of brands, we're also expanding our relationship with the Pro customer across all categories with our strong value proposition, including our 5 Ways to Save as well as advancing our capabilities to connect with the Pro seamlessly across channels through LowesForPros.com and our growing ProServices team. The addition of Maintenance Supply Headquarters and Central Wholesalers further expands our capabilities to serve multifamily property management customers throughout the country with enhanced product and service offerings while strengthening our platform for future growth with this important customer. In fact, we are pleased with the early results of the MSH and Central integration efforts. The teams are leveraging best practices to build a new product catalog with an expanded offering from the maintenance, repair and operations professional, which were rolled out this spring. And we're working with our suppliers to improve terms and pricing. Finally, our ProServices teams are collaborating to serve customer needs, including serving multifamily property managers in the hurricane-impacted areas. We continue to build Pro awareness with targeting marketing as well as Pro exclusive offers to grow our share of wallet with existing Pros while also expanding our base of Pro customers. We continue to execute on our strategic priorities, including 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. We are leveraging our investments in Lowes.com, providing an upgraded online shopping experience with enhanced functionality and display for touch screen devices to deliver an optimized mobile experience; improved product and content recommendations; refined search algorithms; optimized assortments informed by digital line reviews; and expanded product views, including video content. Along with our flexible fulfillment options of buy online, pickup in-store and buy online, deliver from store and our enhanced digital marketing, our efforts combined to drive online comp growth of 33%. We will continue to advance our online platform, adding more functionality such as inventory and order status visibility to improve the customer experience. Our interior and exterior project specialists are another important element of our omnichannel strategy and a differentiated capability in capturing and serving project demand for the DIFM customer who needs a bit more help navigating their project. We're making it even easier for customers to engage with our in-home project specialists and request services on Lowes.com. And we're working to centralize our process for providing installation quotes, allowing for greater efficiency and more consistent customer experiences. We're rolling out this capability in the flooring category over the remainder of the year, with all U.S. markets expected to be online by Q1 2018 and expanding to other categories throughout 2018. We're also driving brand loyalty through our MyLowe's platform. Our simplified military recognition program allows active duty personnel and veterans to register through MyLowe's and receive 10% off their purchases every day. We're also offering free parcel shipping exclusively for MyLowe's members. We've seen great customer response with 1.5 million new memberships since we offered the expanded benefits in Q1. And we've seen those customers increase their spend by 15% after registering for MyLowe's. We continue to focus on driving productivity and profitability and drove 27 basis points of leverage in store payroll in the quarter. This leverage was primarily the result of our new store leadership model, which streamlines management hours to provide better oversight and accountability. As we discussed on our second quarter call, to more fully capitalize on our strong traffic trends and ensure we're delivering an excellent customer experience, we began adding incremental associate hours this quarter and continue to provide the necessary training and resources to all associates. We worked through the quarter to increase hours and will continue to optimize our labor allocation to ensure resources are utilized in the areas of greatest need in order to improve traffic conversion. We also made progress in centralizing indirect spend, leveraging our scale to drive efficiencies in procurement. We have now centralized 60% of indirect spend compared to 30% at the end of 2016. Our supply chain is another productivity focus area, offering opportunities to streamline costs even as we improve fulfillment options for customers. For example, we are working to consolidate freight shipments for both import and domestic freight to drive greater efficiency and optimize the flow of inventory, significantly reducing the number of trucks arriving at our distribution centers and stores, allowing us to reinvest labor in other areas. As we look forward to the fourth quarter, we are enthusiastic about our plans for an integrated omnichannel holiday experience, including exciting Black Friday and Cyber Monday events. We'll continue to highlight our project expertise and our best-in-class kitchen and appliance offerings. And we'll leverage our in-store and online assets to create unique holiday decor experiences, capitalizing on the nostalgia of the holiday season and providing cohesive decorating solutions as well as compelling gift ideas across all of our assortments. We are excited to announce the introduction of Craftsman Products in-store and online in the second half of 2018. We're committed to offering a wide selection of brands DIY and Pro customers trust, and Craftsman strengthens our ability to deliver on customer expectations across many product categories. The partnership between Stanley Black & Decker and Lowe's will bring some of the most innovative products into our omnichannel home improvement shopping experience, allowing both DIY and Pro customers even greater access to high-quality, value-oriented product offerings for the next home improvement project. We are proud to be the partner of choice in the home center channel for the Craftsman's brand and look forward to sharing additional information with you in 2018. Thank you for your interest in Lowe's, and I will now turn the call over to Marshall.
Marshall Croom:
Thanks, Rick, and good morning, everyone. Sales for the third quarter increased 6.5% to $16.8 billion, supported by total customer transaction growth of 0.7% and total average ticket growth of 5.8% to $72.63. The acquisitions of MSH and Central contributed 70 basis points of the growth in the quarter, while new stores contributed 50 basis points. The calendar shift from the 53rd week in fiscal 2016 had no impact on comp sales, but it did decrease third quarter total sales growth by approximately $60 million or 40 basis points.
Comp sales were 5.7%, driven by an average ticket increase of 4.8% and transaction growth of 0.9%. Looking at monthly trends, comps were 3.9% in August, 8.2% in September and 4.5% in October. And as Rick indicated, we drove traffic in-store and online with optimized messaging and our strategic investments in integrated omnichannel experiences, capitalizing on customers' continued desire to invest in their homes. Our teams also responded to the demand generated by hurricanes Harvey and Irma this quarter, and we estimate that the storms positively impacted comp sales by approximately 140 basis points. Gross margin for the third quarter was 34.07% of sales, a decrease of 28 basis points from the third quarter of last year. And as we've grown our market share in appliances, gross margin has been impacted from both a mix and rate perspective. Additionally, there was a mix impact from hurricane-related demand. And lastly, we continue to take competitive actions, which were partially offset by benefits from value improvement as well as early results from pricing optimization efforts. SG&A for the quarter was 22.71% of sales, which leveraged 323 basis points. In last year's third quarter, we reported $462 million in noncash charges, which drove 293 basis points of the leverage for this year. Please refer to Page 14 in our supplemental slides for a summary of those charges. The main driver of the remaining 30 basis points of leverage was 27 basis points of payroll leverage, primarily the result of our new store leadership model. Depreciation and amortization for the quarter was $358 million, which leveraged 31 basis points. Operating income increased 326 basis points to 9.23% of the sales. The prior year noncash charges accounted for 292 basis points of the increase in operating income. Interest expense for the quarter was $160 million, which leveraged 8 basis points. The effective tax rate for the quarter was 37.1% compared to 51.2% in the third quarter of fiscal 2016. The higher rate last year was driven by the joint venture noncash charge, which was a long-term capital loss. And earnings per share was $1.05 for the third quarter, a 19.3% increase over last year's adjusted earnings per share of $0.88. This is in line with our expectation. Now turning to the balance sheet. Cash and cash equivalents at the end of the quarter was $743 million. Inventory at $12.4 billion increased $1.4 billion or 12.8% versus the third quarter last year. This is primarily driven by investments in key categories such as appliances and tools as well as investments across Pro categories. Part of the increase is also attributable to the addition and the acquisitions of MSH and Central. Inventory turnover was 3.94, an increase of 5 basis points over the third quarter of last year. Asset turnover increased 12 basis points to 1.91. Accounts payable of $8.9 billion represented $1.1 billion or 13.6% increase over the third quarter of last year due to the timing of purchases and terms improvement. At the end of the third quarter, lease adjusted debt to EBITDAR was 2.16x, and return on invested capital was 19.5%. Now looking at the statement of cash flows. We generated strong operating and free cash flow in the quarter of $5.4 billion and $4.6 billion, respectively. Our capital allocation strategy first focuses on investments that align with our strategic priorities to expand our home improvement reach, develop capabilities to anticipate and support customer needs and generate profitable growth and substantial returns. For example, our acquisition of Maintenance Supply Headquarters is a strategic investment to further grow our Pro business by expanding our ability to serve the multifamily housing industry. The transaction is expected to be slightly accretive to earnings this year. And after strategic investments, we look to return excess cash to shareholders. In the quarter, we paid $344 million in dividends. In August, we entered into a $250 million accelerated share repurchase agreement, which settled in the quarter for approximately 3.2 million shares. We also repurchased approximately 3.2 million shares for $250 million through the open market. In total, we repurchased $500 million of stock in the quarter. We have approximately $2.1 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's' business outlook. We are reaffirming our guidance for the year. While we expect incremental hurricane-related sales in the fourth quarter, we continue to optimize our investments in customer-facing associate hours to fully capitalize on the strong traffic trends generated by our enhanced marketing efforts. We're also facing a tough prior year comparison, and as you know, weather in the fourth quarter is unpredictable. Also, earnings per share of $1.05 in the third quarter was again in line with our expectations. With that backdrop, for the year, we expect a total sales increase of approximately 5%, driven by a number of factors. First, we are forecasting comp sales increase of approximately 3.5%. Second, the RONA acquisition is expected to drive about 2% growth due to a full year of RONA results versus roughly 7 months from 2016. Also, we expect new stores and acquisitions of MSH and Central to add approximately 1%. Also, keep in mind, total sales growth will be reduced by roughly 1.5% related to the comparison of 52 weeks in 2017 to 53 weeks in 2016. On a GAAP basis, we are anticipating an operating margin increase of 80 to 100 basis points. Remember, full year of RONA results versus roughly 7 months last year will pressure operating margin by an estimated 15 to 20 basis points for 2017. The effective tax rate is expected to be approximately 37% for 2017. For the year, on a GAAP basis, we expect earnings per share of $4.20 to $4.30. Again, please refer to Page 14 in our supplemental slides for a summary of adjustments as you compare 2017 to 2016. We are forecasting cash flows from operations to be approximately $5.4 billion and capital expenditures of approximately $1.2 billion. This results in estimated free cash flow of approximately $4.2 billion for 2017. Our guidance assumes approximately $3.5 billion in share repurchases for 2017. Christie, we're now ready for questions.
Operator:
[Operator Instructions] Your first question comes from Peter Benedict with Baird.
Peter Benedict:
First is around the efforts to drive better conversion. Can you maybe help us with the key actions you're taking here in that area? How did the third quarter do relative to your expectations there? That's my first question.
Rick Damron:
Sure, Peter. Several actions that we're taking as we think about conversion. As you know, we have been able to begin tracking our traffic inside the stores. So it's first time we've got real solid data on a year-over-year comparison, which allows us to really understand what's happening inside of the stores. We're working through the optimization of our hours. As we talked about in Q3 or Q2, we invested incremental hours to really be able to maximize the opportunity to convert our traffic that we're seeing from the marketing spend investment and the traffic that it's generating. During Q3, we worked to fully deploy those hours, and we're able to achieve that by the end of the quarter as we added the incremental hours throughout the quarter. And now we continue to work on better utilization of those hours and deploying those during peak traffic times when we see the opportunity to increase our conversion more holistically. And as always, we continue to work on the training and development of our employees to meet the demands of our customers. So if I'm looking at it from that perspective, we've done a solid job in adding the hours that we committed to. Now we're working to continue to optimize those hours to customer traffic and continue to work on training and development of all of our employees to meet the needs of the customers.
Robert Niblock:
Peter, this is Robert. The only thing I would add is this highlighted in my comments and progress that Rick took you through with -- that we're making on this effort was somewhat impacted by our need to redeploy resources into the hurricane-affected areas, as we spoke about. So kind of get that behind us and so it, like I said, made progress and continued to be focused on it throughout the fourth quarter.
Peter Benedict:
Okay, that's helpful. And then just shifting over to some of your omnichannel stuff. Maybe talk about your delivery capabilities today, where they stand, where you think you need to take these. And also -- and you just updated commentary around buy online, pickup in-store and deliver from store, where you sit with those and where you see those going?
Rick Damron:
Yes, Peter. As it relates to -- I'll start with online, pickup and delivery from store. Those 2 aspects of omnichannel delivery have been part of our Lowes.com platform since its original launch in 1999. So it's something that we're very familiar with. From an execution standpoint, 60% of our dot-com sales are currently picked up in-store, with 40% of those customers buying incremental product when they arrive to pick up their item. Another 10% to 15% is delivered from store, with the remaining 25% to 30% being parcel. So for us, that tells a great story of the role of the store in the omnichannel environment and how our customers continue to utilize our stores for fulfillment options in our omnichannel strategy. As it relates to delivery holistically, as you know, we operate both in-house deliveries and a third-party model in order to continue to drive the capacity that we want to be able to be nimble enough to meet the changing needs of our customers. We are very pleased with our delivery programs and how our teams continue to execute against those offerings, which is evidenced by, I think, our growth in appliances, as we highlighted, which is a strong delivered category. And our teams are able to continue to meet the demands of that business and be able to drive that -- drive those sales. So we're comfortable with where we are. We continue to look at options for fulfillment. If you look at parcel, we'll be opening our first direct fulfillment center in Q3 of this year in 2018 in Nashville, and we continue to shift parcel from our stores from a fulfillment perspective.
Peter Benedict:
And anything -- that's great. And then just about -- how about delivery to the Pros? What -- how are we thinking about that?
Rick Damron:
Sure. Delivery from the Pros has been part of our ongoing programs since we've been executing against the Pro initiative. We feel very comfortable with our ability to meet the needs of the Pros through various different fulfillment options. We are able to narrow delivery windows to a 2-hour time frame for our Pros when we run through the process in the program. So we feel confident that we are able to meet their needs on an ongoing basis, both within our in-house model and the third-party models. Mike Tummillo and the Pro team continue to work on options to continue to improve that from a fulfillment perspective. So we feel good about our existing ability to execute versus the Pro as well as our ongoing strategic options that we're building out to continue to meet their needs in a dynamic marketplace.
Operator:
Your next question comes from Brian Nagel with Oppenheimer.
David Bellinger:
This is David Bellinger on for Brian. So a couple of questions from us. First one on the progression of comps throughout the quarter. You're coming off the strong 7.9% gain in July, and that's slowed to 3.9% in August. Can you give us more detail on what drove that? And was there more traffic versus ticket? And also, what led to the improvements in September and October? Was there some type of internal change you made or in addition to the $200 million lift from the hurricanes?
Marshall Croom:
I'll take the first part. I mean, we were actually pleased with what we're seeing from in-store and online traffic in August. And as Rick mentioned, we were working on investing in increasing our associate hours for customer facing in the areas where we needed them most to ultimately help us drive better conversion. So as that played out in the quarter, we began to see that pick up in September, but a little bit soft in August.
David Bellinger:
Okay. And then just looking at the comp guidance for the year and sticking with the 3.5%. It looks like comps year-to-date are up about 4%, and that implies Q4 slowing to something below 2%. Should we read anything into that? Or is that simply conservatism in your forecast? And can you comment on the early trends into November and how that compares to what's implied in your outlook?
Marshall Croom:
Okay, certainly. We think that our guidance for the quarter and for the year is appropriate and balanced as we look to invest in running the business and continue to invest in our ongoing capabilities. We are confident in our ability to drive traffic in Q4. We do expect some benefit from the hurricanes as we move into Q4 and into 2018. But one of the things again, we've been optimizing our selling hours in the stores, and still improving that, like where we are today. But again, recognize Q4, we have tough comparisons to last year. As we mentioned, weather can be kind of wildcard in the fourth quarter. So just keep those in mind as we head into Q4. As far as where we are quarter-to-date, we're just slightly ahead of our expectations for the quarter.
Robert Niblock:
Dave, this is Robert. I would layer on this. As Marshall talks about tough comparisons to the prior year, keep in mind that we also slightly in the fourth quarter of last year had the benefit of hurricane Matthew and the Louisiana flooding. So we've tried to take all that into our guidance. And just to reiterate, we're seeing approximately 3.5% comps for the year is what we're looking at. So...
Operator:
Your next question comes from Kate McShane with Citi.
Kate McShane:
My question is centered around the multifamily acquisitions that you made. It's helpful for you to break out the contribution of that business going forward. But I wondered if you could walk through how the integration is going and how much of a lift do you expect in your stores once it rolls out to all the Lowe's stores?
Marshall Croom:
Sure, Kate. The integration, as I talked about in my opening comments, is going extremely well. The organizational aspects of the design have been implemented as we continue to work to integrate the 2 companies. And we're seeing some strong leverage from our initial business case through working to continue to harmonize our pricing and our terms with our merchants and working with Mike's organization to make sure that we're able to leverage that and continue to move forward. Our existing focus currently is to continue to work on the integration of both companies into one operating model. As I highlighted, we are -- the teams are building out a new product catalog, which will effectively improve the customer experience across both verticals. And then as we continue to move forward, we will continue to work for the in-store integration, but that is further out in the current integration plans than today. Currently, it's really focused heavily on the integration of the 2.
Kate McShane:
Okay, great. And my second question was just on the growth that you saw for ticket above $500. Was the majority of that driven by appliances? Or can you help us break down some of the bigger categories that drove that growth?
Michael McDermott:
Sure, Kate. This is Mike McDermott. We continue to see great progress in the appliance business, obviously leveraging our #1 share position and the great brand portfolio and values that we're communicating to our customers. We also continue to see Pro outpace the company average, and Pro certainly is also driving significant growth in big ticket. So our project specialists, interior and exterior, continue to drive remodel and refresh business across a number of different categories. And we continue to see momentum really across the business in regard to tickets above $500.
Operator:
Your next question comes from Christopher Horvers with JPMorgan.
Christopher Horvers:
Can you talk about the comp trends in Canada and Mexico? It seems like they did improve from the last quarter. Did RONA contribute to that comp? I think it was only in the quarter for a partial period. And can you talk about how much the FX lifted the reported total comps as well?
Richard Maltsbarger:
Yes, Chris. This is Richard. The -- we had a very strong quarter up in Canada. As Robert noted in his comments, we had a high single-digit comp within Canada, and there is a very strong contribution to that across all of the different banners. Just a small point, we actually had RONA in our comp for the entire quarter this quarter. So this will be the first quarter where all of their sales are rolled into our comp comparisons. And as Robert said, we are very strong -- we're very pleased with the progress that we're making there. We have brought our first 2 big-box evolutions live from the RONA brand into the Lowe's brand out from Western Canada. We're underway with several more now. We have expanded our appliance mix to more than 70 stores on track and above our plan in terms of rollout, given the opportunity for share in the appliance market in Canada. And we're seeing really good strong Pro results in our business in Canada, given our higher mix of the Pro across our different banners, including those specifically focused on the Pro in both Quebec and out west. Similarly, very strong, as Robert noted, double-digit comps in Mexico. I'm very proud of the team there. The team has also, to the plan that we laid out last year, had begun down the path of expansion again, having recently opened 2 new stores in the Monterrey, Mexico market and putting us well on path to our goals to double the business across 3 years.
Christopher Horvers:
And then the FX contribution? And then I had a follow-up.
Marshall Croom:
That was fairly minor for the quarter. It was largely driven by operational results from Canada and Mexico.
Christopher Horvers:
Okay, understood. And then how -- I was curious how you thought about the market growth rate in the U.S. and that the census category show about 7%-ish type growth year-to-date. You're running year-to-date about 5%. And in 3Q, that gap persisted. Do you think the census is a fair estimation of the market growth rate? Do you have insights into sort of market share trends in the key categories, I think, because one of the questions that we get from investors is not per se the comp gap, but just trying to understand how your share is playing out in the United States relative to the census benchmark.
Robert Niblock:
The -- Chris, certainly, I mean, it's indicator of the health of the overall market. It's not a perfect match. We look more specifically at just -- at the leading indicators from housing from home improvements. We feel really good about that. We think that leading indicators certainly remain supportive, have done a good job and income gains, driving strong growth in both disposable income and consumer spending, revolving credit usage continuing to be favorable as we mentioned it and probably most important, home price appreciation, which is driving increased housing wealth. So as we look at that, we feel good about the macro environment. We feel good about housing. We feel good about from looking at things like our Consumer Sentiment Survey, homeowners' willingness and intention to engage in projects around the home, driven by one of their views of the overall housing market is as well as views about the increasing values of their homes. So overall, we feel good about it. And as Mike said, when we look at our trajectory of comp growth, as we look at the quarterly progression that we've had through the year, the focus of the team has put behind -- improving our execution. And we're pleased with our performance and excited about the opportunity ahead of us.
Operator:
Your next question comes from Charles Grom with Gordon Haskett.
Andrew Minora:
This is Andrew Minora on for Chuck. I have one question on hurricane impacts. Can you guys quantify the impact on gross profit margin and SG&A from hurricanes? And I have one follow-up.
Marshall Croom:
So ultimately, the gross margin impact obviously hurt our mix because it is below average company rate on the gross margin. So that certainly had an impact. We did have incremental SG&A expenses, but all told, net-net, while it was slightly positive, it wasn't a driver to our earnings for the quarter.
Andrew Minora:
Okay. That's helpful. And then just on the Pro comments. I mean, it's just -- it's a little bit nitpicky, but you guys went from saying the growth is well above the company average to above the company average for the last 2 quarters. Is that more a function of the overall comp doing better last 2 quarters? Or are you seeing any slowdown in the Pro business? Any color there would be helpful.
Michael McDermott:
This is Mike. What I've highlighted is we continue to see positive strength in our DIY business, which maybe tightens the balance between Pro performance and DIY. I still feel very good about our Pro performance. Team is doing a great job engaging the customer in a variety of different segments across that marketplace. Pro represents about 30% of our business, and we continue to see expanded penetration.
Operator:
Your next question comes from Michael Lasser with UBS.
Michael Lasser:
Can you give us some quantification of how far along you are into the competitive pricing actions you've been taking? Are you close to being done?
Michael McDermott:
Michael, this is Mike McDermott again. Obviously, we're going to continue to react to the competitive intensity of the marketplace. I feel good about the actions we took coming out of the first quarter when we recognized an opportunity to improve our value perception. Team has done a great job on both base price, stock and SOS as well as our promotional pricing strategy to make sure that we are delivering those great values in the market to our customers. I also feel good about the actions the team is taking around leveraging new pricing and analytics tools and refining our pricing strategy across categories to make sure we're optimizing our effectiveness. Recognize that in the May time frame, we also drove 2 loyalty actions, which are having a positive impact. The first was our simplified approach to military recognition, offering both active and veteran military personnel the ability to enjoy 10% discounts every day. And on top of that, we launched free parcel delivery for MyLowe's members. So we're seeing both customer growth and loyalty from those actions and -- but they will have some impact as to our gross margin performance.
Michael Lasser:
And are you seeing competitors respond as you take price actions?
Michael McDermott:
Yes, I think the marketplace remains competitive. And what I would tell you, as I look at third quarter versus second quarter, it's consistent with our expectations. And as we go into the fourth quarter, again, I think consistent with where we were in 3Q.
Operator:
Your next question comes from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Hello. Can you hear me?
Robert Niblock:
Yes.
Michael McDermott:
We can hear you now.
Simeon Gutman:
Sorry. Okay. I was on the different line. A follow-up to Michael's question. It's around gross margin. And in this quarter, in the slide deck, the gross margin headwind was described -- one of them was described as competitive actions. If in the first quarter you called the pricing investments, in second quarter you called the promotional activity, can we discuss what these descriptions? Are they just different ways to say the same thing? And then, Mike, just to follow up on that, can you describe what's going on in the marketplace broadly?
Michael McDermott:
Yes, Simeon, what I would tell you is that you should translate both of those descriptions as the same. When you think about promotional activity, actually think about advertising and promoting value with a customer as well as some of the actions I highlighted around loyalty. So they would be in the same bucket. And as it relates to, again, the competitive environment, consistent with our expectations.
Simeon Gutman:
Okay. And then regarding execution, we've talked over the past 12 months, there's been some management change. There was -- we talked about some inconsistency between merchants and some of the marketing, and then you've added some labor hours back to stores. If you think about how you performed in Q3 and going forward, are the bumps more or less ironed out? And can you talk about where you could be or where you should still be getting better?
Robert Niblock:
Yes, Simeon, I'll start and let the others jump in. Yes, certainly, we've made a lot of changes to set us up for the future. As I said, we're pleased with the -- our new store leadership model and what we're seeing out of that. I'm pleased with the work that's being done to try and add hours back into the stores. As Rick indicated, we'll continue to focus on getting those hours in the right kind of daypart if you wanted to focus on the high profit at times to better match with customer demand. There was certainly a little bit of an impact as we had to redeploy people to the hurricane-affected areas in the quarter. In addition to that, we've -- as we indicated earlier, we made some changes to the organizational structure here, corporate office to kind of flatten the organizational structure, improve our span of control and we're pleased with the way the team has responded and working together to focus on driving the business forward, so.
Operator:
Your next question comes from Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things for you. First of all, the step-up in online growth the past 2 quarters. I know a component of that is easier compares to some changes you were making a year ago. But just curious if you give us a little bit more color what's driving that? And also, if there are categories that are leading that improvement? Some insight on that would be helpful.
Michael McDermott:
Eric, I'll take that. We continue to see great progress as it relates to our digital performance with the 33% comp we saw for the quarter. We continue to optimize our online platform. We continue to add and invest in additional functionality, improving everything from content to our checkout process, adding visibility for the customer around inventory and order status and essentially driving more of a simple and seamless approach online. When I think about the categories that continue to perform well, appliances, fashion fixtures and seasonal outdoor living led the way as it relates to our online performance. So team's doing a great job bringing that experience to life and connecting it to our overall omnichannel platform and driving additional traffic into our stores.
Eric Bosshard:
Secondly, it was roughly a year ago that you all started to talk about productivity. And I'm curious now coming up on a year later within this, what the emphasis is within this now. It seems like it started with a little bit more focus on profitability. Feels like you're trying to shift to a little bit more balanced or focused on sales. But I'm just curious how you're thinking about the productivity initiatives, especially with the 2% comp in 4Q and the 3.5% in a year where the market feels like it's stronger, which way are you leaning and focusing on with the productivity initiative?
Marshall Croom:
Eric, this is Marshall. Actually, yes and yes, we want both, sales productivity and SG&A productivity cost out. So those will continue to be focus areas. So if you think about some of the investments we're making from the omnichannel capabilities, we want those to be sales drivers. If you think about processes within the stores from this customer experience to services, again, trying to eliminate employee and customer pain points. But we've got good line of sight into actions one that we took this year. Rick highlighted a couple of those with indirect spend, moving the needle on how much we centralized indirect spend, along with some of the changes we've made to the payroll staffing model, the leadership changes that we made earlier in the year, along with things that we're doing from supply chain efforts to drive better productivity, reduce burden for the distribution center and stores. So all of that wrapped up into the amount of investments we've made in 2017 to be able to drive flat operating margin on an adjusted basis for 2017 and knowing that we've got future opportunity to keep getting after it from a productivity standpoint, so moving to '18 and '19 and beyond.
Operator:
Your next question comes from David Schick with Consumer Edge Research.
David Schick:
On -- you're talking about Craftsman, and I know there's been work on merchandising around Pro. Is there any metric you can give to the amount of skew or category newness that you're introducing now versus the past?
Michael McDermott:
Yes, Dave, we don't really look at it that way as it relates to new assortment. But what I can tell you is the merchants continue to work with our strategic partners across every category to make sure that we refine our assortments and expand value. Obviously, we're very excited to welcome the Craftsman brand to the Lowe's portfolio, iconic brand that customers know, innovation and high quality and value. So if you think about all the brand work that we've done over the last 4 years, adding more than 25 brands back to the portfolio, brands that DIY and Pro customers know and trust. I really think Craftsman, when it launches in 2018, will continue to propel us forward with customers in both of those segments.
David Schick:
Great. And then any comment on how you're thinking about the wage -- potential wage pressures on your business, just that we're observing in the economy, whether nationally or regionally would be helpful?
Marshall Croom:
Yes. Again, as we think about that, obviously, there's been some wage pressure. Just one of the things that our productivity efforts are designed to help offset, along with continuing to challenge, are we rightsizing the staff and the stores and the DCs and corporate offices and always looking to balance, again, how we're getting better productivity in the processes throughout supply chain and then the appropriate mix of hours in the stores from selling and nonselling to make sure that we're appropriately flowing freight, taking care of our customers and providing the best experience that we can.
Michael McDermott:
And David, I will just add that based on the model and experiences we try to create and a product knowledge required of our associates, we pay a higher average hourly rate already than the marketplace, so that helps us also mitigate that, just understanding the fact that because of the model itself, we do have a higher rate than the industry as well.
Marshall Croom:
Yes. And we take a look at it, not just on the base rate, but all in from incentives and benefits to be competitive in the marketplace.
Robert Niblock:
Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you, again, when we report our fourth quarter results on Wednesday, February 28. Have a great day.
Operator:
This concludes today's conference call. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' Second Quarter 2017 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. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Richard Maltsbarger, Chief Development Officer and President, International; and Mr. Mike McDermott, Chief Customer Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's.
We delivered second quarter comparable sales growth of 4.5%, driven by improved transaction growth of 0.9% and a 3.6% increase in average ticket. We're pleased with our improved top line performance versus Q1 and the acceleration of our comp growth through the quarter as we built momentum with successful holiday events and enhanced messaging, driving traffic improvement to end the quarter with comp sales of 7.9% in July. Our U.S. home improvement comp was 4.6%, with broad-based project demand across product categories and geographies. We achieved positive comps in 13 of 14 regions and in all product categories. Appliances led product category growth with high single-digit comps, leveraging our investments in customer experience, both in-store and online. We achieved strong comps in lawn and garden as we capitalized on seasonal demand. We also continued to advance our Pro business, driving outperformance in rough plumbing and electrical and lumber and building materials. While we're pleased with our sequential comp growth through the quarter, we are disappointed with some aspects of our performance during the first half of the year. In the first quarter, we identified an opportunity to drive more traffic with improved messaging and an optimized promotional strategy. We amplified our marketing messages in early June, and we're pleased with our traffic growth. However, in the second quarter, comp growth was constrained as a result of disruption caused by changes to our store staffing model earlier in the year, which became more apparent with increased traffic. While we remain confident that the leadership model is right for our long-term growth, change brings certain short-term challenges. I'm proud of the way our teams are responding diligently to respond to these challenges, filling open positions, learning new roles and adapting to the new model. But we also recognize an opportunity to invest in incremental customer-facing hours to ensure that we're providing an excellent customer experience in light of increased traffic. We're taking these decisive actions to ensure our results meet our expectations going forward. We continue to advance our omnichannel strategy, driving 43% comp growth on Lowes.com this quarter. A year ago, we upgraded our online shopping experience to make it easier for customers to find the products and information they're looking for. In fact, Internet Retailer recognized us with an excellence award for Web Redesign of the Year. We will continue to make omnichannel investments to ensure we're supporting customer needs and seamlessly connecting with them whenever, wherever and however they choose. During the quarter, we made further progress to enhance our product and service offering for the Pro customer, delivering another quarter of comps above the company average. In addition to Central Wholesalers last year, we further expanded our Pro customer reach and share of wallet with the acquisition of Maintenance Supply Headquarters. These acquisitions are significant steps forward in our strategy to deepen and broaden our relationship with new and existing Pro customers, enabling us to better serve the multi-family housing industry through expanded products and services. Internationally, we delivered solid mid-single-digit comp growth in both Canada and Mexico. We continue to make great progress with our RONA integration, including the conversion of our first RONA big-box store to a Lowe's-branded store, where we're combining the best of Lowe's store experience, merchandising and brands with the best elements of RONA's strong Pro offerings to create a new, stronger Lowe's for the Canadian market. And we remain excited about the successful execution of our e-commerce strategy, improved operating efficiencies and the further rollout of appliances across our national footprint in Canada. We continue to unlock the full value of the acquisition, which will culminate in over $1 billion of realized revenue and cost opportunities. For the quarter, we delivered earnings per share of $1.68. These results included a $96 million gain from the sale of our interest in the Australian joint venture. Adjusted earnings per share were $1.57, a 15% increase over last year's adjusted earnings per share. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $1.25 billion of stock under our share repurchase program and paid $299 million in dividends. Turning to the economic landscape for the second half of the year. The home improvement industry should continue to see solid gains as consumer health remained strong and economic fundamentals continued to support solid spending growth. Persisting job and income gains should continue to drive disposable income growth, and favorable revolving credit usage continues to hover near the highest rates of the current economic expansion, supplementing the spending power generated by stronger incomes. The outlook for housing remains a -- the outlook for housing remains bright as household formation in the first half of the year is encouraging and expected to continue amidst steady job gains. Home price appreciation should persist as housing demand continues to outpace supply. And mortgage rates, drifting lower from their postelection levels, should support home affordability in the near term. Our second quarter Consumer Sentiment Survey underscored similar favorable trends. Consumers continue to have a favorable view of the national economy and their personal financial situation. Over half of consumers believe their home value is increasing and have strong expectations for continued appreciation, resulting in strength in home improvement project intentions. Looking ahead, we're focused on further strengthening our operation -- operating discipline and investing in capabilities that maximize value for customers and shareholders. We will continue to leverage our new store leadership model and make necessary investments to customer-facing hours to further improve the customer experience. We will also enhance our marketing efforts and leverage promotions in key areas to drive sales in what we believe is a supportive macroeconomic backdrop for home improvement. We're confident that these investments position us for future success. We will also continue to capitalize on our strengths in capturing project demand in the marketplace and further invest in specific actions required to better serve the needs of Pro, DIY and DIFM customers. We've seen positive customer response to our evolving omnichannel capabilities, continuing to meet customers at every critical moment, whether they choose to connect in the store, online, in their home, from their job site or through Lowe's' contact centers. Importantly, I would like to thank our more than 290,000 employees for their passion and commitment to serving customers. Before I close, I want to stress that we are taking decisive action. The team is focused on executing the plans we have in place to capitalize on our strong position in the market. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning, everyone.
As Robert shared with you, we saw significant improvement in our Q2 comp sales as we drove increased traffic to our stores and Lowes.com. We successfully leveraged holiday events designed to take advantage of spring and summer project demand with amplified marketing messages, compelling offers and an integrated omnichannel experience. In fact, we built momentum as we moved through the quarter, reflected in our significant traffic improvement in June and July. Value perception was a theme we discussed in Q1, and I'm pleased to say that we made great strides this quarter. We took a surgical approach to selecting the right products and price points to message in the right media channels, successfully highlighting Lowe's everyday competitive pricing. In the second quarter, we achieved positive comps in 13 of 14 regions and posted positive comps in all product categories. We delivered a 4.5% comp, with balanced performance in both indoor and outdoor categories. As we capitalize on a supportive macroeconomic backdrop and customers' continued desire to invest in their homes with our project inspiration and expertise, events and targeted promotions, we drove above-average comps in categories such as appliances, lawn and garden, lumber building materials and rough plumbing and electrical. We drove high single-digit comps in appliances, leveraging our investments in customer experience, both in-store and online. We know that an omnichannel experience is critical for appliance customers as they gather information to give them confidence in their selection. In-store, we have invested in a best-in-class experience, with an extensive product showroom and a broad selection of leading brands, as well as expert associates, who can provide valuable advice, and appliance suites, which allow customers to visualize how their appliance purchase will look in their refreshed or remodeled kitchen. And online, we have continued to invest to enhance the customer experience with an improved product search, integrated and upgraded product videos, enhanced presentations like 360-degree views, extended descriptions and specifications and simplified groupings to make it easy for customers to fully research our extensive appliance options and make their selection with confidence. Our omnichannel customer experience, together with leading brands, breadth of assortment, competitive pricing, knowledgeable sales specialists as well as service advantages of same or next-day delivery, haul away and facilitation of repairs and maintenance continues to drive our performance in appliances. We capitalized on seasonal demand, driving above-average comps in lawn and garden, with particular strength in live goods and lawn care as well as double-digit comps in patio. Once again, we saw continued strength from the Pro customer with comps above the company average. Pro demands drove solid comps in rough plumbing and electrical as we captured Pro sales by improving our assortment with destination brands like SharkBite, the industry leader in plumbing fittings. We continue to be excited about the effectiveness of destination brands in attracting Pro customers. This strength is evidenced with the addition of A. O. Smith, the leading brand of residential water heaters, which drove double-digit comps in the category. Pro demand also drove strong comps in lumber and building materials. In addition to our outstanding portfolio of brands, we're also deepening and broadening our relationship with the Pro customer across all categories with our strong value proposition through our 5 Ways to Save as well as our omnichannel offering through our growing ProServices team and LowesForPros.com. We continue to evolve our capabilities to better connect with the Pro across channels and make it simpler for them to do business with Lowe's. We're seeing the Pro engage in more -- more in the channels that best fit their unique needs, whether that's online with LowesForPros.com, at the market level with our Account Executive ProServices, or AEPs; at the store level with our dedicated teams of specialists; or our growing national ProServices team. The addition of Maintenance Supply Headquarters complements our acquisition of Central Wholesalers last year and further expands our capabilities to service multi-family property management customers throughout the country with enhanced product and service offerings while strengthening our platform for future growth with this important customer. We continue to leverage targeted marketing as well as Pro exclusive offers to grow our share of wallet with existing Pros while also generating new business. We're also driving increased awareness of our enhanced Buy in Bulk program with new signage in-store, messaging on LowesForPros.com and marketing campaigns to showcase the great values we provide for the Pro. We remain focused on leveraging our omnichannel capabilities to help DIY and DIFM customers throughout their project journey. This quarter, we drove 43% comp growth on Lowes.com, driven by events as well as continued strong customer response to the investments we made to enhance our online shopping experience such as optimized functionality and display for touchscreen devices to support a better mobile experience; improved product and content recommendations; refined search algorithms; improved click-to-chat capabilities; larger product images; optimized assortments informed by digital line reviews; and expanded product views, including video content. We're also leveraging our MyLowe's platform to drive brand loyalty. Our simplified military recognition program allows active-duty personnel and veterans to register through MyLowe's and receive 10% off their purchases every day. We're also offering free parcel shipping exclusively for MyLowe's members. Our interior and exterior project specialists are another critical element of our omnichannel strategy and a differentiated capability in capturing and servicing project demand for the DIFM customer, who needs a bit more help navigating their project. We're advancing our omnichannel experience, making it even easier for customers to engage with our in-home project specialists and request services on Lowes.com. And we're working to centralize our process for providing installation quotes, allowing for greater efficiency and consistency. We're rolling out this capability in the flooring category over the course of the year, with all U.S. markets online by Q1 2018. As Robert discussed, comp growth improved sequentially through the quarter but was constrained as a result of the disruption caused by our changes to our store leadership model earlier in the year. Those changes streamlined management to provide better leadership and accountability. Specifically, we reduced the number of assistant store managers and eliminated the department manager role and created the service and support managers in an effort to increase stores' focus on training and empowering associates to deliver an improved customer experience. We are confident that the leadership model is the right one for our long-term growth to more fully capitalize on our strong traffic trends and ensuring we're delivering an excellent customer experience. We are investing in hours at the customer service associate level. As we look forward to the second half of 2017, we are excited by our new floor tile reset, which showcases leading style options, simplifies the shopping experience and helps the customer visualize how their new floor will look in their home. We're also proud to announce the launch of Scott Living indoor furniture, with fully coordinated collections from Drew and Jonathan Scott of HGTV's Property Brothers available on Lowes.com. Our digital showroom features coordinated looks and design tips, helping customers envision their newly decorated space. We will continue to focus on optimizing our digital marketing efforts to deliver customized messaging and compelling content to the right customer at the right time, driving improved engagement and increased sales. While we've already seen positive results from these efforts, media optimization is an ongoing process. Thank you for your interest in Lowe's, and I will now turn the call over to Marshall.
Marshall Croom:
Thanks, Rick, and good morning, everyone.
Sales for the second quarter increased 6.8% to $19.5 billion, supported by total customer transaction growth of 3.1% and average total ticket growth of 3.5% to $71.40. RONA sales were approximately $1 billion or 3% of sales growth. As a result of the calendar shift from the 53rd week in fiscal 2016, this year's second quarter included 1 less week of spring and 1 more week of summer than last year. While this had no impact on comp sales, it did decrease second quarter total sales growth by approximately $285 million or 1.7%. Comp sales were 4.5% for the quarter, driven by an average ticket increase of 3.6% and improved transaction growth of 0.9%. RONA was included in the comp calculation for the first time in the month of July. Looking at the monthly comp trends. Comps grew 0.6% in May, 5.3% in June and 7.9% in July. As Robert and Rick indicated, we were pleased with our improved top line performance versus Q1 and the acceleration of our comp growth through the quarter as we built momentum with successful holiday events and enhanced messaging, driving traffic improvement in both June and July. During the quarter, we continued to capitalize on market opportunity as we opened 4 more new stores in the U.S., which drove 80 basis points of growth. Gross margin for the second quarter was 34.21% to sales, a decrease of 23 basis points from the second quarter of last year. The decline was primarily the result of promotional activity and excessive benefits from Value Improvement and 10 basis points of inflation. SG&A for the quarter was 20.16% of sales, which leveraged 101 basis points. In last year's second quarter, we recorded an $84 million loss on the settlement of a foreign currency hedge entered into in advance of the RONA acquisition. This provided 46 basis points of leverage this year. An additional 49 basis points of leverage was driven by a $96 million gain from the sale of our interest in the Australian joint venture. Also, we drove 20 basis points of favorable leverage primarily as a result of our new store leadership model. Somewhat offsetting these items was 10 basis points of deleverage in advertising as a result of our efforts to amplify our consumer messaging. Depreciation and amortization for the quarter was $357 million, which leveraged 20 basis points. Operating income increased 98 basis points to 12.2% of sales. The comparison to the prior year loss on the foreign currency hedge positively impacted operating income by 46 basis points. And the gain from the sale of our interest in the Australian joint venture also positively impacted operating income by 49 basis points. Interest expense for the quarter was $159 million, which leveraged 10 basis points. Effective tax rate for the quarter was 36.2% compared to 38.1% in the second quarter of fiscal '16. The year-over-year change in our effective tax rate was primarily the result of the gain from the sale of our interest in the Australian joint venture. The gain represents the proceeds in excess of book value but did not result in tax expense in the quarter due to a reduction of previously established deferred tax valuation allowances. Earnings per share on a GAAP basis was 1.68% for the quarter. The gain from the sale of our interest in the Australian joint venture increased EPS by approximately $0.11 for the quarter. Adjusted earnings per share was $1.57, a 14.6% increase over last year's adjusted earnings per share of $1.37. Turning to the balance sheet. Cash and cash equivalents at the end of the quarter was $1.7 billion. Inventory at $11.4 billion increased $803 million or 7.6% versus the second quarter of last year and was primarily driven by appliances to support sales growth as well as timing associated with seasonal builds. Inventory turnover was 4x, an increase of 11 basis points over the second quarter of last year. Asset turnover increased 8 basis points to 1.86. Accounts payable of $8.6 billion represented a $953 million increase or 12.4% over the second quarter of last year due to the timing of purchases and terms improvement. At the end of the second quarter, lease-adjusted debt-to-EBITDAR was 2.21x. Return on invested capital was 17%. The net impact of the gain from the sale of our interest in the Australian joint venture and prior year charges negatively impacted ROIC by 153 basis points. Now looking at the statement of cash flows. We generated strong operating and free cash flow in the quarter of $5.1 billion and $4.6 billion, respectively. As we allocate capital, we are focused on investments that align with our strategic priorities to expand our home improvement reach, develop capabilities to anticipate and support customer needs and generate profitable growth and substantial returns. Our recent acquisition of Maintenance Supply Headquarters demonstrates how we've made strategic investments to further grow our Pro business by expanding our ability to serve the multi-family housing industry. The transaction is expected to be slightly accretive to earnings this year. After strategic investments, we look to return excess to cash shareholders. In the quarter, we paid $299 million in dividends. And in May, we entered into a $500 million accelerated share repurchase agreement, which settled in the quarter for approximately 6.4 million shares. We also repurchased approximately 9.4 million shares for $750 million through the open market. In total, we've repurchased $1.2 billion of stock in the quarter. We have approximately $2.6 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. First, as we discussed, we were pleased with the acceleration of our comp growth through the quarter, the result of our amplified marketing messages, compelling offers and integrated omnichannel experience. The incremental investments we've made in these areas are paying off. We will continue those investments into the second half of 2017. Second, as Robert and Rick shared, we've also made the decision to reinvest in incremental customer-facing hours in the second half. We believe this will allow us to more fully capitalize on our strong traffic trends and ensure we're delivering an excellent customer experience. Finally, we are seeing incremental pressure from a private-label credit card program due to increase in program costs driven by higher losses as well as casualty claims due to increased workers' compensations costs. We still expect a total sales increase of approximately 5% driven by a number of factors. First, we are forecasting a comp sales increase of approximately 3.5%. Second, the RONA acquisition drives about 2% growth. And also, we plan to open 25 stores, which represents approximately 1% sales growth. Keep in mind, total sales growth will be reduced by roughly 1.5% related to the comparison of 52 weeks in 2017 versus 53 weeks in 2016. However, on a GAAP basis, we are now anticipating an operating margin increase of 80 to 100 basis points as a result of the investments and incremental expense pressures that I just described. Remember, a full year of RONA results versus roughly 7 months last year will pressure operating margin by an estimated 15 to 20 basis points for 2017. The effective tax rate is expected to be 36.9% this year. For the year, on a GAAP basis, we are now expecting earnings per share of $4.20 to $4.30. Please refer to Page 13 in our supplemental reference slides for a summary of adjustments as you compare 2017 to 2016. We are forecasting cash flows from operations to be approximately $5.9 billion and capital expenditures of approximately $1.4 billion. This results in estimated free cash flow of approximately $4.5 billion for 2017. Our guidance does assume approximately $3.5 billion in share repurchases for 2017. Regina, we're now ready for questions.
Operator:
[Operator Instructions]
Our first question comes from the line of Peter Benedict with Robert Baird.
Peter Benedict:
First, just on the store labor hour investment. Is that full time or part time? Is that weekend, weekday? Help us a little bit more about what you're going to be adding there.
Rick Damron:
Sure, Pete. This is Rick. We are primarily focused on adding the incremental labor to the weekend time frames as well as high-traffic area time lines during the week. The effort is to continue to retain our seasonal labor from our spring hires as those still have significant knowledge. And we're simply retaining those whereas historically, we would be moving down from a stack and labor standpoint into the fall from the peak of summer.
Peter Benedict:
Okay, that's helpful. And then as you guys think about -- I know back in the December meeting, kind of the 3-year plan that was laid out had some benchmarks, 25 basis points of flow-through, around 50% OpEx growth as a percentage of the sales growth. Obviously, 2017 numbers aren't meeting those objectives. What -- curious kind of -- or do we need to rethink kind of the longer-term algorithm a little bit here? Or you assume a little bit more OpEx, a little less flow-through? Is that how we should be thinking about it? Just curious your thoughts here.
Marshall Croom:
Yes, Peter, this is Marshall. We are maintaining our targets that we previously communicated back in December. Obviously, this year won't hit those targets, but productivity is still alive and well, and it's actually helping us offset the incremental investments we're making this year. And we know we've got more runway to go as we move forward. So the investments we're making from staffing, again we're leaning into it to take advantage of the increased traffic, leaning into optimize promotions and knowing that we've got opportunities to utilize price optimization tools, continuing evaluate improvement efforts and continuing to evaluate promotional effectiveness. And so longer term, we've got other productivity measures for optimizing labor, leveraging fixed costs, reducing indirect spend, lower depreciation and enhancing profitability in Canada.
Robert Niblock:
Yes, Peter, this is Robert. As Marshall outlined, we're still holding to our 3-year guidelines that we gave last year and productivity is still a key focus that we're working on. We've seen actually a lot of benefits from our productivity efforts. As we've outlined, part of those is part of what Mike McDermott and his team did, is in amplifying and improving our marketing message, particularly when we look at opportunities in the digital space. We saw great results from that, including the improved traffic performance that we saw in the stores. I mean, we think we got a better opportunity to capitalize on that. So what Rick and his team are doing is saying, let's hold the labor that we normally would have been pulling back on, see if we can do a better job of capitalizing on that and see if we can drive incremental sales through the process. So that's what we're doing, is reinvesting on some of the benefits of productivity in what we feel is a strong macro environment, so.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Joshua Siber:
This is Joshua Siber on for Simeon. On gross margins, what's going to enable you to make numbers in the back half? Because it looks like gross is expected to be up. Just curious your thoughts there.
Michael McDermott:
Yes, this is Mike McDermott. Obviously, as we communicated at the end of the first quarter, we needed to focus on improving our value perception and making sure we were amplifying our marketing reach with our customers. We did that by leaning hard into changing our anchor points and communicating critical values to customers. We're also continuing to improve our competitiveness, both on in-stock as well as special order items, and that's putting some level of pressure on gross margin. We've got optimization efforts in place, working closely with our vendors to make sure we're improving our first cost as well as pricing tactics, making sure that, from a head core tail perspective, we're competitive on head items, where required, and we're working hard on pricing tail items to make sure we're harvesting profitability to offset that investment. So we've got a lot of work under way in the merchandising team to balance the improvement of value perception with our cost position.
Joshua Siber:
Okay. And then the long-term EBIT margin guidance of 11.2%, it's a pretty substantial expansion from what's expected to be in '17. So how do investors gain confidence in that margin opportunity? And do you think this happens in the back half or in 2018?
Marshall Croom:
Again, just recognizing that those were 3-year targets, so it won't be all accomplished in 2017. So it'll be baked into the productivity opportunities we have moving forward, again leveraging the traffic driver with marketing optimization, again focusing on optimizing labor. As we move forward, that will continue to be an ongoing discipline. So even with the reinvestment in back half of the year, we'll still leverage payroll in 2017. And again, excited about the other opportunities we have from a productivity standpoint to drive towards that 11.2% EBIT growth, that target that we set. So -- and obviously, very excited with what we have in the Pro space with the Maintenance Supply Headquarters and opportunity to grow and expand that footprint and leverage back into our existing store base.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Just curious, how would you think about the shift of the spring business in 2017 between the first quarter and the second quarter? And to play devil's advocate, we've heard others, such as Tractor Supply and Scott's, talk about a very strong July. So what gives you the confidence that July's strength is actually driven by your actions versus the weather working with you that month against the backdrop of what's been a pretty tough year otherwise?
Michael McDermott:
This is Mike McDermott. I can lay some foundation there. Actually, I feel good as we take a look at our July performance was very well balanced across categories. And we certainly enjoyed positive performance across all products and outside and inside -- indoor categories. So it was not all isolated to just seasonal in the June and July time frame. At the same -- to that same message, we did enjoy an extended spring. It was clear our Lawn and garden business did perform above the average, and the team took full advantage of those weather conditions to really highlight the quality of our products. The merchants and the growers did a fantastic job on quality of live goods, and we feel really good about our performance of our private-label Sta-Green fertilizers, seed and soil products. So innovation as well as market events served us well.
Christopher Horvers:
And can you talk about your view on share in Pro and DIY? Obviously, you are stepping up advertising dollars. It sounds like dollars spent, not necessarily promotional level. And you're also stepping up the commitment on the labor hours. So is there something that you're seeing on the share side in either Pro or DIY that is causing you to step up these investments?
Michael McDermott:
Yes, we continue to see both macro environment opportunities as well as favorability in both Pro and DIY markets. Pro out comped our average again this quarter, so we continue to feel good about that. We see an opportunity to continue to expand our penetration in that category. Pro represents about 30% of our sales and about 50% of the home improvement market. So again, a lot of the investments we're making and the actions we're taking, we think, will yield fruit. From a DIY perspective, we saw nice advancements in our DIY product categories, again both interior and exterior, giving us positive momentum going into the back half.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things. First of all, curious as you think about the investment that you've outlined today, what you expect or where you expect the payback from that to show up is the first thing I'd be curious.
Robert Niblock:
Yes, Eric, I'll start. As we said, you saw from the comp trajectory in the quarter, May was not what we had anticipated. By the time we got through the month in the Memorial Day performance. Our incremental investments in marketing and the enhanced focus on digital had not been fully kicked in by then. As we saw that kick in and we saw the incremental traffic that we're driving into the stores, we were very pleased, obviously, with the trajectory through the quarter but recognized that we probably had an opportunity to have provided a better customer experience that even better capitalized on the trends. So our belief is that we'll hold on to these labor hours, that we've got people that are trained in the stores that Rick and his team have trained. As we get into the fall, we'll continue to monitor that as Mike and his team work to even further optimize our marketing message. And we hope to see that translate into better experience, continue to drive better in-store experience and better sales trajectory. We've put a lot of effort into our online experience here over the past year or so, as highlighted with a 43% growth in the quarter. We think there's an opportunity to improve our in-store experience as we head into the fall of the year, and we hope then that, that resonates into capturing additional sales from the traffic that the marketing team is driving into our stores.
Eric Bosshard:
So does that -- as you look at -- you affirm the full year comp guidance of 3.5%, does this investment -- should we believe or expect that this could create upside to that sales guidance if you get payback from this? Or is this more defensive of defending your ability to just get to that original target?
Robert Niblock:
Yes. I think, yes, we're still early in the process. Obviously, we're excited about the trends that we're seeing, but we're investing because, one, first of all -- first and foremost, to deliver our guidance for the year for those. We've been just slightly short of that for the first half of the year, so it's a make up the shortfall. And to the extent that we execute well, hopefully some upside to those numbers, but we've not baked that in, so.
Eric Bosshard:
And then secondly, in terms of the point of emphasis, because we came into the year hearing the productivity focus, the 11.2% margin target and seeing you making decisions that seem more of profitability. Now it sounds like there's a little bit of a shift to balance more of driving sales and sales growth. Even Marshall's comments to the comments regarding price optimization and even labor optimization while labor is being invested here. Is, I guess, the central goal, Robert, or is the focus improving the sales growth? Or is the focus improving profitability?
Robert Niblock:
I think it's both. So as I indicated, Eric, we've had actually great success from our productivity efforts. We still have a lot more work to do there. But we've said all along that productivity is not just about cutting costs. It's also investing back into areas that matter most to the customer. So -- and we think, as we said, with the -- we knew we had an opportunity with -- to improve our marketing as we've had new tools, and we'll continue to better optimize that. The team is working to even -- to get better leverage out of our marketing spend. We saw an opportunity there. We're pleased with the, like I said, the online performance, the traffic we're driving into our stores, and we think there's an opportunity to even capitalize further on that. So it's partially using that productivity savings to invest in a better experience and capture share in what we think is a robust market placing with that. And we think it allows us to achieve those 3-year targets that we laid out.
Operator:
Your next question comes from the line of Alan Rifkin with BTIG.
Alan Rifkin:
Robert, you said that the second quarter comps were disrupted by the store staffing that you've outlined. Do you guys -- can you infer from the sharp acceleration in your July comp that you think those issues are largely behind you? And if so, why then has your comp and revenue guidance at the back of the year not been lifted?
Robert Niblock:
I'll start and then ask others to jump in, Alan. But certainly, as we indicated, we do think there were some disruptions from the model. The further we get away from the change, obviously people are getting settled into their new roles. We've talked about some of the attrition with some of the prior department managers and them -- their attrition in into permanent roles has actually gone faster than we had originally budgeted. So we knew there was some disruption. But the further we move away from the change, people are getting settled into their new roles. I'm pleased with the way the team is responding. As we indicated, we're a little bit behind where we anticipated when we laid out our guidance for the year. Thus, the revisions in guidance. But more than anything, the work that we've done, as I've said, in -- from a marketing standpoint to sharpen our messages and the enhanced efforts, we're seeing the great performance online, and we're also seeing better traffic trends coming into our stores. So we're using that as an opportunity, if you think about the changes that we've made from a management standpoint, getting the right management structure in the store. It allows us to put more associate customer-facing hours on the floor of the store to take advantage of that opportunity. So we think that's going to drive additional sales, but we don't want to get ahead of ourselves from a guidance standpoint.
Rick Damron:
Yes. Alan, I would say that we're making investments, as Robert said, to capitalize on the traffic growth and better leverage the long-term benefits of the model that we have in place. The reality is our omnichannel environment today requires us to continually evaluate how we're meeting the needs of our customers, and that will continually drive change both in how we meet those needs. It requires us to be perpetually learning, training, ideating and getting better every single day, and I think those changes are beginning to pay off, and it shows in our June and July performance. Our teams remain extremely focused on serving the customer. Their dedication to serving the customer is second to none, and I'm extremely proud of what they've done and how they've led through that change throughout the year. And we'll continue to make sure that we support them with the resources and the training and the tools they need to be able to meet the needs of our customers every day in this environment.
Alan Rifkin:
Okay. And then a follow-up, if I may. With respect to appliances, you guys continue to put up terrific comps with high single-digit gains in this quarter. Obviously, with the recent news about Sears and Amazon, are there any changes contemplated in terms of marketing within this category?
Michael McDermott:
Alan, this is Mike McDermott. Well, certainly, we don't take our #1 position in appliances or continued growth in market share in the category for granted. We've made significant investments over time to be the #1 player, and our customers continue to tell us that our focus on omnichannel engagement and experience is what they expect and what they desire. So we're very, very focused on continuing our leadership, from selection through enjoyment, through the service proposition, all the way through to retirement and making sure that our displays, our well-trained associates, our expansive brand and innovation portfolio continue to make a difference. Now in the second quarter, we grew at 3x the market in the appliance business. The operations team added inventory to make sure we could take advantage of the opportunity. I think Rick and his team increased staffing. We added delivery drivers, and we continue to take advantage of the market by providing great experiences. So from a marketing perspective, we're going to continue to lean into the category, as we have, and make sure that digitally, we've got great content online, fantastic navigation. And obviously, we're going to maintain our competitive posture from a pricing perspective. So I feel good about the appliance business. I feel good about continuing to grow our #1 position.
Operator:
Your next question comes from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My question is around conversion. I know you guys have been able to track conversion pretty well historically. Can you give us a sense of what the trends have been like lately? That'd be helpful in framing some of the changes you're making.
Rick Damron:
Yes, I'm glad to. As we look, and we talked about the increased traffic that our marketing efforts were driving into the stores, we saw an opportunity to continue to improve our conversion. Conversion is something that, quite frankly, we always want more of. No matter where we are, we always want more. And we're working -- our store operators are working essentially in making sure that our people in the stores and our associates in the store, that the times are there, the customers are there, that we're merchandise (sic) [ merchandising ] correctly and that we're executing the fundamental basics of the business inside the box. I'm extremely pleased with the progress they're making and the efforts they're taking. And we see that as an opportunity, thus the investment in labor into the back half of the year, to ensure that we continue to make sure that we meet the needs of the customers when they come in. So we feel good with where we are. We still know there's opportunity for us to continue to get better, and we're making the investments necessary for us to be able to do that with the teams.
Michael McDermott:
The other thing I'd add to that from a dot-com perspective, we saw balanced improvement and strength actually in traffic, conversion and ticket across all product categories. So as it relates to the omnichannel experience, we really look at conversion, both in-store and online and to Rick's point. So we'll continue to invest there to make sure it improves.
Seth Basham:
And that's helpful. And just to understand, for the back half of the year, the primary improvement in sales trends that you're expecting is coming from conversion as opposed to improvements in traffic, right?
Michael McDermott:
Well, we actually would anticipate a more balanced view of transactions and ticket as we move into the back half of the year versus the first half.
Operator:
Your next question comes from the line of Seth Sigman with Credit Suisse.
Seth Sigman:
I wanted to just clarify on the updated EPS guidance for the year. So there's no change in sales. Is the change just SG&A? Or did you guys lower the gross margin expectation also? I think at one point, you were expecting it to be flat for the year.
Marshall Croom:
Yes. As we updated in our guidance, we're expecting about 10 more basis points of incremental gross margin pressure, driven by some of the actions that we're taking, leaning into the amped up -- amplified marketing that we are doing that's helping drive the traffic. So that's putting pressure on the gross margin line for the year. So it actually went from about 20 basis points of drag to about 30 basis points as you think about that from the year standpoint.
Seth Sigman:
Okay, understood. And then -- so as a follow-up on the pricing strategy, it feels like the discussion around promotional activity, value perception, even marketing has escalated quite a bit over the last few quarters. Can you help us understand that trend a little bit better? What is causing that? What are you seeing in the marketplace perhaps? And how should we think about that in the context of what's been a pretty stable EDLP type of strategy in the space over time?
Michael McDermott:
Yes, this is Mike McDermott again. We certainly saw an opportunity in the first quarter to get more competitive as it relates to our promotional strategy specifically around holidays. So obviously, that was seen in our value perception metrics. We leaned in there. We matched the competitive intensity of the marketplace in some of the select categories where we saw some expansion of aggressiveness. But for the most part, as we go into the back half of the year, our focus is really exposing the values that we've already had in our plan. So some of that's going to be -- some of that margin pressure is going to be mix oriented. But we feel good about our position. We got to focus on optimization to make sure that we're making the right investments. But a big focus on the macro environment strength and our ability to jump in and take advantage of that.
Operator:
Our next question comes from the line of Mike Baker with Deutsche Bank.
Michael Baker:
I just want to clarify a little bit. This quarter, what happens? You said you're below plan year-to-date. And it seems like that sales are on plan. Correct me if I'm wrong. So is it that the gross margins were below plan year-to-date? Or expenses are above plan year-to-date? And if it's the expenses what I'm trying to reconcile, it sounds like you didn't have enough labor earlier in the quarter, I suppose, in May to drive sales. So I'm just trying to figure out how expenses overran. Is it really just because you ramped up so much in June and July?
Robert Niblock:
Mike, this is Robert. I'll -- we started off in Q1, we indicated that we were behind. We missed our sales plan. We felt we'd make up over the next couple quarters. So we're still in the process of working towards that. As I said, we did -- as we talked about in first quarter call and Mike had indicated, we had an opportunity to, one, enhance our marketing message, things like making sure we're highlighting the price points at the lower end of the -- leveraging price points at the appropriate time. As well as, we also saw opportunity to invest more in digital, and that's part of what drove our online outperformance. We had great payroll leverage in the second quarter. We think there's an opportunity to invest part of that to capitalize on the traffic that the marketing team is driving in. And then from an SG&A standpoint, I'll let Marshall talk about it, we had -- he talked about some of the onetime drivers and some of the specific things, that we're above what we had planned in the quarter and for the back half of the year, so.
Marshall Croom:
Yes. Well, we leveraged retail operating hours and did have the incremental advertising spend. And there were a couple of other items I alluded to, some of the pressure we'll see in the back half with casualty claims, worker's comp claims and costs there. We saw a little bit of that in the second quarter. And also, sort of being competitive in the marketplace from a client standpoint, a little pressure on delivery and fleet. But the bigger drivers are -- in the back half are leaning into the marketing message, reinvest in that and to try to capture more of the sales that we're seeing coming through to offset some of those back-half pressures.
Michael Baker:
Okay, makes sense. As a follow-up, you did slightly lower your store count outlook for the year. What's behind that? And how does that play into the guidance?
Marshall Croom:
So we came in with a plan, I think, with roughly 35 stores. We since have went through and scrubbed and evaluated certain locations, and some of them we decided not to open at this time or we'll defer until a later point in time.
Robert Niblock:
Yes, we have an approximate number, Mike. We had a couple that have slid into 2018. We've had a couple of sites that we chose not to move forward with, so we thought -- went ahead and updated guidance on that, so -- but didn't make any change to our sales guidance.
Michael Baker:
So were those big-box stores in Canada? Orchard Supply? Just curious what -- which ones are sliding.
Richard Maltsbarger:
So this is Richard. It was a relative mix primarily within the Canadian market in our Orchard operation is where we decided to either postpone and/or observe some of the changes that were making before we proceed. Or, as Robert said, we have taken a few sites where we've made different decisions than we approved those estimated last fall.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Goldsmith:
It's Michael Goldsmith on for Michael Lasser. The flooring category has been in line or above the company average recently, but this quarter was a bit softer. Are there any specific call-outs to explain the underperformance of this category?
Michael McDermott:
Yes, flooring continues to be an important category for us. We were certainly positive, and the category actually posted very strong performance in carpet, vinyl and laminate flooring but saw some opportunity in floor tile as well as hard wood. We're in the middle of a significant reset in the floor tile category. It's obviously becoming more and more important as customers lean into the new and innovative styles. But we have felt disruption as we ramped down our existing assortment. That reset should be complete by the end of the month, and we anticipate to be back on a growth trajectory above average on the other side of that reset.
Michael Goldsmith:
That's helpful. And then with regards to the incremental labor being put in the stores, is this broad based? Or is it focused on specific categories?
Rick Damron:
We're looking at it from a perspective of analyzing the data as we look at our marketing plans as we move into the second half of the year. We're investing in those hours against those categories where we're putting the additional weight from the marketing investments that we're making. So it will be more -- most of it will be spent into those categories.
Operator:
Our final question comes from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
My first question relates to juxtaposing the recent results and the guide for this year against your reiterated long-term guidance. So your productivity initiatives have been under way for a period of time. And the profit growth and the margin trajectory that you're generating in absolute terms are quite solid. Is it possible that looking for the kind of incremental margins that the guide, the long-term guide, calls for is ambitious in an environment where you need to invest? In omnichannel, you're facing wage pressure. Not many retailers are putting up operating leverage, just as we think about the appropriate forecasting context for 2018 and beyond.
Marshall Croom:
I just think, Matt, this is Marshall, at this point in time, we're comfortable with reconfirming the guidance as we lean into the back half with some of these incremental investments. Again, we have better line of sight to not only productivity efforts that we're driving this year but in '18 and '19, above and beyond that, and also looking at what we're leveraging from '17 into '18 and '19 from capability builds, how we're leveraging Pro, continuing to take a look at our office staffing complement and how we're trying to match labor to drive traffic that we're seeing and fixed costs, indirect spend I've mentioned earlier. So again, at this time, we're comfortable with those longer-term targets and the productivity at this point in time, if we have better line of sight to revise that. I will provide that on an upcoming call.
Robert Niblock:
And...
Michael Goldsmith:
And then -- oops, sorry.
Robert Niblock:
And Matt, this is Robert. I would just say also keep in mind that we've made quite a few changes this year, both with our store labor model, that will settle in over time as they settle in within new roles, the incremental lifts within -- from a marketing standpoint as we continue to refine and get better at that. So I think there's opportunity for additional leverage against those things as we settle into the new cadence there. And then keep in mind that Marshall took you through some onetime items, the [ IDNR ] and other stuff that he talked about, credit losses. And we think moderate -- those things don't necessarily repeat as we get into the next 2 years of that 3-year guidance.
Matthew Fassler:
And then by way of my follow-up, just a couple cleanup items on the P&L and on the guide. The impact of the -- of Canada on the different line items this quarter. And also, if there's any -- what kind of buyback is embedded in the guide? And that's all I have.
Marshall Croom:
Basically, for the year, we just talked to 15 to 20 basis points impact to operating margin. And then for...
Robert Niblock:
Canada.
Marshall Croom:
For Canada.
Robert Niblock:
Yes.
Matthew Fassler:
Right.
Marshall Croom:
And so...
Matthew Fassler:
And what about in the quarter? Because I think you've given that out in prior quarters.
Marshall Croom:
It was roughly about 20 basis points for the quarter. And then share repurchase, yes, again, we'll target $3.5 billion this year in '17.
Robert Niblock:
Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our third quarter results on Tuesday, November 24 -- 21, I'm sorry. Have a good day.
Operator:
Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies' First Quarter 2017 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 McDermott, Chief Customer Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Rick Damron, Chief Operating 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's.
This quarter, we delivered comparable sales growth of 1.9%, driven by a 3.5% increase in average ticket, partially offset by a 1.5% decline in transactions stemming from weaker outdoor performance. We posted positive comps in 8 of 11 product categories, with one -- while one category was flat. A solid macro backdrop, combined with our project expertise, drove above-average performance in indoor project categories across the appliances, kitchens and flooring categories. We also continue to advance our sales to Pros customers, driving outperformance in rough plumbing and electrical, lumber building materials and tools and hardware. We drove 27% comp growth on Lowes.com and above-average comps in in-home sales, demonstrating the continued strength of our omnichannel foundation. Our ability to connect to customers in our stores, online, through our contact centers or in their homes ensures that we provide solutions to customers across the most relevant moments of their project journey. We're pleased with the progress we've made to enhance our product and service offering for the Pro customer, delivering another quarter of comps well above the company average. And we continue to expand our capabilities to better serve this growing customer group. Last week, we announced that we've entered into a definitive agreement to acquire Maintenance Supply Headquarters, a leading distributor of maintenance, repair and operations, or MRO, products to the multifamily housing industry in the Southeast, South Central and West. This is an important step in our strategy to deepen and broaden our relationship with Pro customers and better serve their needs. When combined with our November 2016 acquisition of Central Wholesalers, a prominent MRO distributor in the Mid-Atlantic and Northeast, this acquisition will substantially expand our ability to serve the multifamily housing industry as both the primary and secondary supplier while also increasing our presence in major metro markets and strengthening our foundation for future growth. This combined multifamily MRO business is expected to generate more than $400 million in annual sales with 16 distribution centers and over 200 additional outside sales representatives. From a geographic standpoint, our U.S. business achieved 2% comps for the quarter with positive comps in 12 of 14 regions. And internationally, we delivered double-digit comps in Mexico, while comps in Canada were flat in local currency. Canadian comps were pressured by unusually high snowfall in addition to 4 years of high single to double-digit comps. Last week marked an important milestone, the 1 year anniversary of our acquisition of RONA. This acquisition has fortified our presence in Canada with a market-proven asset. We remain excited about the compelling opportunity to bring together Lowe's global scale and resources with RONA's local expertise, and we're well positioned to capitalize on the market's strong, long-term fundamentals. We're pleased with early wins in key areas such as introducing our best-in-class appliance offering in RONA-branded stores, serving a new portion of the market and positioning us to capture additional market share; building on our e-commerce capabilities, which are already delivering strong growth above initial expectations; converting as many as 6 RONA big-box stores to Lowe's-branded stores in fiscal 2017; and driving improved profitability by leveraging our shared supplier relationships. Due to great work of our Lowe's Canada team, we have begun unlocking the value of the acquisition and remain confident that we will deliver the revenue and call synergies we expected. For the quarter, we delivered earnings per share of $0.70. These results included a $464 million pretax loss associated with the early extinguishment of debt from our recent tender offer. Adjusted earnings per share were $1.03, an 18% increase over last year's adjusted earnings per share. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $1.2 billion of stock under our share repurchase program and paid $304 million in dividends. Turning to the economic landscape for the balance of the year. The home improvement industry should continue to see solid gains. Job and income growth should drive solid gains in both disposable income and consumer spending. And revolving credit usage remains favorable, supplementing the spending power generated by stronger incomes and supporting bigger ticket purchases. Housing is expected to remain a bright spot. Increasing household formation is encouraging and is expected to continue amidst steady job gains. Home price appreciation should persist as mortgage rates has -- have eased from their postelection increase, which will support home affordability. And as we survey the consumer, we're seeing similar favorable trends. Our most recent Consumer Sentiment Survey revealed that homeowners have an increasingly favorable view of the national economy and their personal financial situation. Rising home prices are continuing to encourage homeowners to engage in more discretionary projects in addition to ongoing maintenance and repair spending, and we believe that this trend will continue as well over half of homeowners we surveyed believe their home values will continue to increase. Also, nearly half of homeowners we surveyed indicated that they intend to engage in a home improvement project in the next 6 months, and home improvement spending is expected to continue to outpace overall spending. As we reflect on the quarter, we're very pleased with the continued growth of our Pro customer sales and excited about the opportunity we have to further expand that business and gain additional market share. For the DIY customer, we recognize the near-term opportunity we have to drive more traffic with improved messaging and an optimized promotion strategy. Mike will share more with you on that in a moment. Longer term, we continue to focus on actions and invest in capabilities that will add the most value for customers and shareholders. We're focused on omnichannel project experiences and expanding the reach of home improvement, ultimately serving more customers more effectively. We're developing capabilities to anticipate and support customers' evolving needs. We're also focused on improving operating discipline and execution and are committed to making productivity a core strength for Lowe's. Before I close, I'd like to thank our employees for their dedication and ongoing commitment to anticipating and serving customers' needs. Our employees are truly the foundation of our business. Thanks again for your interest. And with that, let me turn the call over to Mike.
Michael McDermott:
Thanks, Robert, and good morning, everyone. In the first quarter, we achieved positive comps in 12 of 14 regions and posted positive comps in 8 of 11 product categories, while one category was flat.
We delivered a comp of 1.9% on top of 7.3% last year despite softer performance in outdoor categories, which gave rise to a modest decline in transactions. As you know, Lowe's has built a very strong seasonal business over the years, with approximately 35% of Q1 and 40% of Q2 sales historically driven by outdoor categories. Given the tough comparison to Q1 last year, we designed a spring strategy intended to balance indoor and outdoor projects. However, as the quarter unfolded, we found we weighted our messaging too heavily towards indoor categories. We made the appropriate adjustments to our messaging mid-quarter and saw a corresponding improvement in April. As we look to capitalize on strong demand for indoor projects and customers' continued desire to invest in their homes with our project inspiration and expertise and targeted promotions, we drove above-average comps in interior categories such as appliances, kitchens and flooring. Once again, we achieved strong comps in appliances, leveraging our investments in customer experience, both in-store and online. In-store, our appliance suites allow customers to visualize how their appliance purchase will look in their refreshed or remodeled kitchen. Online, we've enhanced the customer experience and presentation to make it easy for customers to select their products. Our omnichannel customer experience, together with leading brands, breadth of assortment, competitive pricing, knowledgeable sales specialists as well as delivery and haul away service, continues to drive our performance in appliances. Kitchens also benefited from our omnichannel customer experience. In order to provide a holistic project 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 both envision and design their dream kitchens. Following the trend from last quarter, we again drove above-average comps in kitchens through a combination of project inspiration and expertise, our investment in project specialists and targeted events. We also drove above-average comps in flooring, leveraging our strong assortment as well as targeted promotions to capture indoor projects. We continue to advance our Pro customer sales, driving comps well above the company average, by further optimizing our product and service offering to better serve the Pro. We achieved strong comps in lumber and building materials, driven by strong Pro demand, continued recovery efforts from Hurricane Matthew and Louisiana flooding and inflation. Pro activity also drove solid comps in rough plumbing and electrical and tools and hardware. We captured Pro sales by improving our brand assortment with exclusives like Hitachi and Bostitch, the #1 and #2 brands in pneumatics; and the extension of brands like Vaughan, Owens Corning and GAF. We continue to be excited about the effectiveness of destination brands in attracting Pro customers. This strength is evidenced with the addition of Marshalltown, a trusted Pro brand and a leading supplier of masonry tools, which drove double-digit comps in the category. In addition to our outstanding portfolio of brands, we're also deepening and broadening our relationship with the Pro customer with our strong value proposition as well as advancing our capabilities to connect with Pro seamlessly across channels through LowesForPros.com and our growing ProServices team. The addition of Central Wholesalers, along with our pending acquisition of Maintenance Supply Headquarters, further expands our capabilities to serve multifamily property management customers throughout the country with enhanced product and service offering while strengthening our platform for future growth with this important customer. We continue to drive Pro awareness with targeted marketing, including expanded digital capabilities as well as Pro exclusive offers to grow our share of wallet with existing Pros while also generating new business. We've also enhanced our buy in bulk program with new signage in-store, messaging on LowesForPros.com and marketing campaigns designed to drive awareness of the great values we provide for the Pro. Our focus on further strengthening our portfolio of brands, continuing to build upon our omnichannel offering through our growing ProServices team and LowesForPros.com, are all part of a broader commitment to build our strong foundation to anticipate and serve the needs of the Pro customer. We also continue to focus on our strategic priorities, leveraging our omnichannel capabilities to help customers achieve great project results. Customers can engage with our associates in-store for expert advice, on Lowes.com for content and inspiration, with our contact center for ongoing support or with our project specialists to bring their solutions to life. As customers engage in both indoor and outdoor projects, we leveraged our omnichannel capabilities to help them throughout their project journey, driving 27% comp growth on Lowes.com and above-average comps for in-home sales. Our interior and exterior project specialists represent another important element of our omnichannel strategy as they serve the do-it-for-me customer, who needs a bit more help navigating their project, meeting them in their homes to design, plan, pull together products across multiple categories and manage their project through to completion. We're also advancing our omnichannel experience, making it even easier for customers to engage with our in-home project specialists. On Lowes.com, we've added online scheduling capabilities to our in-home selling model, and we've seen a very strong response to these enhancements with increased leads and appointment requests. For the quarter, gross margin contracted 64 basis points. We had 35 basis points of impact from product mix and RONA. The remainder of the decline was primarily the result of promotional activity; inflation, predominantly in lumber; and pricing investments in key product categories. Looking ahead, we're working to refine our promotional strategy by improving the balance between big-ticket and smaller-ticket projects, eliminating less-effective promotions and reducing the overall margin impact to the business. We continue to make progress in driving productivity throughout the enterprise while investing in the areas that matter most to customers. This quarter, we drove 40 basis points of payroll leverage as we realized the benefits of our new store staffing model. We took decisive action to design and implement a new structure that provides better leadership and accountability, allowing us to grow sales with more efficient staffing. We're also working to drive productivity in our supply chain by introducing new international carriers into our system and realigning our network to balance our volumes against 3 new shipping alliances in Southeast Asia. As these improvements are implemented, they're expected to benefit gross margin in the back half of the year.
As we look forward to the remainder of 2017, we're proud to welcome 2 new additions to our expanding portfolio of brands that appeal specifically to Pro customers:
SharkBite, the industry leader in plumbing fittings; and A. O. Smith, the leading brand of residential water heaters.
And for DIY customers, we're leveraging our MyLowe's platform to drive additional brand loyalty. We're proud to announce that we've simplified our military discount program by allowing active duty and veterans to register through MyLowe's. We're also offering free parcel shipping exclusively for MyLowe's members. And as we move to Q2, we look forward to our compelling Memorial Day, Father's Day and July 4th events as well as our outdoor entertaining event featuring unique omnichannel experiences such as online tools to build the ideal backyard retreat. We are well positioned to capitalize on a favorable macroeconomic backdrop for home improvement as we continue to execute on our strategic priorities and make progress on our initiatives to drive top line growth while improving operating discipline, productivity and profitability. We look forward to sharing further progress with you over the course of the year. Thank you for your interest in Lowe's, and I'll now turn the call over to Marshall.
Marshall Croom:
Thanks, Mike, and good morning, everyone. Sales for the first quarter were $16.9 billion, an increase of 10.7%. Total customer transactions increased 6.4%, and total average ticket increased 4% to $70.79. Our transaction growth was aided by the addition of RONA. RONA sales were approximately $630 million or 4.2% of sales growth. As a reminder, RONA is not included on our comp calculations until the second quarter of this year.
As a result of the calendar shift from the 53rd week of fiscal 2016, this year's first quarter included 1 less week of winter and 1 more week of spring than last year. While this had no impact on comp sales, it did benefit first quarter total sales by approximately $500 million, contributing 3.6% to sales growth. Comp sales were 1.9%, driven by an average ticket increase of 3.5%, partially offset by a transaction decline of 1.5%. Looking at monthly trends. Comps were positive 3.8% in February, negative 1.2% in March and a positive 4.0% in April. Lastly, new stores drove 100 basis points of comp growth -- or total growth, excuse me. Gross margin for the first quarter was 34.4% of sales and, as Mike mentioned, decreased 64 basis points from the first quarter of last year. We had a combined 35 basis points of impact from product mix and RONA combined. The remainder of the decline was primarily the result of promotional activity to match the intensity of the marketplace; inflation, primarily driven by lumber; and pricing investments in key product categories. SG&A for the quarter was 22.99% of sales, which deleveraged 73 basis points. The deleverage was driven by the comparison to an unrealized gain in last year's first quarter when we recorded $160 million associated with the foreign currency hedge we entered into in advance of the RONA acquisition. This year-over-year comparison drove 105 basis points of expense deleverage. And in the first quarter of this year, we experienced 40 basis points of payroll leverage in the stores, so we realized benefits of our new store staffing model. We also experienced 37 basis points of leverage in incentive compensation due to lower payment levels relative to last year. Somewhat offsetting these items was deleverage from our private-label credit portfolio due to an increase in program costs, driven by higher losses, as well as risk insurance, which was driven by a favorable actuarial adjustment last year that didn't repeat this year. Depreciation and amortization for the quarter was $365 million, which was 2.1% of sales and leveraged 20 basis points. Operating income decreased 117 basis points to 9.25% of sales. The RONA impacts associated with the mix of business and integration costs negatively impacted operating income by approximately 65 basis points in the quarter. Additionally, the comparison to the prior year unrealized gain of the foreign currency hedge negatively impacted operating income by 105 basis points. This quarter, we completed a cash tender offer for $1.6 billion of our higher coupon bonds. And as a result, we recognized a $464 million loss on the early extinguishment of debt. To fund the tender offer and finance current year maturities, we issued $3 billion of unsecured bonds in April. The issuance consisted of 10- and 30-year notes with a weighted average interest rate of 3.58%. For the quarter, interest expense was $161 million. Effective tax rate for the quarter was 35.5% compared to 38.2% in the first quarter of fiscal 2016. The year-over-year change in our effective tax rate was primarily driven by the implementation of a new accounting standard for excess tax benefits associated with share-based compensation. Earnings per share was $0.70 for the first quarter, including a benefit of approximately $0.06 from the calendar week shift. The loss associated with the early extinguishment of debt reduced EPS by approximately $0.33 for the quarter. Adjusted earnings per share was $1.03, an 18% increase over last year's adjusted earnings per share of $0.87. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $1.96 billion. The lower cash balance this year is a result of a larger April 2016 bond issuance in anticipation of the RONA acquisition. Inventory was at nearly $12.3 billion at the end of the quarter and increased $1.2 billion or 10.8% versus the first quarter of last year, with roughly 60% of the increase related to the addition of RONA. Inventory turnover was 3.95, an increase of 12 basis points over the first quarter of last year. Asset turnover increased 5 basis points to 1.83. Moving on to the liability section of the balance sheet. Accounts payable of $9.9 billion, representing a $1.1 billion or 12.3% increase over the first quarter of last year, primarily due to the timing of purchases year-over-year, terms improvement as well as the addition of RONA. At the end of the first quarter, leased adjusted debt to EBITDAR was 12.27x (sic) [ 2.27x ]. Return on invested capital was 15.6%. The prior year charges offset by the net gain on the foreign currency hedge related to the RONA acquisition negatively impacted return on invested capital by 225 basis points. Now looking at the statement of cash flows. Operating cash flow was $3.3 billion; and capital expenditures were $202 million, resulting in free cash flow of nearly $3.1 billion, which was up 2.7% to last year. In March, we entered into a $500 million accelerated share repurchase agreement, which settled in the quarter for approximately 6.1 million shares. We also repurchased approximately 9.2 million shares for $750 million through the open market. As Robert mentioned, in total, we repurchased $1.2 billion of stock in the quarter. We have approximately $3.8 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in our Lowe's business outlook. We expect to recover our first quarter sales miss over the next 2 quarters by increasing our media weight with a focus on value, improving our promotional effectiveness and rebalancing our indoor-outdoor strategy.
And as a result, we are reaffirming our operating outlook for the year. We expect a total sales increase of approximately 5%, and this sales increase is driven by a number of factors:
First, we are forecasting comp sales increase of approximately 3.5%. Second, the RONA acquisition drives about 2% sales growth. Also, we plan to open 35 stores, which adds roughly 1%. To offset that, total sales growth will be reduced roughly by 1.5% to the comparison of 52 weeks in 2017 versus 53 weeks in 2016. And on a GAAP basis, we are anticipating an operating margin increase of approximately 120 basis points. Regarding operating margin, a full year of RONA results versus roughly 7 months last year will pressure operating margin by an estimated 15 to 20 basis points for 2017.
Effective tax rate is expected to be 37.8% for 2017. For the year, on a GAAP basis, we expect earnings per share of approximately $4.30. Please refer to Page 13 in our supplemental reference slides for a summary of adjustments as you compare 2017 to 2016. We are forecasting cash flows from operations to be approximately $5.9 billion and capital expenditures of approximately $1.4 billion. This results in estimated free cash flow of approximately $4.5 billion for 2017. Our guidance assumes approximately $3.5 billion in share repurchases for this year. Regina, we're now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Michael Lasser with UBS.
Michael Lasser:
Is your decision to make price investments in response to something that you're seeing in the marketplace? Or is it more proactive in an effort to regain some of the share that seems like you might be losing today?
Michael McDermott:
Michael, throughout the quarter -- this is Mike McDermott. Throughout the quarter, we saw an opportunity to improve our DIY value perception. We feel good about our competitiveness, our assortments, our brand portfolio and the innovation we're bringing to market. We've had to adjust our marketing to more frequently include lower price point values that are already in place throughout our product offering to drive increased traffic.
Michael Lasser:
So it seems like you're maybe making some changes in response to the markets. Are you seeing pressure from more of your big-box competitors? Or is it coming from the online channel?
Michael McDermott:
I think we're seeing significant opportunity in both DIY and Pro as home improvement continues to do very well. As it relates to the competitors, there are many -- as you know, many competitors in the marketplace, and we've got to face them all.
Michael Lasser:
Okay. And my follow-up question is on the outlook for the year. So the first quarter fell short of where you thought it was going to be. You're going to be a little bit more price-competitive. So to still achieve your prior expectations, is it that sales will come in better than what you previously thought? Or you're going to find other ways to offset some of the cost pressure -- some of the margin pressure you might feel from the price investments?
Marshall Croom:
It's really the latter. We're looking at geography shift with the gross margin pressure we experienced in the first quarter. We're going to experience pressure for the year in total, and we're anticipating roughly 20 basis points. But we do expect to be able to offset that on the SG&A line as we're going to get some visibility and traction through our productivity efforts.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Maybe a question for Mike on the marketing. I think over the summer or maybe postmortem from looking at last year, you talked about a little too much marketing geared towards the millennial. And then this quarter, we heard maybe you were more indoor-oriented. And maybe this quarter was just a tactical change in how the seasons and sales were playing out. How do you feel about the marketing plan the rest of the year? And I'm sure you want to avoid these type of missteps, if you'd characterize them that. And how do you do that?
Michael McDermott:
Yes. I'll tell you, we continue, Simeon, to optimize our media and improve our flexibility and responsiveness to the market opportunity and the weather, ultimately driving improved productivity as we spend on the spend and as we continue to drive traffic. We tried to toggle in and out of weather opportunities throughout the quarter and found that we suboptimized. Our objective, obviously, is to better connect with our customers through more personalized messaging tailored to their specific needs, and we continue to build capabilities to do that. We'll also continue to look for the most effective and efficient ways to drive traffic and build our brand across all of our assets. So that continues to be something that we fine-tune over time.
Simeon Gutman:
Okay. And my follow-up is on RONA. Can you talk about when -- I think you said after Q2 that it comes into the comp base. Is there -- what kind of comp lift should we assume and then the timing and magnitude of synergies as they flow through?
Marshall Croom:
Simeon, this is Marshall. I'll address the RONA question. Basically, it will come in towards the tail end of the second quarter, then we'll be able to roll that into our comp numbers for the company. So -- and once we do that, we've already baked that into our guidance for the year.
Richard Maltsbarger:
And this is also Richard. To play off of what Marshall said there, as well as the comp guidance, all of the synergies that we have for the year have also been baked into the guidance that was provided for the year.
Operator:
Your next question comes from the line of Dan Binder with Jefferies.
Dolph Warburton:
This is Dolph on for Dan. Around the outperformance of the Pro category, are you able to quantify how much pass-through Pro grew? Or how many bps above the average Pro category Pro sales grew?
Robert Niblock:
This is Robert. I will say, overall, the -- as Mike alluded to in his comments, we have been investing heavily in the Pro recently, certainly, with the addition of things like Marshalltown, SharkBite more recently and A. O. Smith as well as the other initiatives we've had over the past few years, the launch of LowesForPros.com [indiscernible]. So I will just say that we saw significant growth in the Pro customer more than 2x our overall comp. And then we take -- and as I said in my comments and highlighted the acquisition of Maintenance Supply Headquarters, the definitive agreement, and we'll get that acquisition closed. Combining that with Central, I think it's just going to give us opportunity to continue to perpetuate the great momentum that we had with the Pro customer. So really pleased with what the team delivered in the first quarter and also really excited about the opportunity that lies ahead as we continue to deepen our relationship, particularly as -- with the opportunity we see in the MRO business.
Dolph Warburton:
Okay. And if I could just ask one last question. I think you mentioned some deleverage on some credit cost. Can you give us an idea of where credit -- Lowe's card penetration is now? And does the deleverage of this quarter have you rethinking any terms or standards for that card?
Marshall Croom:
I'll just say that our credit card penetration for the private-label brand is roughly 28%. So we've seen that steadily grow over time. So when you look at the overall portfolio, just keep in mind that we are coming off of historically low delinquency rates and loss rates. So we're beginning to see a little bit of inflection there and believe that our portfolio is performing relatively well versus others in the marketplace but something we will keep an eye on. You have to be sensitive to how you adjust those terms for your customers because we do see those as sales driver and a tool that they will want. And the use of revolving credit, we see, is a strength to the consumer as they spend in 2017.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
You all talked about in 4Q a big focus on productivity in the business. I'm curious, as you look at 1Q and as you look out through the balance of the year, what ranks kind of first on the emphasis in that area looking at this quarter with gross margin and SG&A in sales? I'm just curious what's at the top of the list when you think about productivity as you define it. What's the metric that you're most focused on achieving or improving?
Marshall Croom:
As we talked about on the fourth quarter call and at our Analyst Day in December, we are increasing our operating discipline and our focus on productivity across the business to driving core strength and a core mindset. The big thing we want to make sure that we get across is this laser focus on productivity doesn't deflect or detract from our efforts to continue to drive our customer-centric omnichannel strategic initiatives. In fact, we see them as complementary. We believe this will continue to allow us to invest and grow in those key areas as the consumer continues to shift. In the quarter, we really focused on 2 key areas. First, that was the rollout and the change of our store stacking models, which was in place to help us drive improved leadership across the store, improved training and oversight to drive a better customer experience across the store. And we also changed our management complement here at the CSC to drive a leaner organization to become more nimble and drive more speed on decision-making. So we're very pleased with how both those initiatives are going and how the organization has responded to those actions. As we think broader about productivity, we're really focused on a few key areas as we continue to move forward, some that are strict productivity initiatives, others, which we believe will have consumer experience impact as well. First, expanding our production offices will continue to be a focus as we look to expand that into our southern division during the second half of the year, which really improves the communication of [indiscernible] business, drives it into our contact centers from a store model, improving our communication and efficiency and connectivity to the customer during that complex install process. We're also optimizing our freight load from the distribution centers, Mike spoke about that earlier, as we look to optimize lanes and flow as well as how we flow the product to the customer as this is the single biggest utilization of nonselling labor in the stores. So the teams are continuing to focus on how to get more effective and more efficient there. Third, we continue to tap alternate delivery options. We have centralized delivery tests ongoing in 4 markets currently, both small, medium and large, to understand how do we optimize our delivery networks more effectively, more efficiently. And then we'll continue to leverage our indirect sourcing opportunity across the enterprise to get stronger. So the core aspects of productivity, we think, will continue to drive the organization and help us deliver against our targets for the second half of the year. And we're pleased with the outcomes that's been implemented today.
Eric Bosshard:
I guess just one follow-up. When you talk about the outcomes -- and great job in leveraging payroll and leveraging SG&A. Is that the scoreboard you're focused on? How are you balancing that relative to growing sales and sales productivity and market share? How are you thinking about balancing those 2?
Rick Damron:
Yes. Eric, the big things that we look at when we're looking at it from a store standpoint is a holistic measures of success from efficiency of process through our customer service metrics. So we're measuring our close rate performances, we're measuring our customer satisfaction scores, I would say, are the 2 dominant drivers of our overall measurement of success. And they will continue to measure it against the anticipated benefits that we have around that. So we're pleased with what we saw across both those attributes in the quarter. As a matter of fact, we saw increases in our overall customer satisfaction scores compared to Q1 2016. So really proud of the way the teams and fields have rallied around this and responded and continue to work to meet the needs of our customers in and out every day.
Marshall Croom:
And Eric, this is Marshall. I'll just pile on just real briefly. The -- you were looking for ways to drive sales productivity. So anything, the process and capabilities that we need to deliver to drive better sales productivity as long as keeping an eye on our expenses, eliminating waste in order to more effective ways and to utilize our spend. So I hope that helps. And if I could just inject one clarification. Just received a note that the lease adjusted debt-to-EBITDAR is 2.27x. I think I said 12.27x. The rating agencies are on the line. Don't want to get them too excited. But it's 2.27x, and we anticipate getting to 2.21 by the end of the year.
Operator:
Your next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
I just want to follow up on the sales performance in the quarter being a little bit lighter than you expected. Can you just clarify, do you think that was driven by some seasonal factors? Or was there more of a share loss component here, and that's why you're making some of the promotional changes?
Robert Niblock:
Seth, I'll -- this is Rob Niblock. I'll start. As we look at the quarter, and as we indicated, there were certainly some weather challenges that impacted our seasonal performance. As you know, seasonal is a big category for us. We had strong comps that were going up against last year from a seasonal standpoint. So as Mike indicated, part of what was done with the heavy reliance on seasonal was to try and pursue some opportunity that we saw in indoor categories. As we toggled between those 2, we recognized that we probably had some opportunity to continue to improve our messaging around seasonal categories, value driving and traffic driving items. So Mike and his team started making those necessary adjustments. But when you look at -- for the -- when we look at the quarter, with -- as we look at it on balance, even with weather challenges, we were only slightly below our plan for the quarter. So all in all, considering weather, we ended up with a good performance against our plan. And as we said, we're making adjustments to continue to capitalize on the opportunity that we see in the market.
Seth Sigman:
Got it. And then the regions and the categories that did underperform in the quarter, did you see signs of improvement late in the quarter in April? And if you could just give us a general sense of how you're feeling about May because it does seem like there's some confidence that the business is going to reaccelerate.
Marshall Croom:
We did see the most significant pressure in our lawn and garden and seasonal and outdoor living businesses. From a lawn and garden perspective, we saw some inconsistent performance throughout the quarter really aligned with that weather that Robert just talked about, leading to a slightly negative comp. We weren't able to offset the underperformance in live goods with some of the positive performance in other areas in that division. But certainly, as weather has improved, we have seen improvement there as well as in our seasonal and outdoor living categories, particularly in patio. So as time moves on and weather stabilizes, we are seeing improvement in those categories.
Rick Damron:
From a geographical standpoint, we had negative comp performance in 2 regions, our Boston or our most Northeast region, primarily driven to the changes in weather from last year. We saw the biggest impact there. And then in our St. Louis region, which we saw with the significant flooding events that took place during the quarter. So both those regions, as Mike said, these -- the product categories have performed better. Those regions have also improved from a performance standpoint as well.
Marshall Croom:
And this is Marshall. I'll just say that from March to April, we like that trajectory. So thus far in May, we're pleased with what we're seeing.
Operator:
Your next question comes from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
I want to dig a bit deeper into the promotional and pricing actions. If you could just reiterate, were these focused in seasonal, where you were seeing some of the challenges? Were they focused in some historically promotional categories like appliances? And where else might you have undertaken them? Or were they pretty much directly connected to some of the changes in marketing? Or should we think about these as 2 separate efforts?
Michael McDermott:
Matt, this is Mike. I would tell you that some of the select pricing investments that we made were really tied to seasonal products, and we executed those mid-quarter. And we certainly saw some improvement, as I just mentioned. The other area of focus has been an investment in special order products, really, across our digital assortment, supporting our omnichannel to engage customers, both Pro and DIY, as they build out their projects and leverage our extended line design through our digital properties. So they are the areas of most significant focus in regard to those investments.
Matthew Fassler:
And just to think for a second about that seasonal business. You spoke about the weather, which, clearly, was an impediment. So was this an effort to try to overcome that impact? Or were you simply saying, "Hey, whatever it takes," whether or not -- or did you feel like there's more of a share issue in that category for you?
Michael McDermott:
It was really designed to -- with the market adjustments we made to try and capitalize on seasonal traffic, recognizing that both in the first in the second quarter, seasonal traffic is a significant driver of the traffic that engages with the portfolio. So that's why we did it to really complement the marketing adjustment and revert on the traffic.
Matthew Fassler:
And to the extent that the full year gross margin outlook seems to be better than what you showed in Q1, presumably a little bit less of a drag from RONA as you cycle the acquisition, but would you expect some of those investments in pricing and promotion to subside?
Michael McDermott:
Yes. For the remainder of the year, Matt, we expect to partially offset the impact of some of those promotions and pricing investments. We have cost improvements from our line review process as well as refining that promotional strategy and eliminating the less-effective promotions as the year unfolds as well as fine-tuning our pricing actions based on the results that we're seeing. As you know, we constantly adjust our approach to optimize gross margin, making sure we deliver value to our customers while balancing the traffic and tick the equation. So that process is managed daily, and we do think we'll see improvement.
Operator:
Your next question comes from the line of Dennis McGill with Zelman & Associates.
Dennis McGill:
Just to clarify a couple of those statements earlier. Can you specify which categories were negative in the quarter? And then also, any impact from Easter as you had estimated on the monthly comps margin in April?
Michael McDermott:
Yes, I can talk to the categories with negative comp. They were the lawn and garden category and seasonal and outdoor living categories.
Marshall Croom:
And on the Easter shift, Dennis, it was a negative 0.5% in March versus the 1.2% I stated earlier. And then it was 3.2% on an adjusted basis for the Easter shift in April versus the 4% that I highlighted earlier.
Dennis McGill:
Okay. And then can you also clarify, when you talked about the Canadian pressure in the quarter, I think that was on the core business. But more broadly, can you just talk about what RONA is comping at today just to give us a sense on what that would -- how that it is impacting the comp when it does come in?
Robert Niblock:
Dennis, this is Robert. As this comps, as you know, that we mentioned -- or as I mentioned in my comments, are for the legacy Lowe's business that we have in Canada. The RONA business that we acquired, as Marshall said, it won't roll into comps until late in the second quarter.
Dennis McGill:
Yes, I understand it's not in the comp base, but can you give us a sense of what it is comping at today?
Robert Niblock:
Go ahead, Rich.
Richard Maltsbarger:
So this is Richard Maltsbarger. The current RONA business is comping at the expectations that we had for Q1, with the exception very similar to what we're seeing in the U.S. to the pressures that Robert mentioned in his remarks regarding the unseasonable late spring snowfall that we experienced, especially across Québec.
Dennis McGill:
And those expectations were consistent with the domestic business? Or plus or minus?
Richard Maltsbarger:
They're consistent with the domestic business.
Operator:
Your next question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
So I wanted to get your thoughts. I've been asking some companies this. As you look at the business, do you think compares really matter from a same-store sales perspective as you think about the cadence of the quarters for the year? In other words, at this point in the cycle, outside of the weather variability that obviously shifts demand, is your comp trend, the comp trend? Or do you look at the next 2 quarters and think there were specific items that impacted the business last year that would suggest we should think more about comp stacks versus the overall trend in the industry?
Robert Niblock:
Well, certainly, Chris, when we look at comps, as we said, first quarter of this year, we were going up against tougher compares from a year ago. And that's why I think we had previously indicated on our fourth quarter call that we expected the best comps in our second and third quarter of the year were rolling up against our weakest compares. If you take the combination of being up against the tougher compares, weather challenges and how they hit in the quarter, you make a good point that you have to kind of look and bring all those factors to bear when you look at the performance. And as we said, overall, when we look at the business in the first quarter even with the weather, we delivered sales that were just slightly below our plan. And with the actions that Mike and his team were taking, I think we have good line to being able to recover that top line as well as being able to continue to mitigate some of the margin impact we had for the first quarter when we get past the acquisition -- the anniversary of the RONA acquisition and those things.
Christopher Horvers:
Understood. And then 2 quick follow-ups. First, on Maintenance Supply Headquarters. Is that -- have you included that in the outlook? I know it hasn't closed quite yet, but is that included in the outlook? And if it's not, can -- or either way, can you give us some understanding on how that might impact gross margin and SG&A when it comes in? Will we see any impact at all? Or is it just too small relative to the total?
Marshall Croom:
Yes. I would say, one, it's still a pending acquisition. We haven't received final regulatory approval for that. We did not bake that into our guidance.
Robert Niblock:
And so once we get through the acquisition, then we would roll any impact that we see from that into our guidance the first time we update after the acquisition.
Christopher Horvers:
Okay. But you -- in the -- you mentioned that you do expect it will be accretive this year. Any indication on what it might be?
Marshall Croom:
Yes. We do expect it to be slightly accretive this year.
Operator:
Your final question will come from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I want to follow up on 2 things. One, housekeeping. What was inflation in the comp? I think you mentioned the gross margin, but not the comp.
Marshall Croom:
Yes. We had about 50 basis point, again, primarily driven by a lumber in the first quarter.
Gregory Melich:
Great. And then it sounds like -- don't want to put words in your mouth. The comp trend through the quarter, that 450 bps deceleration from February into March and then coming back in April, that, that change was entirely traffic-driven and the ticket was pretty steady. Is that a fair assumption?
Marshall Croom:
Yes, it is.
Gregory Melich:
Great. And then finally, maybe just to help frame it a little bit as we think about flow through the rest of the year. Credit profits, remind us, that shows up entirely in SG&A? Or does some of it show up in gross margin? And could you remind us roughly how much of SG&A is a profit share from the credit card?
Marshall Croom:
Well, I will disclose that it does show up in SG&A, so the whole program, income and cost flow through below the margin line. But it is in our operating margin.
Gregory Melich:
So the costs are in gross margin, but the profits or the lack thereof...
Marshall Croom:
No, no, no. Greg, the entire program runs through our SG&A line.
Robert Niblock:
And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter results on Wednesday, August 23. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's meeting. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth 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 McDermott, Chief Customer Officer; and Mr. Bob Hull, Chief Financial Officer. Joining during the Q&A session will be Mr. Rick Damron, Chief Operating Officer; Mr. Richard Maltsbarger, Chief Development Officer and President, International; and Mr. Marshall Croom, incoming Chief Financial Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I'm pleased that we delivered a strong quarter with comparable sales growth of 5.1%, exceeding our expectations. Our comp growth was driven by a 4% increase in comp average ticket and a 1.1% increase in comp transactions.
Our U.S. business achieved 5.1% comp for the quarter, with positive comps in all 14 regions. During the quarter, we delivered positive comps in 12 of 13 product categories. We drove strong holiday performance with our winter wonderland experience as well as compelling offers in appliances and tools. A favorable macro backdrop, our strength in omnichannel retailing and our project expertise drove demand across the quarter, with interior category outperformance in kitchens, appliances and rough plumbing and electrical and outdoor strength in lawn and garden and lumber and building materials. Our emphasis on providing better omnichannel experiences positions us well for continued success, enabling us to better connect with customers and provide the advice and assistance they count on when completing their home improvement projects, whether they choose to connect in the store, online, in their home or through our contact centers. We continue to see strength in our Project Specialist Interiors program, with strong double-digit comp growth this quarter. And we posted 25% comp growth on Lowes.com, driven by robust growth in both transactions and ticket, following our website redesign in Q2. This is a testament to the growing strength of our omnichannel platform. Pro customer sales were robust, with another quarter of comp growth well above the company average. We're proud of our success with the Pro customer and continue to make investments to expand our capabilities to better serve this important customer. We also drove continued strong performance in international markets, with double-digit comps in Mexico and mid-single-digit comps in Canada in local currency. We're pleased with the progress and early success on the integration of RONA, including the execution of our e-commerce strategy, rollout of appliances and store conversions, and remain excited about this compelling opportunity to bring together Lowe's' global scale and resources with RONA's local expertise. For the quarter, we delivered adjusted earnings per share of $0.86, a 46% increase compared to last year's fourth quarter adjusted earnings per share of $0.59. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $551 million of stock under our share repurchase program and paid $306 million in dividends. Turning to full year fiscal 2016 results. We delivered comparable sales growth of 4.2%, with all regions and product categories achieving positive comps. Sales growth, combined with our sharp focus on improving profitability, led to a 21% increase in adjusted earnings per share. Our fourth quarter and full year 2016 results demonstrate the strong foundation we are building to enhance the value we provide to customers and further differentiate Lowe's in the marketplace. Along with improved operating results, we made meaningful progress this year expanding our customer reach and advancing our omnichannel capabilities, as evidenced by the rollout of our interior project specialists across all U.S. stores, our successful redesign of Lowes.com, strengthening our market position in Canada with the acquisition of RONA and deepening and broadening our relationship with the Pro customer. We've entered 2017 from a position of strength as macroeconomic fundamentals remain favorable and are aligned for another solid year of home improvement industry growth. The industry is poised to grow its share of wallet as a percent of overall consumer spending and should benefit from strong consumer balance sheets and debt service ratios near record lows, as well as continued job gains and income growth. Credit usage continues to improve, supplementing the spending power generated by stronger incomes. We expect housing in 2017 to remain a bright spot. Rising home prices should continue to encourage homeowners to engage in more discretionary projects, in addition to ongoing maintenance and repair spending. Improving incomes and household financial conditions should continue to be a catalyst for household formation, which will help sustain homebuying and related spending. Expected growth in the home improvement market is further supported by the results of our fourth quarter Consumer Sentiment Survey, which revealed that postelection, homeowners have an increasingly favorable view of the national economy and their personal financial situation. And we believe this trend will continue as almost half of the homeowners we surveyed indicated that they are very likely to begin a home improvement project in the next 6 months, and more than half of homeowners believe that home values are rising and will continue to increase. In 2017, we look to build upon our strong foundation to better serve the needs of the rapidly changing customer and capitalize on a favorable macro backdrop. As discussed at our December analyst and investor conference, we're focused on 3 strategic pillars to drive value for customers and shareholders. First, we're dedicated to expanding our home improvement reach and ultimately serving more customers, DIY, DIFM and the Pro, more effectively. And we will further differentiate ourselves by establishing market leadership for home improvement project solutions. Second, we're developing capabilities to anticipate and support customers' changing needs. We are evolving our business to further drive trust and loyalty by empowering customers at every critical moment of their project journey. That includes advancing our customer capabilities through our omnichannel assets. And finally, we are committed to generating long-term profitable growth and substantial returns for shareholders. Across the enterprise, we are actively seeking to enhance our operating discipline and focus and make productivity a core strength. This laser focus on improving productivity will not detract from our ongoing efforts to deliver customer-centric omnichannel experiences. Rather, we see these efforts as complementary and, together, will further strengthen our relevance and allow for investment and future capabilities to grow the business and better connect with customers. These efforts give us confidence in our business outlook for 2017. Bob will share those details in a few minutes. I would like to express my appreciation to our employees for their unwavering commitment to anticipating and serving customers' evolving needs. We're proud of our employees and their tireless effort to help customers love where they live. Our employees fuel our success and have been instrumental in enabling our transformation to a customer-centric omnichannel home improvement company. Before I close, I would like to take a moment to personally thank Bob for his distinguished service and his many contributions over the past 17 years, including 14 years as our CFO. During his tenure, Bob's financial discipline and leadership have played an invaluable role in our growth and transformation to an omnichannel home improvement company while, at the same time, delivering exceptional returns to our shareholders. We congratulate Bob on his retirement. We look forward to a smooth transition, as Marshall Croom, a 20-year Lowe's veteran, with over 30 years of deep financial and operational experience, transitions to his new role as our CFO. Marshall's extensive experience and intimate knowledge of our business, coupled with his proven leadership, positions us well for future success. Thanks again for your interest. And with that, let me turn the call over to Mike.
Michael McDermott:
Thanks, Robert, and good morning, everyone. As Robert shared with you, we delivered a strong quarter, with positive comps across all regions in 12 of 13 product categories, growth driven by both average ticket and transactions.
We leveraged our omnichannel platform, project expertise, customer experience design capabilities and enhanced digital marketing to deliver strong holiday performance. Our winter wonderland experience provided an inspirational holiday showroom where customers could see everything from artificial trees and poinsettias to indoor and outdoor decorations, providing cohesive decorating solutions for the holidays. We connected our compelling in-store display with digital assets, leveraging Pinterest, Facebook, Instagram and YouTube as well as a seamless shopping experience on Lowes.com. In addition to evolving our holiday experience, we've also continued to innovate with our product assortment and exclusives such as our Disney light day. The customer response to our winter wonderland experience was strong, driving comp sales increase of 8%. We also drove strong comps through our holiday events, with Black Friday representing our largest sales day in company history, both in-store and online. We expanded our events, capitalizing on customer excitement for the season with compelling offers in tools, holiday decor and appliances. Throughout the quarter, we captured project demand, leveraging our in-store experiences, in-home selling program, strong value proposition, enhanced online selling tools and improved marketing speed from our digital capabilities, driving gains in multiple categories. We recorded above-average comps in appliances, lawn and garden, kitchens, lumber and building materials and rough plumbing and electrical. We saw broad-based strength in both indoor and outdoor projects. We drove high single-digit comps in appliances, leveraging our investments in customer experience both in-store and online. In-store, our appliance suites showcasing coordinated appliances allow customers to visualize how their appliance purchase will look in a refreshed or remodeled kitchen. Online, we have enhanced the customer experience and presentation, including improved product search, integrated and upgraded product videos, enhanced product presentation like 360-degree views and simplified product groupings to make it easy for customers to select their products. Our focus on advancing the customer experience through our omnichannel assets, together with leading brands, breadth of assortment, competitive pricing, knowledgeable sales specialists as well as delivery and haul-away services, drove our share gains in appliances. This quarter, we also delivered high single-digit comps in kitchens, led by strength in cabinets and countertops, through a combination of targeted promotions, our investments in project specialists who meet customers in their homes and our strategy of focusing the entire kitchen project. In order to sell a complete kitchen, we display our products, including cabinets and countertops, immediately adjacent to our appliance offering. We're leveraging our customer experience design capabilities to create store sets that inspire customers to envision a variety of project possibilities, such as a series of kitchen vignettes to show all the elements of a complex installation, like a kitchen remodel, pulled together into a beautiful finished project. We're using our stores as an additional source of inspiration while making the buying process for projects simpler and more intuitive. We also saw strength in outdoor project categories. We achieved high single-digit comps in lawn and garden as customers in the South and West took advantage of warmer weather early in the quarter to complete lawn and garden projects. And we also achieved strong comps in lumber and building materials, driven by continued demand related to recovery efforts from Hurricane Matthew and the Louisiana flooding and not to mention the strong performance with our Pro customer. As customers engage in both indoor and outdoor projects, we leverage our omnichannel capabilities to help them throughout their project journey. We drove 25% comp growth on Lowes.com as well as above-average comp growth from our in-home sales program. Our interior and exterior project specialists represent another important element of our omnichannel strategy as they serve the do-it-for-me customer who needs a bit more help navigating their project while we meet them in their homes to design, plan, hold together products across multiple categories and manage their project to completion. We're also deepening and broadening our relationship with the Pro customer, driving comps well above the company average, with our outstanding portfolio of brands, our strong value proposition through our 5 Ways to Save as well as our omnichannel offering through our growing ProServices team and LowesForPros.com. We continue to evolve our capabilities to connect with the Pro across channels, and we're seeing the Pro engage more in the channels that best fit their unique needs, whether that's online with LowesForPros.com, at the market level with our Account Executive ProServices specialists or at our stores with our dedicated in-store ProServices teams. Our AEPs have been very effective in growing our business with larger Pro customers, especially maintenance, repair and operations, or MRO, customers, further solidifying our relationship and targeting property management companies as they make more trips and shop more categories across our platform. We've greatly improved our Pro offering with key brand introductions and investments in the breadth of assortment to ensure that Pro customers have the right selection of products, ultimately serving as a one-stop shop, a place where Pros can purchase all the products they need to complete their project and get back to the job site quickly. Our 15% comp in pneumatics this quarter, driven by our home channel exclusives with Hitachi and Bostitch, the top 2 brands in pneumatics, is a testament to the power of our successful brand partnerships. We're also reconnecting Pros who we believe have not recently purchased at Lowe's to show them what's changed in our stores and online, using targeted marketing, including expanded digital capabilities as well as exclusive Pro offers to drive awareness and generate new business. We've also enhanced our buy-in-bulk program with new signage in-store, a new digital focus on LowesForPros.com and marketing campaigns designed to drive awareness of the great values we provide this customer. During the quarter, we also demonstrated the strength and flexibility of our supply chain as we were faced with a variety of weather conditions, ranging from unseasonably warm temperatures to severe winter storms. We're proud to say that we were able to serve customers regardless of unpredictable weather. Our supply chain demonstrated agility and flexibility, holding inventory centrally then working to efficiently move product to areas of heightened demand to meet customers' needs, reaching areas in the path of storms within hours of impact. We continue to focus on opportunities to drive further efficiencies in our supply chain as well. In addition to our efforts to drive top line growth, we also continue to focus on making productivity a core strength while investing in the areas that matter most to customers. The latter portion of the quarter, we rolled out a new store staffing model across all U.S. Lowe's home improvement stores to ensure that we are optimally prepared for the upcoming spring selling season. The changes streamline our management structure to provide better leadership and accountability to drive improved customer experiences. We're also expanding our central production offices, moving scheduling of installation services from a store-level activity to a more efficient, centralized approach in our call centers, enhancing consistency and proficiency of communication and delivering a better customer experience. We're pleased with our fourth quarter results and the progress we are continuing to make on our initiatives to drive top line growth, enhance our productivity and profitability and position Lowe's for the future. Turning our attention to the first quarter. As spring approaches, we're excited about our omnichannel kitchen and bath and outdoor refresh events, which offer unique customer touch points, compelling content and superior values. Our events coordinate engaging experience for customers, designed to capitalize on their excitement for the season, including our refreshed seasonal pad and new online patio experience that showcases curated collections and the latest in style trends; and our new grill display, featuring Weber Genesis and Char-Broil grill innovations. We'll leverage the national launch of our in-home selling program during our kitchen and bath event and all year long to help customers bring their project aspirations to life. We're also excited about our upcoming Pro events, delivering great values both in-store and online at LowesForPros.com. Thank you for your interest in Lowe's, and I'll now turn the call over to Bob.
Robert Hull:
Thanks, Mike, and good morning, everyone. Sales for the fourth quarter were $15.8 billion, an increase of 19.2%. Total customer transactions grew 15.1%, and total average ticket increased 3.6% to $69.58. The transaction growth was aided by both the 53rd week and RONA. The extra week in the period added roughly $950 million in sales, contributing 7.1% to sales growth. RONA sales were approximately $825 million or 6.2% of sales growth. Comp sales were 5.1%, driven by an average ticket increase of 4% and transaction growth of 1.1%. The comp sales calculation included 14 weeks this year versus the comparable 14-week period.
Looking at monthly trends. Comps were 4.7% in November, 6.3% in December and 4.2% in January. We estimate that weather positively impacted comp sales in the quarter by approximately 100 basis points. The majority of this came from serving customers in storm-impacted areas in the aftermath of Hurricane Matthew and the flooding in Louisiana. Lastly, new stores drove 80 basis points of growth. For the year, total sales were $65 billion, an increase of 10.1%, driven by comp sales of 4.2%, RONA contributing 3.8%, the 53rd week adding 1.6% and new stores. Gross margin for the fourth quarter was 34.1% of sales, which decreased 25 basis points from Q4 last year. Gross margin was negatively impacted by RONA due to both purchase accounting adjustments and the mix of business. In the quarter, these items negatively impacted gross margin by 25 basis points. SG&A for the quarter was 23.99% of sales, which leveraged 455 basis points. In last year's fourth quarter, we recorded a $530 million noncash impairment charge associated with the decision to exit our Australian joint venture. This year-over-year comparison drove 403 basis points of expense leverage. In Q4 2016, we experienced 59 basis points of benefits leverage, primarily related to incentive comp as we had lower attainment levels relative to last year. We also experienced leverage in store environment, store payroll and many other lines as a result of the strong sales growth in the quarter. Somewhat offsetting these items were severance-related costs for organizational changes that are a part of our comprehensive effort to focus and prioritize resources. The changes resulted in a charge of $84 million, which caused 53 basis points of deleverage. Depreciation and amortization for the quarter was $374 million, which is 2.37% of sales and leveraged 44 basis points. Earnings before interest and taxes, or operating income, increased 474 basis points to 8.05% of sales. For Q4, we estimate that the 53rd week aided EBIT by roughly 30 basis points. The severance-related costs hurt EBIT by 53 basis points in the quarter. The RONA impacts associated with purchase accounting adjustments, the mix of business and integration costs negatively impacted EBIT by 36 basis points in the quarter. For the quarter, interest expense was $159 million. The effective tax rate for the quarter was 40.3%. The higher rate was driven by a tax charge, primarily related to final Internal Revenue Code Section 987 regulations, which triggered the reversal of deferred tax assets associated with cumulative currency translation adjustment for our international operations. Earnings per share were $0.74 for the quarter, including approximately $0.08 from the 53rd week. There were a number of discrete items not in our business outlook that impacted EPS for the quarter. First, the charge associated with severance-related costs hurt EPS by approximately $0.06. Next, the impact of the new tax regulation noted a moment ago reduced earnings per share by $0.04. Lastly, there was a $0.02 negative impact associated with the takeout of RONA's preferred shares in the quarter, which reduced net earnings allocable to common shareholders in the EPS calculation. Adjusted earnings per share was $0.86, which was 45.8% higher than Q4 2015's adjusted $0.59. For 2016, adjusted earnings per share of $3.99 were up 21.3% versus 2015. The extra week in 2016 aided EPS growth by 250 basis points. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $558 million. Inventory at nearly $10.5 billion increased $1 billion or 10.6% versus the end of last year. Just over 60% of the increase related to the addition of RONA, with the balance to support strong sales growth. Inventory turnover was 4.05, up 13 basis points to last year. Asset turnover increased 5 basis points to 1.85. Moving on to the liability section of the balance sheet. Accounts payable of $6.7 billion represents $1 billion or 18.1% increase over Q4 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 fourth quarter, lease adjusted debt to EBITDAR was 2.21x. Return on invested capital is 15.8%. The impact of the charges hurt ROIC by 154 basis points. Now looking at the statement of cash flows. Annual operating cash flow was $5.6 billion, and capital expenditures were $1.2 billion, resulting in free cash flow of over $4.4 billion, which was up 24% to last year. In November, we entered into a $190 million share -- accelerated share repurchase agreement, which settled in the quarter for 2.6 million shares. We also repurchased approximately 5 million shares for $361 million through the open market. In total, we repurchased $551 million of stock in the quarter and $3.5 billion for the year. In January, our Board of Directors authorized a new $5 billion share repurchase program. The new program has no expiration date, and when combined with our prior share repurchase program, we have approximately $5.1 billion remaining authorization. Looking ahead, I'd like to address several items detailed in Lowe's' business outlook. In 2017, we expect total sales increase of approximately 5%. The sales increase is driven by a number of factors. First, we are forecasting a comp sales increase of approximately 3.5%. Second, sales growth will be higher for the first 5 months until we anniversary the RONA acquisition, which provides about 2% growth. Also, we plan to open 35 stores, which adds approximately 1%. However, total sales growth will be reduced by roughly 1.5% related to the comparison of 52 weeks in 2017 versus 53 weeks in 2016. On an adjusted basis, we are anticipating an EBIT increase of approximately 50 basis points, driven entirely by expense leverage. For 2017, we expect expenses to grow at roughly 60% of sales growth. Regarding EBIT, a full year of RONA results versus roughly 7 months last year will pressure EBIT by an estimated 15 to 20 basis points for 2017. The effective tax rate is expected to be 37.8%. For the year, we expect earnings per share of approximately $4.64, which represents a 16.3% increase over 2016's adjusted EPS. On a 52- versus 52-week basis, EPS growth will be 240 basis points higher. In comparing our guidance model to first call estimates, the quarterly earnings per share estimates look fine, but there are a couple of items I'd like to address related to the complexion of Q1. There's a calendar week shift as a result of 2016's 53rd week. This year's first quarter will include 1 less week of winter and 1 more week of spring than last year. While this has no impact on comp sales, it does benefit first quarter total sales by approximately $500 million. As I mentioned a moment ago, the mix of RONA's business will impact EBIT until we anniversary the acquisition in the second quarter. The estimated negative impact to the first quarter EBIT is approximately 60 basis points. We are forecasting cash flows from operations to be approximately $5.9 billion and capital expenditures of approximately $1.4 billion. This results in an estimated free cash flow of approximately $4.5 billion for 2017. Our guidance assumes approximately $3.5 billion in share repurchases for 2017. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
A question for Bob Hull, and wish you well, Bob. Something I asked at the Investor Day, thinking about the flow-through for 2017, I think the guidance was somewhere around 25 basis points for every point of comp above 1. I think the question then is the same now, what's driving it? I think it applies slightly higher incremental margins than what the business has been delivering. And so what's changing? And any other color on that?
Robert Hull:
Thanks, Simeon. So as we look at the outlook for 2017, on an adjusted basis, we're looking at 50 basis points of EBIT expansion. I commented that the impact of the full year RONA results versus 7 months in 2016 pressures us by 15 to 20. So if you take the midpoint of that, call it, 67 basis points with a 3.5% comp, the flow-through per point of comp above 1 is about 27 basis points. So we feel good about that. As I indicated, we're expecting flattish gross margin for the year, with all of the increase coming from expense leverage.
Simeon Gutman:
Okay. And then my follow-up, more of a near-term question, and no secret that Feb and March are tough compares. Seems like the business has good momentum through January. I know you don't normally comment on it. Curious if you have any thoughts, and I don't think tax returns are normally a factor for the segment, so just curious on sort of what you're seeing currently in the business.
Robert Hull:
Yes. So Simeon, Q1's off to a great start. We're ahead of plan. We're really excited about 2017.
Operator:
Your next question will come from the line of Peter Benedict with Robert Baird.
Peter Benedict:
I had a question kind of around the marketing plans for '17. I mean, I'm not sure you'll divulge too much, but just remind us, I think, marketing was kind of an issue last year, at least during the middle part of the year. How are you planning it -- to do that differently as we look through '17? That's my first question.
Michael McDermott:
Peter, this is Mike McDermott. Look, we're excited to welcome Jocelyn Wong to the expanded role of Chief Marketing Officer. She's going to have responsibilities in 2017 for customer experience design, content strategy and development, customer relationship management and advertising and media across all of our U.S. home improvement businesses. So we think we've got the right collection of areas to focus on, and I'm confident that she and the team will continue to enhance our efforts to drive a more integrated and omnichannel approach, recognizing that we have a number of touch points to leverage with our customers to drive traffic. So you'll see us be very focused on connecting with customers with more personalized messages, really tailored to meet their specific needs. And we'll continue to reach out and leverage the advances that we've made in our assortment and our offering with the Pro customer. So we've got a lot of activity going on in marketing. I feel very, very good about our new campaign, and the team's really poised for success in '17.
Peter Benedict:
That's helpful. And then maybe one for Bob. The hurricane and the flooding impacts, do you expect that to continue, Bob, through 2017? Or so anything you need to call out on that front?
Robert Hull:
So Pete, we do expect some benefit in 2017. We do, however, expect that to wane as the year progresses, especially as we get closer to the activity in the second half of 2016.
Operator:
Your next question will come from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
Bob, Bob Hull, best of luck to you going forward. I know that at your analyst conference in December, you spoke about the effort to align costs, and that had followed a difficult third quarter on the expense line. I guess there have been 2 rounds of activity that we've essentially read about, one relating to some restructuring in the stores, a second more recently relating to some restructuring at headquarters. If you could just help frame some of that activity in the context of the plan that you set out in December, particularly with regard to how roles are changing in the stores and around the organization, how labor dollars are being reallocated and then how that flows into your financial outlook.
Robert Niblock:
Yes. Matt, It's Robert Niblock. I'll start. Yes, as you're aware, we have announced some staffing changes over the last 30 days or so, both in the store and at the corporate office here. And as we see what's -- rapid shift that's changing in customer expectations and what they expect from retailers, our whole movement to be a customer-centric, omnichannel home improvement company, really dictating that we needed to allocate our resources differently so that we could better meet the needs of customers. It's something we have to continually do obviously to make sure we have our resources in the right places and -- so we can continue to meet their needs. From a store standpoint, yes, I think our new staffing model helps ensure us that we're optimally prepared for the upcoming spring selling season. The changes we've made in the store, we think, have really improved our leadership capabilities with an enhanced focus on training and really empowering our associates to deliver on an improved experience for the customers. We're really pleased with the receptivity we've seen and getting that done before -- ahead of the spring selling season. Here at the corporate office, the changes we just made at corporate headquarters are really designed to create more agile, efficient and customer-focused operating structure. We needed -- as we continue to migrate from being a single-channel retailer to an omnichannel home improvement company, we really need to step back and make sure that we have our resources aligned in the proper way so we can best take advantage of the opportunity that we see in front of us. And as we've talked for many quarters here, online, in-home, contact centers, those other things that are part of our omnichannel strategy are where we're seeing the highest growth. And we want to make sure we have our resources aligned behind that. So we're excited about it. It's always tough when you make those changes that impact people's lives, but I think it's the thing -- that it was the right thing to do to continue to move us forward and capitalize on the opportunity we see ahead of us.
Robert Hull:
Matt, related to the impact to our guidance provided at the analyst conference, they were incorporated in the outlook that we shared at that time.
Operator:
Your next question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
Best of luck, Bob. It's been a pleasure all these years. Wanted to talk about the sort of outlook that you put out in December, specifically related to 2017. There's this big pause in the industry over the summer, but things have accelerated strongly. So 2 parts to the question. In retrospect, what do you think drove that pause? And then thinking about the -- what you were looking at when you put your Analyst Day outlook, did that affect your outlook? In other words, it doesn't appear like the -- it appears the backdrop has actually accelerated since then. So do you think that your outlook could prove conservative in that regard? I guess, better asked, did that summer pause actually impact how you put out forward guidance?
Robert Hull:
So Chris, we look at a number of factors, macroeconomic factors, our ongoing performance, input from vendor partners and other sources, trying to understand what's going on with the consumer, industry demand drivers, et cetera. So certainly, as we came out of the third quarter and saw trends in fourth quarter leading up to the December meeting, we're certainly aware of our performance, also mindful of actions we were taking to drive consumer demand, to drive productivity, et cetera. So what I would say as we talk about our outlook for the year is I feel really comfortable about our opportunity to hit the $4.64 for the year. It's going to happen differently than we planned it, but as far as getting the EPS, I think there's confidence with the team that, that figure's more than achievable.
Christopher Horvers:
So I guess it's not just from a top line perspective, that summer pause really impacted putting out the 3.5% comp guide.
Robert Hull:
No real impact, Chris.
Christopher Horvers:
Okay. And then one follow-up. Can you share with us -- I'm assuming you're going to report comparable weeks -- same-store sales for comparable weeks. Can you share with us what the comparable same-store sales would have been based on the week shift in 2016?
Robert Hull:
So our comparable sales calculation does use the comparable weeks. So week 53 of 2016 comped over week 1 of 2016, which is the comparable week for the period, which is consistent with how we've reported comps the prior 3 53-week years since I've been CFO.
Christopher Horvers:
Okay. So there's no -- we can look at what you reported as comps last year as the right comparable when we're putting our estimates together?
Robert Hull:
The 14-week period was compared against the comparable 14-week period. So yes, the comps as reported are what they are.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
Bob, best of luck. Robert, I wanted to ask about the increasing focus on productivity. Your SG&A per foot stands around $70. There's obviously a lot of moving pieces in there. But what do you see as the optimal level of SG&A per square foot? Is there a way to size the aggregate opportunity from your productivity measures? And how do you harvest that opportunity on enhancing the culture to ensure that you have the necessary level of in-store execution?
Robert Niblock:
Yes. Well, Michael, I don't think we really measure it that way. What I can tell you is that as we've gone through and looked at, as I said earlier, the evolution, as we've gone from a single-channel retailer to an omnichannel home improvement company, we certainly had made changes along the way as the way that we have reallocated the resources. But when you look at the continual shift that you see taking place in the customer and the way that they want to interact with us, you realize that we need to continue to evolve. So if you think about it, you're sitting back with an organizational structure today that has evolved over time, not the one that we would have designed from scratch if you were starting out as an omnichannel company. So as we continue to see that evolution, we said we really need to step back and say, okay, where do resources need to be allocated at the corporate office? We took out some spans and layers to make us a more agile, nimble organization from a corporate office standpoint so that hopefully, we can better respond to opportunities, better respond to the stores and our other channels after they've taken care of the customer on a daily basis and then also did some hard look at our management structure in the stores to say, how can we ensure that we're managed -- that we're organized in the right way to make sure that, from a leadership standpoint, we're leading people in a way that's going to provide a better experience. So it was really more driven -- from that standpoint, we look at productivity more as, how do we take dollars and reinvest them in the areas that will drive better performance? So yes, there's obviously -- through that process, there's a cost savings impact as well. But it's also, if we get them aligned appropriately, then we think we'll drive better performance, which leads to the productivity leap.
Michael Lasser:
Okay. And my follow-up question is on the average comp ticket growth during the quarter of 400 basis points, driven by the 9% increase in the transactions above $500. Presumably, that was helped by the growth, the above-average growth in appliances and kitchen. Was there something from an execution standpoint that you did better that contributed to the growth? Or do you think that it was just growth from the marketplace?
Robert Hull:
So you're right. It was strength of our kitchen and appliance business in the quarter, Michael, that drove that. Also, the above-average Pro performance is a driver for growth in average ticket. Certainly, as we take a look at our own execution, we strive to do better every day as the items that Mike described in his comments were all items of focus for the quarter to allow us to take advantage of demand and serve customers.
Operator:
Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Robert Iannarone:
Robert Iannarone on for Scot. So just 2 quick ones. Given some of the volatility you guys have experienced over the -- in the top line over the course of the year, what gives you confidence in your comp outlook of 3.5% for the year? And have you seen any changes to trend in the Northeast specifically, I think, where Pro was a little bit weaker last quarter?
Robert Niblock:
Yes, this is Robert. We did see a continued improvement in the North in our performance there. So I think, certainly, some of the actions that the team has taken to better resonate with the customer has certainly started to take traction. So we're pleased with the improvement in performance that we saw there. As we look at 2017, we look at -- if you look at whether it's the underlying macro fundamentals that are out there, still seeing a very healthy housing market, whether it's from a turnover standpoint, whether it's from an appreciation of standpoint on housing, incomes continuing to rise as we spoke about employment continuing to improve. All of those things, I think, set up home improvement to see -- to continue to gain shares as a percentage of share of wallet in 2017. We've seen that trend for the past few years. I think it sets us up well for this year. And then on top of that, we've actually -- behind or postelection, we've actually seen, from our Consumer Sentiment Survey, a really strong increase in homeowners' intention to invest in their home and start a project over the next 6 months, as we talk about. So if you look at just the underlying factors, some of the momentum that we saw coming out of our quarterly Consumer Sentiment Survey sets us up that -- we think that it sets us up well that a 3.5% comp should be achievable as we look out to 2017.
Robert Iannarone:
And just one follow-up. Can you guys give us any idea of what the productivity and cost savings are on more of a run rate basis from some of the recent changes you made last quarter and you've talked about incurring this quarter?
Robert Hull:
So as we talked about in addressing Matt's question, the productivity savings were contemplated in the model we put together at December Analyst Conference and consistent as the outlook today. What I would say is, if you think about prior EBIT expansion prior [indiscernible] to expectations, there is a component of gross margin in there. We've taken that out, and the entirety of the flow-through in EBIT expansion is driven by expense leverage. So it's embedded in our SG&A outlook for the year going forward.
Operator:
Your next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
First, congrats, Bob, and thanks for all the help over the years. And Marshall, welcome back to the jungle. That's the only way I can put it. So I have 2 questions. One is, what was commodity inflation in the fourth quarter? And if you look at your guidance for this year, what do you have factored in? Then I have a follow-up on Pro and ticket.
Robert Hull:
So in the fourth quarter, Greg, we actually had modest deflation. We had building material deflation of 25 basis points driven by roofing installation, which offset the, call it, 15 basis points of inflation in lumber. For 2017, there's only very modest inflation contemplated for the year.
Gregory Melich:
Modest would be something less than 20 or 30 bps?
Robert Hull:
Less than 20.
Gregory Melich:
Okay. And on ticket, I saw that the -- it was up 9% for the larger tickets. Could you help us understand a little bit more as to how much of that would have been, say, driven by appliances versus really building the Pro basket and driving Pro?
Robert Hull:
Greg, really don't have a de-composition of that 9% growth in front of me. It is all of the above, right? It is the strength of the performance of those categories, and it's the tactics we have been taking over the number of years to better serve Pro customers that are driving the 9% growth.
Gregory Melich:
Great. I guess so to follow up on Pro, just do you have a credit penetration number for private-label cards?
Robert Hull:
The private-label card penetration was 28.7%, up about 20 basis points versus the same period last year.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things I'm curious on. One, the 35-store opens, I understand the emphasis and the opportunity with omnichannel. But the 35 number, can you just remind us what you're spending and the focus and the expected payback from that? And then secondly, would love to understand what you felt you did differently in appliances, which underperformed in 3Q and was a much stronger performer in 4Q.
Robert Hull:
I'll take the first part and let Mike address the second part. So as we think about the 35-store openings, that's roughly 9 U.S. big-box stores, 10 stores in Canada, a few in Mexico and 14 Orchard locations. So there are varying formats in varying geographies. As we think about the spend for new stores, that is roughly $400 million in 2017. As we think about return hurdles, we've got risk-adjusted return hurdles for all of our investments, including real estate. We do expect the portfolio of stores to more than exceed those hurdles going forward.
Michael McDermott:
Eric, this is Mike McDermott. On the product side of appliances, obviously, the fourth quarter's a significantly promotional quarter. We made some adjustments in both our traditional and digital advertising approach to make sure that we were engaging customers in an exciting way. We continue to see benefit from our Lowes.com replatform that we did mid-2016. And certainly, our associates in the store are providing the right level of experience for our customers, have been great. Credible vendor partnerships, great values, innovative products and just incredible performance by our supply chain team to make sure that we were in stock in this critical season, really driving significantly positive performance in the laundry [ph] businesses as a result of some of those buys and the ability to move that inventory where it was needed.
Eric Bosshard:
Great. And then if I could just add one more, there was a reference earlier on incentive comp. I'm curious in terms of what happened with store-level incentive comp in 4Q and what the expectations in strategy is in that area moving forward.
Robert Hull:
So Eric, if you recall, we had fairly substantial deleverage in the fourth quarter of last year based on the strength of performance, which really impacted our annual accruals. So we had significant deleverage Q4 last year, which, as we planned 2016, that was expected. While we had really good performance this year, it didn't compare to what we saw last year. Therefore, the rate of change was less, giving rise to expense leverage in the incentive comp area Q4 '16. Going forward, we've got a variety of plans that incent the store management and store associates to serve customers every day to ensure we help meet their needs, omni needs, going forward. So no real change in how we're thinking about incenting the folks that are on the front lines, interfacing with our customers every day.
Operator:
Our final question will come from the line of Keith Hughes with SunTrust.
Judy Merrick:
Our question has already been answered. Thank you.
Robert Niblock:
Thank you. Okay, thanks, and as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2017 results on Wednesday, May 24. Thanks, and have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining, and you may now disconnect.
Operator:
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.
Robert Niblock:
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.
Rick Damron:
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.
The Louisiana floods and Hurricane Matthew drove broad-based demand across product categories. Our merchant, vendor, logistics and store teams worked closely together to identify the products needed before and after the storms and efficiently moved inventory to the areas of greatest need. Historically, most major storms have 4 distinct phases:
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.
Robert Hull:
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.
Adjusting for the noncash charges, SG&A for the quarter was 23.05% of sales, which deleveraged 16 basis points. This deleverage was from the following items:
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.
Looking ahead, I'd like to address several items and details in Lowe's business outlook:
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.
For 2016, we now expect total sales increase of 9% to 10%, driven by a variety of factors:
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:
[Operator Instructions] Our first question will come from the line of Michael Lasser with UBS.
Michael Lasser:
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?
Robert Hull:
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.
Michael Lasser:
And how do you expect to -- how do you anticipate improving that with cost under pressure?
Michael McDermott:
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.
Michael Lasser:
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?
Rick Damron:
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.
Operator:
Your next question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
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.
Robert Niblock:
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.
Simeon Gutman:
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?
Robert Niblock:
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.
Simeon Gutman:
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.
Robert Niblock:
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...
Operator:
Your next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
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?
Robert Hull:
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.
Seth Sigman:
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.
Rick Damron:
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.
Operator:
Your next question will come from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
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?
Robert Hull:
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.
Michael McDermott:
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.
Matthew Fassler:
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?
Robert Hull:
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.
Robert Niblock:
[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.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research Company.
Eric Bosshard:
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.
Robert Niblock:
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.
Eric Bosshard:
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?
Michael McDermott:
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.
Operator:
Your next question comes from the line of Alan Rifkin with BTIG.
Alan Rifkin:
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?
Robert Hull:
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.
Alan Rifkin:
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.
Robert Niblock:
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?
Richard Maltsbarger:
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.
Alan Rifkin:
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?
Robert Niblock:
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.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
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?
Robert Niblock:
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.
Michael McDermott:
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.
Christopher Horvers:
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?
Michael McDermott:
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.
Christopher Horvers:
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?
Robert Hull:
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.
Operator:
Your final question will come from the line of Greg Melich with Evercore ISI.
Gregory Melich:
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.
Robert Hull:
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.
Gregory Melich:
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...
Robert Hull:
That's a good way to think about it.
Gregory Melich:
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?
Michael McDermott:
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.
Gregory Melich:
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?
Michael McDermott:
There was both ticket and traffic in that improvement.
Robert Niblock:
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.
Operator:
Ladies and gentlemen, this concludes today's call. Thank you all for joining, and you may now disconnect.
Operator:
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.
Robert Niblock:
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 and a national accounts team. Our LowesForPros.com website relaunched in the second quarter of last year continues to gain traction. And we will continue to build on this strong foundation by incorporating the feedback we received from Pros and our ProServices team to constantly improve the customer experience and deepen our relationships with this important customer segment. From a geographic perspective, our U.S. home improvement business achieved 1.9% comps for the quarter, with all regions of the south and the west comping positively. Our northern regions were challenged by an abbreviated spring, which hindered outdoor activity. We continued our strong performance in international markets, including double-digit comps in Canada and Mexico in local currency. We closed the RONA acquisition on May 20, and I'm pleased with the progress of our integration. By bringing together Lowe's global scale and resources with RONA's local expertise, we can enhance relevance and expand customer reach ultimately enhancing our competitiveness and profitability in Canada, establishing a strong presence in Québec and positioning us to capitalize on the significant long-term potential of the market. We welcome RONA's talented team into the Lowe's family. For the quarter, operating margin contracted 13 basis points, and we delivered earnings per share of $1.31, a 9% increase over last year's second quarter. These results include an $84 million loss in the foreign currency hedge entered into in advance of the RONA acquisition. This loss had a $0.06 impact on earnings per share for the quarter. Delivering our commitment to return excess cash to shareholders, in the quarter we repurchased $1.2 billion of stock under our share repurchase program and paid $251 million in dividends. Looking ahead to the second half of 2016, the outlook for the home improvement industry remains positive. Persisting gains in the job market and disposable income growth that continues to outpace the economy should further contribute to solid growth in consumer spending. And the outlook for housing remains bright, with strong home sales and construction in the first half of the year poised to benefit growth in the second half of the year. With home value appreciation expected to persist and incomes continuing to rise, we expect homeowners to be motivated to spend on their homes. Overall, strong consumer housing fundamentals should continue to benefit the home improvement industry. Our second quarter Consumer Sentiment Survey showed similar trends. Consumers continue to view their personal finances and home values favorably, with half of homeowners believing the value of their home is increasing. We believe this positive sentiment around home values is driving home improvement spending. Consequently, we continue to see home improvement spending outpace overall consumer spending as well as positive home improvement project intentions, including strong engagement in big-ticket discretionary projects. Our key priorities in 2016 are focused on leveraging this favorable home improvement backdrop. We are pursuing further top line growth by differentiating ourselves in better omni-channel customer experiences that make us the project authority and continue to focus on improving our product and service offering for the Pro customer. At the same time, we continue to focus on driving productivity and profitability. The execution of our strategic priorities, along with a solid macroeconomic backdrop, gives us confidence in our business outlook for 2016. Before I close, I would like to express my appreciation for our employees' unwavering commitment to serving customers. In particular, I would like to thank those Lowe's team members who worked diligently to assist our neighbors that were impacted by the historic flooding in West Virginia and those that are now assisting our neighbors in Louisiana. In circumstances like these, we ship truckloads of critically needed supplies to affected areas, and many of our employees pledge their time to help individuals in need. Lowe's has also donated a total of $750,000 to the American Red Cross to assist with the relief efforts. Thanks again for your interest. And with that, let me turn the call over to Mike.
Michael Jones:
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 both envision and design their dream kitchens. This quarter, we drove above-average comps in kitchens through a combination of project inspiration and expertise; our investment in project specialists, who meet the customers in their homes; and targeted promotions. Within fashion fixtures, we leverage our customer experience design capabilities to optimize our lighting reset, featuring an expanded collection of lighting styles, finishes and brands, including the expansion of Kichler Lighting, the largest lighting showroom brand in the industry, along with Progress Lighting and Quoizel Lighting. Adding to our attractive product offering, we also simplified the presentation, looping lighted fixtures by style and collection to provide a cohesive decorating solution and make selection easier. Customers have responded well, driving strong comps in fashion fixtures. We've also expanded this enhanced display approach to ceiling fans. Our shower door reset also leverages our customer experience design capabilities, enhancing our shower door offering by designing a complete solution for customer needs, providing a great line design, offering innovation and expanded selection and product delivery and installation services. In doing so, we are differentiating ourselves as the retail destination for bathroom refresh as well as the thought of being a best-in-class in-store customer experiences that can also serve as a selling center for Pros and our project specialist teams. We're also officially leveraging our network of regional distribution centers to offer customers product when and where they want it. Our seasonal living business also performed well in Q2, driven by robust air conditioner sales due to warmer-than-average temperatures and patio furniture and fashions. We also saw continued strong demand from the Pro customer, with comps well above the company average. Once again, productivity drove solid comps in lumber and building materials. Tools and hardware also benefited from increased project activity from both DIY and Pro customers. We're able to capitalize on this demand by improving our tool brand assortment with exclusives like Hitachi and Bostitch, the #1 and #2 brands in pneumatics; and the extension of brands like Vaughan; along with our extensive private label line of Kobalt tools. And we're proud to announce the return of yet another destination tool brand to Lowe's, Marshalltown, a trusted Pro brand and the leading supplier of cement masonry tools, which will roll out to our stores in the upcoming weeks. We also continue to focus on our strategic priorities, leveraging our omni-channel capabilities to help customers achieve great project results. Customers can engage with our associates in-store for extra advice, our content on Lowes.com for inspiration, our contact center for ongoing support or our project specialists who work with them in their homes. This quarter, we launched our new Lowes.com site, advancing our online shopping experience with optimized functionality and display for touch screen devices to support a better mobile experience; improved product and content recommendations; refined search algorithms; improved click-to-chat capabilities; larger project images; and expanded product views, including video content. As anticipated, following the launch, we had a brief period of disruption as customers increase their familiarity with the redesigned site. We are now seeing improved performance and have received great customer feedback on the new site. Our interior and exterior project specialists are now the critical element of our omni-channel strategy and a differentiated capability in capturing and serving project demand. They meet with customers in their homes to design, plan and manage their home improvement projects. Our exterior project specialists are currently available across all U.S. home improvement stores and we're expanding our interior project specialist program, reaching all U.S. stores by the end of this year. We are very pleased with our in-home sales program performance, with above-average comp growth again this quarter. Our expertise in project inspiration, design, advice and execution are setting us apart as the project authority in home improvement at a time when consumers continue to demonstrate a desire to invest in their homes. We continue to advance our Pro business, driving comps well above the company average by continuing to optimize our product and service offering to better serve the Pro customer. Beyond improvements in our tools offering, we have also strengthened our portfolio of Pro-focused brands with the addition of GAF roofing, Owens Corning Installation, Lennox HVAC, Masonite entry and interior doors and Hubbell residential wiring devices. We are also working closely with our field-based merchandising team to identify local market opportunities and brands to further optimize our offering for the Pro customer. And with the relaunch of LowesForPros.com last year, we've also made it easy for Pros to manage multiple properties and quickly and easily purchase items nationwide. Thus far, we've been pleased with our program rollout, given positive customer response and results, which have exceeded our expectations. We're also serving the Pro customer through our Account Executive ProServices or AEPs. AEPs work with larger regional customers to help them order and replenish products across both geographies and locations. Our AEPs have been very effective in growing our business with larger Pro customers. We currently have over 200 Pro outside sales representatives in the field and continue to be very pleased with the program's results. Excluding the AEPs we added this year, we saw double-digit growth in AEP sales, which contributed to the strong Pro comp growth in the quarter. Building on this success, we continue to grow the program, adding additional AEPs to continue capturing market opportunity with large Pro customers. Our further -- our focus on further strengthening our portfolio of brands continue to build our omni-channel offering through our growing Pro services team, and our relaunch of LowesForPros.com are all a 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. For the quarter, gross margin declined 3 basis points. Our operating performance drove 17 basis points of improvement with the result of our ongoing line review process. The RONA transaction negatively impacted gross margin by 20 basis points, Bob will provide the details in a moment. As you can see, we had a solid first half of the year. As we look forward to the second half of 2016, we believe we are well positioned to capitalize on the favorable macroeconomic backdrop for the home improvement industry, and we continue to execute our strategic priorities and make progress on initiatives to drive top line growth, improve productivity and profitability. Thank you for your interest in Lowe's, and I'll now turn the call over to Bob.
Robert Hull:
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 in comp sales; 1.5% from RONA; and 0.5% from new stores.
Gross margin for the second quarter was 34.44% of sales, which decreased 3 basis points from Q2 last year. Gross margin was negatively impacted by the RONA transaction due to both purchase accounting adjustments and mix. The purchase accounting adjustments were required to write the opening inventory balance up to fair value, as this product is sold, the higher cost of goods per gross margin. The mix impact was a function of RONA's lower gross margin rate. In the quarter, these items negatively impacted gross margin by 20 basis points, which more than offset 15 basis points of benefit from value improvement. Year-to-date gross margin was 34.71% of sales, a decrease of 21 basis points from the first half of 2015. SG&A for Q2 was 21.2% of sales, which deleveraged 26 basis points. The deleverage was primarily driven by a foreign currency transaction loss and store payroll. As mentioned on our first quarter call, in anticipation of the RONA acquisition, we entered into a foreign currency hedge to lock in the purchase price in U.S. dollars. In the first quarter, we recorded a $160 million unrealized gain. However, in the second quarter, the Canadian dollar strengthened, resulting in an $84 million loss. This item negatively impacted Q2 SG&A by 45 basis points. In the quarter, store payroll deleveraged 30 basis points, driven by wage pressure as well as lower-than-planned sales. These items were partially offset by 24 basis points of leverage in bonus and 16 basis points of leverage and employee insurance. Year-to-date SG&A was 21.69% of sales, which leveraged 70 basis points versus the first half of 2015. Depreciation for the quarter was $366 million, which was 2% of sales and leveraged 16 basis points. In Q2, earnings before interest and taxes were even -- decreased 13 basis points to 11.24% of sales. The RONA impacts to gross margin and the foreign currency hedge negatively impacted EBIT by 65 basis points in the quarter. For the first half of 2016, EBIT was 10.86% of sales, which was 68 basis points higher than the same period last year. For the quarter, interest expense was $166 million. The effective tax rate for the quarter was 38.1%. Earnings per share was $1.31 for the second quarter, an increase of 9.2% over last year. The foreign currency hedge negatively impacted earnings by $0.06 per share. For the first 6 months of 2016, earnings per share were $2.29, representing a 20.5% increase over the first half of 2015. The foreign currency hedge aided earnings per share by $0.05 in the first half of the year. Now to a few items in the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $2 billion. Inventory at $10.6 billion increased $900 million or 9.3% versus Q2 last year. Approximately 85% of the increase relates to the addition of RONA. Inventory turnover was 3.89x, essentially flat to last year. Asset turnover increased 4 basis points to 1.78. Moving on to the liabilities section of the balance sheet. Accounts payable of $7.7 billion represented an 8% increase over Q2 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 second quarter, lease adjusted debt-to-EBITDAR was 2.45x. Return on invested capital was 15%. The net impact of last year's noncash impairment charge related to our Australian joint venture and this year's foreign currency hedge gain hurt ROIC by 194 basis points. Now looking at the statement of cash flows. Year-to-date operating cash flow is $4.6 billion. Capital expenditures were $490 million, resulting in free cash flow of just over $4.1 billion, which is up 15% to last year. In May, we entered into a $500 million accelerated share repurchase agreement. At this point, we expect to receive approximately 6.3 million shares, but the open number of shares will be determined upon completion of the program in the third quarter. We also repurchased approximately 8.9 million shares for $700 million through the open market. In total, we repurchased $1.2 billion of stock in the quarter. We have approximately $1.2 billion remaining on the share repurchase authorization. Looking ahead, I'd like to address several items detailed and Lowe's business outlook. First, a reminder, fiscal 2016 will include an extra week in the fourth quarter for a total of 14 weeks and 53 weeks for the year. Second, since we've closed the RONA acquisition, our outlook now includes the impact of the transaction as well as their operating performance. Finally, the first half of 2016 came in essentially unplanned. We are confident in our ability to achieve our goals for the year. As a result, the only changes to our outlook are related to RONA. Now let's get into the outlook. As Robert noted, the forecast for home improvement industry remains positive. For 2016, we expect a total sales increase of approximately 10%, driven by a variety of factors. First, we are forecasting a comp sales increase of 4%. Second, we expect RONA to contribute 4% to sales growth. Next, we estimate that the 53rd week will aid total sales by 1.5%. Lastly, we plan to open approximately 45 stores, which adds 0.5%. For the EBIT growth rate, we are excluding the impact of last year's Australian joint venture impairment charge and this year's net FX hedge gain. We believe excluding these large onetime items is a better representation of our operating performance. We're anticipating an EBIT increase of approximately 50 basis points. While the acquisition of RONA adds EBIT dollars, there's a negative impact to the percent of sales. There are 2 factors causing this. First, RONA's EBIT is lower as a percent of sales. As part of our synergy case, we expect RONA's EBIT will improve over time. Second are the impacts of purchase accounting I noted a moment ago. This primarily hurts 2016 with minimal impact in 2017 and beyond. Combined, these items pressure EBIT by 35 basis points for the year. The negative impacts to Q3 and Q4 are estimated to be 60 and 50 basis points, respectively. For the year, we expect EBIT dollars to grow by approximately 16%. The effective tax rate is expected to be 38.1%. For the year, on a GAAP basis, we expect earnings per share of approximately $4.06. We are on target to hit our original 2016 operating plan. I'd like to walk you through our EPS outlook, starting with the $4 per share we communicated on the Q4 call in February. From here, we add the net gain from the foreign currency hedge of $0.05. Lastly, we add $0.01 as we expect RONA's operating results to more than offset the acquisition and integration costs. As a result, we do expect the RONA transaction will be modestly accretive for the year. We are forecasting cash flow from operations to be approximately $5.6 billion. Our forecast for capital expenditures is approximately $1.5 billion. This results in an estimated free cash flow of $4.1 billion for 2016. Our guidance assumes approximately $3.5 billion in share repurchases for 2016. Regina, we are now ready for questions.
Operator:
[Operator Instructions]
Our first question comes from the line of Michael Lasser with UBS.
Michael Lasser:
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?
Robert Niblock:
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.
Michael Jones:
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.
Michael Lasser:
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?
Michael Jones:
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.
Operator:
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
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?
Robert Hull:
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.
Robert Niblock:
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.
Simeon Gutman:
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?
Robert Hull:
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.
Operator:
Your next question comes from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
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?
Robert Hull:
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.
Matthew Fassler:
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?
Robert Hull:
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.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
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?
Michael Jones:
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.
Robert Hull:
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.
Christopher Horvers:
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.
Robert Hull:
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.
Operator:
Your next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
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?
Richard Maltsbarger:
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.
Robert Hull:
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.
Gregory Melich:
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?
Robert Hull:
That's about right.
Gregory Melich:
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.
Robert Niblock:
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.
Gregory Melich:
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.
Robert Hull:
There's more of that. That's why there's a $60 million...
Gregory Melich:
That's the $50 million to $60 million. Okay.
Robert Hull:
That's the purchase accounting and the EBIT mix.
Gregory Melich:
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?
Robert Niblock:
Yes, I just spoke to them. It's outdoor power equipment, millwork and paint.
Operator:
Your next question will come from the line of Dan Binder with Jefferies.
Daniel Binder:
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?
Robert Hull:
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.
Michael Jones:
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.
Daniel Binder:
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?
Robert Niblock:
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.
Richard Maltsbarger:
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.
Operator:
Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
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?
Robert Hull:
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.
Scot Ciccarelli:
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?
Robert Hull:
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.
Scot Ciccarelli:
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?
Robert Hull:
There was almost a 400 basis point gap in the Pro comp relative to the DIY comp.
Operator:
Your next question comes from the line of Peter Benedict with Robert Baird.
Peter Benedict:
Sticking with the Pro a bit. Just curious how the MRO business has been trending for you guys? Maybe you got a comment there.
Robert Niblock:
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.
Peter Benedict:
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?
Robert Hull:
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.
Operator:
Our final question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
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?
Robert Niblock:
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.
Michael Baker:
Okay. You think you gained share in the second quarter?
Robert Niblock:
When we look at our performance in appliances versus the industry, we actually believe we gained share in the second quarter.
Michael Baker:
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?
Robert Niblock:
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.
Michael Baker:
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?
Robert Hull:
So the number is 400 basis points.
Michael Baker:
400. Okay.
Robert Hull:
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.
Michael Baker:
And why was that weak again? Just the weather, you think?
Robert Hull:
Yes.
Robert Niblock:
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.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies First 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 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. Comparable sales grew 7.3% in the first quarter, exceeding our expectations, driven by comp transaction growth of 5.1% and a 2.2% increase in average ticket. I'd like to thank our employees for their continued efforts in serving customers, which enabled our strong transaction growth. The team's project expertise and commitment to customer service allowed us to capitalize on the strong home improvement demand in the quarter. Healthy macro fundamentals, favorable weather and our compelling offers drove demand, resulting in strength in indoor as well as outdoor projects. In fact, we recorded positive comps in all 13 product categories, with particular strength in lumber and building materials, millwork, paint, lawn and garden and tools and hardware. Our emphasis on providing better omni-channel experiences positioned us well, enabling us to connect with customers and provide the advice and assistance they count on when completing their home improvement projects, whether they choose to connect in the store, online, in their home or through our contact centers. We're also pleased with the investments we've made to build deeper relationships with the Pro, as our Pro business performed well above the company average. The work we've done to enhance our product and service offering is allowing us to better serve this important customer segment, and we will continue to deepen those relationships.
From a geographic perspective, our U.S. Home Improvement business achieved 7.5% comps for the quarter, with all 14 regions delivering positive comps, and we continued our strong performance in international markets, including double-digit comps in Canada in local currency. For the quarter, we generated 170 basis points of operating margin expansion. Included in the quarter's results is a $160 million unrealized gain on a foreign currency hedge entered into in advance of our pending RONA acquisition. Including this benefit, we delivered earnings per share of $0.98, a 40% increase over last year's first quarter. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $1.2 billion of stock under our share repurchase program and paid $255 million in dividends. I'm also pleased with the progress of our previously announced acquisition of RONA. The transaction was approved by RONA's common shareholders in March. And last week, we received authorization from the Canadian regulatory agencies clearing the way for closing on the transaction this Friday. The time is right to fortify our Canadian market presence to take advantage of the significant long-term potential we see. We expect to build on the recent progress our team in Canada has made and the positive results RONA has achieved over recent years as a result of their restructuring efforts. Turning to the economic landscape for the balance of the year. The outlook for the home improvement industry remains positive. Persistent gains in the job market as well as disposable income growth is expected to outpace growth in the economy, should contribute to solid growth in consumer spending, and housing remains a bright spot with home sales and construction activity posting healthy gains to start the year, while home prices continue their steady upward trend. As a result, the home improvement industry should continue to benefit from the solid consumer housing backdrop even as the benefit of favorable weather at the start of the year normalizes. And as we survey the consumer, we're seeing similar things. Our most recent consumer sentiment survey revealed that favorable views around personal finances and home improvement spending are holding steady. Rising home prices are motivating homeowners to invest in their homes. Admittedly, that this trend will continue, as the survey reveal a significant increase in future home value expectations. Likewise, we continue to see home improvement spending outpace overall spending as well as positive home improvement project intentions. We will continue to focus on improving our product and service offering for the Pro customer and differentiate ourselves through better omni-channel customer experiences that make us the project authority in order to leverage the favorable home improvement backdrop. Our strategic framework, along with efforts to improve our productivity and profitability, give us confidence in our business outlook for 2016. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning, everyone. We executed well in the first quarter, growing both average ticket and transactions. In addition to our successful Spring Black Friday events, we grow traffic through compelling offers designed to take advantage of early spring project demand, leveraging enhanced digital capabilities and improved marketing speed and flexibility to reach the spring customer earlier in the season. And as Robert shared with you, we delivered positive comps across all regions and product categories, as we continue to capitalize on a favorable macro backdrop and consumers' increasing desire to invest in their homes. These favorable trends in home improvement, coupled with our compelling product offering and strength in omni-channel retailing, contribute to a particularly strong performance in categories such as lumber and building materials, millwork, paint, lawn and garden and tools and hardware. We achieved double-digit comps in lumber and building materials, driven by a continued surge in outdoor construction projects coupled with stronger demand from the Pro customer. Millwork also benefited from this dynamic as outdoor projects drove strong performance in windows and doors. And as customers look to improve and enjoy their outdoor living space, the outdoor living experience we introduced in 2014 continued to pay dividends, deliver high single-digit comps in patio and outdoor fashions for yet another year. We also continue to see robust attachment of accessories as the showroom feel and created style help customers envision and create their outdoor space. Our targeted offers, in advance, designed to capitalize on early spring drove demand high single-digit comps in lawn and garden category with particular strength in garden pipelines, live goods, soil and mulch. Our landscape lighting experience was also a success, helping customers visualize their outdoor living -- lighting projects and making selection and installation easy, while offering innovative technologies like LED. This project strip extended to inside the home as well as we also strong -- saw strong performance in interior project categories.
Within fashion fixtures, we leveraged our customer experience design capabilities to optimize our recent lighting resets, showcasing an expanded collection of lighting styles, finishes and brands available both in-store and online, including the introduction of Kichler and Koesell [ph] lighting, both Home Channel exclusives. Along with Progress Lighting, we now offer the top 3 lighting brands in the industry, providing our customers with an exceptional array of options and styles. We combined our extended product offering with a simplified presentation, designs with the needs of the customer in mind, grouping lighting fixtures by style and collection to provide a cohesive decorating solution and simplify selection. Customers have responded well, driving double-digit comps in interior decor lighting and chandeliers. And we're now extending this approach to ceiling trends to leverage our relationship with Hunter Fans as well as our private-label brand and sourcing capabilities. We saw mid-single-digit comps in appliances, flooring and kitchens, further demonstrating the consumers' continued willingness to engage in interior projects. Paint performed above the company average, driven by strength in both interior and exterior projects. Our paint lineup, which showcases Valspar, Sherwin-Williams and PPG/Olympic, provides customers with a full suite of top brands they trust for the paint projects. Tools and hardware also benefited from the increased project activity from both DIY and Pro customers. We were able to capitalize on this demand by improving our tool brand assortment with exclusives like Hitachi and Bostitch, the #1 and #2 brands in pneumatics and the extension of brands like Bon [ph] along with our extensive private-label line of Kobalt tools. Whether working on indoor or outdoor projects, our omni-channel capabilities help customers achieve great results. Customers can engage with our associates in-store for expert advice, our content on lowe's.com for inspiration, our contact center for ongoing support, or our project specialists who work with them in their homes. On lowes.com, we have upgraded our online shopping experience with enhanced product content and search functionality, improved additional tools such as 360-degree product views, improved video content and the continued expansion of click-to-check capabilities to better support the customers' digital experience. As a result, we continue to see positive customer response and very strong growth in our online channel. Our exterior and interior project specialists, dealing with customers in their homes to design, plan and complete their home improvement projects, represent another critical element of our omni-channel strategy. Our exterior project specialists are available across all of U.S. home improvement stores, and we're expanding our interior project specialist program reaching all U.S. stores by the end of this year. Our in-home sales program continues to outperform with above-average comp growth again this quarter. Our expertise in project inspiration, project design and project execution are setting us apart as the project authority in home improvement at a time when the consumer continues to demonstrate a willingness to take on home improvement projects. We continue to strengthen our Pro business, driving comps well above the company average by further advancing our product and service offering to better serve the Pro customer. Beyond improvements in our tools offering, we have also strengthened our portfolio of Pro focus brands with the addition of GAF roofing, Owens Corning insulation, LENOX HVAC and Masonite entry and their interior doors. We continue to play feedback from Pro customers, our outside sales team and store employees, while working closely with our field-based merchandising managers to identify local market opportunities and brands to further optimize our offering for the Pro. We have also advanced our omni-channel resources for the Pro. We continue to utilize feedback from our Pro customers and Pro services team to enhance the features and functionality of our LowesForPros.com site that we relaunched last year, making it easy for Pros to manage multiple properties and quickly purchase items nationwide. Thus far, we have been pleased with the program rollout given the positive customer response and early results, which have exceeded our expectations. Another critical element of our omni-channel offering for the Pro customer is our account executive Pro services or AEPs. AEPs work with larger regional customers to help them order and replenish products across multiple geographies and locations. Our AEPs are a key component of our strategy to grow our business with larger Pro customers. We currently have over 180 Pro outside representatives in the field and have experienced great success with the program with continued strong growth in AEP comp sales. Building on this success, we will continue to grow the program, adding additional AEPs to continue capturing market opportunity with large Pro customers. We are also reaching out to the Pros through targeted marketing and special events such as credit events, bonus days and Spring Pro Appreciation days to drive awareness and generate new business. We have been pleased with these results in driving both incremental purchases with existing Pro customers and building relationships with new customers. Our work to strengthen our portfolio of brands as well as expand our omni-channel offering through our growing Pro services team and our relaunch of LowesForPros.com are part of our broader commitment to build on a strong foundation with the Pro. This foundation includes dedicated service in our stores, inventory depth aligned with the needs of the Pro, including a 5% off everyday loyalty program for Pros using Lowe's proprietary credit as well as reduced delivery rates. In addition to our efforts to drive top line growth, we continue to focus on driving productivity and profitability. For the quarter, gross margin contracted as strong performance in lower margin category, such as lumber and building materials, led to a negative mix impact. And while we plan targeted promotions to capitalize on strong spring demand, the participation rate in those offers exceeded our expectations, which, together with markdowns associated with reset activity, led to a negative rate impact. Our stores once again effectively managed payroll hours on very strong comp sales growth, driving payroll expense leverage. They drove this leverage while achieving continued strong customer satisfaction scores. As you can see, we had a strong first quarter. We continue to make progress on our initiatives to drive top line growth and are focused on improving productivity and profitability. We look forward to sharing further progress with you over the course of the year. Thank you for your interest in Lowe's, and I will now turn the call over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the first quarter were $15.2 billion, an increase of 7.8%. Total transaction count increased 5.5% and average ticket increased 2.2% to $68.08. Comp sales increased 7.3%, driven by comp trends -- transaction decreased 5.1% and average ticket growth of 2.2%. Looking at monthly trends, comps were 8.3% in February, 9.1% in March and 4.9% in April. Comps were stronger earlier in the quarter, as we capitalized on favorable weather to drive above-plan comps. April sales were consistent with our plan coming into the quarter. Gross margin for the first quarter was 35.04% of sales, a decrease of 43 basis points from last year. The decrease in gross margin as a percent of sales was due to rate pressure as well as the mix of products sold. The rate pressure related to targeted promotions and markdowns associated with reset activity. SG&A was 22.28% of sales, which leveraged 188 basis points. In anticipation of the RONA acquisition, we entered into a foreign currency hedge to lock in the purchase price in U.S. dollars. In the quarter, we recorded a $160 million unrealized gain, driving 105 basis points of expense leverage. Also, store payroll leveraged 13 basis points as we continue to optimize our staffing model. Utilities leveraged 11 basis points as a result of warmer weather relative to last year. Lastly, there were numerous other expenses that leveraged between 5 and 10 basis points in Q1. Depreciation for the quarter was $357 million, which is 2.34% of sales and leveraged 25 basis points compared to last year's first quarter as a result of higher sales and assets becoming fully depreciated. Earnings before interest and taxes increased 170 basis points to 10.42% of sales. The unrealized gain on the FX hedge accounts for 105 basis points of the increase versus last year. Interest expense at $156 million for the quarter delevered 8 basis points to last year as total debt increased $4.1 billion versus the first quarter of 2015. We issued $3.3 billion of unsecured bonds in April. The transaction consisted of 3-, 10- and 30-year issuances with a weighted average interest rate of 2.72%. The proceeds will fund the RONA acquisition as well as refines current year maturities. Effective tax rate for the quarter was 38.2%. Earnings per share of $0.98 for the quarter represents a 40% increase over last year's $0.70. The $0.98 includes $0.11 related to the FX hedge gain. We exceeded our earnings plan for the quarter even without the gain.
Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter were $4.6 billion. The higher cash balance is a result of the April bond deal. Our inventory -- first quarter inventory balance of $11.1 billion, increased $441 million, or 4.2% over the same period last year. Inventory turnover was 3.83x, an increase of 5 basis points over Q1 2015. Moving on to the liability section of the balance sheet. Accounts payable, $8.8 billion, increased $798 million, or 10% over Q1 last year. The increase in accounts payable is due to the timing of purchases in the quarter versus last year and a 3-day improvement in days payable outstanding. At the end of the first quarter, lease adjusted debt to EBITDAR was 2.45x. The higher target leverage was the result of the April bond deal. We expect to be back in line with our 2.25x target within 1 year of the RONA transaction closing. Return on invested capital increased 64 basis points for the quarter to 14.98%. The net impact of the non-cash impairment charge recognized in the fourth quarter related to the exit of our joint venture in Australia and FX hedge gain this quarter reduced ROIC by 145 basis points. Now looking at the statement of cash flows. Operating cash flow was $3.2 billion. Capital expenditures were $208 million, resulting in free cash flow of $3 billion. Free cash flow was $766 million, or 34.1% over the same period last year. In February, we entered into a $500 million accelerated share repurchase agreement. We expect to receive approximately 6.8 billion shares, but the ultimate number of shares will be determined upon the completion of the program in the second quarter. We also repurchased approximately 9.7 million shares for $700 million through the open market. In total, we repurchased $1.2 billion in the quarter. We have approximately $2.4 billion remaining on our share repurchase authorization. The remaining $53 million of share repurchases showed on the statement of cash flows relates to the shares withheld from employees to satisfy statutory tax withholding liabilities. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. First, as a reminder, fiscal 2016 will include an extra week in the fourth quarter for a total of 14 weeks and 53 weeks for the year. We estimate that the 53rd week will aid total sales by approximately 1.5% and earnings per share by $0.05 to $0.06. Second, while we have received shareholder approval and authorization from regulatory agencies, we have not closed on the RONA acquisition. As a result, our outlook excludes the impact of this transaction. Finally, while we did outperform our Q1 sales and earnings plan, we continue to think about spring within the context of the first half of the year. We are confident in our plans and hope to sustain a momentum, but we are in the middle of the spring season and believe it's prudent to maintain our previously provided outlook. Now let's get into that outlook. As Robert noted, the forecast for home improvement industry remains positive. For 2016, we expect total sales to increase of approximately 6%, driven by a comp sales increase of 4%, the impact of the 53rd week and the opening of approximately 45 stores, which includes 20 offshore locations and 12 stores in Canada. For ease of modeling, the EBIT growth rate excludes the impact of last year's Australian joint venture impairment charge and this year's FX hedge gain. We are anticipating an EBIT increase of 80 to 90 basis points. The effective tax rate is expected to be 38.1%. For the year, on a GAAP basis, we expect earnings per share of approximately $4.11 with the incremental $0.11 from our prior guide coming from the FX hedge gain. We are forecasting cash flows from operations to be approximately $5.4 billion. Our capital plans for 2016 is approximately $1.5 billion. This results in estimated free cash flow of $3.9 billion for 2016. Our guidance assumes approximately $3.5 billion in share repurchases for 2016. The share repurchase assumption is not expected to be affected by the RONA acquisition. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
I hate to kind of lead with a short-term factor like weather, but, Bob, is there any estimate you guys have in terms of what kind of impact the weather had on the comp in the quarter in total? And by any chance, would you have, let's call it, a monthly cadence kind of on a weather-adjusted basis month by month?
Robert Hull:
Scot, so we estimate that weather impacted Q1 performance by roughly 150 basis points. As I mentioned in my comments, that impact was more pronounced first part of the quarter. I don't have the 150 basis points dissected by month at this time.
Scot Ciccarelli:
Okay, and then just -- I appreciate that. And then just on the margin, you mentioned a couple of different things impacting it, from the promotions to mix. Can you give us any color regarding the relative size of the impact of each of those factors?
Robert Hull:
Scot, the 3 factors that we mentioned, the mix of products sold, the recent activity target promotions, each had roughly 15 basis points impact.
Scot Ciccarelli:
So roughly even. Thanks a lot guys. I will pass the torch.
Operator:
Your next question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
So first, I guess, a follow-up to Scot's first question regarding the 150 basis points, Bob, you answered on the seasonal impact. Can you talk about how much -- or the weather impact, how much that could've been from projects that were -- got started earlier versus outdoor seasonal products that sold through?
Robert Hull:
As I mentioned in my comments, Simeon, we think about spring is more the first half event. We don't spend a lot of time trying to dissect what might have sloshed between quarters. So certainly, the mild winter weather enabled exterior projects. We saw that show up in some of the categories that Rick mentioned did outperform, but the ultimate impact will be determined at the completion of the second quarter when we review our spring results.
Simeon Gutman:
Got it. Okay. And then thinking through gross margin, are you able to share with us the difference in product margin in some of those category, seasonal lumber and building materials? And should we see the gross margin bounce back to that -- to some extent in the second quarter reflecting the product mix?
Robert Hull:
So what I would say is the lion's share of the mix impact related to lumber and building materials. So if the demand for those categories remain strong, we could have additional mix pressure in the second -- or the remainder of the year. However, we would also generate additional sales from that demand. In addition, the other 2 items, the targeted promotions and the reset activity are largely Q1 events, and we don't expect a lot of residual impact beyond Q1 for those items.
Operator:
Your next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
Two questions. One is about the guidance and the fact that it was a good strong start to the year and if we keep that 4% comp guidance, my math, it implies that the rest the year, we're going to be running like 3% or 3.5%. Is that what you're seeing now, especially given, if I remember correctly, May is actually an easier comp than April was a year ago? Then I have a follow-up.
Robert Niblock:
Greg, this is Robert. I'll start and then I'll turn it over to Bob. I think just as we've done the past few years, generally coming out of the first quarter, we've not changed our guidance for the year. So we're following a cadence very similar to what we've done in the past. We think it's too early in the year to be changing our guidance. I think this is very consistent with what you've seen the past few years, whether we've started off with a robust, hot first quarter or first quarter that was, let's say, weather challenges we had a couple years ago. But Bob, if you'd like to...
Robert Hull:
Yes, a couple things, I'll redirect my comments. First, we felt good about April, April was on plan. Second, we hope to sustain a momentum that we're seeing. So Rick started about our plans to remain confident in our ability to execute. There's nothing to suggest that we're not able to execute the guidance we look for.
Gregory Melich:
So if April is on plan, so presumably, May is on plan.
Robert Hull:
As we talk about the guide annually, we feel good about the opportunity to deliver our results. We're not going to get into the short-term nuances of this quarter versus that quarter, but we are confident in our ability to execute.
Gregory Melich:
Okay, great. And, I guess, the follow-up was for the margin progression in the first quarter and more on the gross margin side. You talked about targeted promotions unrelated to reset. Are there other categories that you're going to be resetting doing this with that we should expect in the second and third quarter just for the rest of the year? Or was that something more specific to the first quarter, as we think about the rest of the year, and how it plays out?
Rick Damron:
Greg, it is more specific to the first quarter and normalizes throughout the balance of the year.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So following up on the margin, so was gross margin in line with your plan? And then, the other side of it is the SG&A came in much better even if you back out the foreign currency hedge gain, so that was very strong, so was that also in your plan? And as you think about putting up a 7% comp in the first quarter, which is fantastic, the flow-through, I guess, wasn't very large, and I know that you talked about that, that 1Q was going to be light, but you're also, I think, embedding more of like a 5% comp. So I guess that there was actually 2 points in drive as much flow-through as one would have thought.
Robert Hull:
So the gross margin came in a little bit below our plan for a couple reasons. First, as Rick talked about, we had greater take rate in the targeted promotion, so we had an estimate of the impact. The customers' activity was stronger than we anticipated, which is certainly a good thing and kudos to the team for identifying the items that resonate with customers. Second, we expected the impact from the reset to be able to more balance Q1 and Q2. We had good sell-through on the recent activity, therefore the impact was more pronounced in the first quarter. As I mentioned, that kind of clears the deck Q2 going forward. And then lastly, the mix pressure was little higher than we anticipated based on the strong demand in lumber and building materials. As it relates to the flow-through, so the lower-than-anticipated flow-through is almost entirely attributable to the declining gross margin versus plan again based on the factors I just described.
Christopher Horvers:
Understood, understood. So the SG&A came in where you thought it would be, and there was no up and down because of -- like you talked about in the fourth quarter, a switch between financing offers versus promotional offers.
Robert Hull:
No. There was a subtle nuance within credit as it relates to our partner and they made a change that impacted us last year regarding the loan loss reserve. The trailing impact of that hit Q1, that was modest pressure in Q1 that's largely done, so that's a pressure in Q1 that we won't see Q2 going forward, but not otherwise, Chris, nothing out of the norm.
Christopher Horvers:
Understood. And then as a follow-up, there are a lot of companies who are sort of talking negatively about the consumer target, for example, this morning, following other companies' department stores last week, Costco being a little bit late. So is there anything as you peel back demand, whether it's regionally, California is ticket versus traffic, deceleration in the quarter, is there anything that you're seeing that would suggest a deteriorating consumer backdrop?
Robert Niblock:
Chris, this is Robert. As I outlined in my comments, as we've seen the consumers, we look through our consumer sentiment survey, what their intentions are around spending, what their intentions are around investing in the home, as we're seeing continual improvement in the job market, we're seeing continuing improvement in wages. We're seeing continued improvement in home values is driving continued improvements in their intentions for discretionary spending, which I think the best evidence of that is in the top 1% increase that we saw in top transactions during the quarter. And nothing that we've seen in our segment surveys has led us to believe that the consumer, when we ask them how do you feel 6 months out with regard to purchases, nothing shows any change in their intentions as we survey them today. So that, I think, is why as Bob took you through strong first quarter, we are aware of what others are saying out there with regard to the consumer. But when we take our strong first quarter performance and what we're hearing from the consumer home survey, gives us confidence in reiterating our guidance for the year that Bob has taken you through.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
So this is the second quarter in a row where you were a little bit more promotional, it seemed to have maybe a greater impact this quarter. Can you talk about the influence that some of the increased promotional activity that you engage in had on the comp? And what are you learning about consumer price elasticity across various categories as -- this is a 3 part question, I apologize. Is the promotional activity more pronounced in-store or online?
Michael Jones:
I can take that. First, let me just talk about where we focused our promotions and a little bit about how we went about it first quarter. We are more focused on lawn and garden seasonal living, tools and hardware, major appliances and interior projects, because we thought those would be the types of products and projects the consumers' mindset will be geared towards. So we leveraged our sales and operation planning process. And what's important about this process is it allows us to have a better sense on the micro seasons that apply to the consumers' mindset, so that we hit the consumer with the right promotion at the right time. We're much faster in being able to flex our promotions in our digital assets because it's one of the investments that we made in our digital capabilities and what we saw was a higher take rate. And as Bob said earlier, that's certainly a good thing. Our flexible supply chain allows us to make adjustments to where the consumer is making purchases and ensure that we don't disappoint them by not having product. But I wouldn't say that the intensity and depth of promotion was greater. What I would say is that our execution around promotions continues to get better. So we're doing a much better job of getting the right promotions in front of the customer at the right time, leveraging our digital capabilities as well as some of the process that we put in place.
Michael Lasser:
Are you learning anything about price elasticities? It seemed like last quarter it was more focused on appliances. Maybe this quarter was more on seasonal in tools? And so maybe the construct of the home improvement industry, which conventional wisdom says that there's not -- that the elasticity isn't as great here as in other categories. It may not be true and you can push that a little harder to drive more traffic. Is that the right way -- is that the way you're thinking about it?
Rick Damron:
So Michael, we've got tools that allow us to understand the effect of promotions and price elasticity of items. That's the magic is to have the right level of promotions that resident customers -- not too much because too much promotion creates some leakage in the system and less than ideal flow-through. So we do have some tools in place to allow us to evaluate the effectiveness of the promotion of drawing customers in, try to get the sense of the close rate, as well as elasticity of the item. So we are continuing to turn knobs and pull levers to maximize the effectiveness there.
Michael Lasser:
And, Bob, you mentioned that you think promotions will be less of an impact on the gross margin in the second quarter, is that because you're going to pull back on the promotions? Or you think this is more effective and less dilutive? And then I'm done.
Robert Hull:
So as Mike said, one of the key areas that was a focus in Q1 was lawn and garden and some of the higher take rate, higher effective promotions were around that category. Those are not things we expect to repeat in the second quarter or beyond for that matter regarding lawn and garden, which allows us to be comfortable that the impact is largely contained in the first quarter.
Operator:
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
A couple of quick ones here. I know you gave the monthly cadence as reported, did the Easter calendar shift impact the monthly cadence at all?
Robert Hull:
It did, Matt. As we think about Easter impacted it -- with the change, Easter would have impacted March. March would have been 9.7%, April would have been 3.4%.
Matthew Fassler:
Got it. That's very helpful. Second question, can you talk about what you saw directionally for online growth this quarter? And any changes in how the customer DIY and/or Pro is using lowes.com?
Rick Damron:
Yes, Matt, lowes.com and e-commerce grew 23.5% for the quarter, and we saw strong growth in traffic as well as conversion to the sites. We feel good about the investments that we've made over the past year and really beginning to drive increased shopability of the site. I think the key aspects there is when we go back and we talk about the things we've done to the site to really make it more customer friendly, like I said in my comments, the enhanced video content that we are adding to the site, the improved product descriptions, as well as increased content there is also resonating well with the customer. So those aspects have, I think, continued to help us drive incremental growth from the dot-com platform. LowesForPros, from an e-commerce perspective, is performing extremely well, as we said, exceeding our expectations, and we're extremely pleased with what we were hearing and the feedback we're getting from consumers as well as our AEPs in the field about the usability of the site. The functions of the site enables to make the ability for the Pro to shop much more easily with us. So we're really proud of those 2 things as we continue to move forward. We had not seen a shift in the mix of business regarding the in-store pickup. We still see that as roughly 60% of all e-commerce transactions that have picked up. That's even heavier as it relates to LowesForPros delivery. Still continues to grow as a proponent of that and parcel is about 30% of our dot-com sales.
Operator:
Your next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
So one follow-up question on the gross margin. In the past, you guys have talked about some offsets in either product cost deflation or value improvement, which I don't think was called out in the quarter. Can you speak to those items and if you see those as bigger opportunities as we through the year?
Robert Hull:
So Seth, those items continue to be in play. We did see some modest spending for both of those items in the quarter, but they were offset by the 3 negative factors that were mentioned.
Simeon Gutman:
Got it. Okay. And then just a specific question on the appliance category. I think that category saw one of the biggest swings in the quarter, went from outperforming in the past, to below the company average, and I think that's just optics to some extent as I think that you said the category was still up mid-single digits, but is there anything else to read into that, as we try to understand both where we are in the cycle and also, perhaps how the competitive landscape may be changing in that category specifically?
Rick Damron:
No. We don't think there is anything else to read into it. If you look at our appliance business, it's outperformed for the last 5 quarters, it's cycling over a double-digit comp. The 2-year stack is well above the company average. We continue to have one of the best assortments with all of the national brands. We continue to take advantage of next-day delivery, haul away, in-house consultation, repairs and maintenance. We're really proud of the fact that we control the last 3 feet of the appliance experience. We don't outsource that. J.D. Power's just recognized us as the best in appliance retail satisfaction. The investment that we made in floor space gives us one of the largest floor space in the industry and the reason why we think that's important is that if you consider our floorspace in appliances coupled with our floorspace in cabinets, it positions us well to take advantage of the cycle in '16 as it plays through. The last thing I'd say is that in kitchens in particular, if you look at the high-ticket items in kitchen, things like cabinets and countertops, we saw strength there. So that's a test to us that the cycle is still well intact.
Operator:
Your next question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
One follow-up question to an earlier one. How much did the greater uptake on the promotional activity impact the comps?
Robert Hull:
Certainly had some impact, Michael, as lawn and garden is one of the best-performing categories. So it was certainly a driver of the quarter. But as the team described, there's many actions impacting the Pro, impacting the paint category, impacting a variety of things that help drive the totality of the performance in the quarter.
Michael Baker:
Okay. I think the 4 product categories, I think was -- Mike Jones mentioned as where you focus promotions, 2 were above, 2 were below company average. So I was looking for more color on that, but okay, understood. Another question, you did keep the 80 to 90 basis point guidance for the year on the margins, which means for every comp point above 1%, you're going to look for between 27 and 30 basis points improvement. You're obviously below that here. So is the reason that you didn't change that, is it what you said earlier about not changing the comp outlook just too early in the year? Or are there specific reasons to believe the flow-through will be not only better than it was in the first quarter, but better than that 27 to 30 typical rule of thumb?
Robert Hull:
So I would say, Michael, we think there's potential upside on the sales line. Again, we feel good about momentum we saw in Q1. We hope to sustain the momentum. However, we feel it's way too early to start thinking about changing outlook for the year. So we do think there's some upside in the comp line. We talked about some gross margin pressure in the first quarter that won't continue. So we certainly take that into account. However, we do feel even better than we did 90 days ago about our ability to continue to drive expense productivity and leverage, which gives us confidence in the outlook to the extent sales are better. And so that's driven by lumber and building materials categories that flow-through might be closer to 25 basis points. But again, it's too early to start changing pieces of the outlook.
Operator:
Your next question will come from the line of Eric Bosshard with Cleveland Research Company.
Eric Bosshard:
Two things. First of all, from a bigger picture perspective, just wonder, Bob, if you could comment on how we should be thinking about gross margin, understand the moving parts in the first quarter, but as we think about this year or the next couple of years, strategically, how are you thinking about balancing promotions and sales relative to gross margin, and what path does that suggest for gross margin?
Robert Hull:
So two things. One, it ties back to a previous answer and then secondly, long-term gross margin performance. So as I mentioned earlier, we do have tools to allow us to evaluate the effectiveness of promotions. As we think about promotions, some are to drive -- specifically to drive sales, some are specific to grow the basket and some are just general awareness around the brand and the categories we carry. So we continue to turn knobs and pull levers to maximize the effectiveness there. Taking a step back, Eric, as we think about gross margin, we do expect some modest gross margin improvement annually. As we think about gross margin, it's probably not going to be 2017 to actually eclipse the gross margin rate we had in 2010. So it's not like we're forging new ground and looking for gross margin peaks that have never occurred before. So roughly over that year period, it is called flattish gross margin over a long period of time.
Eric Bosshard:
Okay. And then secondly, I understand the influence of weather and your desire to not talk about the very near-term, but the difference in performance in April and May relative to February and March, anything that you learned in looking through that? Can you isolate the weather? Or is there anything else different that's going on that explains the magnitude of the step down?
Robert Hull:
Two things regarding weather. So I mentioned 150 basis point impact in the quarter. If we exclude the weather, we would still meet our sales plan. So the underlying demand for our category is from the macro fundamentals that drive our business housing and incomes continue to be constructive beyond that. No other nuance is impacting the quarterly -- excuse me, the monthly cadence.
Eric Bosshard:
Okay, and within -- I guess, your commentary within April being on plan would suggest that's where you expected to be despite whatever happened with weather, is that the proper way to read that?
Robert Hull:
That is correct.
Operator:
Your next question will come from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My first question is just around Pro and specifically LowesForPros. You've had that in place now for a couple of quarters. Can you give us an update on the effectiveness and the traction you're gaining from that initiative?
Robert Niblock:
Sure. As we stated earlier, we have been very pleased with the receptivity from the consumer and the Pro customer regarding LowesForPros. We continue to see strong growth quarter-over-quarter as customers come aware of the site. When we look at Q1, we saw significant growth in new registered Pros on the site as well as conversion in growth as a percent of total dot-com business. So we feel great about what we're seeing. We continue to improve the functionality of the site through feedback from our customers and our sales teams to make it more conducive and easier for the customers to navigate. The other thing I would say as we continue to look at the site is to keep in mind the functionalities that it did provide that we did not have the capabilities of before. So the Pros, for example, we're not capable of using their in-house credit. They can now. Pros did not receive their 5% val prop usage on prior lowes.com, they can today. Tax-exempt accounts weren't available to them prior usage, but they are today. So all of those things are resonating extremely well, and we continue to work on making the site more effective, more efficient. But to date, we've been extremely pleased with what we've seen both from a risk reducer content as well as sales performance.
Seth Basham:
Great, that's helpful. And then secondly, on cost control, great performance this quarter. As you look through the balance of the year, Bob, when you think about labor optimization, marketing, indirect costs, can you give us some order of magnitude of the benefits you expect from each of those?
Robert Hull:
Sure. I'll give you some high-level perspective. For the year, we continue to think indirect spend is going to pay dividends for us. That's in the 50 or so basis point range, bonuses is 10. Like to talk about the analysis around promotions. We continue to do the same thing regarding resets and things of that nature. We think we'll get about 10 basis points of leverage on that spend this year. Risk insurance is going to be less of a drag. It's about 5 basis points. Employee insurance, also less of a drag. Advertising, about 5 basis points. And couple kind of indirect logistics cost leverage, 10 or so basis points, and the impact of the 53rd week gives us about 5 basis points. So a lot of good items to drive expense leverage for 2016.
Operator:
Your next question comes from the line of Kate McShane with Citi Research.
Kate McShane:
One area that I just wanted to make sure I address today is just about the supply chain. I know something that has been discussed by both you and your biggest competitor in the home improvement channel as a competitive advantage and there's a way not to get disrupted. Can you walk us through any efficiencies achieved in the supply chain this quarter, and what opportunities you're working on over the next 6 to 12 months?
Rick Damron:
Sure. The aspect of the supply chain has been a significant advantage for us for years, as we talk about how we build out supply chain and the avenues that we have. I think as we look at the omni-channel environment over the last several years, we've enabled several new functions to the supply chain to allow us to continue to meet that demand, flexible fulfillment, which allows us to shift from a store group as well as our RDC. So we're able to meet 94% of our customer demand with next-day shipping rates by utilizing that flexibility within the system. We continue to maximize the productivity of the supply chain through new initiatives, such as project rhythm, which we work with vendors in smoothing out orders and order flow to make sure that we are as effective as possible. We continue to drive labor efficiency in the supply chain through utilization of Lean Six Sigma practices and processes and making sure that we are able to get the effective use of tubing out to trailers and the trucks to move forward. Fleet and fuel costs continues to be an advantage in the tailwind currently. So we continue to see those avenues play-in significant dividends for us over the next several months, and quite frankly, the next couple of years. As we look into the construction of possibly the Internet Fulfillment Center, or DFC, Direct-to-Customer Fulfillment Center, which we have currently plans underway and being built out for -- by forecasted opening in the 2018 time horizon.
Robert Hull:
Regina, if we got time for one more question?
Operator:
Our final question will come from the line of Peter Benedict with Robert W. Baird.
Peter Benedict:
So a couple of questions. First, I mean, the comment about Pro being well above the company average. I know it was above average in the fourth quarter, but it sounded obviously the tone to that comment was a lot stronger. Any way to quantify that, this gap relative to maybe historical trend? Is this about as strong a gap as you've seen? Just trying to get a flavor for just how strong that momentum is right now.
Robert Hull:
So the Pro performance, Pete, in the first quarter was approaching double-digits.
Peter Benedict:
Okay, good. That's helpful, Bob. And then on the online business, what are the largest categories that you guys are selling online right now? And then what are the fastest-growing, I mean, are there certain categories that are kind of coming on strong, just curious how that looks?
Michael Jones:
A couple of things. I'd say for the most part, where you see simple replace items, they tend to do better online, like appliances as an example. But one of the differences in our strategy is that we help customers pull together projects and that tends to lend itself more towards omni as the best tool to serve those customers' needs. But our encouraging of online is automated by the fact that we tend to be more project-oriented than simple replace, thus we talk about being the project authority and not talk to just product.
Rick Damron:
Yes and I would like to add to that. As we continue to look at overall traffic, as I said earlier, we have been extremely pleased with receptivity to new functionality of the site from the consumer. And I think that's representative in the results over the last couple of quarters as well as the investments that we're making to make content more effective for the customers from a aggregation of data perspective as well as product information. As such, we've been extremely pleased with the sales from the site. The visits to the site have continued to grow as well as improvements in conversion and average ticket. So as Mike talked about, we continue to see those core fundamental categories continue to do well, the single product categories, particularly in appliances and those categories. And again, I think it's important to highlight that the store still plays a critical role in the omni-channel world where our customers are choosing to either pick up or have delivered 70% of all of our transactions from lowes.com, from the store, with 30% still be in parcel. So we feel good with where we are. We feel good with the traction we're making and making the site much more effective and user-friendly.
Peter Benedict:
Very helpful. Last point would be on lawn and garden. Obviously, strong in the quarter, but curious about the spread North versus South? I mean, certainly a lot stronger in the South, I think, than in the North. How large was that gap? And what kind of opportunity do you see in lawn and garden in, call it, the North, Northeast, over the balance of the second quarter?
Michael Jones:
We think spring is still to come in the Northeast, certainly, so we think there is still some lawn and garden business to go get. But I do want to just say one thing, if you think about our business, we had some strong promotions in lawn and garden. The rest of our business continues to do extremely well. So if you look at paint, as an example, where we had really high comps above the company average. Applicators, exterior stains, exterior paint, spray paint, caulk, interior stains, all double-digit. So we feel good about some of the spring that's ahead of us. We think that's going to drive our lawn and garden business. We feel even better about some of our big initiatives that are also driving our business.
Robert Niblock:
Thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter results on Wednesday, August 17. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you, all, for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2015 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. We delivered another solid quarter, with comparable sales growth of 5.2%, which exceeded our expectations. Our efforts to drive traffic, which Mike will share in more detail, have resonated with customers, resulting in a 3.6% increase in comp transactions, along with a 1.6% increase in average ticket.
Our U.S. Home Improvement business achieved 5.5% comps for the quarter, with all 14 regions generating positive comps. And our strong performance in Canada continues, with double-digit comps in local currency for the third year in a row. During the quarter, we generated positive comps in all 13 product categories. We capitalized on increased demand for exterior products as a result of warmer weather, with strength in lumber and building materials, outdoor power equipment, lawn and garden and millwork, while at the same time, driving strong mid-single-digit comps in interior project categories, such as paint and fashion fixtures. And as a result of our strong brand and service advantages, we continue to drive strong comps in appliances. Lastly, our Pro business performed above the company average as we continue to build deeper relationships with the Pro by enhancing our product and service offering to meet their unique needs. For the quarter, we drove 79 basis points of adjusted operating margin expansion and adjusted earnings per share of $0.59, a 28% increase over last year's fourth quarter. For the year, we delivered comparable sales growth of 4.8% and adjusted earnings per share of $3.29, a 21% increase over 2014. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $562 million of stock under our share repurchase program and paid $257 million in dividends. For the year, we repurchased $3.8 billion of stock and paid $957 million in dividends. As we head into 2016, the outlook for the home improvement industry remains positive. Continued support from steady job gains and improved incomes, as well as favorable trends in housing, should keep home improvement growth buoyant. Further, despite recent volatility in the financial markets, the fundamentals for continued growth in consumer spending remain intact. Consumers should continue to benefit from improved household financial conditions and lower gas prices on top of broader job and income gains. These trends aligned with results for our most recent consumer sentiment survey, where favorable perceptions around personal finances remained stable, even though respondents' assessment of the national economy declined slightly. For the home improvement industry specifically, we continue to see favorable trends, as the desire to invest in the home continues to grow. Roughly half of homeowners believe the value of their home has increased, which is double the number feeling that way in 2009. And many believe this trend will continue, as we saw a significant increase in future home value expectations. And while most homeowners indicated their spending levels are staying the same, they are more likely to allocate funds to home improvement compared to other areas. In 2016, we will continue to leverage the favorable backdrop for home improvement, delivering great service to customers while also anticipating how Lowe's will meet their needs in the future. We take a prudent approach to managing our portfolio of businesses, making decisions that shape how we serve and connect with customers. Giving careful consideration to how we position Lowe's favorably for sustainable growth, we invest to obtain compelling returns over the long run. As we carry out our capital allocation priorities, which remain unchanged from what we shared previously, our first priority is to invest in the business. We then seek to return excess cash to shareholders in the form of dividends and share repurchases. We demonstrated our disciplined approach to capital allocation with the recent changes in our international business. First, after a comprehensive strategic analysis, we decided to exit the Australian home improvement market by withdrawing from our joint venture with Woolworths. We made the decision to focus our resources on areas of the business where we see greater potential return on investment. Second, seeking to reinforce our portfolio of businesses in North America, we committed to accelerating our growth in Canada by announcing our agreement to acquire RONA. The time is right to strengthen the company's Canadian operations to take advantage of the significant long-term potential we see. We expect to build on the recent progress our team in Canada has made and the positive results RONA has achieved over the past several years as a result of their restructuring efforts.
With this transaction, we see opportunities to further increase revenue and operating profitability in Canada, including:
Enhancing customer relevance by utilizing our strengths as a leading omnichannel home improvement company and drawing on our customer experience design capabilities; expanding customer reach and serving a new portion of the market by applying our expertise in certain product categories, including our best-in-class appliance offering; driving increased profitability in Canada by leveraging shared supplier relationships and enhanced scale, as well as Lowe's private-label capabilities in addition to eliminating RONA's public company cost.
At the same time we're reinforcing our international businesses, our U.S. home improvement business, with a dedicated focus from Mike and Rick's team, is diligently working to drive profitable share gains within the U.S. market. In 2016, their efforts will continue to focus on improving our product and service offering for the Pro customer and differentiating ourselves through better customer experiences that make us the project authority. Across the enterprise, we strive to be a customer-centric omnichannel company. So we'll continue to enhance our omnichannel capabilities, evolving from a multichannel offering to an omnichannel experience, where all of our channels work in concert with one another. We will support customers at every step of their home improvement journey and build a greater affinity for the Lowe's brand. This strategic framework, along with our efforts to improve our productivity and profitability, give us confidence in our business outlook for 2016. Bob will share those details in a few minutes. This is an exciting time for Lowe's, and I would like to thank our employees for their incredible contribution they make every day. It's their hard work and commitment to delivering outstanding customer service that makes this company great, and I look forward to what their efforts produce in 2016. Thanks, again, for your interest. And with that, let me turn the call over to Mike.
Michael Jones:
Thanks, Rob, and good morning, everyone. As Robert shared with you, we delivered another solid quarter, with positive comps across all regions and product categories. We executed well in the fourth quarter, growing both average ticket and transaction.
We drove traffic through our Black Friday event, which drove sales increases of 8% overall and 26% online, with compelling offers and special buys in tools, holiday decor, appliance and other traffic drivers, creating strong values for customers while remaining true to our strategic focus and core strength in home improvement. We drove increases in traffic for the quarter through competitive offers, enhanced online selling capabilities and improved marketing speed and flexibility from our digital capabilities, where we tested new concepts like deal of the day. We also rebalanced year-end promotions to take advantage of the extended outdoor selling season. Looking at product category performance, we recorded above average comps in lumber and building materials, appliances, lawn and garden and paint. We saw particular strength in outdoor project categories, led by lumber and building materials, lawn and garden, and to a lesser extent, outdoor power equipment and millwork, as customers took advantage of mild weather to complete exterior projects, such as roofs, fence and decks. In outdoor power equipment, we drove double-digit comps in off-season products, such as pressure washers, walk-behind and riding mowers. And in lawn and garden, we saw double-digit comps in soil, mulch and lawn care. Our new landscape lighting experience drove strong performance as well, bringing outdoor lighting projects to life by providing inspiration and making selection and installation easy for customers while offering new product technologies, like LED. We also achieved strong comps in appliances for yet another quarter, leveraging our investment in customer experience both in-store and online. In-store, our 17 appliance suites showcasing coordinate appliances allows customers to visualize how their appliance purchase will look in their existing or remodeled kitchen not just as a same replacement purchase, but as a full set of new appliances, and allows us to showcase innovations, such as black stainless steel, a new appliance finish, and new product collections, like the Frigidaire Professional Collection, a Lowe's Home Channel exclusive. Online, we have enhanced our customer experience and presentation on Lowes.com, including improved product search, integrated and upgraded product videos, enhanced product presentation, like 360-degree views, and simplified product groupings to make it easy for customers to make their selection. Our continued focus on omnichannel customer experience, together with leading brands, breadth of assortment, competitive price, knowledgeable sales specialists, as well as delivery and haul-away service, combine to drive our sustained share gains in appliances. In fact, J.D. Power & Associates ranked Lowe's the #1 appliance retailer for 2015. Paint benefited from increased project activity, as well as broad awareness of our 3-brand offering. With the launch of HGTV HOME by Sherwin-Williams in the beginning of second quarter we are now providing customers with a full suite of top brands they trust for their next paint project. Olympic provides quality at a great value and easy application. Valspar specializes in color authority with their love your color guarantee. And HGTV Home by Sherwin-Williams provides strong brand recognition, designer-coordinated colors and quality that customers trust. We are also proud to announce the expansion of HGTV HOME by Sherwin-Williams with the introduction of Infinity, our premium one-coat paint and primer with exceptional hiding power and coverage, available on our stores in March. As customers engage in both indoor and outdoor projects, we leverage our omnichannel capabilities to help them achieve great results, not only in our stores and online, but also through our project specialists, who meet the customers in their homes. This capability represents another important element of our omnichannel strategy. We have project specialists who focus on the exterior of the home available across all U.S. stores, and we're expanding our interior project specialist program, reaching all stores by the end of 2016. We're very pleased with our in-home sales program performance with above average comp again this quarter. With our ability to coordinate style, provide design expertise and find the right contractors for the job, we are rapidly becoming the project authority in home improvement. And our customer experience design capabilities continue to pay dividends, leveraging our largest store format in space initially created for the outdoor living experience, we again showcased our holiday decor experience, an inspirational holiday showroom where customers can see everything, from point setters (sic) [poinsettias] and artificial trees to indoor and outdoor decorations and gifts. Developed in collaboration between our merchants, stores and dedicated customer experience design team, the holiday decor experience inspire customers to decorate, raise their awareness of the breadth of our holiday decor and gift offerings and provide the project solutions relevant to the holiday microseasons. The customer response is very positive, driving strong sales and attachments for the products included in the set. We're now transitioning this space back to our outdoor living experience in preparation for the critical spring selling season. Toward the end of the quarter, as Winter Storm Jonas approached, we're able to serve customers' needs as they worked to prepare for and clean up from the storm. Our supply chain demonstrated agility and flexibility, as we worked with inventories such as snow throwers, generators, ice melt and heaters to the areas in the path of the storm. We're proud of the way our supply chain teams and associates responded to the needs of our customers during Winter Storm Jonas. We also continue to strengthen our Pro business, driving comps above the company average by continuing to advance our product and service offering to meet their unique needs. Throughout the year, we strengthened our portfolio of Pro-focused brands with the addition of Goldblatt masonry tools, GAF roofing, Owens Corning insulation, Lennox A-sat [ph] and Masonite entry and interior doors, in addition to leveraging our long-standing partnerships with Hitachi, Stanley Bostitch, Bosch, Vaughan and Paslode to develop a broad Pro-relevant selection of tools and fasteners. We're also proud to introduce Cabot Stains, one of America's most recognized stain brands, rolling to our stores in the first quarter. We continue to incorporate feedback from the Pro customer and store employees into a better offering and experience by working closely with our field-based merchandising managers to identify local market opportunities and introduce products optimized to local norms to further increase our relevance with Pros. Along with strengthening our brand portfolio, we relaunched LowesForPros.com at the beginning of the second quarter, making it easy for Pros to manage multiple properties and easily purchase items for their locations nationwide. We're also actively serving the Pro through our account executive pro services, or AEPs. AEPs call our regional customers to help them order and replenish products across multiple stores. 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 160 Pro outside sales representatives in the field and are very pleased with the program's results. Excluding the AEPs we added this year, we saw a double-digit growth in AEP sales, which contributed to solid Pro comp sales growth in the quarter. Building on this success, we plan to add an additional 35 AEPs in the first half of 2016. We're also reconnecting with Pros who have not recently purchased from Lowe's to show them what's changed in our stores and online, using targeted marketing as well as Pro-focused events to drive awareness and generate new business. For example, our Pro services team engaged with customers at the International Builders Show in Las Vegas, driving awareness of the platform and services we provide. We then extended the interaction to our stores for a first-time builder week, with special product and credit offers for the Pro. Our focus on strengthening our portfolio of brands, serving Pro customers through our Pro services team as well as our relaunch of LowesForPros.com are part of a broader commitment to put in 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. Gross margin was flat year-over-year, as improvements driven by our line review process and inflation were offset by the impact of product mix and promotions. Once again, our stores effectively managed payroll hours on solid comp sales growth, driving 25 basis points of payroll expense leverage, but also driving strong customer satisfaction scores. We also continue to drive productivity in marketing by optimizing our media allocation, increasing our presence in targeted digital advertising, expanding our social media presence and reducing print advertising, thereby increasing the efficiency and effectiveness of our media buy by improving our advertising spend, all while maintaining our customer reach and improving exposure. And we continue to identify and implement additional expense efficiencies by consolidating the procurement of some of the types of goods and services across our corporate and store functions. During the quarter, we demonstrated the flexibility and capabilities of our supply chain as our distribution teams worked efficiently to move inventory to meet customer needs, not only as they prepare for winter storms in the mid-Atlantic and the Northeast, but also to meet the heightened demand in the Pacific Northwest. While inventory at quarter end was up 6% to last year, it reflects our commitment to being in stock for items that are most relevant to our customers, as well as timing of spring buys, including the impact of Chinese New Year's, and a higher level of inventory to support strong sales growth in categories such as appliances. As you can see, we are pleased with our fourth quarter results and the progress we continue to make on our initiatives to drive top line growth, productivity and profitability. We look forward to sharing further progress with you over the coming quarters. Thank you for interest in Lowe's. And I will now turn the call over to Bob.
Robert Hull:
Thanks, Mike, and good morning, everyone.
Sales for the fourth quarter were $13.2 billion, a 5.6% increase over last year's fourth quarter. Total transactions increased by 4% and total average ticket increased 1.5% to $67.15. Comp sales were 5.2% for the quarter. As you heard from Mike, solid execution drove balanced performance in the quarter. Comp transactions increased 3.6% and comp average ticket increased 1.6%. Looking at monthly trends, comps were 2.8% in November, 7.3% in December and 5.3% in January. For the year, total sales were $59.1 billion, an increase of 5.1%, driven by comp sales of 4.8% and new stores. For 2015, comp average ticket increased 2.5%, and comp transactions increased 2.2%. Gross margin for the fourth quarter was 34.66% of sales, which is flat to last year. In the quarter, product cost deflation and value improvement aided gross margin, but were offset by pressure from the mix of products sold and promotions. For the year, gross margin of 34.82% of sales represented an increase of 3 basis points over 2014. In January, we made the decision to exit our joint venture in Australia. There is a process in the joint venture agreement for purposes of determining the value of our portion of the joint venture. We are working our way through that process and expect it to be completed in the next month or so. We recorded a $530 million non-cash impairment charge in the fourth quarter. The charge includes the cumulative impact of the strengthening U.S. dollar over the life of the investment. The valuation is based on our best estimate of our 1/3 interest in the joint venture. This valuation is subject to potential adjustment as additional information becomes available as we complete the process. For the quarter, the impairment charge impacted SG&A leverage and EBIT by 401 basis points and earnings per share by $0.58. For the year, the SG&A EBIT impact was 90 basis points, while the earnings per share reduction was $0.56. Finally, as a majority investor, we have been recognizing our share of the losses which were reflected in SG&A. In 2015, we recorded $11 million and $48 million for Q4 and the year respectively. As a result of our decision to exercise our put option, we are no longer required to make capital contributions or absorb future operating losses.
My comments from this point will be focused on our operating performance and will exclude the impact of the joint venture impairment. Adjusted SG&A was 24.55% of sales, which leveraged 69 basis points. The leverage came from a number of areas. Mike mentioned 2:
Store payroll and marketing, which leveraged 25 and 20 basis points, respectively. Utilities expense leveraged 12 basis points, primarily the result of warmer weather. Employee insurance leveraged 12 basis points in the quarter due to a reduction in both the number and severity of claims. Also, given the sales growth, we were able to leverage fixed costs. For the year, adjusted SG&A was 23% of sales and leveraged 62 basis points versus 2014.
Depreciation expense was $369 million for the quarter, which is 2.79% of sales and leveraged 10 basis points. Adjusted earnings before interest and taxes for the quarter were 7.32% to sales, which represented a 79 basis point increase. For the year, adjusted EBIT of 9.31% represented an increase of 78 basis points over 2014. Interest expense at $144 million for the quarter deleveraged 3 basis points as a percentage of sales. Regarding the reported tax rate. The impairment gives rise to a capital loss versus an operating loss and therefore is not immediately deductible. To the extent the company has future capital gains, we'll be able to offset this loss. Adjusted net earnings for the quarter were $541 million, which increased 20.2% versus last year. Adjusted earnings per share of $0.59 for the quarter were up 28.3% to last year. For 2015, adjusted earnings per share of $3.29 were up 21.4% versus 2014. Transitioning to the balance sheet. Cash and cash equivalents at the end of the quarter were $405 million. Inventory at $9.5 billion was up $547 million or 6.1% over last year. Roughly $200 million or 2.2% of the growth was driven by the timing of Chinese New Year, with the rest of the increase to support sales growth. Inventory turnover was 3.92, an increase of 7 basis points over last year. Moving on to liabilities. Accounts payable at $5.6 billion was up $509 million or 10% over last year. The increase relates to both higher inventory levels and a 2-day improvement in days payable outstanding. At the end of the fourth quarter, lease-adjusted debt-to-EBITDAR was 2.14. Return on invested capital increased 18 basis points to 14.1%. We estimate that the impairment charge negatively impacted ROIC by 238 basis points. 2015 was the third consecutive year that ROIC improved by more than 200 basis points. Now looking at the statement of cash flows. Cash flow from operations was $4.8 billion, capital expenditures were $1.2 billion, resulting in free cash flow of $3.6 billion. During the quarter, we repurchased 7.6 billion (sic) [ 7.6 million ] shares for $562 million through the open market. For the year, we repurchased almost 54 million shares, which included $3.8 billion from the company's share repurchase program, as well as shares withheld from employees to satisfy statutory tax withholding liabilities, for a total of $3.9 billion. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. But first, I want to highlight that fiscal 2016 will include an extra week in the fourth quarter for a total of 14 weeks and 53 weeks for the year. Lowe's fiscal year ended on the Friday nearest the end of January; this means we have a 53-week year roughly every 5 years. Our last 53-week year was 2011. For 2016, we estimate that the 53rd week will aid total sales by approximately 1.5% and earnings per share by $0.05 to $0.06. Secondly, while we have reached agreement to acquire RONA, we have shareholder and regulatory approvals ahead of us. As a result, our outlook excludes the impact of the RONA transaction. Now let's get into the outlook. As Robert noted, the forecast for the home improvement industry remains positive. While we're optimistic about that forecast, we've taken a prudent approach to our 2016 outlook. For 2016, we expect total sales increase of approximately 6%, driven by a comp sales increase of 4%, the impact of the 53rd week and the opening of approximately 45 stores, which includes 20 Orchard locations and 12 stores in Canada, largely the result of the Target lease acquisition. For ease of modeling, the EBIT and EPS growth rates exclude the impact of the impairment charge. We are anticipating an EBIT increase of 80 to 90 basis points from a combination of gross margin, SG&A and depreciation. As you've heard from others, there is wage pressure in the marketplace. Our outlook for 2016 assumes roughly 7 basis points or $0.03 per share of pressure associated with above average wage inflation. For 2016, we expect 25 to 30 basis points of EBIT expansion per point of comp above 1%. While this is our expectation for the year, there will be some choppiness quarter-to-quarter. Similar to last year, 2000 -- EBIT expansion will be stronger in the second half of the year, primarily driven by gross margin, bonus and the impact of the 53rd week. As a result, we are forecasting EBIT expansion of 50 to 60 basis points for the first half and 115 to 125 basis points for the second half of the year. And looking at our guidance model relative to First Call, the mean estimate for the first half of the year appears to be heavy by about $0.02 per share in both Q1 and Q2, and the fourth quarter looks light, likely as a result of the 53rd week. The effective tax rate is expected to be 38.1%. For the year, we expect earnings per share of approximately $4, which represents an increase of 21.6% over 2015 adjusted EPS. We are forecasting cash flow from operations to be approximately $5.4 billion. Our capital plan for 2016 is approximately $1.5 billion. This results in estimated free cash flow of $3.9 billion for 2016. We expect to issue incremental debt during the year as we manage to the 2.25 lease-adjusted debt-to-EBITDAR target. We had approximately $3.6 billion remaining under share repurchase authorization at the end of the fiscal year. Our guidance assumes approximately $3.5 billion in share repurchases for 2016. The share repurchase assumption of $3.5 billion is not expected to be affected by the RONA acquisition. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Bob, just a quick follow-up on the progression of the flow-through for the year. I guess that we were under the impression there were some indirect cost that had come out in the middle part of this -- the last year, and that would still roll through the model in the first part of '16. And so why, I guess, isn't that the case? And then can you just put a little more color around a wide bonus in GM? I don't know if those were mentioned any part of the year, but what are the factors that are going to, I think, help you with flow-through in those areas?
Robert Hull:
So assuming -- there's a variety of factors that contribute to flow-through being a little bit heavier in the second half of the year. Gross margin really based on the mix of products, primarily, with a greater mix impact in the fourth quarter and the second half of the year than we did in the year as a whole, that's a primary difference, driving a little bit heavier gross margin expansion in the second half than the first half. For bonus, we came into the year expecting to leverage bonus roughly 10 basis points, ended up being flat as percent of sales for 2015 relative to 2014. A lot of that difference came in the fourth quarter on the strength of our sales performance. Our bonus programs are predicated on sales and earnings performance. And based on the strength of the sales results for the fourth quarter, we increased bonus accruals. As a result, we'll have the opportunity to leverage against that build in Q4 2015. Another smaller item, store environment, so just the timing of projects weighted more in the first half versus second half as we think about 2016 versus 2015. And the impact of the 53rd week, we have roughly $900 million of additional sales in the fourth quarter. That's going to drive roughly 15 basis points of higher EBIT in the second half of the year as a result of that. So those are the major factors giving rise to the difference in flow-through second half versus first quarter.
Simeon Gutman:
And to clarify, are there incremental indirect cost that could come during the year? And then I'll just ask my follow-up in case I get cut off. Just the volatility or the variability in the months in the quarter, November was weak, I think, but you mentioned Black Friday was good, I think. But November was a little weak, December was great against tough compares. Did anything explain that? Anything strategically? Does it sync up with promotions, et cetera?
Robert Hull:
As it relates to the second question, really tough weather first half of November, primarily in the Southeast. So as you think about our footprint, our Southeast orientation, that had an impact on the first half of November. After that, we saw much improved performance in the second half of November. As Mike indicated, we had very good Black Friday performance. As it relates to other indirect costs, we continue to work on our indirect spend, and would expect to see a leverage throughout 2016 from those efforts.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
It's about the promotional activity that you undertook during the quarter. Is that something that you had planned on doing? Or was it more in response to what you saw in the marketplace and then responded in kind?
Michael Jones:
Michael, this is Mike Jones. I'd say it like this, most of it was planned. We do make adjustments as we see the competitive activity in the marketplace. And we will, at times, move out of one form of promotion to another. One of the things that you saw us do was move from credit as a primary form of promotion in certain points in the quarter into other forms of motion. But the total activity level is exactly where we planned it to be. The execution towards that activity level, we can make adjustments within the quarter.
Michael Lasser:
So just to trying to interpret what you're saying, Mike, you had planned to do some promotions in the fourth quarter, you were going to move away from offering extended terms of free financing towards more pricing and discounting. That's how it happened. And is that a right interpretation of how it unfolded?
Michael Jones:
I'd say a little different. We planned to do promotions within the quarter, we promoted to the level that we planned to promote to, and one of the adjustments that we made in the quarter was less financing and more towards discounts, is what we did in the quarter. So total level's exactly where we expected it to be, with some adjustments within the quarter on how we got there.
Michael Lasser:
Are there signs that the sector's becoming more promotional? Maybe as some struggle just with their survival, they're doing things to be more relevant? And so you're having to respond? Or is it just that -- the direction the world's heading?
Michael Jones:
I don't think so. I think where those are having challenges, the challenges are probably something other than just straight price. I think there are folks having some challenges around their format, and I'm not sure they're going to promote their way out of those kind of challenges. And so I would describe the market as very rational. When we go after where we target for share gains, we do it in a way that's rational. I think the majority of us do exactly that. So I don't see it becoming more promotional, I don't see -- I don't think I see anyone doing anything that's going to suggest that the market goes in a bad space as a result of people trying to survive. I just haven't seen that.
Robert Niblock:
Michael, this is Robert. Also keep in mind, it's not just the promotional cadence that we executed in the quarter versus our plan, it also comes into play the success of those promotions. So for example, we didn't plan on appliances to be high single-digit comps for the quarter. There was opportunity there, obviously, as we've talked about in the past, that particularly in the fourth quarter, that's a category of merchandise that is, from a competitive standpoint, is something that gets promoted through the holidays. And we've had great receptivity, great success with the appliance offering, the suites that Mike talked about being in the store. So part of it is not only staying on the program but the success of what we saw, which drove some of that mix impact as well, so.
Robert Hull:
I'd like just to clarify. So the product promotions impact gross margin, so we called out the negative impact to gross margin based on the product promotions. The reduction in finance promotions hit SG&A. So roughly speaking, the EBIT impact of promotions in Q4 was about as planned. The complexion, as Mike described, between gross margin and SG&A was a bit different.
Operator:
Your next question will come from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
Couple of follow-up questions. So in January -- was there any benefit from the weather in January? I'm assuming the warm weather. Home Depot talked about it yesterday, that being mainly a December phenomenon. Was there a benefit from the big storm in January? Trying to get an understanding of what's real good indication of the underlying run rate of demand in the business. That was, like, a 5.3% in your guiding to a 4% for the year.
Robert Niblock:
I'll start, Chris, and then I'll let Bob talk specifically about how things fell in January. Just kind of as we've said in our comments, if you think about the quarter, ending a year or what, but certainly, overall warmer weather for the majority of the quarter. That extended the season for the outdoor product categories, which is what we went through, your kind of lawn and garden, lumber and building material, those that we saw really strong. Outdoor power equipment, that we saw a really strong performance for. But then we had stuff like Hurricane Jonas hit -- I'm sorry, Superstorm Jonas hit, we were in really great shape with the products that customers needed at that point in time. So any time that you're selling snow throwers and ice melt and those things, you're not selling a lot of other stuff. But when the customer needs that product, being in supply of those products, which our merchants did a great job with having secured the access to the product, as Mike took you through our supply chain, did a great job of getting that product in the market where the customer needed it, where it was impactful for the customer to have that product. So all in all, there was a great execution in the quarter in taking advantage of the opportunity that was there. Bob, you want to talk specifically to the weather impact to January?
Robert Hull:
So as Robert said, with extreme weather, you selling the pack of products, but your traffic is basically done. You're not selling any of the exterior products. The weather impact for the quarter was largely contained to December, roughly 50 basis points impact for the quarter. But as I mentioned, most of that impact was felt in December.
Christopher Horvers:
And then so as a follow-up to that, the 5.3% in January, maybe thinking about that and then reflecting on the comp progression throughout the year and how you're thinking about the first quarter, first half versus second half.
Robert Hull:
So as we think about 2016, we see the 4 quarters in a relatively tight band. There's some movement up or down, but it's not substantial for the year. So as we think the 4%, it should be fairly consistent across the 4 quarters.
Christopher Horvers:
Understood. And then one follow-up, which is on the EBIT line. So we had modeled, I think, almost 20 basis points of bonus leverage so in the fourth quarter, and it sounds like that was flat. Was that basically the delta versus your model in terms of driving the leverage? And as you think about getting to the 25 to 30 basis points next year, it seems like sales upside results in less margin flow-through, as you saw in the fourth quarter. So I guess trying to reconcile those 2 things.
Robert Hull:
So the flow-through was impacted in the quarter and for the year by 2 factors, and we've talked about both. Bonus is one and the mix impact on gross margin is the second. If you roll it back, it would suggest, Chris, that those items combined for a 5 basis point flow-through impact on the year, which would get us into the 25 to 30 basis point range. We are comfortable with that -- with the guided range for 2016, it would also be in that 25 to 30 basis point range.
Operator:
Your next question comes from the line of Peter Benedict with Baird.
Peter Benedict:
Just a question kind on the spring upcoming. I mean, how does the warmer winter kind of set you up for the spring? Have you guys made any adjustments in terms of the timings of your sets? How you're approaching the spring business?
Michael Jones:
Peter, it's Mike Jones. Simply would suggest from an inventory perspective, I talked earlier to having brought in inventory a little sooner to be sure that we're prepared for the spring. But we're also looking at category performance so that we can take advantage of what we think is going to be some upside with the way -- we've made some adjustments to how we're doing our resets in terms of outdoor patio and some of those categories. So yes, we're ready for the spring. We think it could be a good spring for us, and we want to be there to take advantage of it. And you saw us do that on the other side of the fall as well, taking -- carrying some of the fall lines longer into the year to take advantage of what looked like a longer fall season.
Rick Damron:
Peter, this is Rick. I'd also add to that, just from a inventory perspective, Bob talked about the impact of Chinese New Year and the timing of that and the impact that had on inventory layers for the quarter. So majority of that product is spring-related. So we have that in our systems, it's in our DCs and being loaded into the stores. So we feel good, both from a stacking perspective as we plan the quarter, as well as the flow of inventory that will -- we won't have or we won't see any significant gaps if the weather continues to hold as is or accelerate into an early spring.
Peter Benedict:
Okay. That's helpful. And then just on the big-ticket comps, they were solid, 6.6%, those transactions above $500. But they did slow a little bit or decelerate from the third quarter. Just curious, given what's going on in the stock market, some of these energy markets, just curious if you're seeing anything kind of when you peel back the onion, any kind of wealth effect impacts on some higher-ticket project demand. Again, it doesn't look like it's impacting the overall business, but anything in particular you can point out there? Either regionally or what have you.
Robert Hull:
We're not -- Peter, our business continues to be driven by income and housing. So really solid progress on the number of jobs added throughout 2015, as well as late in the year, as we started to see some real wage appreciation. As it relates to housing, continued solid turnover through 2015, as well as mid [indiscernible] with the oil price depreciation. So all of those factors continued to drive demand for home improvement, and we see similar factors going into 2016.
Operator:
Your next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
A couple of questions. I want to start with deflation, what you're seeing in lumber and copper in the quarter and what the outlook do you think is into this year.
Robert Hull:
So those 2 items, lumber and copper, they only impacted Q4 by 35 basis points. We expect roughly similar impact in Q1, but the impact dissipates as we progress through 2016.
Gregory Melich:
Okay, great. And then second, I just wanted to make sure I got the CapEx cash flow buyback tied together correctly. It looks like you'll be generating $3.5 billion of free cash flow but buying back $3.5 billion of stock, and that's excluding the acquisition or anything you might get from the Australian joint venture. So if we get the deal in Canada done early, should we expect that $3.5 billion to be less? Or does that $3.5 billion sort of factor in that, that expense is kind of out there? And I guess, why CapEx ticked up this year to $1.5 billions.
Robert Hull:
So regarding CapEx. The higher number of store openings is the biggest driver for CapEx. There was some timing of projects, a couple stores slipped from '15 to '16, as well as some other projects, which moved about $100 million from 2015 to 2016. Adjusting for that, we basically compare $1.4 billion in '16 to $1.3 billion in '15. Bear in mind that the '15 number includes roughly $200 million associated with the purchase of the Target DC and leases. Specific to the buyback and cash flow generation, you are correct that it excludes both the RONA transaction and any funds received from the joint venture. However, even if the transaction goes through in the middle of the year, we do not expect that the $3.5 million (sic) [ $3.5 billion ] share repurchase would be reduced.
Gregory Melich:
Okay, great. And then online growth, I think Mike, you mentioned up 26%, but that was around Black Friday. Do you have a number for the whole quarter?
Rick Damron:
Yes. Greg, this is Rick. For the quarter, the online business was up 26% in total. So that was the quarter number.
Gregory Melich:
Okay, got it. And what percent of sales now?
Rick Damron:
3% of total sales.
Operator:
Your next question comes from the line of Seth Sigman with Crédit Suisse.
Seth Sigman:
First, a question on the long-term guidance, the 11% EBIT margin goal. I know you said you would update us at some point, but just as we look at the numbers, it seems to imply a similar margin improvement in '17 as '16. But of course, '16 has that extra week. So on a 52-52-week basis, it implies an acceleration. How should we be thinking about that at this point?
Robert Hull:
So still on target for the 11% in 2017. Our guidance would suggest roughly the same level of EBIT improvement in '17 versus '16, so you're correct on that. Regarding the 53rd week, while it is an extra week, it's essentially one of our lowest, if not the lowest, volume sales week of the year, so it's not a terribly productive sales week. It has some impact on the second half of the year, as I mentioned, but the EBIT impact is only about 3 basis points for the year. So little impact in '15 going into -- excuse me, in '16 going into '17.
Seth Sigman:
Okay, got it. And then a question on the Pro side of the business. You mentioned that was performing above the company average. That seems to be a change versus the last couple quarters, at least. Can you elaborate on that trend? Do you think that's an industry trend or something specific that's resonating? And then I guess, on the other side of that, does it imply any major change in the trend for the DIY side of the business?
Robert Niblock:
This is Robert. I'll start and then I'll let the other guys jump in. Yes, I think part of what we signaled was, given the favorable weather that we had during the quarter, that I think that also helped drive some strength in the Pro business, when you think about the ability for a lot of the project categories that we talked about, for them to continue to work and implement. And on top of that, a lot of the other initiatives that we've put in place, such as LowesForPros.com, the incremental resources that we put in place after, that is resonating with the consumers. So I think part of it is kind of an industry macro that the weather setup had allowed for incremental opportunity in those product categories, which drove some of that business. Then on top of that, some of the specific stuff that -- and resources we've put behind our Pro initiative and becoming more relevant with that Pro customer.
Rick Damron:
Yes. This is Rick. And I'll agree with Robert, weather had an impact on the Pro when we look at the categories and performance, particularly through the months of December. But I think it also continues to resonate in how the way the Pro continues to respond to our initiatives, both from a brand perspective, as the merchants continue to work the operations team to make sure that we have the relevant brands that the Pros are responding to. And then also, with our continued focus on making sure that, both from a service standpoint and a value standpoint, that we remain relevant to the marketplace in what we're doing there. So they continue to respond well to the brands. The outside sales organization that Mike commented earlier of 160 people, adding another 35 into that organization, continues to perform extremely well and resonate with the customer, particularly on our large MRO accounts and our national accounts, as we continue to see those grow. And the -- our core programs, of our 5 Ways to Save for the Pro customer, continues to resonate really well. So we think we'll continue to build upon the solid foundation that we put in place over the last couple of years.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Curious if you could talk a little bit about your thoughts on market share with both the DIY customer and Pro customer, how you'd evaluate the performance in '15 and how you think about how that might performance -- how that performance might compare in 2016.
Robert Niblock:
I'll start, Eric. Obviously, we think that as we look at the market share data that you can get out there, that our performance in 2015 exceeded the growth in the markets. We feel good about our performance, it exceeded our own plan and expectations. I think the team did a good job of capitalizing on opportunity that presented itself in the market. For example, appliances and how we -- the amount of business we did in appliances consistently throughout the year. As we look forward to what the market looks like in 2016, the initiatives we have in place, I still believe that we feel good at some of the changes that have taken place in the marketplace, that we feel good that we'll continue to, with our initiatives, gain share in 2016 as well.
Robert Hull:
Eric, specific to the numbers for the calendar fourth quarter, makes 4.44 [ph] was up 4.6%. Our comparable growth is up 5.1%. We know that's not a precise measure of the industry, but directionally, we feel like we're growing a little bit ahead of share. As we think about 2016, we do some work with some partners to try to estimate what the expected growth rate is for our industry, and that would suggest roughly a 4% growth rate for 2016, which sits right on top of our comp with other -- with new stores that should get us an opportunity to take share in '16.
Eric Bosshard:
I guess specifically, I had a follow-up on the Pro side, the investments you're making there, especially in the outside selling efforts. Curious if you think that allows for a notable improvement in your market share performance with the Pro. Or is 2015 reflective of what that growth rate or what that market share performance is going to continue to look like.
Michael Jones:
Eric, this is Mike Jones. We think there's potential for it to continue. If you look at some of the brands that we've brought back in fashion lighting with Kichler, progress lighting in Korzel [ph], that's a 3-brand approach. This approach is a Home Channel exclusive, you won't find these brands at any other Home Channel. And if you look at our strength in fashion lighting through this past quarter, we were up double digits. Paint, above the company average, with Sherwin-Williams now bringing on Infinity [indiscernible] and Olympian. Again, another 3-brand approach. You won't find this particular approach at any other home channel. And with the addition of Cabot to couple with Olympic as the knockout punch, #1 and #2, you won't find that at any home channel as well, that's going to let us continue to drive share gains in paint. If you look at our approach in pneumatics, with Hitachi pneumatics, coupled with Stanley Bostitch, that's the #1 and #2 pneumatic brand in the U.S., you won't find that at any other home channel. I can go through our portfolio of brands that we bought back and an exclusive set we have and [indiscernible] fantastic job. We think that positions us to continue to build more relevance with the Pro. And when you couple that with the other initiatives that we have, we think we got runway. And we've talked before about GAF coming back, Owens Corning insulation [indiscernible] exclusive, we talked about Goldblatt coming back. I mean, we've got a portfolio of brands that we brought back to Lowe's that we think position us for share gains, to Robert's point, both with Pro and with DIYs. So we're comfortable about how we're positioned going into 2016. The team's done a fantastic job of bringing back brands. We think we continue to build towards being the project authority in home improvement. We're very comfortable with how we're positioned.
Rick Damron:
Yes. Eric, this is Rick. The only thing I would add to that, again, is the introduction of LowesForPros.com in the second half of the year, just getting its legs under. As we continue to gain traction from that initiative, I think it sets us up well to continue to gain share from the MRO customer, as we continue to get traction with LowesForPros.
Operator:
Our final question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I have 2 questions. The first relates to big-ticket, and this was your category disclosure. One category you cited as being a bit softer is kitchen, which I know is kind of a traditional big-ticket, project-oriented category. My sense is that world had, had some momentum for you. So anything in particular holding you back? And any macro reading you would take from performance in that category.
Michael Jones:
This is Mike Jones. No, we don't think it's anything macro, just the kitchens were largely challenged by some pull-forward due to October promotions. We had some reset activity in the kitchen as well. Today, we talked about those credit promotions, it also impacted the kitchen. So we don't think there's anything macro there.
Matthew Fassler:
Got it. And then the second question. As we think about bonuses and incentive compensation, it sounded like what really happened was that the sales beat by a greater degree than the earnings, and the way the incentives are structured, that essentially worked against you and sort of dug the earnings hole just a little bit deeper. As you think about the incentive structure for the stores and the way you pay out bonuses, is there any thought being given to reworking those in a way that they're more profit- or gross-profit-driven? I understand that the store-level associate can't necessarily think about the earnings for the enterprise. But in a way that incentivize sort of the best kind of business that you can do.
Robert Niblock:
The -- Matt, this is Robert. I think yes, you obviously hit one of the items that put a little pressure on the quarter, and that was the sales growth rate versus the earnings growth rate, if you want to call that. And what I'll to tell you is that every year, we looked at a set of competition programs all the way across the organization, and try and set us up for what we think is going to drive the right response across the organization to take care of the customer and drive the business. And this has been an evolution that we've been on all the way back from when we were just single channel and everything, the incentive compensations were heavily focused to what took place in the 4 walls of that store, to really now today, being an omnichannel organization, where a store manager is not only compensated on what happens inside their store but also what happens in their market as well. So it's an evolution we're gone through as we're going from single channel to multichannel to now omnichannel. But that's part of what Rick and his team do every year, is look at the incentive compensation structure and make sure that it's appropriately aligned. We're very happy with the behaviors that it's driving, but it is something, as we continue to evolve, the other parts of our business become bigger parts of the total sales, it is something to look at to make sure that we're driving the right behavior of keeping the customer in the center and always focus on what's best for the customer. That's our job, and we'll be doing that, so.
Well, great. Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter results on Wednesday, May 18. Have a great day.
Operator:
Ladies and gentlemen, this concludes your conference for today. Thank you all for joining. And you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2015 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I'm pleased that we delivered another solid quarter with comparable sales growth of 4.6% or 9.7% on a 2-year basis. Our comp growth was balanced with a 2.5% increase in comp transactions and a 2% increase in average ticket. Our U.S. home improvement business achieved 5% comps for the quarter with all 14 regions generating positive comps. While our businesses in Canada and Mexico delivered high single-digit comps in local currency, our consolidated comp was negatively impacted by foreign currency translation.
We generated positive comps in 12 of 13 product categories with outdoor power equipment delivering flat comps on top of double-digit comps last year. We had strength in seasonal living as customers took the opportunity to extend the outdoor season, driven by warmer and drier weather early in the quarter. Tools and hardware also performed well as both Pro and DIY customers responded to the improvements we continue to make in our assortment, further enhanced by exciting home center exclusives. And our strong brand and service advantage in appliances continue to drive double-digit comps in the category for the fourth quarter in a row. Lastly, our Pro business also performed well as we continue to build deeper relationships with the Pro by enhancing our product and service offering to meet their unique needs. For the quarter, gross margin expanded 26 basis points, and we effectively controlled expenses, delivering 130 basis points of operating margin expansion and earnings per share of $0.80, a 36% increase over last year's third quarter. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $750 million of stock under our share repurchase program and paid $260 million in dividends. We've been working to improve our product and service offering for the Pro customer and differentiating ourselves through better customer experiences that make us the project authority. And we continue to enhance our omni-channel capabilities, transforming our brand from a multi-channel offering, in-store, digital, in-home and by phone to an omni-channel experience where all of our channels work in concert with one another. To clarify, this transition is -- this transformation is about much more than growing our e-commerce business. Our efforts were centered around supporting customers at every step of the home improvement journey and building greater affinity for the Lowe's brand. I'm particularly encouraged by the momentum we're gaining through increased engagement with our in-home selling efforts. During the third quarter we expanded our Project Specialist Interiors program to an additional 475 stores and now offer the program in 1,365 stores across the country. Coupled with our Project Specialist Exteriors program, which is available at all U.S. home improvement stores, and our highly motivated team of account executive ProServices who continue to strengthen relationships with regional Pro customers, we have a strong outside selling force of more than 3,000 people who are able to meet customers on their terms either in their home or at their place of business. The execution of our strategic priorities alongside a favorable macroeconomic backdrop make this an exciting time for Lowe's. In fact, the forecast for key drivers of the home improvement industry remain conducive for growth at least through 2017. Steady job and income gains coupled with persistent home price appreciation and strengthening homebuying should keep home improvement growth buoyant. We continue to be pleased with the results of our quarterly consumer sentiment surveys. Most encouraging this quarter is that the desire to invest in the home continues to grow as survey respondents are indicating that growth in their home improvement spending is outpacing increases in their overall spending. In fact, the number of homeowners indicating that their home improvement spending increased has almost doubled since 2012, boosted by the persisting recovery in home prices. This trend underscores the opportunity we have to address the needs of 75 million homeowners across the country who are increasingly willing to engage in home improvement projects in addition to the 5 million who relocate or move into a new home each year. Before I close, I'd like to express my appreciation for our employees' purposeful commitment to serving customers. In particular, I'd like to thank those Lowe's team members who worked diligently to assist our neighbors that were impacted by the historic flooding in South Carolina. In addition to working round the clock to ensure our stores in the affected communities were able to provide products needed for storm recovery efforts, many of our employees also pledged their time to help individuals in need. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning. As Robert shared with you, we delivered another solid quarter. The team executed well, driving traffic to our stores growing both transactions and average ticket for the quarter. Our appliance category experienced the strongest growth in the quarter producing double-digit comps.
In addition to our leading brands and service advantages in this category, our investments in customer experience are also having an impact both in-store and online. We have further enhanced our appliance offering with the introduction of 17 appliance suites showcasing coordinated appliances, allowing customers to visualize how their appliance purchase will fit into their space not just as a single replacement purchase but as a full set of new appliances. And because we understand that more than 80% of customers begin their appliance purchase by researching and shopping online, we have enhanced our customer experience and presentation on Lowes.com, including improved product search, enhanced videos, upgraded presentation by 360-degree views and simplified product groupings. In fact, J.D. Power and Associates ranked Lowes.com the #1 appliance retailer website for 2015. Our continued focus on improving the omni-channel customer experience together with leading brands, breadth of assortment, competitive pricing, knowledgeable sales specialists as well as delivery and haul away combined to drive our share gains in appliances. Seasonal living also outperformed as we effectively anticipated customer needs and capitalized on favorable weather conditions. Warmer weather in the north and west in the first half of the quarter drove strong demand for air conditioners, and we were able to meet that demand, thanks to the flexibility and capabilities of our distribution teams as they worked efficiently to move product. Further, our customer experience design capabilities continued to pay dividends. These capabilities were first introduced with the outdoor living experience showcasing patio and outdoor fashion, which recorded strong comps again this quarter. Along with the strong sales of patio furniture, we continue to see an increase in attachment of related products such as cushions and other outdoor accessories. Our customer experience design capabilities take advantage of our larger store format to produce a showroom feel and create a more shoppable environment, which drives higher customer engagement and stronger attachment rates. The layout and adjacencies also make it easier for store associates to offer a more coordinated project solution to meet customer needs. As we transition to fall, we leverage this capability to create a seasonal stage to anticipate customers' needs for the season like planting, leaf removal and exterior maintenance. And as winter arrives, we will continue to leverage this capability and seasonal stage to help customers refresh their homes for holiday guests, decorate then organize their home after the holidays. This quarter, we also saw above-average comps in tools and hardware, driven by strong demand as well as our expanded offering, including continued innovation from brands such as Stanley Black & Decker, Hitachi, Bosch, DEWALT, LENOX and IRWIN, and improved brand relevance in critical categories like pneumatics with our expanded line of Hitachi pneumatic nailers and fasteners, a home channel exclusive to Lowe's. We recently completed the reset of our pneumatics destination featuring the 3 strongest brands in the category, Hitachi, Bostitch and Paslode. Our pneumatic brand partnerships make us a clear destination for pros and create opportunities to be more relevant to their business. Our paint performance was in line with the industry with a low single-digit comp. With our launch of HGTV HOME by Sherwin-Williams at the beginning of the second quarter, we are now providing our customers with top brands they trust for their next paint project. Olympic provides quality at a lower price and easy application. Valspar specializes in color authority with their Love Your Color Guarantee, and HGTV HOME by Sherwin-Williams provides a strong brand recognition, designer coordinated colors and quality customers trust. Paint employees are now able to meet the needs of both DIY and Pro customers who have been shopping us for paint sundries and requesting Sherwin-Williams. We also continue to see strength in our portfolio of Pro-focused brands. In addition to the brands we rolled out in the first half of the year, including Goldblatt masonry tools, GAF roofing, Owens Corning insulation and Lennox HVAC, we are proud to introduce Masonite entry and interior doors, offering a key brand that pros know and trust. These new brands continue to build a momentum with the Pro customer and also represent the powerful partnership between our ProServices and merchandising teams as we work together to incorporate Pro feedback into a better offering and experience. This commitment is also evident in the assignment of field-based merchandising managers who are working closely with the Pro customer to identify local market opportunities and introduce products optimized to local norms to be more relevant with the Pro. Along with strengthening our brand portfolio, we relaunched LowesForPros.com at the beginning of the second quarter, making it easy for pros to manage multiple properties and purchase items like appliances for their locations nationwide. This full omni-channel experience allows pros to easily order online and choose their preferred fulfillment option of parcel, store pickup or store delivery, saving them time and money. We are also reconnecting with pros who have not recently purchased from Lowe's to show them what's changed in our stores and online. We're using targeted marketing as well as pro-focused events to drive awareness and generate new business. For example, September was Pro Appreciation month. During the event, we offered vendor demonstrations, special values on core Pro products throughout the store and drove awareness of the support we provide like job site delivery and credit offers. Our focus on strengthening our portfolio of brands, serving Pro customers through our account executive ProServices team as well as the recent relaunch of LowesForPros.com are part of a broader commitment to build on our strong foundation with the Pro. In addition to our efforts to drive top line growth, we continue to focus on driving productivity and profitability. During the third quarter, our store teams once again effectively managed payroll, increasing sales power in line with comps. We continue to leverage our power investments, optimizing store labor to meet customer demand and continue to focus on shifting more hours to customer-facing roles. Most importantly, we have achieved this greater payroll efficiency while improving customer satisfaction scores. We also drove productivity in marketing by using a robust set of analytic tools to optimize our media allocation, leading to a reduction in print advertising and an increase in digital advertising and an expansion of social media, increasing the efficiency and effectiveness of our media buy and improving our advertising spend, all while maintaining our customer reach and improvement exposure. While we've already seen positive results from this work, media optimization is a multi-year effort and opportunity. We also continue to identify and implement additional expense efficiencies by consolidating the procurement of similar types of goods and services across our corporate and store functions. For example, this year, we have worked cross-functionally to streamline the procurement process for supplies used across our stores, distribution centers and our corporate office. Early results are favorable with savings across multiple lines. We have also worked to increase profitability for the services we offer without impacting the customer experience. For example, as part of our appliance offering, we provide service advantages such as free delivery and haul away. This year, as part of our appliance recycling program, we work directly with the end-recyclers to increase recycling income despite a decline in the metals commodity market. As you can see, we are pleased with the third quarter results and the continued progress of our initiatives to drive top line growth, productivity and profitability. We look forward to sharing further progress with you over the coming quarters. Thank you for your interest in Lowe's, and I will now turn the call over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the third quarter were $14.4 billion, an increase of 5%, driven primarily by comp sales. Total cost per transactions increased 2.8%, and total average ticket increased 2.1% to $67.34. For the quarter, comp sales were 4.6% as comp transactions grew 2.5% and comp average ticket increased 2%.
The monthly comps were 5.1% in August, 4.8% in September and 3.7% in October, while the monthly 2-year stack accelerated through the quarter. Year-to-date sales of $45.8 billion were up 4.9% versus the first 3 quarters of 2014 driven by a 4.6% increase in comp sales and new stores. Gross margin for the third quarter was 34.75% of sales, which increased 26 basis points over Q3 last year. The increase was driven primarily by better sell-through of seasonal products and product cost deflation. Year-to-date gross margin was 34.87% of sales, an increase of 5 basis points over last year. SG&A for Q3 was 22.89% of sales, which leveraged 91 basis points, driven primarily by 4 items. Advertising expense leveraged 17 basis points as we transitioned to a more efficient and effective media mix. The proprietary credit program leveraged 16 basis points due to continued growth in the program and lower operating costs. Costs associated with building maintenance and repairs leveraged 15 basis points, largely due to the timing of projects as more of them occurred in the first half of the year versus last year. Store payroll leveraged 13 basis points as we continue to optimize hours against customer traffic. Numerous other expense lines also leveraged as a result of sales growth. Year-to-date SG&A was 22.55% of sales, which leveraged 60 basis points versus last year. Depreciation for the quarter was $375 million, which was 2.61% of sales and leveraged 13 basis points compared to last year's third quarter as a result of sales growth. In Q3, earnings before interest and taxes or EBIT margin increased 130 basis points to 9.25% of sales. For the first 3 quarters of 2015, EBIT margin was 9.89% of sales, which was a 79 -- which was 79 basis points higher than the same period last year. For the quarter, interest expense was $141 million which is flat to last year as a percent of sales. The effective tax rate for the quarter was 38%. Net earnings were $736 million for the quarter, an increase of 25.8% over Q3 2014. Earnings per share of $0.80 for the third quarter were up 35.6% to last year. For the first 9 months of 2015, earnings per share of $2.70 was in line with our expectations and represented a 20.5% increase over the same period last year. Now to a few items on the balance sheet starting with assets. Cash and cash equivalents at the end of the quarter was just over $1.2 billion. Our inventory balance of $10.4 billion increased $672 million or 6.9% versus Q3 last year. The increase was driven by timing associated with seasonal builds. Inventory turnover is 3.85, up 12 basis points over last year. Asset turnover increased 10 basis points to 1.75. Moving on to liabilities. Accounts payable of $7.3 billion represented a 13.6% increase over Q3 last year caused by the timing of purchases year-over-year. In the third quarter, we issued $1.75 billion of unsecured bonds. The bonds consisted of 3-, 10- and 30-year issuances with a weighted average interest rate of 3.45%. A portion of the proceeds was used to repay a $500 million obligation in October. At the end of the third quarter, lease-adjusted debt-to-EBITDAR was 2.17x. Return on invested capital increased 276 basis points for the quarter to 15.78%. Now looking at the statement of cash flows. Operating cash flow was $4.5 billion. Capital expenditures was $844 million resulting in year-to-date free cash flow of $3.7 billion. In September, we entered into a $500 million accelerated share repurchase agreement. We expect to receive approximately 7.3 million shares but the ultimate number of shares will be determined upon completion of the program in the fourth quarter. We also repurchased approximately 3.5 million shares for $250 million through the open market. In total, we purchased $750 million in the quarter. We have approximately $4.1 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, the forecast for key drivers of home improvement industry remained conducive for growth. And as our year-to-date performance is in line with our expectations, we are maintaining our outlook for the year. We expect a total sales increase of approximately 4.5% to 5% driven by comp sales increase of 4% to 4.5% and the addition of 15 to 20 stores, which includes 5 Orchard and 2 city center locations. We're anticipating an EBIT increase of 80 to 100 basis points and are targeting 25 to 30 basis points of EBIT expansion per point of comp above 1%. While this is our expectation for the year, as we've seen, there will be some choppiness quarter-to-quarter. For the year, we expect that most of the EBIT improvement will come from SG&A. Expense leverage will come from store payroll, marketing and leveraging our scale to achieve cost savings on indirect spend. In addition, we expect fixed cost leverage associated with sales growth. The effective tax rate is expected to be 38.1%. The higher rate relative to 2014 is a result of settlement of prior tax matters recognized in Q1 2014. The higher rate negatively impacts earnings growth by roughly $0.06 per share. For the year, we expect earnings per share of approximately $3.29, which represents an increase of 21.4% over 2014. We are forecasting cash flows from operations to be approximately $5 billion. Our capital forecast is approximately $1.3 billion, which results in estimated free cash flow of $3.7 billion. We will continue to manage to the 2.25x lease-adjusted debt-to-EBITDAR target. Our guidance assumes approximately $3.8 billion in share repurchases for 2015. Regina, we're now ready for questions.
Operator:
[Operator Instructions] Our first question comes the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
The first question, I think, it could be a key question of the quarter is the flow-through, which was a welcome improvement. My question is on the sustainability of it. You've been discussing it especially in the back half, some indirect expenses coming out of the business, and I think Q4 also screens pretty well for it. So as we head into Q4 into next year, any reason why we shouldn't see this type of incremental margins continue?
Robert Hull:
So Simeon, no. As we think about Q4, the drivers that came to fruition in Q3 should remain for Q4. Obviously, our outlook is 25 to 30 basis points of EBIT expansion per point of comp above 1%. In Q4 we do have tougher comparisons going up against a 7.3% comp for Q4 last year. So the EBIT expansion will be largely determined based on the comp growth in the quarter. But the factors that drove the 130 basis points in Q3 should remain going forward.
Robert Niblock:
And Simeon, this is Robert. Just as we indicated throughout the year, this year, as we've had our quarterly earnings releases, we give guidance for the year with the flow-through, but there can always be choppiness quarter-to-quarter just like you've seen this year. But on an annual basis, it's basically what Bob has told you from a guidance standpoint.
Simeon Gutman:
Okay. And then second -- the follow-up, you mentioned the Consumer Sentiment Survey that the growth in home improvement is outpacing spending. Can you -- do you have additional context on that? Is the rate of what they're going to spend in home improvement, how is that changing?
Robert Niblock:
If you look at -- once again, this is -- Simeon, as we survey our customers and what they tell us were their intentions with respect to spending, and we look at -- overall, their level of spending is not increasing, but the amount that they're allocating to home improvement, they're indicating that they're spending more in home improvement than obviously how much of that winds up in our channels, which you have to look at. But it was a significant increase over what we had seen last year on the third quarter. And as you know, sentiment doesn't always turn into action, so it's a leading indicator. But we think that the -- you look at what's happening in the overall microenvironment and we look at what's happening with home prices, it once again speaks to the fact that consumers are reengaging in discretionary spending around the home. And so when we see them leaning that way, it gives us confidence in all the numbers that are built into our outlook for the remainder of this year and also as we lean into 2016, but we did see a nice pickup at what their intentions were.
Simeon Gutman:
Right. And then the survey, does this push into your 2017, I guess, your outlook? Or is there other factors that more of a macro look?
Robert Hull:
These are the same factors that we used to provide the 2007 (sic) [2017] outlook at the analyst conference last year. Obviously, the drivers of our business, income and housing, right? So as we think about more people working and starting to see some wage appreciation. Those are positive factors that had been on the housing front. Housing turnover continues to pick up, and we see ongoing home price appreciation. So all the macro factors that drive our industry continue to line up for sustained growth through 2017.
Operator:
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
My first question relates to inventories. If you can just give us a little more clarity about the increase, which was a bit of a departure for you. And also whether or how we should think about the relationship between that inventory number and your gross margin increase, if any.
Rick Damron:
Matt, I'll start. This is Rick. The 6.9% increase in the inventory reflects our preparation for our Q4 events coming up as well as being in stock on some critical items our customers deem to be most relevant. So the increase is really driven by timing associated with getting inventory in for our events for Q4. Looking forward, as we look into year-end inventory in Q4, we expect our inventories levels to be marginally higher, but this is being primarily driven by the timing of the Chinese New Year, which is roughly 11 days earlier this year than last, which pushes some order purchases earlier in the cycle for their seasonal build for 2016. But when you look at the number in totality, it's really driven by our preparation for Q4.
Robert Hull:
Matt, the second part of your question related to gross margin. We don't see any gross margin pressure. This is -- as Rick said, this is inventory purchased for anticipated sales in the quarter, nonperishable product. And the other item I would add is really no working capital impact as we've seen a corresponding increase in accounts payable.
Matthew Fassler:
Got it. And just a quick follow-up. You did everything you said you would do on the margin net expense front in the third quarter. In the fourth quarter, you certainly need to do it again. Now I know that the drivers of expense leverage were pretty diverse, given a bunch of different places. As we think about the fourth quarter drivers, anything you would point to, in particular?
Robert Hull:
No. That's really the same drivers, so we should see some, again, modest gross margin expansion. We all see leverage in credit and bonus, in advertising, in store payroll. So all the factors that drove Q3 should, again, drive operating margin expansion in Q4.
Operator:
The next question comes from the line of Peter Benedict with Robert Baird.
Peter Benedict:
I was wondering, can you talk a little bit about the Pro marketing efforts in the second half. I know you mentioned September being the Pro Appreciation month. You've done a lot of work to kind of get the foundation in place to serve the Pro better. Can you talk about -- or give us a sense of how you're going to be speaking to the Pro more aggressively over the next several quarters?
Rick Damron:
Peter, this is Rick. As we think about the Pro, we continue to leverage our account executive ProServices teams to meet with Pros on their job sites to really understand what their needs are and where they're moving. We continue to leverage our in-store teams and our account management processes to make sure that we're communicating effectively around the relevant products for the particular time of the year and the particular jobs that we're working on. And then from a mix perspective, most of our Pro marketing is really targeted messaging from a direct communication standpoint, targeted messaging through email or radio. So we'll continue to build upon what we've done over the last several quarters, leveraging both our field teams as well as our marketing programs to communicate effectively with the Pro.
Michael Jones:
And just to build on that, you see us leverage some of our digital assets as well. So we talked quite extensively about LowesForPros.com. Gives us a [indiscernible] reach the Pros [indiscernible] some of our more creative online techniques to get the right promotion in front of the Pro at the right time. You see us -- as we continue to migrate more towards digital away from print, with Pros, you'll see us take a slightly different balance where we use some print to talk to them as well. I think the key is that what we've done is we've made a considered effort to make sure we have the right brands that Pros need. And now we're starting to reach out to those Pros much more efficiently and effectively, so we can get the right promotion along with those brands in front of the Pros.
Peter Benedict:
And then just maybe a follow-up for Bob, the 2.25 leverage target. I know you've been operating below that to a degree. I mean, it sounds like you got your view on the macro continues to kind of get better. What conditions do you think need to be in place for you to kind of get to that 2.25 level, if you can share that?
Robert Hull:
Sure. So it's a couple of things, Pete. So it's a matter of forecasting. Number one, we were at 2.17x into Q3, so not too far off. As we think about the fourth quarter, we've got a perspective on sales and profitability, perspective on working capital. It's just a matter of how close do we want to balance the borrowing at year end relative to our expectations. So we expect us to be somewhere in the 2.15 to 2.25x range at year end.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So store payroll leverage showed some very nice improvement from 2Q. Can you talk about what's driving that overall? Is there something more systematic going around, around labor management systems? Is it process improvement? Is it focus? Any detail there would be great.
Rick Damron:
Yes, Chris. This is Rick. As we continue to look at store labor, we've talked about the tools that we've deployed to help our store teams and our field teams manage our labor more to customer traffic. So we're continuing to see those tools play dividends for us as we continue to match our hours more to traffic. We continually focus on making sure that we're doing everything possible to increase our customer-facing roles. Most of that is through process improvement as well as the utilization of technology within the stores, making it simpler for our employees to engage with the customer and improving our processes that make it easier for them to interact, both with the customer as well as through the tasking process that we have within our stores. Chris, one of the things -- to give you an example of something that seems simple that can have a significant impact is we're now leveraging one of the tools that we used in our stores, which is the wayfinding app on our digital platforms. And now we incorporate that information on every product label for every item shipped from our distribution center. So when that package arrives, it will tell the employee the exact aisle and bay location that product stops. So as you imagine, tremendous efficiency for newer employees and try to manage and navigate our stores makes the whole process much more effective, much more efficient. We transferred several of our processes that were manual paper-driven processes to more technology-driven, leveraging the iPhones and the iPads that we've deployed into our stores to make them more efficient. So what you're seeing is an accumulation of better tools to drive greater payroll efficiency, the continued focus on making sure that we're leveraging customer employee hours to customer traffic and then the continued work to drive greater productivity through the tools that we provide our employees.
Christopher Horvers:
And so do you think -- because it was a lot better in 3Q versus 2Q, do you think that this is the inflection that truly gelled around the payroll management process as you look forward?
Rick Damron:
Yes, as we continue to look forward, I think we'll continue to see solid payroll efficiency.
Christopher Horvers:
Okay. And one of the questions that we're getting is the performance in October and how to interpret the deceleration. 2-year stacks did accelerate and they did look very strong, but if we held stacks into 4Q, it would suggest comps decelerated about 200 basis points. So anything to point out there around October, and your thoughts about the current quarter?
Robert Hull:
So Chris, in the quarter, weather has no net impact to the 3-month period. We did have favorable weather in the first part of the quarter, a little tougher weather toward the end of the quarter. Second, as you suggest, we did see a 2-year stack acceleration throughout the quarter. So we feel really good about our ability to deliver comp on comp. As we look to 4Q, we would expect further acceleration on interior basis into Q4. As it relates to November to date, we are in line with our expectations, and we're really excited about Q4.
Operator:
Your next question comes from the line of Laura Champine with Cantor Fitzgerald.
Laura Champine:
You did a good job of expanding gross margin despite such strength in appliances, which is typically a lower margin category. What is your expectation in Q4 for mix's impact on your gross margins?
Robert Hull:
So mix should have a negligible impact. As Rick noted, we're now into 4 straight quarters of double-digit appliance comps. So we've cycled some tougher compares although appliance has continued to perform well. So mix should be a little bit less pressured in Q4 and going forward for that matter.
Operator:
Your next question comes from the line of David Schick with Stifel.
David Schick:
Rick, a question for you or maybe Rick and Mike. You're talking about sitting down with the Pro and the merchandising changes and all of that. Where do you think the balance of the opportunity is in the Pro? Is it Pros you already have spending more? Or is it Pros you're not reaching? And if so, where are they coming from?
Michael Jones:
This is Mike Jones. I'll start. We think the answer is yes. We think it's the Pros that we really have spending have more, and we know that there are Pros today that have -- that drive past us to go someplace else. And we know we can do a better job at bringing them into our stores. And so we started by ensuring that we have the right inventory depth, the right brands, the right local market assortment. And as that was corrected, we feel real comfortable about where we are. From there, we started to turn on our marketing so that we can start to invite those Pros back in. So we're excited about both the Pros we have and still a big part of our business, and we're excited about the Pros that historically have purchased someplace else that can now come in and try and experience at Lowe's.
Rick Damron:
Yes, Dave, this is Rick. I'll just add when we look at the Pro, in general, we're very excited about what we're seeing from both a transaction point of view and a comp across all ticket ranges. So when you look at comps by ticket size and the way that we evaluate those, we're seeing positive growth across all tickets, which is telling us that we're getting some new accounts in, but we're also selling our existing accounts more. The other thing, through our Pro Appreciation events and what we're doing to really target Pros to the new brands, the increased inventory depth and our 5 ways to save value propositions we're doing, we saw a strong double-digit growth in new accounts during Q3 as well. So I think that also goes to support the fact that we're becoming more relevant, that the brands that we're introducing are having increased awareness with the Pro, and then the aspects of services that we're providing is beginning to resonate as well.
David Schick:
Great. As a follow-up, Bob, you mentioned more efficient and effective media mix. I understand a think the efficient side. Could you give numbers on effective in terms of how many you're reaching or some way for us to think about that?
Robert Hull:
So I'll start and let Mike jump in. So, Dave, we're doing some media mix modeling. So we're trying to understand impact of different mediums on different markets, and we're adjusting according. So ultimately, we're taking a look at the most effective yield, which is the sales dollar yielded for $1 of marketing spent. We have shifted some -- as Rick mentioned in his prepared comments, we've shifted some dollars away from print towards more digital assets. We are able to reach more folks on a very cost-effective way, which gets into the effectiveness of inefficiency of marketing.
Michael Jones:
And just to build on it, if you look at the way we've remixed our advertising and marketing spend, we're moving more towards digital, more towards social media, and less out of some of the more traditional one, advertising vehicles. I'll give you some numbers, the way to think about this. So just looking at social media. Lowe's followers on Facebook are over 3 million. Pinterest, just about 3.5 million followers. Lowe's video views, well over 70 million. So we see -- one of the easiest ways for us to track is just watch our activity in social media. Our digital footprint is very, very large, and we continue to increase it. So we're quite proud of the work that's happened there.
Operator:
Your next question comes the line of Budd Bugatch with Raymond James.
David Vargas:
This is David Vargas on for Budd. On the Pro business, can you tell me what the Pro penetration was this year versus last year? And also what categories within Pro saw the strongest comp sales growth?
Robert Hull:
So David, the Pro isn't an exact science. We have some direct measurements of them relative to managed accounts and credit vehicles. There's some imprecise measures. Currently, the Pro mix is about 30%. It's grown -- in the past 3 quarters, it's grown in line with the company average. The fourth quarter last year was a little bit faster, so that would suggest it's migrated from a little bit higher in that 30% range.
David Vargas:
Okay. And then what categories did you see the strongest growth in year-over-year?
Michael Jones:
A couple actually. I'll pick on our tools, where we've really worked diligently to get the right brands. So we've added brands like IRWIN and LENOX. We've added Hitachi. We've added Goldblatt, as an example. You couple that with brands like DEWALT, Kobalt, Porter-Cable and Bosch. We saw a double-digit growth in pneumatics. We saw a very strong growth in cordless[ph] power tools and accessories and rotary tools. And we watched tools, in particular, because it's a good indicator of how well we're engaging the Pros. And this isn't just adding brands by happenstance. If you look at the way we've added brands around pneumatics, we've added Hitachi to complement our offering in Bostitch and Paslode. So we have the 3 best brands in pneumatics. If you want to buy pneumatic as a Pro, we feel that Lowe's is certainly the best place to come. And so we look at each category. We strategically say how to best serve the Pros. We build brands that complement one another. And from there, we increased our relevant engagement with the Pro. But we certainly saw it in tools, we see it across the stores as we continue to grow our Pro business.
David Vargas:
Got it. And then finally, one more question on just the consumer in general. What are you seeing this year versus last year in terms of customer spend on large-ticket discretionary like kitchen remodel, bathroom remodel? And are they moving towards more of that discretionary spend from, I guess, general maintenance and repair of large ticket items?
Robert Niblock:
I'll start. This is Robert, and I'll let the other guys finish. Certainly, when we look at consumer's discretionary versus nondiscretionary spend, we're seeing that when you combine small and large discretionary spend, what they're telling us is that more than 50% of their spend is on a discretionary basis, which is tripped over from where it would have been prior year. So we're seeing it move above that 50% level. When you look at -- and we've talked about appliances being double-digit comps for the quarter, we've talked about some of the project spending and initiatives that we're putting behind that, whether that's Project Specialist Interiors, which is major interior remodels, or Project Specialist Exteriors, which is the exterior programs we do, fencing, siding, new windows, those type of things. Both of those had -- both of those programs had double-digit comps in the quarter. So appliances, PSI, PSE, all running double-digit comps in the quarter. So we are seeing that consumer take on that willingness to spend around the home on discretionary projects, driven by, as I said in my comments, the macro factors as well as continued comfort that comes from home price appreciation that they're seeing.
Robert Hull:
Yes, and I would add in addition to Robert's comments is if you take a look at tickets above $500, comps at 7.2%, so continue to see strong growth in the big-ticket categories.
Operator:
Your next question comes from the line of Mike Baker with Deutsche Bank.
Michael Baker:
I'll finish up with -- or it looks like we're getting towards the end with one bigger picture question. This is for Mr. Niblock. You're still a couple of hundred basis points away from your peak operating margin, but I think, as you guys like to say, you have a line of sight to it. When you start to get to that double-digit operating margin, how do you think about balancing further margin gains with some top line initiatives? Ever so subtly, you're increasing your store count growth in other regions, in other formats. Your competitor just made an acquisition. How do you think about maybe some new top line growth initiatives to balance that margin gain?
Robert Niblock:
It's a great question, Mike. When you think about it from where we had peaked our operating margins previously to where we're at today and trying to hone back in on that, we really are a totally different company. If you think about back in those days, it was single channel. We were on a rapid expansion of the store footprint, we think the store is still the nucleus of our relationship with the customer, but the store in and of itself is not enough. We really have to be there on an omni-channel basis for the customers. So that's why everything we've been investing in for the past few years is really to be able to deliver that omni-channel offering, so that we take those stores, we continue to build on those and leverage, and we -- the PSI, PSE programs that we just talked about, whether it's the improvements that we've made on dot-com, whether it's all the improvements that we've made with the Pro customer to really get us back to the fore, whether we can look at other opportunities to try and grow that top line. So certainly, we expect to continue to have gross margin -- I mean, operating margin improvement, continue to have nice flow-through that will drive our comp sales improvement like the guidance that we've given you, but we will continue to look at how are the other opportunities -- as the consumer changes, the way the consumer wants to interact with us changes, what are the other opportunities where we can do things that will continue to allow us to pursue opportunities for growth, particularly in a recovering market and the affinity that we're seeing with the consumer around investing in the homes. So whether it's stuff like LowesForPros.com that we invested in because we know that that was a key gap that we had there, whether it's rolling out the additional PSI programs like we added this quarter in the store, you'll see us looking at ways that we can continue to make sure that we're responding to where the customer wants to go and will -- whatever that ends up being, we'll end up evaluating that, but also use the base stores we have to continue to drive nice flow-throughs.
Michael Baker:
Okay. One follow-up on the previous question, you had said that more than 50% of spend as you talk to your customers is discretionary. Can you tell us where that was at a peak probably 2006 or '07, and where it troughed out when housing crashed.
Robert Niblock:
I don't know -- I don't have the numbers back before the peak as to the exact numbers as to where it was at. That would be back in the 2000...
Robert Hull:
2009 is when we started the survey.
Robert Niblock:
2009 is when we started the survey, Bob is saying. So we don't have numbers back before the decline.
Robert Hull:
So what we are seeing, though, is a greater proportion of customers telling us they're leaning into the big-ticket discretionary from smaller-ticket discretionary as you think about greater consumer sentiment and confidence around their personal job situation. There's home appreciation, they're starting to think about those bigger ticket discretionary projects.
Operator:
Your next question comes the line of Michael Lasser with UBS.
Michael Lasser:
So how do we think about the underperformance for the below-average comp in categories like kitchen, millwork, flooring in light of your commentary about the success of the Project Interior Specialist program?
Michael Jones:
This is Mike Jones. The categories were below average. But driven largely by the strength in appliances and seasonal living, we had a couple of categories like millwork and OPE that were up against significant comps well into the double-digit comps last year same time. So I think the Consumer Sentiment Survey is probably a better indicator. They're looking at the distribution of our above average and below average. I'd just encourage, keep in mind that all of our categories are positive with the exception of OPE, which was about flat. So, again, we're pretty encouraged by what we see both on the big ticket as well as on the transaction side of our business.
Michael Lasser:
So then if we assume that those 2 categories added about 100 basis points to your overall comp, do you think that the market in the areas surrounding your store for categories like kitchen, flooring, appliance, millwork is growing in the 3% to 4% range?
Robert Hull:
I can say that the categories that you asked about did comp in the 3% to 4% range. As Mike said, they were positive, but they were below the company average based on the strength of the appliance and seasonal living businesses.
Michael Lasser:
Okay. Is that the rate of growth you would expect at this point in the cycle for those categories?
Robert Hull:
So the market-specific growth is based on the state of the economy and housing in those markets, so that the factors that drive the macro Lowe's business also drive each individual market, housing and incomes in those markets, some higher, some lower, depending on where they are in the housing cycle.
Michael Lasser:
Got it. My last question is -- and I'm sorry, to pick on all the categories, but paint has been below the company average for 5 quarters in a row despite the launch of some new products within the category. Can you talk about the reason for the underperformance, especially -- because paint is a category that's attached to a lot of other home improvement products whether it's inside or outside of a house.
Michael Jones:
Sure, I can talk to that. The paint industry, in total, is below the average. And so our paint performance is about in line with the industry. I'd say we're not satisfied with that. We want our paint performance to be above the industry as are most of our other business units. That's how we've seen good momentum with HGTV HOME by Sherwin-Williams. We've got a great relationship with Valspar and with PPG with the Olympic brands. We've leaned pretty heavy into some promotions around paint as I'm sure you've seen. Our promotional cadence year-over-year is about the same, but we did redirect a little more towards paint, and we're pretty excited about our paint lineup. But that said, the industry is below the average, and we're running about average with the industry.
Operator:
Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
I actually have another SG&A follow-up. I mean, obviously, you guys had very strong leverage in the quarter. You talked about that continuing going forward. But looking at the data a little bit differently, you generally have been posting SG&A per store growth about 2% to 3% unless comps were, call it, sub-1%. This quarter it was only about 50 basis points on a very strong mid-single-digit comp. Can you help us better understand what changed in the expense growth rate? Is it -- you just don't have to spend anymore on labor and you've kind of talked out? Is it advertising flattening out? Is it reduced losses on international ops? I guess I just want to understand kind of what's changed in that run rate and how that -- how we should think about that going forward?
Robert Hull:
So we talked about the choppiness quarter-to-quarter and the flow-through. That's a variety of factors, performance relative to plan drives those accruals year-over-year, the nature of the credit program as we think about portfolio performance, loan loss reserves, that's driving some expense leverage second half of this year relative to first half. As I mentioned in my comments regarding building repairs and maintenance, our plan is more front half-loaded. Therefore we're getting leverage based on the timing of projects year-over-year. So there's just a variety of factors that contribute to movement year-over-year. I think that if I had to leave you with a punchline, you heard us talk about steps we're taking in payroll, in advertising, in direct spend that are sustainable will drive benefit through 2015 into 2016.
Scot Ciccarelli:
So our run rate, is it something -- Bob, is it something between kind of what we saw -- in terms of SG&A actual growth, is it something between what we saw in the first half and third quarter because of kind of the timing differences? Or when we try to think about the longer-term model, what's the right way to think about it?
Robert Hull:
So for 2015, SG&A grows at roughly 46% of the rate of sales growth. I think something close to that 50% is probably the right way to think about it.
Scot Ciccarelli:
Got you. And then just -- hopefully a clarification, there's a bunch of questions on Pro sales and ticket size. When you guys look at your ticket size buckets, the strongest growth continues to be in those higher ticket transactions over $500. Is it fair to assume that is primarily driven by Pro customers? Or is it kind of more of a 50-50 deal between Pro and DIY because of appliances and other high-ticket items, specifically within that over $500 bucket?
Robert Niblock:
Hull
So as you think about the mix of our business, it's 70% Pro and -- excuse me, 70% DIY, 30% Pro. However, the Pro ticket is larger than the DIY Pro. So the driver of the big ticket is probably going to be closer to 60-40 DIY to Pro.
Operator:
Your next question comes from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My question is around close rates. You guys had talked in the past about how you've done with close rates given the fact that you're optimizing labor. Any update there on how close rates and customer satisfaction is proceeding here?
Robert Hull:
So Rick talked about customer satisfaction. We continue to see very strong customer sat results through our customer-focused program. As you think about close rates, we've done a lot of things to address all potential factors that might impact close rate, both the quality and quantity of labor, the depth of inventory, the local sorting. Rick mentioned wayfinding, which is the ability to navigate our stores. So a lot of good steps we've taken. As a result, we're seeing roughly a 100 basis point improvement in close rate this year relative to last year.
Seth Basham:
That's helpful color. As a follow-up, just to tie the knot on the near-term outlook, comp store sale trends accelerated throughout the third quarter to a 6.6% comp in October, 11% on 2-year stack. How do you think about the fourth quarter? And can you hold that 11% 2-year stack rate?
Robert Hull:
That's the expectation. So we've seen good sequential progress through the quarters. We saw sequential progress through the months of Q3. And as Robert talked about in his comments, good momentum as it relates to the consumer and drivers of our industry. And each day, our execution continues to improve. So we feel good about the ability to drive and achieve or exceed the outlook we put forth for the year.
Robert Niblock:
Thanks. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter results on Wednesday, February 24. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2015 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. We delivered solid results for the quarter, and I would like to thank our employees for their hard work and commitment to serving customers. Comparable sales grew 4.3%, primarily driven by a 3.3% increase in average ticket. We achieved this growth by executing well in a challenging environment that included an increasingly severe drought in California and historic flooding in Texas. In fact, comparable sales growth for our U.S. home improvement business was 4.6% for the quarter with all 14 regions generating positive comps and positive comps in 11 of 13 product categories.
Our seasonal business performed well. Strength in outdoor power equipment and seasonal living offset some of the weakness in -- some of the softness in lawn and garden, which was most pronounced in the West. We also experienced solid growth in big-ticket discretionary project categories such as kitchens, flooring, millwork and fashion fixtures. And for the third quarter in a row, we drove double digit comps in appliances. Our team in Canada continued to deliver strong comps in local currency. Building on the momentum we've been gaining, we're accelerating our store expansion in this market. We recently acquired 12 former Target store locations and 1 distribution center with plans to open these locations in 2016 and 2017. Combined with our organic expansion plans, we expect to have roughly 70 stores in Canada by 2017. Our business in Mexico also performed well during the quarter, achieving double-digit comps in local currency. However, as the U.S. dollar strengthened, we experienced a 30 basis point drag on our consolidated comp due to foreign currency. For the quarter, gross margin contracted 8 basis points, primarily due to the strength in appliances and outdoor power equipment. We leveraged operating salaries in the quarter and delivered earnings per share of $1.20, a 15% increase over last year's second quarter. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $1.5 billion of stock under our share repurchase program and paid $218 million in dividends. In May, our Board of Directors approved a 22% increase in our quarterly dividend from $0.23 per share to $0.28 per share. Looking forward to the second half of 2015, key drivers of the home improvement industry remain supportive for growth. Economists are forecasting a modest acceleration in both incomes and consumer spending this year, and recovery in the housing market continues with moderate home price appreciation and stronger gains in housing turnover. We also continue to be encouraged by the results of our second quarter Consumer Sentiment Survey. Roughly half of respondents indicated that they believe their home values are increasing, double the number from 2012. And this positive sentiment around home values is reading [ph] through to spending patterns with plans to begin a home improvement project in the next 6 months continuing its recent upward trend. Further, survey respondents indicated that growth in their home improvement spending is outpacing increases in their overall spending, suggesting an affinity -- the strengthening affinity for the home. Our key priorities in 2015 should allow us to capitalize on opportunities within an improving economy. We are pursuing further top line growth through continued development of omni-channel capabilities, differentiating ourselves through better customer experiences and improving our product and service offering for the Pro customer. We also remain committed to improving our productivity and profitability with opportunities in a few specific areas including store payroll, marketing and leveraging our scale to get cost savings on indirect spend. The execution of our strategic priorities alongside an improving macroeconomic backdrop, together with our keen focus on productivity and profitability, give us confidence in our business outlook for 2015. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning, everyone. During the second quarter, we recorded our strongest performance in big-ticket categories such as appliances, kitchens, outdoor power equipment and seasonal living. This is a reflection of consumers' increasing desire to invest in their homes as well as the strength of our product offerings in these categories and our evolving omni-channel capabilities.
In appliances, we drove double-digit comps for the third consecutive quarter. In addition to our leading brands in this category such as Whirlpool, KitchenAid, Bosch, Samsung, LG, Electrolux, Frigidaire and GE, we provide service advantages like delivery and haul away and facilitate in-home repairs and maintenance. We have further strengthened our offering with the home channel exclusive launch of the Frigidaire Pro appliance series and the introduction of 17 kitchen suites. And understanding that more than 80% of customers start shopping for appliances online, we have enhanced our presentation on Lowes.com including improved product search, enhanced videos, improved presentation like 360-degree views and simplified product groupings. It's no wonder that for the seventh time in the last 8 years, J.D. Power and Associates has ranked Lowe's highest in customer satisfaction among appliance retailers based upon our knowledgeable sales specialists, breadth of assortment, competitive pricing and delivery. In order to sell the entire kitchen, we display our kitchen products including cabinets and countertops immediately adjacent to our appliance offering. This quarter, we drove above-average comps in kitchens through a combination of targeted promotions and our investment in projects specialists who meet customers in their homes. These employees represent another important element of our omni-channel strategy. We now have project specialists who focus on the exterior of the home available across all U.S. stores. And we're expanding our interior project specialist program into another 470 stores, reaching over 3/4 of our stores by year-end. With our ability to coordinate style, provide design expertise and find the right contractor to do the job, we are rapidly becoming the project authority in home improvement. We achieved high single-digit comps in outdoor power equipment with particular strength in walk-behind and riding mowers and pressure washers. We offer a wide range of mowers to help customers maintain their yards, and we continue to provide compelling and exclusive brands and innovations like our innovative Kobalt 80-volt Handheld Outdoor Power Tools, and our home channel exclusive, Hustler Raptor 60-inch Zero-Turn Mowers, a brand landscapers know and trust. The outdoor living experience we introduced last year drove strong comps in our seasonal living product category. In fact, our patio and outdoor fashion area recorded strong solid comps again this quarter on top of double-digit comps last quarter assisted by robust attachment of replacement cushions and other outdoor accessories. Entering the second half of the year, we will use this seasonal stage to address customer needs for the fall, like planting, leaf removal, home winterization and exterior maintenance. Then as winter arrives, we will help customers refresh their homes for holiday guests, decorate and organize their home after the holidays. We will focus on using this space to provide the inspiration, guidance, products and services that customers need to tackle the projects that are relevant for each micro-season. Our performance in paint was in line with the industry. We are pleased with the launch of HGTV HOME by Sherwin-Williams and look forward to building further momentum with this brand. Brand is the #1 purchase driver in paint and Sherwin-Williams is the most recognized brand in the category. We expect the addition of HGTV by Sherwin-Williams to appeal to both DIY and Pro customers. Its long-standing reputation for quality as well as the color expertise of HGTV allows Lowe's to offer customers the top brands they trust for their next paint project. Combined with our outstanding Valspar and PPG/Olympic brand partnerships, we expect to grow traffic to our stores and increase overall market share in paint. We also continue to strengthen our portfolio of Pro-focused brands. In addition to the brands we rolled out in the first quarter including Goldblatt masonry tools, GAF roofing and Owens Corning insulation, last month we expanded our line of Hitachi pneumatic nailers and fasteners, a home channel exclusive to Lowe's stores nationwide. Lowe's now offers the broadest selection of Hitachi power tools with the latest innovations that deliver lighter, faster and more durable products. We continue to collect feedback from our Pro customers and employees to identify other local and national brands that best meet the needs of Pro customers. Along with strengthening our brand portfolio, we officially relaunched LowesForPros.com at the beginning of the second quarter and have seen an increase in use by our Pro customers, in line with our expectations. So far, we have been promoting LowesForPros online and through Pro social media, and in the third quarter, we will begin the formal launch through our Pro Appreciation days as well as other media. We continue to actually serve the Pro through our Account Executive ProServices or AEPs. AEPs call in regional customers to help them order and replenish products across multiple stores. We currently have approximately 135 AEPs in the field, an increase of 25 over last year. Our AEPs have been very effective in growing our business with larger Pro customers, especially Maintenance, Repair and Operations or MRO customers. We are pleased with the program's results. Excluding the AEPs we added this year, we saw double-digit second quarter growth in AEP sales, which contributed to solid Pro comp sales growth in the quarter. Our focus on strengthening our portfolio of brands, serving regional Pro customers through AEPs as well as our recent relaunch of LowesForPros.com are part of a broader commitment to build on our strong foundation with the Pro. In addition to our efforts to drive top line growth, we continue to focus on driving productivity and profitability. For the quarter, we capitalized on big-ticket market share opportunities with strong growth in categories like appliances and outdoor products, which contributed to a slight decline in gross margin rate, but substantial margin dollar growth. We mitigated the unfavorable mix impact by continuing to partner with our vendors to drive innovation, improve first costs through shared efficiencies and to achieve higher sell-through of seasonal products. Our store teams once again effectively managed payroll, increasing sales per hour in line with comps. We continue to leverage our prior technology investments as well as improved selling processes enabled by our customer experience design team. Most importantly, we have achieved this greater payroll efficiency while improving customer satisfaction scores. We also drove productivity in marketing by increasing our presence in targeted digital media and leveraging our investment in MyLowe's. And we continue to identify and implement additional expense efficiencies throughout the year by consolidating the procurement of similar types of goods and services across our corporate and store functions. The quarter tested the flexibility and capabilities of our supply chain and we passed that test with flying colors. To meet a heightened demand in the Pacific Northwest where temperatures were unusually warm, our distribution teams worked efficiently to move portable air-conditioners from the Northeast. Likewise, they were instrumental in moving products to Eastern Texas so we could help customers recover from flooding and begin the process of repairing and rebuilding in the wake of storms. While inventory at quarter end was up 4% of last year, it reflects our commitment to being in stock for items that are most relevant to our customers. For instance, we ended the second quarter with higher levels of appliances to support exceptionally strong sales as well as higher levels of portable air-conditioning units and grills. We expect to sell through most of the seasonal inventory in the third quarter and to end the year with minimal growth in seasonal -- in inventory per store. We are pleased with our agile execution in the second quarter. We continue to make progress on our initiatives to drive top line growth and are focused on improving productivity and profitability. We look forward to sharing further progress with you over the course of the year. Thank you for your interest in Lowe's, and I will now turn the call over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the second quarter were $17.3 billion, an increase of 4.5%. The sales increase was driven by both ticket and transactions with total average ticket up 3.3% to $67.83 while total customer transactions grew 1.2%. Comp sales were 4.3% driven by a comp average ticket increase of 3.3% and comp transactions growth of 1%.
Looking at monthly trends. Comps were 3.6% in May, 4.6% in June and 4.6% in July. In Q2, July 4 fell in fiscal July this year and fiscal June last year. While the shift did not affect comp sales for the quarter, it did impact the monthly spread. We estimate that normalizing for the timing of the holiday, June and July comps would have been 3.9% and 5.8%, respectively. Year-to-date total sales of $31.5 billion were up 4.9% versus the first half of 2014 driven by a 4.7% increase in comp sales. Gross margin for the second quarter was 34.47% of sales, which decreased 8 basis points from Q2 last year. The decline in gross margin was driven by mix and promotional activity. The mix of products sold, primarily appliances and outdoor power equipment, negatively impacted gross margin by approximately 20 basis points. Also, we have noted our efforts to adjust our promotional calendar to be more competitive with the market. We anniversary-ed this promotional change in the third quarter. The pressure from these items was largely offset by value improvement. Year-to-date gross margin was 34.92% of sales, a decrease of 6 basis points from the first half of 2014. SG&A for Q2 was 20.94% of sales, which leveraged 39 basis points, which brings leverage in a variety of expenses including store payroll, bonus, maintenance and repairs, utilities, advertising and payroll taxes. These items were somewhat offset by store closing costs of $13 million related to a lease termination for recent relocation as well as updated lease assumptions for stores closed in 2011. Also, in the quarter, our Canadian business incurred $4 million of expenses associated with the recent purchase of certain Target assets. This was primarily related to lease termination costs for our existing distribution center as we worked to transition into the larger former Target facility. In addition, there were carrying costs associated with the 12 store leases that we assumed. These 2 items totaled $17 million and impacted EBIT and EPS by 10 basis points and a $0.01 per share, respectively. Year-to-date SG&A was 22.39% of sales, which leveraged 48 basis points versus the first half of 2014. Depreciation for the quarter was $375 million, which was 2.16% of sales and leveraged 10 basis points. In Q2, earnings before interest and taxes or EBIT increased 41 basis points to 11.37% of sales. For the first half of 2015, EBIT was 10.18% of sales, which was 56 basis points higher in the same period last year. For the quarter, interest expense was $133 million. The effective tax rate for the quarter was 38.8%. Earnings per share was $1.20 for the second quarter, an increase of 15.4% over last year. For the first 6 months of 2015, earnings per share of $1.90 represented a 15.9% increase over the first half of 2014. The $1.90 was in line with our year-to-date plan. Now to a few items on the balance sheet starting with assets. Cash and cash equivalents at the end of the quarter was $900 million. Our inventory balance of $9.7 billion increased $389 million or 4% versus Q2 last year. As Rick mentioned, the increase was driven by appliances that support sales growth as well as seasonal inventory. Inventory turnover was 3.9, up 16 basis points over last year. Asset turnover increased 11 basis points to 1.74. Moving onto the liability section of the balance sheet. Accounts payable of $7.1 billion represented a 15% increase over Q2 last year, primarily due to the timing of purchases year-over-year. At the end of the second quarter, lease-adjusted debt-to-EBITDAR was 2.08x. Return on invested capital increased 237 basis points for the quarter to 14.98%. Looking at the statement cash flows. Year-to-date operating cash flow was almost $4.2 billion and capital expenditures were $570 million, resulting in free cash flow of nearly $3.6 billion, which is up 2% to last year. In May, we entered into a $1 billion accelerated share repurchase agreement. At this point, we expect to receive approximately 14.5 million shares, but the ultimate number of shares will be determined upon completion of the program in the third quarter. We also repurchased approximately 7.2 million shares for $500 million through the open market. In total, we repurchased $1.5 billion in the quarter. We have approximately $4.9 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, the key drivers of the home improvement industry remain supportive for growth. For the year, we expect total sales increase of approximately 4.5% to 5% driven by account sales increase of 4% to 4.5% and the addition of 15 to 20 stores, which includes 5 Orchard and 2 city center locations. We are anticipating an EBIT increase of 80 to 100 basis points and are targeting 25 to 30 basis points of EBIT expansion per point of comp above 1%. While this is our expectation for the year, there will be some choppiness quarter-to-quarter. For the year, we expect most of the EBIT improvement will come from SG&A. Expense leverage will come from store payroll, marketing, bonus and leveraging our scale to achieve cost savings on indirect spend. In addition, we expect fixed cost leverage associated with sales growth.
Our confidence that flow-through will accelerate in the second half of 2015 is based on a few items:
first, gross margin pressure from both the changes in the promotional calendar and mix should dissipate in the second half and we have much easier second half prior year comparisons. Also, in the fourth quarter of 2014, we increased bonus accruals, which should drive leverage in Q4 this year. Lastly, we expect additional leverage from credit as a result of program growth.
The effective tax rate is expected to be 38.1%. The higher rate relative to 2014 is a result of a settlement of prior tax matters recognized in Q1 2014. The higher tax rate impacts earnings growth by roughly $0.06 per share. For the year, we expect earnings per share of approximately $3.29, which represents an increase of 21.4% over 2014. We are forecasting cash flow from operations to be approximately $5 billion. Our capital forecast for 2015 is now approximately $1.3 billion, which results in an estimated free cash flow of $3.7 billion for 2015. We expect to issue incremental debt during the year as we manage to the 2.25x lease-adjusted debt-to-EBITDAR target. Our guidance assumes approximately $3.8 billion share repurchases for 2015. Virginia, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
So I think the key question is on flow-through and thanks for some of that color, Bob. You mentioned that there is going to be some seasonal choppiness first half of this year. That looks like it was the case because it's below average. You mentioned a couple of items that will, I guess, accelerate that for the back half. I guess can you reiterate, I guess, what gives you the confidence? Are there some indirect cost saves that are in place or those are still to come? And then as far as the promotional cadence goes, can you just remind us what -- is that a general comment about the overall business? Or is that within certain categories?
Robert Hull:
So Simeon, I'll start with kind of the mechanics of the improved flow-through in the second half and I'll let Mike talk about changes to the promotional calendar and impact on the second half. So there's a number of items that gives us confidence that second half flow-through is going to be higher than the first half. I called out 3 in my comments, so let me give you a little bit more color around those 3. I mentioned the promotional calendar and mix pressure dissipating as well as easier compares. If you look at 2014, gross margin improved 42 basis points in the first half of 2014 and declined 6 basis points in the second half, so we do have easier compares in the second half. For 2015, gross margin declined 6 basis points. We expect about 20 basis points of improvement in the second half or roughly a 26 basis point swing. Second, in bonus, for the first half of 2015, we've seen 7 basis points of deleverage in bonus. We expect about 13 basis points of leverage in the second half of 2015 or roughly a 20 basis point swing. Lastly, credit. Credit was flat to 2014 for the first half. We expect about 15 basis points of leverage in the second half of 2015 for a swing of 15 basis points. So those 3 items are the lion's share of what gives us confidence in the flow-through. We do have a couple of other items given timing of projects like facilities, repairs and store enviro projects where the first half was a little bit heavier than second half, but we do have a number of items that we can point to that give us confidence in the second half flow-through.
Michael Jones:
I'll talk to the promotional environment. I would describe the promotional environment as stable. I'd say in the second quarter, we targeted promotions largely at appliances or the big-ticket categories with the intent to match the promotional intensity of the competition. So while our promotional intensity increased relative to the second quarter of last year and was consistent with the competitive environment, we expect that to abate in the second half of the year as we wrap -- when we started to increase our promotional intensity last year, which is around Labor Day.
Rick Damron:
Yes, Simeon, this is Rick. I would add just to that is the one thing we did in the second half of last year, which was timing around the promotional events is around the holidays with the 2-day extensions of the events. We will not comp that until Labor Day this year so that's what also Bob was mentioning when we talked about promotional pressures, those incremental 2 days that did not happen last year this time during the first half and we'll begin to comp that actually in Q3.
Simeon Gutman:
And just to clarify. The store closing costs, I think some of the Canada costs, those -- any of those linger into the third or back half? And then I'm assuming that's -- you're excluding that from some of your leverage assumptions for the remainder of the year.
Robert Hull:
So those $17 million I mentioned was in the first half. The only thing that extended into the second half is the carrying costs for the 12 Target leases. That's relatively small. That was only about $0.5 million of the $4 million in Q2 that is embedded in our outlook for the year.
Operator:
Your next question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I want to focus on a couple of sales items. First of all, can you talk about the impact of the weather-related businesses on the comp overall and -- especially on transaction count whether that had a material impact and whether you saw the cadence of the business change as both you move past the peak of the outdoor season and perhaps some of the weather issues, particularly in Texas, would have faded?
Robert Hull:
So Matt, I'll start with the transaction count impact. So we mentioned that we had 2 categories that were below average. Lawn and garden was actually negative. If you think about tickets below $50, they were only up 0.8% so they were positive, but really hurt by lawn and garden and the weakness in that business largely because of the strange weather we had in the quarter.
Matthew Fassler:
Okay. And then a second follow-up. I know that paint based on your slide deck was also below the company average. You do have some new product intros. What's the state of that category for you? Was there a weather impact there as well? Was it product transition that you think is impacting that business for Lowe's?
Michael Jones:
It's where the bulk of our pressure in paint largely in exterior categories as well, exterior stains in particular is where we saw the bulk of our pressure largely in Texas and the Midwest. We're very pleased with the Sherwin-Williams rollout. We love our relationship with Valspar and PPG. We're excited about our paint business, but we did see some weather impact in the second quarter.
Matthew Fassler:
That's great. And just a final quick follow-up, Mike. So just to play devil's advocate on the promotional cadence, you did get more promotional last year. Your appliance business has been extremely strong, presumably hand-in-hand with that promotional stance. How are you thinking about the sales in the businesses where you got more promotional as that promotional intensity abates?
Michael Jones:
We like the fact that the paint shop is clean. We think we've done a number of things. We think the promotional piece was a part of it, but keep in mind that our promotional cadence was aligned to match the promotional environment that we were in. I'd say a little different, we went from under promoting to promoting at the industry level. That said, when we look at the outperforming appliances, it's not coming from a [indiscernible] holding at the level of the industry and our outperformance coming from the things that Rick talked about, improved display of appliances, having the vignettes and the suites of appliances that we talked about having the next-day delivery of appliances. The fact that we control our appliance in this inventory is a powerful thing, one of the few that controls to our appliance inventory. So we like the growth in big ticket, but it's not coming from additional promotion beyond what we see at the industry level.
Robert Niblock:
And Matt, this is Robert. Just as a reminder with respect to paint. When bringing in the HGTV HOME by Sherwin-Williams product, that reset didn't complete till the end of April. So now obviously after we've had the reset complete end of April, we've been working obviously through this quarter to build the awareness with the consumer that, that product is now available in our stores. In addition to, as Mike mentioned, the Valspar and Olympic product that we have, so building that awareness in the consumer and we're pleased with the traction that we're starting to get with that brand.
Operator:
Your next question comes the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
You guys have clearly made a lot of merchandise changes to appeal to your Pro customers more. But I'm curious, when you talk to your Pro customers, what attributes do they seem to value the most from your segment? Is it price? Is it brand? Selection? Proximity of the store? Like if you guys could kind of create a hierarchy, that would be very, very helpful.
Rick Damron:
Scot, this is Rick. I'll talk a little bit about it then I'll turn it over to Mike to talk a little bit about the brands. When we talk to the Pro, one of the largest, I think, contributing factors is location. Proximity to the store is a definite aspect of the Pro environment. If you're not convenient from a location standpoint, then you don't -- you're not as relevant and that's based on what we know from a research standpoint. I would say that we continue to look at other aspects of where we are from a general purpose and we talk about the 5 Ways to Save. We know that delivery and services play an important role as well as price. But I would say the biggest things that we've got right now would be location, it would be having the right brands and then making sure that we're competitive from a price standpoint or services standpoint. I think all of that is fairly equal weight when we think through where we are.
Michael Jones:
And I'll build on that, Rick. When we talk to Pro, and this is in no particular order, but brands certainly are important to them. Inventory depth is very, very important to them. Breadth of assortments so they can go one place and complete the job is important. And localization is equally as critical. There are local norms and building codes that we've got to get right. We deployed a field-based merchandising team to help ensure that we get better on localization. We're pleased with the progress that we're making. Then to Rick's point, services are important like job site delivery and access to credit. So I'm careful not to put one above the other; we've got to have them all. And our program is working towards getting better at all of them.
Scot Ciccarelli:
And so when you guys...
Robert Niblock:
I was just going to say, Scot, in addition to the key drivers that Mike and Rick mentioned, two other things that also resonate very well. You've actually got to have the brands, you've got to have the depth of inventory, you've got to have the convenience and that is our value proposition on our proprietary credit resonates very well with the Pro customer and the relaunch of LowesForPros that we just launched. We're also getting great feedback from Pro customers that it's a much more convenient way to do business with us as well. So that's a new item that just really launched this quarter.
Operator:
Your next question comes from the line of Kate McShane with Citi Research.
Kate McShane:
We noticed that you outpaced your largest competitor in ticket by over 150 basis points and I wondered if this was solely a function of the strength of appliances? Or did any other categories contribute to that? And you also saw the meaningful acceleration in sales of greater than $500. Can you talk to the drivers of that as well?
Michael Jones:
It's Mike Jones. I can talk to that. We're very pleased in our growth in ticket. In fact, this quarter's average ticket is the highest recorded since 2007. So the teams did a great job. The higher mix of appliances and outdoor power equipment drove approximately 1/3 of the growth in ticket. The remainder of the increase was driven by customers moving to higher price points within product categories. In fact, we observed a higher ticket growth in pretty much every product category.
Rick Damron:
Yes, Kate, this is Rick. I'd also add to that, that our service businesses also contributes to that. Our services business for the quarter outpaced the total company comp. And when you look at that, the PSI -- our interior specialist programs and exterior specialist programs performed very well. We're very pleased with the results that we get there and those 2 aspects also drive a higher average ticket from a project standpoint.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
I wanted to focus on the acquisition of the stores in Canada. The 4 Target stores, I think you said you'll be at 20 stores by 2017. At what point do you have mass in that market to where you'll see profitability grow? I think you're not making money at this point due to mass. When do you see getting to profitability?
Robert Niblock:
Chris, I think we have 39 stores open today. We've acquired the additional 12 Target -- former Target locations. We obviously already had some stores in the pipeline that we -- in our organic growth pipeline, so we said combined with Target locations what we had in the pipeline, by 2017, we'll be to about 70 stores. Actually, we were just about to the point of -- would have been breakeven next year in Canada with our current operations had we not taken on the additional locations and it'll take a year or so to get those opened and up to speed. So by the time we get to that 70-store mark, we'll have a pretty good critical mass to grow off of -- there in Canada.
Christopher Horvers:
And then on a related note, can you give us -- share your updated thoughts on your Australia investment? I know you've become more involved in that business over the past year or so. How are trends occurring there? And what's your latest thoughts process on your investment there?
Robert Niblock:
Yes, actually I was just down last week for our joint venture board meeting. I met with the team. I walked some of the stores. The team down there has gone in and looked at opportunity to improve the operations. They've come in with a new format and working on resetting the layout of some of the stores -- new stores we're opening obviously have the new layout, but resetting some existing stores, getting -- increasing the range of product in categories where we didn't have quite enough range down there with the customer and creating much better theater for presentation of the product in areas like flooring, tool world, those type of things. And very pleased, we're seeing great performance over the new format compared to the original layout that we had opened in the stores. So very pleased with the progress the team is making down there. As we've talked previously on the calls, we've slowed down the rate of expansion to be able to make sure that we get stores out of the ground, operating at a higher annual rate and then being able to go back and take some of this expanded range and the new layout to the existing base of stores that we have. So overall, very impressed with the visit I had last week and the progress that I see the team making down there.
Christopher Horvers:
Perfect. And then one quick follow-up. On the -- Bob, you mentioned the leveraging credit in the back half. Is there a timing of 3Q versus 4Q where you would expect that -- those basis points?
Robert Hull:
Chris, we'd expected over both Q3 and Q4.
Operator:
Your next question comes from the line of Mike Baker with Deutsche Bank.
Michael Baker:
A couple of questions. One, did I just hear you say so a 1/3 of the ticket increase was due to going to higher price point items, which to me sounds a little bit like uptick continuum? Is that coming back now in the better economy? Can you compare that 1/3 of the ticket increase to how it's been the last couple of quarters?
Michael Jones:
We don't call it uptick continuum, but it certainly is an outtake from the value improvement initiative where we have improved line designs that allow us to sell up the continuum. It's certainly been a lot by way of training with our store associates to enable them to be able to sell up as well. And our relationship with our vendor partners are absolutely critical where we collaborate with them to have -- book better products, more innovation and better line designs and price point progressions that allow us to sell up as well. So why we don't call it uptick continuum? There are certainly a lot of similarities to what was being done under that program as well.
Michael Baker:
And is that something that has been accelerating over the last couple of quarters?
Michael Jones:
I'd say it depends on category. There are some categories where we're seeing it accelerate. There are some categories that some of the innovation starts to get older, where it's starting to modulate some. But what we tell each of our merchants to do is to go out there and find innovation each and every day and to work with our vendor partners to ensure that we have the ability to sell up the price point because innovation allows us to do it. Just to touch on that, if you look at some of the launches as of recent like our Kobalt 80-volt products -- handheld products doing very well. Our American Standard 4 MAX toilet, it's, to my knowledge, the only self-cleaning toilet in the market. That continues to do very well. Our Centipede work surface for Pros holds 2,000 pounds of weight with a 4 by 8 square foot area, doing very well. So we have a number of new launches that give our associates something to talk about so that they can sell up the price point.
Michael Baker:
Okay, makes sense. One more quick one, if I could. Buybacks, if you stick to your guidance for the year, I think you're going to buy back about $1.1 billion in the back half, which is a lot less than you bought back in the first half. Is there any upside to the buyback plan?
Robert Hull:
So Mike, we've repurchased $2.5 billion to date. That outlook suggests $3.8 billion, which would give us $1.3 billion in the second half. Certainly, if we've got better performance in the second half, we could see some upward movement there. But at this point in time, we're comfortable with the $3.8 billion target.
Operator:
Your next question comes from the line of Dennis McGill with Zelman Associates.
Dennis McGill:
Wondering if you could maybe just walk through any regional disparities you saw in the quarter if you think about year-over-year comps just to help flesh out the weather impacts a little bit more?
Rick Damron:
When you look, Dennis, this is Rick, across regional performances, we were very pleased with the consistent -- consistency we saw across regions. If you look at it from a divisional perspective, we saw the strongest performance in our Southern division across the country. But the balance between regions was pretty consistent across the country as well.
Dennis McGill:
So I guess the weather impacts you noted would be more consistent. I guess there's weather impact everywhere as far as an overhang in your view?
Rick Damron:
Yes. Well, I think, we definitely saw more weather impact, particularly if you're talking about rain in the Southern markets, in the Western markets, the drought in California. But you always look at weather from what happened this year to what happened last year. You always have migration between markets and geographies that you see from that perspective. But when we look at it, like I said, the South, the North and then the West was probably our -- the way that we would break out our overall performance from a divisional perspective.
Dennis McGill:
Okay. And then, Bob, with respect to the second half margin expansion guidance and if you were to look at the top and bottom end of your range, what are the potential negative offsets to the positive discrete items you mentioned that would flex you from the top to the bottom?
Robert Hull:
Well, certainly, if you think about negative impacts if revenue comes in lower than expected, that would pressure the amount of fixed cost leverage we've got planned. And then if there's any acceleration in the promotional environment, that would certainly impact gross margin. We feel good about a lot of things we're doing. We've spoken about the capabilities we've put in place with regard to indirect spend. That's going to deliver savings without regard to the sales environment. Also to the extent we've got pressure on sales or gross margin in the second half, that would probably accelerate the amount of bonus leverage that we've got. So we've got some mitigants that we believe would offset any pressure that might come our way.
Dennis McGill:
Okay. But fair to say that the vast majority of the variance is top line driven.
Robert Hull:
I think there's a number of risks, that is certainly one of them.
Operator:
Your next question comes the line of Michael Lasser with UBS.
Michael Lasser:
So over the last 4 quarters, as you've matched the promotional cadence of the market, outdoor, power equipment and appliances have performed above the company's average. So as you think about the second half of the year when you don't expect an incremental step up in the promotional activity, what categories do you anticipate will get better such that your comp through will remain around this level, especially with the comparisons getting more difficult?
Michael Jones:
We expect to still see growth in outdoor and power equipment and appliances. We're excited about seasonal living behind some of the work that you'll see us do with our CX Customer Experience Organization as we go into the back half of the year. We're excited about some of the launches that we have in flooring, in particular laminate. Laminate for the second quarter was up double digits and we've got a great launch that we just did with one of our vendor partners that we're pretty excited about with our Pergo laminate product partnering with Mohawk, so excited about that. I tend of look at it more as where do we have launches that will drive incremental growth. And certainly laminate is exciting for us. Lennox HVAC is excited for us. We did a key launch with Rinnai in tankless water heaters, we're excited about that. Hitachi pneumatics and some of the work that we did in tools, we're excited about as well behind Goldblatt. And so again, I'm cautious to try to predict where the industry is going to drive growth. I tend to focus a little more on where the initiatives are. And we've got some great initiatives and some great resets that we think it will drive performance in the back half.
Rick Damron:
Michael, this is Rick. The one thing I would add to that is, we think, in lumber and building materials you'll see the deflation begin to abate, which will help as well. And then paint will be another key category as we go into the back half of the year as we create more awareness around Sherwin-Williams and we see the weather become more conducive, especially on the exterior side of the business, to drive that category.
Michael Lasser:
Let me ask the question again from a different way. Are there categories or product areas right now where you're under the market from a promotional perspective. And could you see yourself going above the market based on the return that you've been able to achieve with the promotional activity that you've engaged in -- over the last year?
Michael Jones:
I think we're promoting at about the market for most of the categories. And to the extent we see share opportunities in a given category that we'll be able to lean a little heavier into promotion for that particular category is how I would answer that.
Robert Niblock:
To Mike's last point, when we think about OPE and appliances, I think there are some share opportunities out there as we've seen shift in -- from an industry standpoint. Certainly, I think we've got a great lineup, as Rick took you through in his comments on appliances, some of the new products that we've got out there that's resonating well in OPE. So we expect that to continue to be strong. But then layer on the other things that Mike talked about including -- from paint, not only is it the new brand, the abatement of the weather challenge, but it's also we reset all the stores in the first half of the year, first quarter of the year. So we had disruption in our paint department obviously as we were going through that reset. That's all behind us as well.
Michael Lasser:
Okay, that's helpful. And just quickly, as my follow-up, Robert, there was -- especially around the MRO market opportunity in your prepared remarks, maybe you could provide some broader thoughts on how you think Lowe's can pursue that market potential, especially in light of what's happening in the competitive landscape.
Robert Niblock:
Yes, Mike. Well, that was actually, I think, in Rick's comments. I'll let him address that?
Rick Damron:
Yes, Mike. When you look at that, we talked over the last several years about our holistic strategy for the Pro and improving our product and service offering, as Mike talked about, with brands and we talked about in the outside selling organizations and what we've done in our 5 Ways to Save program and the launch of LowesForPros.com really help us continue to feel confident in our strategic priorities around the Pro customer. We feel confident in our ability to continue to meet and exceed their expectations from that standpoint. And I think it's also important to remember that the MRO has historically been a very strong customer for us. And really, the advent of our Account Executive ProServices is in place to help us continue to facilitate the growth of the MRO space. And we know that LowesForPros.com will continue to drive affinity with that customer, which has a tendency to shop more as much from a dot-com platform as in the store. So we feel good with where we are, but we're always evaluating our strategies and our priorities to make sure that we remain relevant for that customer.
Operator:
Your next question comes the line of Peter Benedict with Robert Baird.
Peter Benedict:
Bob, quick one on the balance sheet, the improved AP-to-inventory ratio. You mentioned a little bit timing there, but the strength's been going on for about 5 quarters now. So can you give us a sense of maybe what you're doing differently there and how long you think you can sustain these improved trends in payable?
Robert Hull:
Sure, Peter. So accounts payable is up 15% year-over-year, primarily related to timing of purchases at quarter and we also saw roughly a 2.5-day improvement in days payable outstanding. The merchant teams have been working really hard to evaluate their days inventory on hand relative to days payable and try to get better coverage there. That's something that has been reignited of late and we saw about a day improvement last year. We ought to have roughly 1.5-day or 2-day improvement this year. So while the timing will come and go, at year-end we should see some improvement just from the days payable outstanding. There's a number of tools in place including a supply chain financing program that's been quite effective to allow our vendors to leverage Lowe's balance sheet.
Peter Benedict:
Okay. Perfect, sounds good. And then maybe Rick, a quick one for you on the OPE strength, particularly with respect to the riders. Do you think we're running kind of a replacement cycle there? I mean, that's a category that has not had a lot of strength for several years. So just curious what you think is going on there, if it's more than just kind of a one-season type thing.
Michael Jones:
This is Mike Jones. I'd say it's two things, one of which is innovation. We're seeing a lot more innovation on tractors than what you've seen in the past and there is a bit of replacement cycle as well. So I think we're getting a lift from both.
Rick Damron:
Yes. And then the only thing I would add to that, Peter, is, as Robert spoke about earlier, we continue to gain market share in that category and we think with the brand, the lineup, the innovation that we have, we'll continue to gain market share in that category throughout the year.
Operator:
Your final question comes the line of Greg Melich with Evercore ISI.
Gregory Melich:
I guess, 2 questions, first on just overall sales. Bob, if we look at your guidance, it looks like you did a comp of 4.8% in the first half and it implies that the second half you're assuming about 3% to 4%. And if that's the case, how should we think about SG&A leverage ex the bonus stuff that you talked about given that there's less comp in the plan? What else might be helping it?
Robert Hull:
Yes, so first half comps were 4.7%, Greg. Second half comps would be in the 4-ish range. So not terribly dissimilar. There's a variety of factors that would contribute to leverage. Rick talked about the good work done with the store operations team to continue to thoughtfully put associates in front of customers that allows us to be more effective in our utilization of payroll, that certainly continues in the second half of the year. I mentioned the credit. We've got project-related expenses around facilities repairs and store enviro projects that were first half weighted, we'll get benefit there. And then indirect spend is a capability that continues to get momentum; that should give us some benefit -- greater benefit in the second half of the year. So what I would say is that there's not a lot of difference in the comp first half versus second half and we've got some other discrete items that should drive SG&A leverage.
Gregory Melich:
Great. And I love -- and whoever wants to do it, give us an update on your online and your multichannel business, the dot-com sales, how much they grew, and also given the LowesForPros relaunch, any incremental metrics there as to the take-up would be great.
Robert Niblock:
I'll start, Greg, this is Robert, then I'll turn it over to Rick to talk for LowesForPros. We continue to see great performance from an online standpoint. I think, as Rick went through his comments, he talked about some of the additional features and benefits that we're adding to Lowes.com, which is resonating really well with the customer, particularly when we have more and more customers starting their purchase process online. They may, as you know, finish online or come to the store. But overall, Lowes.com was up about 20% in the quarter. And I'll get Rick to talk about the receptivity we've had for LowesForPros launch.
Rick Damron:
Yes, Greg. I think the thing that we've really been looking at, of course, we've had about a quarter worth of data that we've been evaluating as we continue to move through and we're learning as we see shopping behaviors of the Pro on the category and on the site, what they're looking at, what categories are really resonating well. We've been very pleased with receptivity of the site itself. We're measuring things such as category of products that are being purchased, assortments that are being evaluated. We're looking at the amount of channel pickup
Gregory Melich:
And that would take dot-com up to about 3% of the business. Is my guesstimate right there?
Robert Hull:
So Greg, it's about 3% of our business now.
Robert Niblock:
Thanks. And as always, 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 18. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's conference. Thank you all for joining. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies First Quarter 2015 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I am pleased that we've delivered another strong quarter with comparable sales growth of 5.2%. Comp growth was driven by a 2.9% increase in comp average ticket and a 2.2% increase in comp transactions. The team executed our plan and collaborated across the organization to respond to challenges. We employed a coordinated effort to stagger our Spring Black Friday events with a controlled cadence, as Mike will describe further, and we were well prepared to meet customers' needs for the season.
Our ability to adapt to difficult operating conditions was tested by the prolonged labor dispute at West Coast ports. And I'm pleased with the team's diligent effort to minimize the impact these challenges created. I would like to thank our more than 265,000 employees in the field and at our support centers for their hard work and dedication to serving customers. Comparable sales growth for our U.S. home improvement business was 5.3% for the quarter. And while we saw stronger performance in areas of the country where weather was more favorable, specifically in the West and in Florida, all 14 regions generated positive comps. Additionally, our team in Canada delivered their eighth consecutive quarter of double-digit comps in local currency and their highest quarterly comp performance since we entered the market in 2007. We recorded positive comps in all 13 product categories with particular strength in appliances as well as seasonal categories, including outdoor power equipment and seasonal living. We remain focused on improving our profitability even while investing in key capabilities to drive our sales growth. For the quarter, we drove 76 basis points of operating margin expansion despite experiencing some discrete pressures, as Bob will detail. And we delivered earnings per share of $0.70, a 15% increase over last year's first quarter, which was in line with our expectations. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $1 billion of stock under our share repurchase program and paid $222 million in dividends. Looking at the balance of the year from an economic perspective, key drivers of home improvement industry growth, job and income growth, home buying and home price appreciation remain aligned for modestly stronger industry growth. At the same time, lower energy prices should fuel stronger consumer spending in 2015. We continue to see steady recovery within the housing market, including positive trends in turnover and moderate home price appreciation as measured by the FHFA, the broadest measure of home price growth, which is more in line with our store footprint. We're also encouraged by the results of our first quarter Consumer Sentiment Survey, where we continued to see homeowners' views around personal finances and home values improve. According to the survey, homeowners are shifting more of their spending to home improvement. As a result, their intentions to begin a home improvement project in the next 6 months were the highest in 6 years. And these planned projects are now almost evenly split between discretionary and nondiscretionary. Our key priorities in 2015 should allow us to capitalize on opportunities with an improving economy. We're pursuing further top line growth by differentiating ourselves with better customer experiences and improving our product and service offering for the Pro customer. We also remain committed to improving our productivity and profitability with opportunities in a few specific areas, including store payroll, marketing and leveraging our scale to get cost savings on indirect spend. In addition, we continue developing omni-channel capabilities as part of our long-term commitment to meet customers on their terms whenever and wherever they choose to engage with us. The execution of our strategic priorities, alongside an improving macroeconomic backdrop, together with a keen focus on productivity and profitability, give us confidence in our business outlook for 2015. Thanks again for your interest. And with that, let me turn the call over to Mike.
Michael Jones:
Thanks, Robert. And good morning, everyone. We executed well in the first quarter, growing both average ticket and transactions. We drove traffic to our stores to our Spring Black Friday event, aligned to the expected arrival of spring from the Deep South to the North. To ensure our stores are ready to provide inspiration, information and products to customers, we use our enhanced Sales & Operations Planning process to coordinate inventory flow, advertising, product displays and training.
And while the situation at the West Coast ports added complexity to our spring preparation, our transportation and logistics teams successfully collaborated to reroute product to other ports. As a result, our in-stock levels remain high. In fact, sales in our seasonal living category, which includes our highest concentration of imported products, such as patios and grills, exceeded expectations. We are pleased with our first quarter results, notwithstanding some weather-driven softness. Keep in mind that the outdoor selling season extends well past Memorial Day. To this point, in the second quarter, sales have exceeded our expectations. So we remain confident in the full year guidance we provided last quarter. Looking at category performance. We recorded above company average comps in appliances, outdoor power equipment and seasonal living. We achieved double-digit comps in outdoor power equipment as walk-behind and riding mowers drove strong performance in the West and South. We offer a wide range of mowers to help customers maintain their yards. And we continue to provide compelling and exclusive innovations, like our home channel exclusive Husqvarna All-Wheel Drive mower and our recently launched Troy-Bilt Flex product. The outdoor living experience we introduced last year drove high single-digit comps in our seasonal living product category and across all 3 geographical divisions. This particular customer experience most benefits our patio and outdoor fashion areas, which recorded strong comps again this quarter over double-digit comps last year. We continue to see strong sales of patio furniture and robust attachment of replacement cushions and other outdoor accessories. As a reminder, to create our outdoor living experience, we took advantage of our largest store format to produce a showroom feel, which included removing 15 bays of steel racking and opening up 35% more space for curated style. To help customers envision and create their outdoor space, we displayed patio sets with coordinating rugs, umbrellas and accessories like pillows and planters, along with grills and other outdoor products, just as you would expect to see in your own backyard. We're very pleased with the continued performance of our outdoor living experience.
In appliances, we drove double-digit comps for the second consecutive quarter. Lowe's offers leading appliance brands, such as Whirlpool, Kitchenaid, Bosch, Samsung, LG, Electrolux, Frigidaire and GE. And we've further strengthened our offering with the home channel exclusive launch of the Frigidaire Pro appliance series. For customers who aspire to have the look and feel of commercial-grade appliances in their home, this exciting launch provides great value with high-end commercial-like aesthetics and quality at an accessible price point. In addition to great brands, we provide service advantages of next-day delivery and haul-away as well as in-house facilitation of repairs and maintenance. To further enhance on appliance shopping experience, towards the end of last year, we worked with our vendor partners to introduce 17 kitchen suites to each store. Each suite includes 4 coordinated appliances:
a refrigerator, a range, a microwave and a dishwasher. These suites help customers quickly visualize how a full set of new appliances will look in their existing or remodeled kitchen.
We're also excited about HGTV HOME by Sherwin-Williams, an exclusive for Lowe's in the home channel. This is the first time in more than 40 years that Sherwin-Williams-branded products are available through another retailer. Brand is the #1 purchase driver in paint and Sherwin-Williams is the most recognized brand. We expect the addition of HGTV HOME by Sherwin-Williams to appeal to both DIY and Pro customers. Its long-standing reputation for quality as well as the color expertise of HGTV allows Lowe's to offer customers the top brands they trust for their next paint project. We announced this exciting addition in December and set product in all stores by the end of April. Earlier this month, we launched a full national advertising campaign in conjunction with Sherwin-Williams in digital, TV and print. Early customer response to this home channel exclusive brand and to the HGTV curated color set has been positive. Supporting our omni-channel approach to retailing, we are cross-merchandising the Sherwin-Williams brand in key areas throughout the store, like kitchen vignettes, bath vignettes and home decor while also leveraging our color visualizer on Lowes.com. This visualizer helps customers find the perfect color for their walls by virtually painting their own home or experimenting with a simple room. Then they come order a paint sample for shipment directly to the home or come into our stores for help pulling their project together with our specialists. Combined with our outstanding Valspar and PPG/Olympic brand partnerships, we expect to grow traffic to our stores and increase overall market share in paint. We also continue to strengthen our portfolio of Pro-focused brands. We recently finished rolling out brands such as Goldblatt masonry tools, GAF roofing and Owens Corning insulation. And we continued to collect feedback from our Pro customers and store employees to identify other local and national brands that best meet the needs of Pro customers. Along with strengthening our brand portfolio, we recently made the new LowesForPros.com site available to all Pro customers. Our focus on brands as well as our recent relaunch of LowesForPros.com are part of a broader commitment to build on our strong foundation for the Pro. This foundation includes dedicated service in our stores, inventory depth aligned with the needs of the Pro and our 5 Ways to Save value proposition. And our field-based Pro account executives and national accounts team make it easy for medium- to large-sized companies and government entities to do business with us. In addition to our efforts to drive top line growth, we continue to focus on driving productivity and profitability. For the quarter, even with double-digit growth in categories like appliances and outdoor products, we maintained a flat gross margin rate, demonstrating our ability to drive profitability while capitalizing on big-ticket market share opportunities. We accomplished this by continuing to partner with our vendors to drive innovation and improved first cost and by leveraging supply chain fixed costs. Our stores once again effectively managed payroll hours on solid comp sales growth, increasing sales per hour by approximately 4% and driving 13 basis points of payroll expense leverage. They drove this while achieving record customer satisfaction scores and best-in-class inventory shrink performance. We also drove productivity in marketing by increasing our presence in targeted digital media and leveraging our investment in MyLowe's. And we're continuing to identify and implement additional expense efficiencies throughout the year by consolidating the procurement of similar types of goods and services across our corporate in-store functions. Likewise, with solid depth of high-velocity items and job lot quantities in place and through a continued application of improved analytics to a thoughtful line review process, we're able to hold inventory per store roughly flat and increase inventory turns by 17 basis points. As you can see, we are pleased with our first quarter results and the progress we're making on our initiatives to drive top line growth, productivity and profitability and look forward to sharing further progress with you over the course of the year. Thank you for interest in Lowe's. And I would now turn the call over to Bob.
Robert Hull:
Thanks, Mike, and good morning, everyone. Sales for the first quarter were $14.1 billion, an increase of 5.4%. Total average ticket increased 3% to $66.63 and total transaction count increased 2.3%. As discussed on our fourth quarter call, we had planned for normal weather and thus, for Q1, to be our highest comping quarter of the year. In fact, weather in the Northeast was colder than normal and colder than last year while the West and Florida experienced the opposite. Therefore, the net impact of weather year-over-year was not the tailwind we expected.
As a result, our sales for the quarter were slightly below our expectations. But we're still confident in our outlook for the year. Comp sales increased 5.2% as comp average ticket grew by 2.9% and comp transactions were up 2.2%. Looking at monthly trends, comps were 5.1% in February, 6.6% in March and 3.8% in April. Gross margin for the first quarter was 35.47% of sales, essentially flat to last year and in line with our expectations. We had positive rate movement from value improvement, which is offset by 15 basis points of pressure from the mix of products sold. SG&A for Q1 is 24.16% of sales, which leveraged 60 basis points. The expense leverage was driven by advertising, store payroll and impairment. Advertising leveraged 25 basis points, driven by the efforts to improve productivity, as Mike shared. Store payroll leveraged 13 basis points as we continued to optimize our staffing model. In the quarter, we had $8 million of long-lived asset impairment compared with $23 million in last year's first quarter, resulting in 11 basis points of leverage. Also there were numerous expenses that leveraged between 5 and 10 basis points in Q1. These items were somewhat offset by bonus, which deleveraged 35 basis points. Our bonus accruals are based on actual performance-to-date relative to plan. Record customer satisfaction scores, coupled with solid Q1 performance this year relative to a tough first quarter last year, resulted in higher bonus expense, and therefore, deleveraged year-over-year. Depreciation for the quarter was $365 million, which was 2.59% of sales and leveraged 19 basis points compared to last year's first quarter as a result of higher sales and assets becoming fully depreciated. Earnings before interest and taxes increased 76 basis points to 8.72% of sales. On our Q4 call, we discussed the pressure that gross margin and bonus expense would have on first quarter's flow-through. The 18 basis points of flow-through per point of comp above 1% in Q1 was modestly better than our expectations coming into the quarter. Interest expense at $134 million for the quarter deleveraged 2 basis points to last year as total debt increased $1.2 billion versus first quarter of 2014. The effective tax rate for the quarter was 38.7%, which was higher than the fourth quarter due to the expiration of certain tax provisions. The higher rate relative to the last year was primarily due to a tax settlement in Q1 2014 and negatively impacted first quarter earnings per share comparisons to last year by approximately $0.06. Earnings per share of $0.70 for the quarter was in line with our expectations and represented a 14.8% increase over last year's $0.61. Now a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $1.4 billion. Our first quarter inventory balance of $10.6 billion increased $99 million or 0.9% over Q1 last year. Inventory turnover was 3.78, an increase of 17 basis points over Q1 2014. Asset turnover increased 11 basis points to 1.7. Moving on to liability section of the balance sheet. Accounts payable of $8 billion increased $972 million or 13.8% over Q1 last year. The increase in accounts payable is due to the timing of purchases in the quarter versus last year. At the end of the first quarter, lease adjusted debt to EBITDAR was 2.11. Return on invested capital increased 232 basis points for the quarter to 14.34%. Now looking at the statement of cash flows. Operating cash flow was almost $2.5 billion. Capital expenditures were $232 million, resulting in free cash flow of over $2.2 billion. Free cash flow was $446 billion or 24.8% over the same period last year. In the quarter, we repurchased 13.6 million shares for $1 billion. Our board also approved a new $5 billion share repurchase authorization. At quarter end, we had approximately $6.4 billion remaining on our share repurchase authorization. The remaining $109 million of share repurchases shown on the statement of cash flows, relates to the shares withheld from employees to satisfy statutory tax withholding liabilities as well as the timing of share repurchase settlement across quarters. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, economic forecasts remain aligned for modestly stronger home improvement industry growth in 2015. While we are optimistic about both the macro forecast and our improving execution, we continue to take a prudent approach to our 2015 outlook. For the year, we expect a total sales increase of approximately 4.5% to 5%, driven by comp sales increase of 4% to 4.5% and the opening of 15 to 20 stores, which include 6 Orchard and 2 city center locations. We're anticipating an EBIT increase of 80 to 100 basis points and are targeting 25 to 30 basis points of EBIT expansion per point of comp above 1%. While this is our expectation for the year, there will be some choppiness quarter-to-quarter. Specific to the second quarter, there will be some gross margin pressure associated with the additional costs related to the West Coast port issue as well as 1 more quarter impact from increased promotional intensity that began Labor Day last year. For the year, we expect that most of the EBIT improvement will come from SG&A. Expense leverage will come from store payroll, marketing, bonus and leveraging our scale to achieve cost savings on indirect spend. In addition, we expect fixed cost leverage associated with sales growth. The effective tax rate is particularly expected to be 38.1%. The higher rate relative to 2014 is a result of the settlement of prior tax matters recognized in Q1 2014. The higher tax rate impacts earnings growth by roughly $0.06 per share. For the year, we expect earnings per share of approximately $3.29, which represents an increase of 21.4% over 2014. We are forecasting cash flows from operations to be approximately $5.1 billion. Our capital forecast for 2015 is now approximately $1.4 billion, which is roughly $200 million higher than planned as a result of acquiring certain Target assets in Canada. This results in an estimated free cash flow of $3.7 billion for 2015. We expect to issue incremental debt during the year as we manage to the 2.25x lease adjusted debt-to-EBITDAR target. Our guidance assumes approximately $3.8 billion in share repurchases for 2015. Regina, we're now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
A first question, I know you just spent a lot of time discussing the sales trends. But maybe if you could just help us understand better, if you would, the sales deceleration in the month of April, so the final month of your quarter because that was at odds with what your competitor said yesterday about their trends. So maybe just -- maybe some color -- more color there, please?
Robert Hull:
So a couple of things, Brian. First, as we think about the 3.8% for April relative to the 5.2% for the quarter, we did see some softness -- weather-related softness in some areas of the country for our seasonal categories. But as Mike said in his comments, we're exceeding expectations in May. So we're comfortable with what we're seeing regarding those seasonal categories in those parts of the country, where weather has improved. As it relates to what our competitor reported yesterday, if we take a look at -- so we're on a 4-5-4 calendar. If we take a look at our performance on a 4-4-5, which takes out some of the Easter shift noise that would've crossed our fiscal March into April of this year, we would have reported essentially a 5% comp for all 3 months of the Q1.
Brian Nagel:
Got it. It was very helpful. And the second question, I have news that there was a news out over the past few weeks or month or so about the flooring category and some of the actions you've taken. Maybe just update us there on kind of what Lowe's is doing on the flooring category and if that had any impact upon the Q1 results.
Robert Niblock:
Yes. Brian, this is Robert. I don't think we had any impact on Q1 results. But I'll get Mike to address the details of what we're doing in the flooring category. Mike?
Michael Jones:
Yes. There were a couple of articles, some articles out around 2 issues. One was relating to formaldehyde, in particular -- with one particular partner. What we did, in essence, was we took -- we put the products from that particular partner on hold. And we're going ahead and we'll review the certifications. All of our partners are required to give us certification. We're reviewing the certification and making sure that there aren't any issues. And so we'll work through that. As we look at our portfolio, we're very comfortable that we don't have issues. Our vendors are largely U.S. They've all certified with us that there are no issues. So we're very, very comfortable that we're in a pretty good place on this. And as we said, there was no issues relative to flooring going in the quarter.
With respect to phthalates, the other concern that was raised on vinyl flooring specifically, more than 90% of our virgin vinyl flooring today is phthalate-free. We'll move that to 100% by year end. And again, we're comfortable that there's no big issues. And as we work with our vendor partners and we continue to scrub this, they're not finding any issues as well. So we don't see any impact on the quarter. And frankly, our flooring business continues to do well. And our reviews with our vendor partners continues to give us the kind of expected results that we expect.
Operator:
Your next question comes from the line of Laura Champine with Cantor Fitzgerald.
Jason Smith:
This is Jason Smith on for Laura. I know you guys touched upon some of the new products -- introductions in the appliance category. But could you kind of give us a better sense as to just overall what drove the double-digit performance in the quarter and what you're seeing in the competitive environment?
Michael Jones:
Sure, a couple of things. We talked towards the middle of last year of making sure that our promotional cadence was aligned with what we saw in the market. In addition to that, we have more space dedicated to the appliance category than certainly most, if not all, of our competitors. And we offer the full way of brands. And so we like our position to go after market share in appliances. We've done a couple of things. We continue to launch exclusive and innovative products, like the Frigidaire Pro series that we've talked about. That's a home channel exclusive. And we also put in kitchen vignettes so that customers can walk in and see full vignettes of appliances and shop the different brands, looking at the -- how a kitchen would look, be it a recently remodeled kitchen or an existing kitchen with full vignettes. And we've seen a couple of things coming from that. First, our appliance sales remained strong, double digit both this quarter and last quarter. We've also seen an expansion of number of appliances per ticket. And so we feel real good about our position in the appliance business. We feel real good about our initiatives and we feel real good about the support our vendor partners continues to give us to ensure that we retain the #1 position in appliances.
Jason Smith:
Okay, great. And if I could just add one quick follow-up, any early feedback from the LowesForPros now that it's open to everyone?
Rick Damron:
Yes, Jason, this is Rick. Early on, we continue to get good feedback from the site. We've gone through the actual soft launch of that site on May 5. Currently, we have done no incremental marketing to the site. So what we're seeing is the gravitation of normal traffic to it. But we've been very pleased with the organic search and the organic growth of the site. It will continue to generate more awareness and more traffic as we continue to move throughout Q2. But so far, we've been extremely pleased with the interaction to the site, the number of registrations to the site and the activity.
Operator:
Your next question comes from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two things. First of all, could you give us an update in terms of the online, the results, the growth you're seeing in that and as well as the new efforts that you're implementing within online?
Rick Damron:
Yes, Eric, this is Rick. A couple of things, as we looked at dot-com sales for the quarter, they grew 25.5%. On a comp basis, Q1 traffic was up double digits to the site. And our conversion rate improved as well from an overall perspective for the quarter. The great thing was we saw both traffic at double-digit rates every month of the quarter and improvement in conversion for every month of the quarter. A few things that we continue to do, Mike talked about the new paint configuration tool that was launched to help customers visualize paint in their home. We made several other strategic changes to the site throughout the quarter as we continued to look for ways to improve the site, along with the filtering process, improving better filtering and better search terms.
We also introduced 3 other aspects to the site. We introduced new 360 product views to about 11,500 of our highest-viewed items, which gives customers the complete view of the item across all aspects. We also introduced product videos to 214 different items that enhance the video capabilities of the customer to actually see the site, see the item and actually interact with it to a greater degree. And then we also enhanced the images to 9,400 items on the site in the quarter as well to make sure that we did showcase the product in a much better way to the customer. So extremely pleased with the growth that we saw during the quarter, most pleased with the improvement in conversion, which I believe is the result of the improved search terms, filtering and the incremental adds to product content that we've made to the site during the quarter.
Eric Bosshard:
And then a follow-up, Mike, I'd be interested in the magnitude of changes that you are making within merchandising, within LowesForPros. It seems like a number of things going on at the store level. Curious how the organization is digesting that, if this is net benefiting the business, if there are periods where there's some disruption as you implement these. How would you evaluate the pace of digesting the changes that you're implementing?
Michael Jones:
There's been a number of changes over the last, let's say, 2 years. I think the team is working through them well. We don't spend a lot of time talking about some of the new tools that have been deployed, like space planning, some of the workflow tools for our planning and review process, some of the improvements in pricing tools that get to mark-down optimization and promotional management, the efficient item assortment tools. I mean, we've rolled out a number of tools in the merchandising space that make the merchants certainly more data-driven as well as more effective. When you couple that with our approach to go after more of that Pro business, that's also facilitated the need for the merchants to do somethings very different, a different look on how we approach brands relative to national brands versus private label brands and those categories that lean very heavily to Pro. We're doing a lot of things very different. Here's how I answer that. I think you see a difference in our stores. I think our merchants and our vendor partners are excited about the changes that we've made. I think they like the success that we see in growth. And I think they're working through it well. I'm very proud of how the merchants have digested this. I'm equally as proud at how much support we've gotten from our vendor partners as we continue to work through these changes.
Rick Damron:
Yes, Eric, this is Rick. I would just add from a store perspective that you look at many of these initiatives, they've been ongoing for some time now over the last 3 years. And I give Dennis Knowles and the store teams a tremendous amount of credit for the number of hours that we've invested in training our associates over the past 2 years on the utilization of these tools and what these sets mean to our stores. So you mentioned LowesForPros.com. You think about the Pro, it's really been a 3-year journey of implementing brands, implementing inventory levels, implementing processes and organizational design, and then the addition of LowesForPros, which is the last component of that. So from a store perspective, there's been a tremendous investment in training, communication and dialogue to make sure that we're able to execute these programs as they rolled out.
Robert Niblock:
And Eric, this is Robert. If we think about everything that Mike and Rick just described, including the product resets to come with new Pro-focused brands like Mike talked about in his comments in the first quarter when we brought in Sherwin-Williams, significant reset to take place in the stores that was done over the first quarter. Layered on top of that, the training that Rick just mentioned for all the associates at the Pro desk, those types of things, and then be able to deliver the results that we've had in the quarter. We're investing a lot for the future, but we're also doing it with a cadence that allows us to deliver great results like we did for the quarter. So I'm pretty proud with what the team has been able to execute.
Operator:
Your next question comes from the line of Greg Melich with ISI.
Gregory Melich:
So a couple of questions, I wanted to follow up a little bit on the trend through the quarter and where we are into the second quarter. I think, Bob, if you look at your presentation, you can just see how the comps get more difficult all year. Help us to understand how you see the year playing out in terms of what might be your hardest comp the rest of the way or your easiest comp to build up to your full year plan.
Robert Hull:
Sure. So we talked about the first half being stronger than the second half. But we also talked about as the year progresses, our 2-year comparisons, 2-year stack progressively increasing. So you heard the guys just talk about a lot of work the team is doing to improve our offering, our execution to the customer. Robert talked about the modestly improving environment for home improvement. So we do recognize that we are going against tougher comparisons. But on balance, the macro should be more constructive as the year progresses relative to 2014. So we're still confident with our plan for 2015, our ability to execute against that plan.
Gregory Melich:
And it sounds like you think the second quarter, third quarter and fourth quarter, given all those things wrapped together, is actually reasonably even. Is that fair?
Robert Hull:
Not quite fair. I think I would say that our outlook has modestly decelerated comps, Q1 to Q2 to Q3 to Q4 and somewhat reflects the tougher comparison from last year. But as I said, we do expect the 2-year stack to modestly improve as we progress throughout the year as well.
Gregory Melich:
That's great. And if I could have a follow-up question, just to understand a little bit on SG&A, the bonus expense deleverage. So we were below plan, but we deleveraged bonus. Could you help us understand that a little bit better as to how the absolute level versus the plan? Like why do we delever if we were below plan?
Robert Hull:
So a couple of things, Greg. First, we were modestly below our sales plan. We improved the flow-through relative to our expectations. So the earnings came in on plan. Still we accrued, generally speaking, on target for bonus for Q1. However, as Mike indicated, we had record performance from our customer satisfaction scores. So the approved -- the only aspect of plan that was above -- the only aspect above us -- that was above plan was the customer-focus program for the store associates. The majority of deleverage came because of the softness last year. Because of the dramatic performance below plan last year, it caused us to unwind some bonus accruals. So coming into the year, we had anticipated having deleverage in Q1. That's one of the pressures I've talked about on the Q4 call is we would have some bonus deleverage in Q1. It was a little bit higher than expected because of the record customer service scores that were recorded.
Gregory Melich:
Great. And then just quickly, paint was a below-average category. Now that you're through that transition, any estimates to how much that could have hurt the quarter and how -- just give us -- remind us how big paint is as a category for you guys and what that could mean going forward?
Robert Niblock:
Yes, I'll have the guys jump in. But as I said, we're through with the transition. Greg, we basically had the national launch of Sherwin-Williams basically right at the beginning of second quarter. We've got all the products in place, everyone trained. It was a below-average category, which I think is also what we saw from an industry standpoint, that paint was a little bit below average in the first quarter. So we probably had some disruption, I don't know that we've got an amount quantified because it was -- out of the reset as we went through the quarter. So I don't know that we've quantified that. But certainly, I think we've got the ability to show great strength as we're now backing up the national launch of advertising. Mike, is there anything you want to talk about?
Michael Jones:
Yes. I'd just add that we're really not disappointed at Q1. We knew that we had to get through a transition. We're through to transition. We -- the national advertising campaign is kicking in. We're actually very optimistic about it in the back half of the year.
Operator:
Your next question comes from the line of Dan Binder with Jefferies.
Daniel Binder:
I was wondering if you could talk a little bit more about the staff optimization work that you're doing, and then if there were any other notable categories that were softer than plan other than paint.
Rick Damron:
Yes, Dan, this is Rick. I'll start. As we look at the quarter, we continue to optimize our labor to our customer traffic, extremely pleased with the stores and what they were able to do in the quarter. We hired approximately 51,000 employees in the quarter. And during that transition, we were also, as Bob said, able to record customer satisfaction scores across our stores during that timeframe. Productivity increased, from a sales per hour perspective increased 4%, driving the 10 basis points of leverage. We continue to look for ways to optimize the store labor model to traffic as well as to maximize any of our nonselling areas and make sure that we're doing everything we can to drive productivity from those areas and put those hours back to the sales floor. We looked at, of course, our delivery productivities. We're seeing improvement there. We're seeing improvement in capability builds, the technologies that we're deploying and through the scheduling process as we continue to match our customer hour -- our employee hours to customer traffic. So those things, I think, are really helping us from a productivity standpoint, a staffing optimization standpoint, continue to maximize hours on the sales floor to meet the customer traffic to drive continued improvement in close rates during those peak times of day.
Michael Jones:
So I'll just talk to the merchandising divisional performance. So if you think about the ones that were above the average, appliances, outdoor power equipment, seasonal living, they were extremely strong, I mean, well into double digits, very, very strong. We had a couple that we felt real good about that don't show up in the above-average, tools and hardware flooring, millwork, kitchens, as an example, were great performers. I think where we saw pressure was primarily in paint and lumber and building material. And so lumber and building material, we understand that there certainty was a bit of a weather impact. We can track that one back. Paint, we saw pressure, but we expected it as we worked through the transition.
Robert Niblock:
And Dan, this is Robert. Just a reminder, all categories were positive in the quarter, so.
Operator:
Your next question comes from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My question is around sales trends again, just making sure I understand this a little bit better. Because even on a 2-year stacked basis, Bob, we saw a pretty marked deceleration in trend in April relative to earlier in the quarter. Is there anything about that month that you can speak to, particularly given the fact that weather in the Northeast started to improve significantly then?
Robert Hull:
So Seth, as I said to the earlier question, a lot of it was driven to discrete weather across the country, not just Northeast, where we saw some seasonal pressure. That was for a couple of weeks towards the end of the month. However, we have seen trends improve in the seasonal categories in those geographies. So no real concern from opportunity to hit the Q2 and the 2015 outlook.
Rick Damron:
Yes. And Seth, I'd just add one thing, too. As we continue to look at the quarter especially for the North, as Mike said in his opening comments, we staggered our Black Friday events. So our Black Friday events in the North and Upper North actually moved into Q2 this year, not Q1. So that's some of the things that we're realizing as well in Q1.
Robert Niblock:
And Seth, just to bring it into perspective, this is Robert. If you think about looking out over the balance of the year, as you look at our comp guidance for this year, our comp guidance is basically in line with the comps we delivered last year. If you think about last year coming out of the first quarter, we had 0.9% comp, so we had a big deficit to make up going over the balance of the year. Obviously, the first quarter this year, we got a 5.2% comp in the first quarter, so we're running ahead of what our trajectory -- or what our guidance is for the entire year. So obviously, coming out of the first quarter, we feel much better about being ahead of what we guided to for the year than the position we were in last year, where we had a large deficit to make up, so.
Seth Basham:
Great, that's helpful. And then a follow-up question, it's just around about big-ticket sales. Pretty big deceleration in big-ticket comps despite double-digit comps in OPE appliances, seasonal living. Were there categories that you can point to that drove the deceleration?
Robert Hull:
So we did see a pretty strong performance, 7.7% comp is good performance for big ticket that were driven by OPE and appliances. We also saw some good movement across all -- moving up across all categories in ticket size. So we're really not disappointed at all with the big-ticket performance in the first quarter. Obviously, there's a lot more momentum in Q4 last year that drove all categories higher but certainly not disappointed with the big-ticket performance in Q1.
Operator:
Your next question comes from the line of Judy Merrick with SunTrust.
Judy Merrick:
And just as you're looking -- as you're dedicating more space to these kitchen suites, have you seen any more strength across categories aside from appliances?
Robert Niblock:
Yes, I'll start, Judy, and then I'll let Mike jump in on top of that. When Mike talked about the kitchen suites, he's really talking about re-laying the existing space that we had in the department in the way that we're arranging our offering of appliances into more of a suite versus an individual, all washers together, dryers, those type of things. So we haven't really dedicated more space from an overall appliance standpoint. It's just the way that we're going to market with those appliance category. So in that respect, you shouldn't see more space allocation impact on other categories.
Michael Jones:
And then just as an example, some of the categories where we're seeing strength, we certainly saw it in the appliance business as I mentioned. We see it in cabinets. As an example, by having the kitchen suites that are now in the stores sitting next to cabinets, as customers start to engage in some of those remodel projects in the kitchen, it's easier for them to shop at our stores and pull that project together. We saw strength in areas of flooring as well. And so we're pretty optimistic on how the customer is engaging with us to continue to execute and do those kitchen projects. I think -- and I don't know if you're going to talk to the project specialists' performance as well, Rick, which is also a good indicator.
Rick Damron:
Yes. As we say, Judy, the interiors -- or services business grew above the company average for the quarter. So we still see continued strength across our services business. In particular, we continue to see our exteriors and interiors programs work extremely well, which benefits from the experience creation that we're doing across categories. And I think one of the big things that Mike and Robert highlighted is again it's important to understand as we talk about suites, we're not talking about extended cabinet space, we're talking about how we display the appliances together in the appliance department and putting together the appliance, the range, the dishwasher, the microwave into a set, where they're actually showcased together versus being spread across the appliance department, which makes it easier for the customer to visualize that set in their home.
Operator:
Your next question comes from the line of Jaime Katz with Morningstar.
Jaime Katz:
Can you guys just clarify the $3.8 billion of share repurchases? Is that with the debt issuance? Or could there be some incremental repurchases with additional leverage?
Robert Hull:
So the -- we do plan to issue incremental debt during the course of the year as we manage to the 2.25x target. So our outlook goes to contemplate managing up to that target relative to the 2.11 we finished the first quarter to achieve $3.8 billion. That was our guided target. We'll continue to assess that as the year progresses, but that's where we sit today.
Jaime Katz:
Okay. And then I know that it was commented that flooring was slightly below average. But I'm curious if you guys saw any benefit from the brand equity at Lumber Liquidators falling a little bit. Was there any sort of traffic uptick in the category that you guys saw as negative publicity surrounded sort of your peer?
Michael Jones:
I don't want to talk to a competitor. What I would say is that our flooring business performed very well. And when we look at the categories under flooring, we did see strength in laminate. We saw good performance in tile. And there was a little bit of pressure that we saw in carpet. And we're always sensitive to watching carpet because we have a very strong carpet offering, in particular with our STAINMASTER, which is an exclusive brand.
Jaime Katz:
Okay. And then lastly, with inventory turns, they were able to tick up despite West Coast port issues. Do you guys have any thoughts on where you think that metric could go maybe closer to the end of the year?
Robert Hull:
Yes. So we're targeting roughly similar growth that we saw in Q1, 15 to 20 basis points improvement for the year in inventory turn improvement.
Operator:
Our final question will come from the line of Budd Bugatch with Raymond James.
Budd Bugatch:
I guess, I'm still confused a little bit about the merchandising performance because I don't ever remember seeing it so lopsided with above-average and below-average categories. And maybe you can just shed me a little bit of light because I know we had strong performance, I think we'll call it that, in all 3 of the above-average areas. Is there any reason to be concerned about that performance and help us maybe understand that?
Michael Jones:
Yes, I can talk to that, Budd. The appliances, outdoor power -- it's a simple math. The appliances, outdoor power equipment and seasonal living are up extremely strong compared to the -- where the average is. And we looked at this a couple of times as well. If the appliances, outdoor power equipment and seasonal living weren't in strong, strong double digit like we have, then the spread wouldn't be as broad as it is. When we go through each of the divisional performances and we look at which ones fell just below the average as a result of the strength that we saw in the above-average, as I said earlier, tools and hardware, flooring, kitchens and millwork did extremely well, extremely, extremely well. And then where we saw real pressure was in paint and lumber and building materials specifically. So I wouldn't be worried about the spread. I think for us, the bigger question was could we take in this much of the appliance business and outdoor power equipment business and still manage to a flat gross margin? And we're very comfortable that we're able to take in that much market share and hold gross margin about flat.
Budd Bugatch:
Okay, all right. That's helpful. Also I heard that LowesForPros is doing well, but I'm not sure I heard anything about the Pro penetration or what -- if you made -- if you quantified any of that any way towards sales or how do we look at that.
Rick Damron:
Yes, Budd, this is Rick. We continue to be very pleased with our performance in Pro, as Pro has continued to respond to our value statement, our 5 Ways to Save, as we continue to get the great brands into our stores and continue to get those areas working for us, we still see great performance. When you look at Pro, it was in line with the company from a total sales perspective. We still see solid growth in applications for credit, which to me is a leading indicator of the strength of the category and what we're doing. So we still saw solid growth from that. As well as when you look at both ticket ranges as well as comps by ticket size, the Pro categories grew at positive performance across all ticket sizes and all ticket ranges. So we continue to be very pleased with the performance of Pro, especially as they continue to respond to our initiatives and our brand offering. But overall, it was still in line with the company performance.
Budd Bugatch:
And Rick, the penetration then as a percentage of sales? I think you quantified it last quarter.
Robert Hull:
Stays the same at 30%.
Rick Damron:
Yes, right at 30%, Budd.
Budd Bugatch:
30%, still at 30%. Okay, that was what I was trying to get to. And Bob, inflation, deflation, I'm not sure I heard that quantified on the comp.
Robert Hull:
Negligible, Budd. It had about 10 basis points of negative impact.
Robert Niblock:
And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter results on Wednesday, August 19. Have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference. Thank you, all, for joining. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2014 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. These 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I'm pleased that we delivered another strong quarter, with comparable sales growth of 7.3%. Comp growth was driven by a 4.9% increase in comp average ticket and a 2.3% increase in comp transactions. The mix of comp ticket and comp transactions was consistent with our expectations.
Comparable sales growth for our U.S. business was 7.4% for the quarter. We saw balanced performance across the country again this quarter, with all 3 divisions, the North, South and West, generating comps within a tight range. In fact, all 14 regions had comps greater than 5%. Likewise, we reported positive comps in all 12 product categories, and our ProServices business continued its strong performance, with comp sales in line with the company average during the quarter. I'm also pleased to share that our team in Canada delivered double-digit comps in local currency for the seventh consecutive quarter. We remain focused on improving our profitability even while investing in key capabilities to drive sales growth. For the quarter, we drove 115 basis points of operating margin expansion and earnings per share of $0.46, a 59% increase over last year's fourth quarter. For the year, we delivered comparable sales growth of 4.3% and earnings per share of $2.71, a 27% increase over fiscal 2013. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $1 billion of stock under our share repurchase program and paid $225 million in dividends. For the year, we repurchased $3.9 billion of stock and paid $822 million in dividends. As we head into fiscal 2015, macroeconomic fundamentals are aligned for modestly stronger home improvement industry growth. Jobs, incomes, household financial conditions are expected to continue strengthening in 2015, building on the momentum gained in 2014. Coupled with an increase in revolving credit usage, these trends set the stage for higher discretionary consumer spending. And the sharp decline in energy prices should allow consumers to pump less money into their tanks and more into home improvement and other forms of discretionary spending. Improvements in housing should persist in 2015 as well. Strong income gains, mortgage rates that remain historically low and moderating home price growth should keep home affordability at elevated levels and provide more support for home buying in 2015. Expected growth in the home improvement market is further supported by recent consumer confidence readings and the results of our fourth quarter consumer sentiment survey, which revealed that homeowners' views around personal finances and home values continue to improve. In fact, approximately 1/2 of homeowners now believe the value of their homes is increasing. Along with the positive progression in sentiment, this quarter, even more homeowners indicated their home improvement spending was increasing. And while most of the home improvement projects they have planned are still small ticket, the survey indicated a boost in plans for big-ticket projects versus this time last year. In 2015, we will continue to focus on a few key priorities to capitalize on opportunities within an improving economy. We'll further pursue top line growth by differentiating ourself through better customer experiences and improving our product and service offerings for the Pro customer. In addition, we continue developing omni-channel capabilities as part of our long-term commitment to meet customers on their terms, whenever and wherever they choose to engage with us. We also remain committed to improving our productivity and profitability, with opportunities in a few specific areas, including store payroll, marketing and leveraging our scale to get cost savings on indirect spend. These efforts give us confidence in our business outlook for 2015. Bob will share these details in a few minutes. But first, I would like to thank our more than 265,000 employees for their hard work and dedication. Their steadfast commitment to serving customers is critical to our success and an important driver of this quarter's strong results. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning, everyone. As Robert stated, we delivered strong performance in the quarter, and I'm pleased to share that our store employees earned a record payout from our Sales Service Employee Incentive program. This program rewards store employees for achieving their sales and profitability targets and for delivering outstanding customer service. We continue to capitalize on an improving macro backdrop through our enhanced sales operations planning process, improving relevance with the Pro and expanding customer experience design capabilities.
In the fourth quarter, we used our enhanced Sales & Operations Planning process to coordinate inventory flows, advertising and training around our Celebrate the Season winter campaign. With this campaign, we targeted 4 important shopping occasions:
interior refresh, holiday decorating, gifting and getting organized. For each occasion, our store, logistics, merchandising and marketing teams collaborated to ensure that we had relevant products available to customers at the right time, that they were effectively advertised and strategically promoted to drive traffic and cross merchandise to build the basket.
As a result, we drove both online and in-store transactions and ticket growth, and we fulfilled orders in the most convenient manner for customers. Our ability to sell products from a store, online, in-home or through our contact centers is a distinct competitive advantage because it allows us to engage customers on their terms, whenever and wherever they choose. We know that for many projects, more than half of customers research online before making an in-store purchase. And for purchases made on lowes.com, approximately 60% are picked up in-store, 10% are delivered from the store and the remaining 30% are parcel shipped. This speaks to our ability to leverage our existing infrastructure with the omni-channel capabilities we are introducing. From a category standpoint, we drove above-company-average comps in flooring, kitchen, appliances, lumber, building materials, millwork and outdoor power equipment. We drove company average comps in fashion fixtures, tools and hardware. Customers are increasingly interested in refreshing the interior and exterior of their homes, so we used targeted promotions, coupled with our investment in Project Specialists, to drive performance in fashion fixtures, flooring, kitchens, appliances and millwork. We are pleased with the Project Specialist programs. Currently, we have Project Specialists who focus on exterior of the home available across all U.S. stores. Our interior Project Specialists program has an average ticket above $10,000, and customer satisfaction scores over 15 points higher than the industry standard. So we're expanding it to another 470 stores in 2015, reaching over 3/4 of our stores by year-end. With our ability to coordinate style, provide design expertise and find the right contractor to do the job, we are rapidly becoming the project authority of home improvement. Within lumber and building materials, we spent -- we met strong unit demand for dimensional and treated lumber with robust inventory depth. We also leveraged our stores' canopy program, in which each market selects the most relevant lumber and build materials to be stacked just outside of the Pro entrance under the canopy. This program helps Pros quickly find items like lumber, plywood and wall board, quick out -- quickly check out, receive loading assistance and get back on the job. With outdoor power equipment, we met strong Midwest and Northeast demand for snow throwers. In tools and hardware, we saw a particular strength in power and pneumatic tools, we have a compelling assortment of national tool brands and we've expanded our relationship with Hitachi to include pneumatic tools. Combined with Bostitch, Lowe's now has the #1 and #2 brands, making us the destination for pneumatic tools, particularly for the Pro. Kichler, the innovative leader in decorative lighting, is another important brand for Pro customers. And I'm pleased to announce that we just recently added this leading brand to our lighting assortment. The expanded relationships with brands like Hitachi and the additions of brands like Kichler build on a solid foundation to serve the Pro. In fact, 14 consecutive quarters of Pro comps at or above the company average are a testament to this foundation, which includes dedicated service in our stores, inventory depth and our "5 ways to save" value proposition. Additionally, bill-based [ph] Pro account executives and our national accounts team make it easy for medium- to large-sized companies and government entities to do business with us. We are also completing our beta test of LowesForPros.com, which has been well received by our pilot customers. This dedicated platform is fully transactional and will provide Pros useful functionality such as the ability to develop requisition lists and view the purchase history as well as customized product catalogs. This site can also be integrated with purchasing systems Pros use to manage their business, further streamlining their day-to-day operations and help with them working more effectively. We have received positive feedback on the site's flexibility and ease of use and expect to make it available to all Pros this spring. Last quarter, Mike told you about the holiday decor experience we implemented in all of our stores using the stage created for our outdoor living experience. This stage leverages our largest store format. Developed through a collaboration between our merchants, stores and customer experience design team, the holiday decor experience inspired customers to decorate, raise their awareness of the breadth of our holiday decor and gift offerings and provided solutions -- positive solutions relevant to the holiday micro season. The customer response was very positive, and we improved sales, inventory sell-through and gross margin for the products included in this set. We are now transitioning this space back to our outdoor living experience in preparation for the critical spring selling season. In addition to our efforts to drive top line growth, we are focused on driving productivity and profitability. During the quarter, our stores once again effectively managed payroll hours as comp sales accelerated, increasing sales by hour by approximately 5% and driving 28 basis points of payroll expense leverage. They drove this leverage while maintaining great customer satisfaction scores and best-in-class inventory shrink performance. We are pleased with the progress this year on sales growth, productivity and operating profitability, and we're committed to further improvement in 2015. In 2015, we expect to drive sales growth as we further capitalize on the improving macro backdrop through increased relevance with the Pro, improved customer experiences and the continued development of omni-channel capabilities. We will increase gross margin by continuing to partner with our vendors to drive innovation and lower first costs by leveraging our supply chain fixed cost. We will continue to leverage payroll as we further align payroll hours to customer traffic and more efficiently complete noncustomer-facing tasks. We will also drive expense productivity as we increase sales by reducing fixed expenses. For example, we will reduce our total marketing spend even while increasing our presence in targeted digital media. And we will obtain further expense efficiency by consolidating the procurement of [indiscernible] business services across our corporate in-store functions. Likewise, we will increase inventory turns approximately 15 basis points, as we continue to hold the inventory per store flat while increasing comp sales. With solid depth of high-velocity items and job lot quantities in place, we will obtain additional inventory productivity as we continue to thoughtfully conduct our line review process. We are excited about the further improvements we'll make to our business in 2015 and look forward to sharing our progress as the year unfolds. Thank you for interest in Lowe's, and I will now turn the call over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the fourth quarter were $12.5 billion, which represented a 7.6% increase over last year's fourth quarter. Total average ticket increased by 4.9% to $66.17, and total transactions increased 2.5%.
Comp sales were 7.3% in the quarter. As you heard from Rick, further momentum from our initiatives and improving execution drove balanced performance in the quarter. Comp average ticket increased 4.9% and comp transactions increased 2.3%. Looking at monthly trends. Comps were 6.7% in November, 7.2% in December and 8.2% in January. For the year, total sales were $56.2 billion, an increase of 5.3%, driven by a comp sales increase of 4.3%, a full year of Orchard sales compared with a partial year following the August 2013 acquisition and new stores. For 2014, comp average ticket increased 2.4% and comp transactions increased 1.8%. Gross margin for the fourth quarter was 34.6% of sales, which is roughly flat to last year. In the quarter, the mix of products sold negatively impacted gross margin by 25 basis points. Also, price actions hurt gross margin by approximately 10 basis points. These items were essentially offset by value improvement and better seasonal sell-through, which helped by 15 and 10 basis points, respectively. For the year, gross margin of 34.79% represented an increase of 20 basis points over 2013. SG&A for Q4 was 25.24% of sales, which leveraged 88 basis points. The SG&A leverage was driven by a variety of factors. In the quarter, store payroll leveraged 28 basis points due to better alignment of hours and customer traffic and strong comp sales. Property tax expense leveraged 21 basis points due to favorability in property valuations recognized this year. At our analyst conference in December, we noted that expense productivity would come from utilizing our scale to reduce the spend on indirect goods and services. In the quarter, these efforts allowed us to leverage telecommunications and armored car expenses. Also, given the sales growth, we're able to leverage fixed costs. Lastly, we have approximately 30 basis points of expense leverage associated with last year's asset impairments. These items were offset somewhat by employee interest deleverage of 30 basis points. The higher expenses were driven by both higher enrollment as well as cost inflation. For the year, SG&A was 23.62% of sales and leveraged 46 basis points versus 2013. Depreciation expense was $362 million for the quarter, which was 2.89% of sales and leveraged 28 basis points. The leverage was driven by higher sales as well as assets becoming fully depreciated. Earnings before interest and taxes for the quarter were 6.53% of sales, which represented a 115-basis-point increase. For the year, EBITDA of 8.53% represented an increase of 76 basis points over 2013. Interest expense at $132 million for the quarter leveraged 5 basis points as a percentage of sales. Pretax earnings for the quarter were 5.48% of sales. The effective tax rate for Q4 was 34.5%. The lower rate this quarter, relative to the 38.7% last year, was driven by tax provisions that had expired but were retroactively extended by Congress for calendar 2014 in the fourth quarter. The tax rate for the quarter was also lower than our expected 36%, resulting in an EPS benefit of $0.01 per share. For the year, the effective tax rate is 36.9% compared to 37.8% for 2013. The lower tax rate for the year was the result of the settlement of prior year tax matters. Q4 net earnings of $450 million increased 47% versus last year. Earnings per share of $0.46 for the quarter were up 59% to last year. For 2014, earnings per share of $2.71 were up 27% versus 2013. The earnings per share performance for both the fourth quarter and the year represent record highs for the company. Transitioning to the balance sheet. Cash and cash equivalents at the end of the quarter were $466 million. Inventory of $8.9 billion was down $216 million or 2.4% from last year. The decrease was a result of better inventory management and improved sell-through of seasonal goods. Inventory turnover was 3.85, an increase of 11 basis points over last year. Asset turnover increased 10 basis points to 1.69. Moving on to liabilities. Accounts payable at $5.1 billion was up $116 million or 2.3% to last year. The increase relates to an almost 2-day improvement in days payable outstanding. At the end of the fourth quarter, lease-adjusted debt-to-EBITDAR was 2.15. Return on invested capital increased 243 basis points to 13.9%. Now looking at the statement of cash flows. Cash flow from operations was $4.9 billion, an increase of 20% over last year due to net earnings growth and working capital. Capital expenditures were $880 million, down 6% from last year. Free cash flow of $4 billion represented a 28% increase over 2013. During the quarter, we repurchased 14.9 million shares for $1 billion through the open market. For the year, we repurchased almost 74 million shares for a total of $3.9 billion. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, economic forecasts suggest modestly stronger growth in the home improvement industry in 2015. While we are optimistic about both the macro forecasts and our improving execution, we've taken a prudent approach to our 2015 outlook. For the year, we expect total sales increase of approximately 4.5% to 5%, driven by a comp sales increase of 4% to 4.5% and the opening of 15 to 20 stores, which includes 6 Orchard and 2 city center [ph] locations. We expect to report our highest comp in Q1. This is an important quarter for home improvement and the easiest compared to last year. While we expect the first half comp to be higher than the second half, we do expect that 2-year comps will improve sequentially through the year. We are anticipating an EBIT increase of 80 to 100 basis points. As I noted during our analyst investor conference in December, we are now targeting 25 to 30 basis points of the EBIT expansion per point of comp above 1%. While this is our expectation for the year, there will be some choppiness quarter-to-quarter. For example, let me offer 2 items that will put pressure on the flow-through for the first quarter. In Q1 last year, we had 70 basis points of gross margin expansion, our strongest quarter of the year. This year, we expect gross margin to be flattish in Q1 while improving roughly 20 basis points for the year. Also, in Q1 last year, we had our lowest comp and therefore, reduced bonus accruals. This year, we plan to accrue to target levels, resulting in a deleverage of 25 basis points in Q1 while leveraging roughly 10 basis points for the year. We expect that most of the EBIT improvement will come from SG&A. Expense leverage will come in store payroll, marketing, bonus and leveraging our scale to achieve cost savings on indirect spend. In addition, we expect a fixed cost leverage associated with sales growth. The effective tax rate is expected to be 38.1%. A higher tax rate relative to 2014 is a result of the settlement of prior year tax matters recognized in Q1 2014. The higher tax rate impacts earnings by roughly $0.06 per share. For the year, we expect earnings per share of approximately $3.29, which represents a 22.5% increase over 2014. We are forecasting cash flows from operations to be approximately $5 billion. Our capital plan for 2015 is approximately $1.2 billion. This results in estimated free cash flow of $3.8 billion for 2015. We expect to issue incremental debt during the year as we manage to the 2.25x lease-adjusted debt-to-EBITDAR target. We have approximately $2.4 billion remaining under share repurchase authorization at the end of the fiscal year. Our guidance assumes approximately $3.8 billion in share repurchases for 2015. All future share repurchase authorizations are subject to board approval. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Alan Rifkin with Barclays.
Alan Rifkin:
Robert, maybe looking at the industry and your performance kind of from 30,000 feet, it suddenly seems that the macroenvironment is improving even if housing is okay, but not great. As you look at your business, do you think there's less cyclicality and is it less tied to housing today than it has been in years past?
Robert Niblock:
Well, Alan, I think we've talked about this some in the past and how, really, when you look through all the prior cycles, when housing was -- turnover was going up and down, home values continued to maintain their -- homes continued to maintain their value and actually continued to increase during a lot of those cycles. The -- but we saw that kind of disconnect in this most recent -- this most recent downturn, when home prices dropped dramatically. So we're kind of going through this cycle. We're getting home prices starting to come back up. That's driving confidence among homeowners that they can reinvest in their home again. And certainly, there's been a lot of deferred investment, kind of the wish list, the to-do list on the refrigerator. So people are reengaging in that. That's what we saw in our survey, where we're starting to see a slight increase in those that are not only taking the discretionary projects on, but also starting to move into larger projects because they're getting confidence in the macroenvironment, confidence in the value of their home. But at end of the day, income and housing are continuing to be the things that drive our business. So there was a little bit of a disconnect in the downturn, but we are seeing consumers reengage. And we feel good about that, and that was built into our guidance for 2015.
Alan Rifkin:
Okay. And one follow-up, if I may. With respect to foreign currency effects, what were the effects on your '14 numbers in aggregate? And what impact do you have built in, in your 2015 guidance as a result of the strengthening dollar?
Robert Hull:
So Alan, the impact was essentially nominal to us. Our international business, Canada and Mexico, are relatively small pieces of our portfolio of businesses. We did have a modest drag on comps, 10-or-so basis points for the quarter and about the same for the year. As we think about FX going into '15, at this point, we've modeled roughly the same levels as where we are today.
Operator:
The question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Just a minor point, but just to clarify. Investor Day, I think you mentioned margin of at least 9.5% in 2015. I think the guidance range for 2015 now, if our math is right on GAAP EBIT, is around 9.3% to 9.5%. Is that the right interpretation? And if so, is the range -- I guess, the wider range, is that just conservatism? Or has something changed in how you're looking at next year?
Robert Hull:
So what I would say is that, when we put our outlook for the year, this is something that we expect to achieve and hopefully beat. So if you think about our EBIT guidance for 2014, we started the year at 65 basis points and delivered 76 basis points. So I would suggest that it's some level of conservatism. As I mentioned in my comments, we took a prudent outlook -- a prudent approach for our outlook for 2015, and the 80- to 100-basis-point range is consistent with that.
Simeon Gutman:
Okay. And then a follow-up is, I think you mentioned the Pro grew in line with the house. And I think, the past few quarters, it was a little stronger. So is that just a fourth quarter thing? Did you just so well around Black Friday with consumers that, that kept the consumer rate a little bit higher? Or was there something that changed on that side?
Robert Niblock:
Yes. This is Robert. You hit the nail on the head. We actually -- we had, for a number of quarters, the Pro exceeding our overall business. But we had really good strong performance, which led to the strong comp that we delivered in the fourth quarter, with great response from our retail consumer. I'll let Rick jump in and talk a little bit more detail about what we're seeing from the Pro.
Rick Damron:
Yes, Simeon. It was really the result of the holiday and the retail consumer. When you look at the Pro in general, we still saw strong demand across all regions with the Pro. As a matter of fact, when you look at account growth, which is a measure that I look at to determine health of the Pro and still the viability of our processes and programs, our Pro accounts grew 24% during the quarter. So still a huge take rate from Pros as they look to leverage our benefits of our value proposition, as well as we continue to meet their needs. We did see positive comps across all ticket sizes and ticket ranges for the quarter as well, which showed strength that we did not lose anything relative to any type of transaction size that we monitor or watch during that time frame as well. So we feel good for Pro. We still feel good with the strength of the Pro and their response to our process and programs. And we -- and moving into 2015, we still think that we have room to continue that growth with the brands that we're launching in 2015, a lot of what we talked about during the AIC with GAF roofing, Owens Corning, LENOX, Golblatt, other brands that we're bringing back into the portfolio, as well as those brands we launched during the Q4. So we feel really good from where we are today and entering into of 2015 with relevance for the Pro.
Operator:
Your next question comes from the line of Mike Baker with Deutsche Bank.
Michael Baker:
Two questions. One, just on the margin efficiency point. So 25 to 30 basis points, rule of thumb, for 2015, which is higher than you've targeted in the past. But in the fourth quarter, it was only 18 basis points. Is it really just that insurance issue? Was that the only factor that led you to come in below that rule of thumb? Or are there other things on the margins in particular to call out?
Robert Hull:
So Mike, a bit of it was the impact of insurance. Some of it was the bonus payout that Rick mentioned going into the quarter. We expected a little bit more leverage in Q4 on the bonus line than we experienced, but we're happy to pay the associates. They delivered strong results for the quarter and they deserve it. The other piece I would mention, Mike, is the mix between -- that basis point mix impact hurt the flow-through as well.
Michael Baker:
And actually, so if I could follow up on that. Two points. One, within the gross margin, you talked about price action. Can you give us more details there? And secondly, when you say less leverage on the bonus, I'm sure it's not that you expected a better comp. It's just that the payout was evidently higher. Is that the right way to think about it?
Robert Hull:
So 2 things. The payout is based on our planned performance. So as we -- our outlook for Q4 was a 7.3% comp. So we outdelivered our expectations by a greater degree going into Q4, which led to the increased bonus payout. As it relates to your first question on price actions, really, Mike, that ties back to Rick's comment on targeted promotions.
Operator:
Your next question comes from the line of Michael Lasser with UBS Investment Bank.
Michael Lasser:
I was hoping to get a little bit more perspective on how you think your share is trending within the different buckets of ticket. So we saw really good performance for your big-ticket bucket and slower performance from your smaller-ticket stuff. Does that -- is there any suggestion that as the consumer's reengaging with some of the bigger-spend projects that the store location matters a little bit less, so you're picking up more of your fair share in that spending arena? And then conversely, is that potentially coming at the expense of -- from the smaller-ticket stuff?
Robert Niblock:
Mike, I'll start and I'll get Mike Jones to jump in a little bit. I think, certainly, it's a lot of the things we've been working on when we talk about the omni-channel, differentiating on experiences. When you talk about the project nature of the business and the way we're focused on the project nature of the business, why we saw -- that's why we saw strong performance in areas that we outlined for you like kitchen and appliances, flooring, those types of things. And I think a lot of that is dovetailing with my comments earlier about the consumer getting reengaged in some of those projects that, for a lack of a better term, have been deferred in the middle of the downturn, as they're now getting more comfortable with the macroenvironment, getting more comfortable with their income, job outlook and more comfortable, quite frankly, that the value of their home is going to continue to move in the right direction. So a lot of what the team's been working over the past few years was setting ourselves up to take advantage of the macroenvironment that we find ourselves moving into now, which, I think, played itself out in the fourth quarter, and I think it's what's built into our guidance for 2015. So Mike, if you want to dovetail and talk about it?
Michael Jones:
Absolutely. Thank you, Robert. Yes, I'd add to it, that along with -- really doing well on large ticket and gaining share, Rick talked about with respect to Pro, ensuring that we continue to build out our portfolio of brands, have the right inventory depth, have the right breadth of assortment. We think that's going to help us over the long term, continue to build better traffic. So we think our plans will allow us to go after both. We think that we're seeing our -- some of our project execution, relative to being able to engage with customers, start to pay off early.
Michael Lasser:
That's very helpful commentary. My follow-up question is, when you look at your different categories, can you give us some sense of where -- the categories relative to peak that are still furthest off of -- from a sales perspective and where you think you can just still have an opportunity to regain those sales?
Robert Hull:
Michael, that would be all of the big-ticket discretionary categories. As Robert commented, the consumer is feeling better about the situation, feeling better about reengaging with big-ticket categories but hasn't necessarily started in earnest. So if you think about kitchens, flooring, millwork, all 3 of those categories are the furthest away from where they were back in the peak?
Michael Lasser:
Can you give us some -- can you quantify in some way?
Robert Hull:
What I can tell you is, at the peak, those items were -- those 3 categories were close to 19%, 20% of our sales. Today, they're 16% to 17%. So while all of those have been rising, they're still lagging as a percent of the mix.
Operator:
Next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
So it seems to me like you guys have been a lot more aggressive with adding new brands the last couple of quarters, from Sherwin-Williams to some of the new products and brands mentioned during the call. Now are these still all part of the value improvement efforts? Or is this a specific focus to expand your Pro business, which is a clear initiative? Or is this just some of the -- a more overall aggressive stance on the merchandising front?
Robert Niblock:
Scot, I'll start and then have Mike jump in. Certainly, as we talked about it in AIC, we have a strong focus on the Pro customer. And we know that to continue to -- and that we've had great performance, as Rick outlined for you. But to continue to drive that relevance with the Pro, it's everything we're doing from the quality of people to the account executives, the service in the aisle of stores, the depth of inventory and also the key brands that they rely on. So that's been a dedicated focus for Mike and his team to make sure as -- when we talk to the Pro customers, we have the dedicated brands that they want. So Mike, if you want to...
Michael Jones:
Sure, absolutely. I'd say, the customers of Pro, the tools, value improvement that we use to go after better serving this customer and certainly brands we're enabling [ph] to make sure we serve those customers well. And so to Rick's point earlier, if you think about that and heavy-coated [indiscernible] wiring devices, cage [ph] fasteners, LENOX, HVAC, Owens Corning, installation, just really, really great job by the merchants, starting with our team store operations to [indiscernible] the brand. But it's not just in Pro. I think what we've done in the DIY space -- HGTV by Sherwin-Williams, the granddad, that the quality of Sherwin-Williams [indiscernible] HGTV, we're really, really excited about that. And if you look at grills as an example, another one that we don't talk a lot about, but we have both Weber and Char-Broil, the #1 and #2 brand in grilling. So excited, and it's a ton of work in tools very specifically as well. IRWIN, LENOX, we talked about both the IRWIN brand and the LENOX brand. We've made reference of Hitachi pneumatics. You couple that with our exclusives of Bostitch, makes us the destination for pneumatics. Rick spoke about adding back Goldblatt hand tools, and that's added to our current portfolio of brands, which includes Bosch, DEWALT, Kobalt and Porter-Cable, to name a few. So the merchants have done a phenomenal job at really going out into the supply base, working with our vendor partners to bring back the right brands that both the Pros [indiscernible] want as well as shoring up both for DIY and the -- and our customers looking for strong tool performance. We're excited about what's going on. And to your point, great, great work.
Operator:
Next question will come from the line of Jessica Mace with Nomura Securities.
Jessica Schoen:
My question is about the online business. I was wondering if you could give us a little bit more color on the performance. And maybe talk about, with such a large portion of sales from that business, picked up in-store, are there any particular categories you see really driving overall sales?
Rick Damron:
Yes, Jessica. This is Rick. I'll start, and then I'll let Mike jump in as well. We continue to be pleased with our performance at lowes.com. It was up 25% for the quarter, 2.5% of our total sales for the year. When you look at dot-com, the thing that we're really working on is, as you said, we've been doing online pick up in-store for over a decade. So it's something that we really continue to focus on. Dennis Knowles and the team have done a phenomenal job on store operations and improving the experience on the front end to make it easier for the customers to transact and get the products in and out of store quickly. And it continues to focus on our ability to drive our omni-channel aspects of what we're trying to accomplish and do as an organization and create that visibility across stores, dot-com, contact centers and on site or in the home. So it's a component of what we're really doing from an overall strategic standpoint. What we've been focused on over the last couple of quarters and in 2014 is really enhancing the experience that the customers have when they jump on our sites. So we've been working on delivery scheduling. You've seen us work on improving our search capabilities and adding several thousand additional search terms to avoid getting back those no search results. We've improved our filtering of products. And we're also working on improving our content -- improved content for 17,000 highly visible items on the site. So we're really looking holistically at the site to make sure that we continue to drive what we are working on. The thing that we're still extremely pleased with is that the store remains very relevant with the customer. And in fact, almost 97%, 98% of all transactions still go through our stores. That's evidenced by the fact that we talk about a 60% pickup, the other 10% delivered and then a large portion of our parcel orders are actually shipped from our stores. So they continue to play a critical role as we leverage that asset and continue to move forward in the future. Mike, I don't know if there's anything that you want to add.
Michael Jones:
I think I'd just add, anything you purchased online -- so if a consumer often starts online for inspiration, getting a better sense of how they can want to pull their projects together and they'd like to couple that with the in-store experience, so that they can think and work their way through the project. But appliances, fashion fixture, outdoor power and tools are certainly mainstays for online. And we take the approach that for the consumer, they want us to be relevant whenever and wherever they want to interact with us. And so we recognize that often we sell online and from there, it becomes an in-store discussion. We're also very careful to make sure that as we tie back our merchandising approaches, that we're leaning into both what's important from a pricing perspective as well was what's important from an online perspective. To Rick's point earlier, a couple of brands have been added, Progress Lighting and Kichler Lighting will be featured online, and our online tools will help them both make selections and ship to the home or make selections and come into our stores and see that product and make the selection. So it's -- for us, it's about the cohesive experience, of which online is certainly a key piece of it.
Operator:
Your next question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
My first question relates to the mix issues that you discussed impacting gross margin in the fourth quarter. If you could just give us a bit of color as to what categories drove that and how you would expect that dynamic to play out as we start the new year.
Robert Hull:
So Matt, as you might expect, the bigger -- the biggest driver of that was appliance, strong growth of appliances in the quarter, double-digit growth in appliances, also some strength in lumber and building materials, a lower-margin category. Those are the 2 main drivers of the -- and I guess, third, outdoor power equipment, some elevated generator sales in the quarter based on weather. As we think about 2015, we're modeling a lot of mixed rag [ph] going into 2015, but that's embedded in the roughly 20-or-so basis point improvement that I mentioned.
Matthew Fassler:
Great. And then my second question, your inventory was actually down outright year-on-year, which is a very strong performance, perhaps even more than you're guiding for going forward. So is that a function of the strong Q4? Is the port a part of it? Or is it just you're outperforming your goal with no constraint to sales as a result?
Robert Hull:
So I'll take a part of it, and Rick will talk about the ports. As I mentioned, we're trying to grow comps in the mid-single digit, keeping inventories sort of flat. So a lot of effort and energy around improving the productivity of inventories. So -- and that showed up in Q4. The second is improved seasonal sell-through. So I think some of these seasonal goods are good-quality product that we'll choose to carry over throughout the course of the year. We, in fact, did that in Q4 '13. Based on the strength of the seasonal set, the customer experience design worked with far better seasonal sell-through Q4 '14 than we did in '13. Therefore, we didn't have any carryover inventory.
Rick Damron:
Yes. And Matt, I'll just add that we also account in-transit inventory in our numbers. So whether it's sitting at port or in our DCs, that's still in our total inventory numbers. As it relates to our ports -- to the port issues, I'm extremely pleased with the efforts of our supply chain in getting our products moved through the port during this slowdown. As a matter of fact, we feel fairly good and confident about our inventory position heading into spring. Currently, we have over 3 months of forecasted sales of seasonal products already in our distribution centers and in our stores. So we feel good from that perspective. We continue to monitor the process, in general, with the ports. And we continue to take steps to minimize any further impact such as moving product and cargo through other ports, rerouting the product to where we can get it to our stores the most quickly and time-effective means possible. But the teams have done a great job in flowing our product off the port, getting the containers moved through and really proud of what they were able to accomplish. So we feel good going into spring with our current inventory levels, and it's -- particularly against our forecasted expectations for the first 3 months.
Operator:
Next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So I think there's a great debate out there on how much of the gas price declines will flow through to the consumer, what categories are going to benefit and when. From where you sit, whether the consumer research or what you're seeing, is there a way to attribute any of the 4Q comp to -- and the industry growth, really broadly, to lower gas prices? And do you think that the lift is accelerating and still on the come? Or how would you frame that out?
Robert Hull:
So Chris, as we think about drivers of our business, it's really 3
Christopher Horvers:
Is there anything to say that -- I guess, especially because you saw a lot of big-ticket durables, is there anything to say that the benefit should actually accelerate? I mean, I think it's sort of general anesthesia, it helps all categories. Is there anything that you're seeing or could say that, perhaps, that once it's believed to be sustainable by the consumer that the home improvement category would see a greater lift in the future?
Robert Niblock:
Chris, this is Robert. I'm certainly -- I think, as you listen to economists speak out there, they would say that the longer that we're going to go on, yes, the more that it becomes part of your discretionary income versus kind of a onetime impact. And so, yes. So I think it's reasonable to assume the longer that goes on, the more likely consumers will spend a portion of that and more likely part of it winds up in our channels. So that's positive. We view that as a potential positive as we think about our outlook for 2015. On the other hand, depending on how long it takes place, the impact it has almost on a slowing global economy, U.S. exports, multinationals, and the impact that can have on overall jobs and those types of things, don't lose sight of that. It's not just a one-way street. There can be other impacts as well that we need to take them into consideration.
Christopher Horvers:
And you're not seeing anything in the oil patch now that's a concern to you, stores that are exposed there?
Robert Niblock:
No. As I said in my comments, we saw a broad outperformance across all of our divisions in all of our regions in the company. So...
Operator:
Your next question comes from the line of Peter Benedict with Robert Baird.
Peter Benedict:
A couple of questions. First, on the Pro account growth, up 24% in the fourth quarter. Can you give us maybe some perspective around that, give us a sense of how fast that has been growing, how fast it grew for the year? I'm just trying to understand -- put that into context.
Rick Damron:
Sure, Peter. When you look at this, like I said, we've been investing to grow our Pro business over the last couple of years. We talked about the organizational designs that we've made, the inventory investments that we've made and the value propositions. As we go through -- and the addition of the programs continue to resonate very well with the Pros. So when you look at account growth for the year, in context, the accounts grew by 16% for the year.
Peter Benedict:
Okay, good. And then I guess, on some of the categories, you talked about the OP strength, snow throwers, maybe generators. Anything on the early spring side though, maybe out west as you see kind of temperatures warming out there, kind of the view towards the OP category this spring?
Robert Niblock:
The only thing I would say, Peter, is that -- like I said, we're early into the process. If you recall, last year, we talked on the call extensively about the outdoor living experience and how we'd set that and the great response that we saw from customers from an outdoor living. By the time we were setting it out over the majority of our stores, the Deep South, we were already into spring. And so therefore, we didn't want to disrupt the spring selling season in the Deep South. We came back in the fall of the year, reset all of those. And so that's the earliest indication we would have would be from the Deep South. And what we're seeing, the receptivity from those consumers, after what we've done with outdoor living experience, has been very strong. So we're pleased with the early indications and just waiting for spring to get here for the rest of the country.
Peter Benedict:
Okay. And just lastly, just on the flooring business, looks like above-average here in the fourth quarter. It has been running kind of, I guess, I think, in line. So what drove that change? Was there -- it was something that you guys think you did? Or was it just kind of a broader pickup in that category?
Michael Jones:
We did do tile reset late last year. But we're seeing pretty good strength beyond when we did the reset. So I think it's just that the category itself -- the industry has done better.
Operator:
Our final question will come from the line of Aram Rubinson with Wolfe Research.
Aram Rubinson:
Had a couple of questions on the cost. Wondering if you can delineate, round off a few costs that you look like you're digging into in a pretty minute way, which is intriguing to me. So I'm wondering if you can kind of just highlight some of the costs again you're looking to kind of trim back on. You mentioned advertising, I think, and a few other things. And then I know, in the past, when I've asked you, you've mentioned that the profit margin gap between you and your nearest competitor, you think, is almost entirely drew -- due to volume. I'm wondering, though, as you drill in a little deeper, if you think you might be finding some kind of SG&A opportunities that might be -- as the opportunities irrespective of volume.
Robert Hull:
So Aaron, when I take a look at relative profitability, when your gross margins are essentially the same as [indiscernible] as operating expenses. As we think about operating expense opportunities, we do think there's a number of areas that we talked about. So certainly, with some elevated bonus in '14, we'll plan for target levels in '15, increase levers in store payroll, some advertising leverage. Those are the big buckets. And the depreciating dollars actually fall in '15 so we have some healthy leverage there. Beyond that, the whole indirect spend category, we talked about it at the analyst conference in December. I talked about some discrete items in Q4, not because they were large drivers. And I mentioned telecom and armored car. Specifically, this give you a sense that it's real and it's working. And we've got a number of categories in '15 that we're looking at things from store fixtures and displays, supplies, the entire [indiscernible] category and various services. So there's a variety of different activity around that, where we think we can become much more efficient going forward that will help improve the flow-through that we talked about, the 25 to 30 basis points.
Robert Niblock:
And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2015 results on Wednesday, May 20. Thanks, and have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference. Thank you, all, for joining. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2014 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 also 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I'm pleased with our strong performance in the third quarter. Comparable sales were 5.1%, driven by an increase in comp average ticket of 3.4% and an increase in comp transactions of 1.7%.
We saw balanced performance this quarter across our 3 business areas, building and maintenance, home decor and seasonal as all delivered comps within a tight range. We had positive comps in all 12 product categories with particular strength in fashion fixtures, kitchen appliances, millwork and outdoor power equipment. Sales across the country were balanced as well, with all 3 divisions, the North, South and West, all generating comps in the mid-single digits. In fact, all 14 regions had positive comps. We saw continued strength in our Pro Services business, which outperformed the company average during the quarter, and I'm pleased to share that our team in Canada delivered double-digit comps in local currency for the sixth consecutive quarter. We remain focused on improving our profitability even while investing in key capabilities to drive sales growth. For the quarter, we drove 81 basis points of operating margin expansion and earnings per share of $0.59, a 25.5% increase over last year's third quarter. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $900 million of stock and paid $229 million in dividends. We're pleased with our performance in the third quarter and continue to be cautiously optimistic about the home improvement landscape. Disposable personal income and revolving credit usage, which are key drivers of discretionary consumer spending, appear to be improving above the relatively weak trends experienced during most of the recovery to date and the consumer is also benefiting from lower interest rates and falling fuel prices. Existing home sales remain on a modest uptrend and the latest reading on the broadest measure of home price growth, FHFA, improved modestly from last quarter, suggesting home price appreciation in small to midsized markets continues, which bodes well for consumers in Lowe's footprint. These positive trends align with recent consumer confidence readings and the results of our third quarter consumer sentiment survey, which revealed that homeowners' views around personal finances and home values continue to improve. In fact, confidence in both local and national housing markets increased to prerecession highs this quarter. In addition to the improving sentiment, homeowners disclosed that now, more than any time since 2006, they are looking to invest in their homes. And while most consumers' planned projects are still small ticket, we are seeing a rise in big-ticket projects, which is encouraging. Continued improvement in the macroeconomic landscape, together with our strengthening execution, strategic priorities and keen focus on productivity and flow-through give us confidence in our business outlook for 2014. I would like to thank our more than 260,000 employees for their efforts in achieving this quarter's strong results and for their unwavering commitment to serving customers while we further transform our business model. We look forward to sharing our long-term vision for the business at our Analyst and Investor Conference on December 11. Thanks, again, for your interest. And with that, let me turn the call over to Mike.
Michael Jones:
Thanks, Robert, and good morning, everyone. As Robert shared with you, we had a strong quarter with positive comps across all regions and all product categories. We continue to capitalize on an improving macro backdrop to enhance sales and operations planning process, improve our relevance with the Pro and develop customer experience design capabilities.
Our outdoor power equipment category experienced the strongest growth in the quarter with double-digit comps. A milder summer helped lawns stay healthy well into the fall, and we prepared to meet strong demand for mowers and trimmers with great national brands like Husqvarna, John Deere and Troy-Bilt, supplemented with the launch of our Kobalt line of battery-powered handheld outdoor power equipment. In addition, concern about another cold, wet winter prompt many customers to buy snow throwers and other winter products earlier this year. We're able to meet that early demand thanks to strong vendor partnerships and a robust distribution network. We also drilled above-average comps in millwork, kitchens and appliances and fashion fixtures. All 3 categories benefited from the customer's increasing interest in refreshing both the exterior and interior of their homes. We encourage them to choose Lowe's for their project needs through targeted promotions and our investment in project sales specialists. We have project sales specialists that focus on the exterior of the home available across all U.S. stores, and we're continuing to expand our interior project sales specialist program as well. Our project sales specialists are simplifying the process by guiding customers through inspiration, design and installation. Customers have responded positively to these programs and we are pleased with their performance. Fashion fixtures also benefited from a strong sales of light bulbs, particularly our Home Center exclusive line of OSRAM SYLVANIA LED bulbs, a brand customers know and trust.
As Robert mentioned, our Pro business continued to perform well. In fact, our Pro comps outpaced the company average for the 13th consecutive quarter. The Pro continues to grow faster than the rest of the home improvement market, and we strive to provide Pros with great service that makes doing business with Lowe's as quick and convenient as possible. We engage with Pros through multiple channels:
in-store where we have dedicated specialists to answer questions and dedicated loaders to help Pros get back to the job quickly; at the Pro's place of business where account executives help maintenance, repair and operation customers order and replenish products regionally; through our national account representatives who assist Pros who do business with Lowe's across the country and online where we are also committed to providing convenient services to Pros. In fact, our beta test of LowesForPros.com is going very well. This dedicated platform is fully transactional and will also provide Pros useful functionality such as the ability to develop requisition lists and the ability to see their purchase history as well as customized product categories. This site can also be integrated with many purchasing systems that Pros use to manage their business, further streamlining their day-to-day operation and helping Pros work more effectively. We've been expanding our test group and have received positive feedback on the site's flexibility and ease-of-use. We expect a soft launch late in the fourth quarter.
We also continue to work with vendors to add brands that Pros know and trust. I'd like to provide one specific example to convey an opportunity we believe we have with the Pro. In August of this year, we introduced the Henry coating brand of roof repair and driveway sealer products to stores in Southern California, Nevada and Arizona. Henry coatings is a leading and relevant brand among Pros on the West Coast. We use it for both residential and commercial application. In fact, our store employees told us that many Pros in these markets request the Henry brand, which they prefer for its durability and ease of application. Since adding the Henry brand, we have measured double-digit comp sales of roof repair and driveway sealer products in the markets where this relevant brand was added to our assortment. As we improve our service and product offering for the Pros, it will become increasingly important for us to reconnect with Pros who have not recently purchased from Lowe's and show them what's changed in our stores and online. One way we'd do this is through Pro-focused events. For instance, September was Pro appreciation month in all of our U.S. stores. During the event, we offered better demonstrations, special values on core Pro products throughout the store and introductory credit offers. Pro appreciation events help us strengthen partnerships by generating new business. We'll continue to use events like these as well as targeted marketing to drive awareness as we make further progress in addressing product and service opportunities for the Pro. As we have shared with you previously, our enhanced sales and operations planning process has enabled us to improve seasonal planning, including the cadence of inventory allocation, staffing, associate training and marketing. This quarter, this process helped us stay connected and address customer needs for the fall such as planning, home winterization and exterior maintenance. We are now transitioning to a holiday focus as customers refresh their homes for holiday guests, decorate and organize their homes after the holiday. In fact, we have repurposed the space used for the outdoor living experience to create a holiday decor experience like no other in home improvement, one which inspires customers to decorate, raise their awareness of the breadth of our holiday decor and our gift offerings and provides project solutions relevant to the holiday micro- seasons. But it starts even before the customers reach our stores. With inspiration through our marketing and online resources, including Lowes.com, Creative Ideas, Vine videos and Pinterest boards. When customers arrive at our store parking lot, inflatables and live Christmas trees set the holiday mood. Then as they enter the store, they are met with our full holiday story. This space, initially created for outdoor living experience, which delivered strong results and is made possible by a larger-store format, provides an inspirational holiday showroom where customers can see everything from poinsettias and artificial trees to indoor and outdoor decorations and gifts. And our feature display sets the stage, inspiring customers to start dressing up their homes by showcasing coordinated, trend-right holiday decorating solutions. In our cases, whether they feature display or the artificial trees, the vignettes are clearly tagged to help customers coordinate style and easily find nearby take with inventory. We have also consolidated our gift-wrap stack-outs as well as our electric stack-outs to make it easier for customers to identify all the products they would need to wrap gifts and hang lights. There's more, but you get the point. It's bold and it's rooted in research, which indicates that customers want help coordinating holiday themes. We are also excited about the exclusive innovations we continue to bring to market, many of which will make great holiday gifts. These include the Pilot brand InstaBoost Jump Starter, powerful enough to jump start cars, SUVs and pickup trucks, yet small enough to fit in your glove compartment even with the attached jumper cables; the new Troy-Bilt Vortex Three-Stage Snow Blower, with its top-rating from a leading consumer magazine; and our new KOHLER Purefresh line of toilet and toilet seats, which neutralizes odors while providing a night light, slow-close lid and other features. In addition to our efforts to drive top line growth, we are focused on driving productivity and profitability. During the third quarter, our stores did an effective job of managing payroll hours as comp sales accelerated, resulting in a roughly 50 basis points of payroll expense leverage. Additionally, last year, as part of our Value Improvement initiative, we reinvested in inventory to provide greater depth of high-velocity items and more job-like quantities for Pros. We've held inventory per store roughly constant in the third quarter even while increasing comp sales. We are pleased with the progress we're making this year on sales, productivity and operating profitability and we continue to look for ways to improve even further. Thank you for your interest in Lowe's, and now I will turn the call over to Bob.
Robert Hull:
Thanks, Mike, and good morning, everyone. Sales for the third quarter were $13.7 billion, an increase of 5.6%, driven primarily by comp sales. Total average ticket increased 2.9% to $65.97 and total customer transactions increased 2.6%.
We've anniversary-ed the Orchard acquisition, so these stores are now considered comp. For the quarter, comp sales were 5.1%. The monthly comps were 3.5% in August, 5.2% in September and 6.6% in October. When compared to last year, the monthly 2-year stack was relatively consistent across the quarter. Please refer to Page 7 in the supplemental slides for further details. For the quarter, comp average ticket increased 3.4% and comp transactions increased 1.7%. Year-to-date, sales of $43.7 billion were up 4.6% versus the first 3 quarters of 2013 driven by a 3.5% increase in comp sales, the addition of Orchard and new stores. Gross margin for the quarter was 34.49% of sales, which decreased 9 basis points from Q3 last year. The decrease was driven primarily by targeted promotions and the mix of products sold. These items were mostly offset by continued benefits from Value Improvement and better sell-through of seasonal goods as a result of our customer experience design efforts. Year-to-date gross margin was 34.82% of sales, an increase of 25 basis points over last year. SG&A for Q3 was 23.8% of sales, which leveraged 76 basis points. Store payroll leveraged 48 basis points as we continue to optimize hours against customer traffic. Bonus expense leveraged 24 basis points due to lower expected attainment levels relative to last year. Also, recent expenses leveraged 13 basis points, the result of elevated expenses in Q3 last year. Year-to-date SG&A was 23.15% of sales, which leveraged 37 basis points versus last year. Depreciation for the quarter was $375 million, which is 2.74% of sales and leveraged 14 basis points compared to last year's third quarter as a result of sales growth. In Q3, earnings before interest and taxes or EBIT margin increased 81 basis points to 7.95% of sales. For the first 3 quarters of 2014, EBIT margin was 9.1% of sales, which was 67 basis points higher than the same period last year. For the quarter, interest expense was $134 million and deleveraged 1 basis point to last year as a percentage of sales. The effective tax rate for the quarter was 38.6%, which was higher than last year's 37.6%. The higher rate, which was consistent with our expectations, was the result of tax programs that expired at the end of last year. Net earnings were $585 million for the quarter, an increase of 17.3% over Q3 2013. Earnings per share of $0.59 for the quarter were up 25.5% to last year. This is roughly $0.05 higher than our expectations, driven by both higher sales and better expense leverage. For the first 9 months of 2014, earnings per share of $2.24 represented a 21.7% increase over the same period last year. Now to a few items on the balance sheet, starting with assets. Our cash and cash equivalents balance at the end of the quarter was just under $1.6 billion. Our inventory balance of $9.8 billion increased $169 million or 1.8% versus Q3 last year. Inventory turnover was up 2 basis points over last year at 3.73x. Asset turnover increased 9 basis points to 1.65. Moving on to the liabilities section of the balance sheet. Accounts payable of $6.5 billion represented 11.8% increase over Q3 last year caused by the timing of purchases year-over-year. In the third quarter, we issued $1.25 billion of unsecured bonds. The bonds consisted of 5-, 10- and 30-year issuances with a weighted average interest rate of 2.55%. At the end of the third quarter, lease-adjusted debt-to-EBITDAR was 2.21x. Return on invested capital increased 176 basis points for the quarter to 13.02%. Now looking at the statement of cash flows. Cash flow from operations was almost $4.7 billion, an increase of $825 million over last year, largely due to working capital as well as growth in net earnings. Capital expenditures were $587 million, down nearly 4% from last year. Year-to-date free cash flow of $4.1 billion was 26% higher than last year. In the quarter, we repurchased approximately 17 million shares for $900 million. Also in the quarter, we received 2.3 million shares as part of the final settlement associated with the accelerated share repurchase program executed in Q2. We have approximately $3.4 billion remaining on our share repurchase authorization. Looking ahead, let me share our business outlook. We have combined our year-to-date performance with our previous assumptions for the fourth quarter. We now expect total sales increase of 4.5% to 5%, driven by comp sales increase of 3.5% to 4% and the opening of 6 home improvement stores and 4 Orchard locations. We're anticipating an EBIT margin increase of 70 to 75 basis points and expect that the improvement will come from both gross margin expansion and expense leverage. The effective tax rate is expected to be 37.2% for the year. And we expect earnings per share of approximately $2.68 for the year, which represents an increase of 25.2% over 2013. We are forecasting cash flows from operations to be approximately $4.2 billion. Our CapEx forecast for 2014 is approximately $1 billion. This will result in estimated free cash flow of $3.2 billion for 2014.
Our capital allocation priorities are to:
first, invest in the business where we believe we can add value; second, pay dividends, we are currently targeting a 35% payout ratio; and lastly, to repurchase shares. Our CapEx forecast for 2014 is less than originally planned. As a result, we are increasing our share repurchase assumption by $300 million to $3.7 billion for the year.
Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Dan Binder with Jefferies & Company.
Daniel Binder:
My question was related to 2 things, first was on ticket. Was there any significant in inflation? Or was it primarily just in any of categories like lumber? Or was it primarily just big ticket doing better that drove the ticket growth?
Robert Niblock:
So Dan, it was primarily big-ticket categories doing better in the quarter. As Mike talked about, strength in OPE with the performance in appliances, flooring and millwork. As it relates to inflation, deflation, we did see inflation in lumber, but that was largely offset by deflation in OSB boards and copper. So essentially, no net inflation impact on the quarter.
Daniel Binder:
And then you noted targeted promotions for a little bit of the weakness in gross margin. Is there a plan to continue that? And what categories do you expect that to be in?
Michael Jones:
Yes, we do expect to -- we think the impact of promotions in the fourth quarter will be pretty much as the same as it was in the third quarter, largely focused around appliances.
Robert Hull:
Yes, so Dan, the targeted promotions were largely matching competitor offers. Nothing initiated by Lowe's in the quarter. We do expect a similar promotional cadence Q4 relative to Q3. Impact probably less than Q3 as a result of the industry largely going to full promotions for the month of November, primarily in appliances. So roughly a 25 basis point impact in Q3, probably a 15 basis point impact in Q4. So less drag in Q4.
Daniel Binder:
And Q3 was appliances as well?
Robert Hull:
Appliances and big tickets.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
So the spread between your comp and Home Depot's U.S. comp narrowed to its lowest level in 4 years. It's obvious to question about whether you think you benefited from the breach at Home Depot. So if you look at the stores that are in close proximity to The Home Depot stores, did those stores comp better than the others? And if they did, obviously you deserve credit for capitalizing on some of the disruption.
Robert Niblock:
Mike, this is Robert. I think, as we look across the business, I will really attribute our strong performance to the internal initiatives that we've been working on, combined with the strengthening macro backdrop. As I talked about in my comments, the FHFA numbers continue to improve, which means that you're seeing improvement in home values in the small and midsized markets, which, I think, as I said, lines up well with our footprint. So we're focused on our strategic priorities. And I think, if you look at, to your direct question, probably 90-plus percent of our stores are in close proximity to the competition, so we wouldn't have seen anything noticeable by trying to carve that out so...
Michael Lasser:
Okay. And given the cadence to when all that happened, it was hard to discern as well?
Robert Niblock:
Correct.
Michael Lasser:
Okay. My other question is on payroll expenses leveraging 50 basis points, that's a good result. Do you think that you can maintain that type of performance moving forward? Or was there something unique in this quarter that won't let it continue?
Robert Hull:
So Michael, we've made investment in weekday teams in 2013 and really worked to optimize those beginning second half of '13 into 2015. If you look at last year, we actually had some modest payroll deleverage, Q3 2013, which drove some outsized leverage Q3 this year. We've got some good tools in place that allow us to continue to optimize payroll. We do expect further leverage in Q4 and into 2015, but probably not to the same degree we saw in the third quarter.
Michael Lasser:
And Bob, just to follow up on that, are you seeing a benefit to your conversion as a result? Or was it traffic really driven by draw?
Robert Hull:
So we have seen improvement in conversion rates. It's really everything we've been doing for DIYs and Pros as it relates to the payroll investment. I noted the inventory investment last year, the line review process that we went through with Value Improvement to really get rooted in the products that the customer cares about. We saw a roughly 100 basis point improvement in conversion rate in the third quarter.
Operator:
Your next question will come from the line of David Strasser with Janney Capital Markets.
David Strasser:
When you look at your business versus 2005 during the last peak period of time, how different do you see the store? And I guess what I'm trying to look at is when you think about it per square -- sales on a per-square-foot basis, how dramatic have newer products been to the overall mix? And if you were kind of just looking at it just from a mix-to-mix standpoint, how much more opportunity do you think there would be in driving those sales on a like-for-like basis?
Robert Niblock:
Dave, I'll start. Well, first of all, when we think about comparing the business all the way back to 2005, certainly it's a dramatically different environment today
David Strasser:
Okay. I mean, when you just look at -- I guess, just from a dot-com standpoint, you've talked about this a bunch. From an incremental standpoint and I'm -- how much do you think that can ultimately help productivity in the store? I know it's a big question. I'm just kind of trying to think of just a little bit bigger picture.
Robert Niblock:
Well, I think it'll be significant because, I think, today -- in today's world, with where we're at from a technology and a customer expectation standpoint, I don't think you're going to be relevant if you don't have a website that, one, is functional feasible from the consumer's standpoint, but also well connected to your other channels of business. That's why we're after an -- it's not just multiple channels, but it's an omni-channel where these work together because that really gets back to being able to be there and meet the customer whenever and wherever they choose to engage in a simple and seamless manner. That's what we believe our customers are looking for. So even though it may be a small percentage of it that actually transacts online, it's heavily induced by people starting their research online. Like 80% or 90% of people that start on mobile, there's only -- there are only about 10% of them conclude a transaction there, but they are looking for what's available in-store when they're visiting you.
Michael Jones:
So if you think about our holiday decor experience, I talked to the fact that it starts online with Pinterest, it starts online at Lowes.com, it starts online with Vine to drive inspiration and then they come into the store. And likewise, you saw the same thing happen over the spring with our outdoor spring experience.
Operator:
Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
I know you highlighted strength in the Pro and I think Mike mentioned some specific initiatives you guys are doing to drive market share. Your friends in Atlanta are also focused on this pretty important customer base and also doing well. I guess, my question is do you think there's a lot less competition out there to serve the Pro than what we had maybe a couple of years ago due to the downturn, which I'm assuming took out a lot of competitive capacity, number one? Number two, how should we think about your opportunity in this segment going forward?
Michael Jones:
Yes, I don't know that I can say there's less competition. There's been some consolidation of some of the small local and regional players, but I don't know that I would think about the competitive set any different. The example I used was Henry coating in my address earlier where we have the right brands, where we have the right local -- we have the right inventory, where we have the right localization, we see growth. And so we're excited about it and we'll talk more about some of our Pro initiatives at the upcoming AIC meeting.
Robert Niblock:
And Scot, this is Robert. When you think -- it kind of dovetail into our last question when you think about competition. Yes, there might have been consolidation, there may be fewer just dedicated Pro lumber and building material yards than there were before the downturn, but also think about technology and how that's changed. How for example, online and the availability now of being able to interact with the DIY or Pro customer online so that -- that's why we're focused on launching our LowesForPros.com because, yes, it may be different, but it's still a competitive market.
Scot Ciccarelli:
So as you guys can invest more into technology and have those systems and capabilities, in theory, you should be able to continue to gain market share with that customer base?
Robert Niblock:
Correct, and that's why obviously we'll continue to have plans to invest funds in those areas. So...
Operator:
The next question will come from the line of Laura Champine with Canaccord.
Laura Champine:
Robert, could you just comment on how much Orchard Supply added to your comp this quarter?
Robert Niblock:
It virtually added nothing to comps for the quarter. We think about the size of the business, technically it was only in the comp base for 2 months that, really, with or without Orchard to comp, our number would not have changed, Laura.
Laura Champine:
And then can you also comment on what drove the appliance business because we're particularly surprised by the streak that you saw there in the quarter.
Michael Jones:
A couple of reasons. We spoke to being certainly promotional at the same level as our competitive set in the appliance business a few minutes ago. I like our footprint in appliances. I like the amount of space that we dedicated to the floor for appliances. We're proud of the fact that we have large stores and so we can dedicate space to appliances and not have to detract space from other important categories like cabinets that helps the consumer pool the entire project together. And I like our brands. I also like the fact that, as we think about building out better experiences, we own that appliance experience with our customer all the way through to the last [indiscernible]. We deliver the appliances, we facilitate insulation, we really do own that experience. So we feel good about our position. We think that the way we're merchandising appliances, our partnerships with key brands like Bosch, Whirlpool, GE, Electrolux allows us to offer everything the consumers need. And it's an area that we're pretty well focused on.
Operator:
Your next question will come from the line of Seth Basham with Wedbush Securities.
Seth Basham:
My first question is around some of these big-ticket category drivers for the quarter. Would you care to quantify how much appliances and OPE added to the comp?
Robert Hull:
Don't have the exact quantification. As Mike spoke of, OPE was in the mid-teens from a comp perspective. Appliances was above the company average. So both were certainly drivers, Seth. If you look at tickets above $900, that's going to be about $500 comp goes up a little higher than 9%. So certainly, big ticket was driver of the comp in the quarter led by the categories we spoke about previously.
Seth Basham:
Got it. As you roll into Q4 with continued promotional environment in appliances, do you expect to see the same level of comp contribution from that category?
Robert Hull:
I think as we spoke about earlier last year, it was kind of Black November from an appliance perspective. So the -- while the level of intensity will be more consistent, the impact will be muted because we're comping against efforts for last year. Therefore, I think we will see more balanced performance. We do see continued strength in OPE, but probably not to the degree we saw in Q3. So we'd expect a little bit more balanced performance across the categories in Q4.
Operator:
Our next question will come from the line of Budd Bugatch with Raymond James.
David Vargas:
This is David on for Budd. I had a question just about inventory levels and supply chains. You had your competitors mention seeing being in a good in-stock position going into the holidays, but definitely seeing some troubles, I guess, you could say, in the supply chain, notably some congestion at the ports and also issues with the driver shortages. Can you comment on if you're seeing any of that?
Robert Niblock:
This is Robert, I'll start, Dave. When you think about Black Friday, when you think about the holiday season, we think we're in great shape with the inventory already landed and either in our stores or in our distribution networks. Certainly, with what's going on with ports on the West Coast, keeping a close eye on it. Our team is heavily focused on that and working to develop contingency plans based on how that situation unfolds going forward. We've been through this before and so it may cost more to get the freight in, but we'll do what we need to as we think about looking ahead to spring. And keep in mind, when you think about our network of distribution centers, our distribution centers aren't just for cross-docking, they also hold inventory. So that gives us great flexibility, as product is landed, to go ahead and bring it in either in our import centers or in our distribution centers, to have it available then to push out to our stores. So we're in great shape as we head into Black Friday into the holiday season this year. Yes, there has been a little bit of pressure when you think about higher costs from driver availability and stuff like that, but fortunately, with lower fuel prices, that's helped to offset some of that costs to what we've experienced to date.
David Vargas:
Okay, great. And one more question on the modeling going forward. In terms of the 70 to 75 basis points of operating margin expansion you see, can you give us an idea of what that -- the contribution split would be roughly between gross margin and SG&A? Is it going to be similar to what we saw this quarter? Or a little bit more balanced?
Robert Hull:
I assume you're talking about Q4?
David Vargas:
Yes, yes, Q4 or -- yes.
Robert Hull:
So for the year, we expect the gross margin to be roughly consistent with where we are to date. The 2, 3 quarters of performance felt at the last year, the lion's share of expansion is going to come from expense leverage. As you've heard us talk, we're really focused on driving productivity and flow-through, so good expense productivity. We'll see even more of that in the fourth quarter, driving productivity. We talked about payroll. We'll leverage bonus expense in the quarter. We also had some impairment in Q4 last year we don't expect to recur this year, so we'll have some healthy expense leverage in the fourth quarter.
Operator:
Your next question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
Just focusing on that margin. In the past, you've talked about a rule of thumb of 20 basis points of margin expansion for every 1% comp above 1%. Your guidance this year is ahead of that, closer to 25 to 30. So my question is how do we think about that going forward? Is your efficiency and productivity such now that, that rule of thumb should go higher?
Robert Hull:
Yes, we believe so. So we think back to where we've been over the past number of years with the focused initiative we saw on stabilizing the revenue then shifting gears towards productivity and profitability. So we're in that phase of focus on productivity and profitability. We expect 2015 hopefully looks a lot like 2014. We're in the throes of developing our plans for 2015. Like 2014 we hope to grow comps with flattish payroll hours and flat inventory dollars. We'll give you more details on 2015 on the Q4 call in February.
Michael Baker:
So, I guess, to the follow-up question, is that -- would that higher rule of thumb and thinking it might occur next year, does that give you visibility into that 9.7% operating margin for 2015 that you guys talked about in December 2012?
Robert Hull:
Certainly. So that's been part of the plan all along. That's what we've not wavered from the 9.7% is we need to grow both top line and our productivity. We are getting better flow-through now as you suggested, Mike, in the 25 to 30 basis point range. We'd like to see that towards hopefully towards the high end of that range in 2015, but again more to come.
Operator:
Your next question will come from the line of Peter Benedict with Robert W. Baird.
Peter Benedict:
My question is on kind of the Pro versus DIY when we think about it from a margin perspective. Can you talk to kind of the average margin profile of a Pro basket versus the average DIY basket, how materially does it differ?
Robert Niblock:
Peter, this is Robert. I'll start and let the others add in. But when you think about it, as we talk about the Pro and the Pros that generally we target that shop our stores, they're generally buying across the store. So you generally are not seeing a significant difference in the baskets -- on margin rate on the basket with what they're buying versus what our typical DIY customer would be purchasing.
Peter Benedict:
Okay. And then how about the average spend per the year, do you guys kind of benchmark that in terms of what you think your Pros are spending on average?
Robert Hull:
The average Pro spend is probably in the $2,000 range. As Robert indicated, they're buying across the store. There's a healthy margin mix and we feel good about the game plan that serve the Pros.
Operator:
Your next question will come from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
A couple of questions, one long and one short. I mean, for the long one. A lot of talk from you and others about this pretty significant market share shift we're seeing in the appliance business you quoted benefiting from it. As you look at your customer data and you're getting that maybe potentially that new customer now buying an appliance at Lowe's, is that someone that is new to Lowe's store? Or is it an existing customer now that you expand their share of wallet, so to say? And then how sticky has that customer been? If there's any way to determine that.
Robert Niblock:
Well, I think, I'll start, Brian, and then I'll maybe get Mike Jones to jump in. Certainly, as we continue to improve the way we go to market, even improving things like website functionality and the website search and those type of things, now we're making sure that when the customer's in the market to buy an appliance, we're in the top in their consideration set. And still a majority of the appliances -- or a significant amount of the appliances that we sell are still replacement of an appliance that's in a distressed situation. So being there at the right time. But you also know that as the remodeling market is coming back with consumers going to put in a new kitchen, we also -- when they put in the kitchen, we'll sell the appliances as well. So the thing about a lot of our targeted efforts, whether that's our PSI program and those types of things, that are really working on a better -- in a more effective way with the consumer in improving their home, I think all of that helps us how to have the right products, the right brands, making sure that we're there when the customer needs us on a omni-channel basis I think helps in that we've got all the key brands out there, as Mike indicated earlier in his comments. So I think it just positions us well given that the majority of customers that come in our store everyday are homeowners when it is time for an appliance, they're familiar with the brand. They know Lowe's and it sets us up well to continue to gain share with -- in the appliance industry. So...
Michael Jones:
Yes, and I'd add a couple of things to that. When you think about our ability to help the consumer put together their project by deploying our project specialists to their home. That's going to help us expand our relevance for customers that we have and gain some new customers. In addition to that, if you think about the way we're building up better experiences starting online going into the store, we think that also helps us both make the customers that we have more sticky as well as start to lean into some new customers. So we look at it -- we don't look at it as either/or, we look at it as we're going to go after both.
Brian Nagel:
Got it. And the second shorter question, I don't you think you've mentioned this yet. But any comment on sales trend thus far in Q4? I mean, recognizing we're early in back-end weighted period.
Robert Hull:
Yes, so Brian, we're off to a great start. In fact, we're very impressed with our results thus far. But it's still very early in the quarter and there is weather risk in January. So at this point, we're comfortable with the guidance we provided thus far.
Operator:
Your next question will come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two questions. First of all, in terms of market share, your performance this quarter looks improved from what you've posted recently. I know you've talked a bit about appliances and outdoor power. But from a bigger-picture perspective, Mike or Robert, what do you think is changing? And is that sustainable in terms of your market share performance?
Robert Niblock:
Eric, I'll start and then I'll get Mike to jump in. But yes, I think it's a lot of heavy lifting we've been doing over the past few years, past few quarters for this line review process whether it's the incremental inventory that we put in the stores, whether it's the customer experience work that we've been doing to bring better experiences, it's improvements that Mike and his team have been working on for the website to make a better experience, better connected and then just things like we just talked about earlier on in the call with the weekday team here. We launched those a couple of years ago. As people can get more experience, as we get their hours adjusted in the right part of the store at the right time to meet the consumers' needs, yes, it feels good, particularly, as we talked about, with the environment and home prices improving on a broader scale sets us up well for our footprint. And then some of the work that the team is doing to really focus more on the opportunity with that Pro customer. Yes, it does feel like we've got opportunity to continue to gain market share and to be able to deliver better performance.
Michael Jones:
Yes, I'd agree. It's difficult to measure share. It's -- you've got [indiscernible]. You have to use a lot of different data to begin to have a perspective, but we also believe that we're gaining share. I'd add a couple of things. I think our associates have done a phenomenal job. They're energized, they're engaged and they're meeting the needs of our customers and so we're so appreciative of what they do. Our outdoor selling teams, our Pro teams, are doing a phenomenal job. The project specialists continue to do a fantastic job. But to Robert's point, our initiatives are really starting to get good traction. We talked about sales and operations planning, where we started to plan out the upcoming selling season 6 months to a year in advance that helps to make sure that we have the inventory we need, so we meet the customers' needs. We talked about our better utilization of our larger stores, which we believe to be a distinct competitive advantage where we can show products like our Innovations and our Innovation End Caps. And I don't want to miss our vendor partnerships. So, so critical. We've got great vendor partnerships that are bringing us innovations and first-to-markets and working with us to make sure that we have the right brand portfolio to meet both the needs of the Pro as well as the need of other do-it-yourself customers. So a lot of things going well. I know that in your shops, Eric, you've heard lots of things from our merchandising team and how engaged they are and they're doing a phenomenal job as well. So just a lot of things going well and we're proud of the teams.
Eric Bosshard:
Great, that's helpful. And then secondly, in terms of the margin progression, and Bob, your commentary in sticking with the 9.7% next year. I know there was a period of time where there was -- it felt like a larger gross margin emphasis in the company. It feels like there's now, perhaps, recognizing an opportunity to better lever SG&A. I'm just wondering if you can give us a little bit more color on your thought of the slope of margin improvement from here. And other than sales progress, is there something incremental you're accomplishing that allows you to lever or improve margin at a better rate that you've done in the past?
Robert Hull:
So Eric, what I'd say is that we guide to EBIT because there's pushes and pulls with margin and expenses. We want to manage the business with flexibility to respond to competitive actions. We want to have a flexibility to manage our initiatives and put our initiatives in place. So I'm not sure that the mindset's necessarily different, Eric. We certainly expect to have both gross margin improvement and SG&A leverage. It just so happens we're identifying a lot of productivity opportunities that happen to be expense-related at this juncture. As the merchant teams go through round 2 and round 3 of Value Improvement, there are still opportunities to bring value to the consumer. As Mike discussed parts with our vendors, we think there's additional gross margin opportunities from that going forward. So it just so happens, at this juncture, we're seeing a little bit more opportunity from expense.
Operator:
Your next question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I've got a couple of follow-ups. First of all, can you talk to us, if you look through some of the ticket metrics for this quarter, which have some one-offs like OPE, what was the ticket cadence in sort of the customer traffic in some of the bigger-ticket areas telling you about where the customer is in the home investment cycle relative to the past couple of years? Are you seeing a deepening of interest in some of the bigger-ticket project-oriented areas? Or are we still talking about more of the repair and maintenance kind of categories driving the business today?
Robert Niblock:
Well, as we -- I'll start and I'll let the others jump in. As I said in my comments is we see the consumer getting engaged in home and home improvement and their thoughts around the home, their confidence in both local and national housing market and the value of their homes improve, we are seeing continue to get engaged in taking on discretionary projects. Today, most of those are still in the smaller projects, which we label as $500 or less, but we did see an uptick versus same quarter last year and a willingness to take on larger projects, which we think bodes well going forward as we continue to see home values continue to improve and consumer finances continue to improve. So...
Matthew Fassler:
Okay. And then the second element of my question, just following up, and Bob, you just a moment ago that the merchants would go back and take a look at other opportunities for Value Improvement. What do you think is left? Either quantifiably or areas of the business that you feel you maybe didn't optimize in the first round as you look at gross margin opportunity?
Michael Jones:
This is Mike Jones. First of all, from a Value Improvement perspective, we view this as the way we work. So it's not something that will be done. We're going to continue to use that process to continue to work with our vendor partners to create more value for our customers. So we've gone through round 2 this year and made great progress. And I can believe when we finish around 2, there will be a round 3, followed by round 4, followed by round 5. So as we continue to look at our business, we continue to find opportunities where there's [indiscernible] to partner with our vendor partners, to take out more costs, quite frankly, both from our side and from their side and deliver more value to our customers. So this, to me, this is not a -- it's not a one and done. We'll be doing this in perpetuity.
Robert Hull:
And then, Matt, I would add, just think about 400 line reviews and the average line review had 4 clusters, so just know we got 1,600 clusters, right? So there's an opportunity to continue to go back and refine the approach, dig into to the demographics, the customer data, the performance to continue to refine the sets.
Operator:
Our final question will come from the line of Aram Rubinson with Wolfe Research.
Aram Rubinson:
Bob, I got your reference. I'm glad you're impressed with the start to November so -- just so you know. One kind of softer question and then one more specific. You seem like you're on a good glide path where your comps are equal to the competition, maybe even better in October. Your DSIs are down, your DSPs are up. Your business seems to be stable. Can you just tell us about the feeling of the organization? And I know that wins sometimes beget more wins, so I'm just kind of curious whether or not you're at that stage of maybe building momentum internally?
Robert Niblock:
Aram, this is Robert. I mean, momentum is a powerful thing. I think we've see a lot of bounce in people's steps. There are a lot of initiatives that we've been working on. There's been a lot of heavy lifting over the past couple of years all the way across the organization both in stores and the corporate offices. We repositioned the company to the more of an omni-channel environment, made some great strides and great improvements are starting to come together and you're seeing a lot of bounce in people's steps and a lot of wanting to deliver even better performance in the future.
Aram Rubinson:
Great. And my other question is just on the Pro. Tool rental is something that we've heard is near and dear or at least of interest to Pro customers and I think you guys don't really have that in terribly many stores. Can you talk about whether or not that's something you're working on? Or if you just don't see the merit in it?
Robert Niblock:
Aram, we've got it in a handful of locations. It's something that we'll continue to put on list to evaluate. But quite frankly, with all the other things that we had to get done over the past couple of years, we had other things that we thought were higher priority. And so it's something we'll continue -- it's on the list, we'll continue to evaluate it. It's something we may look at doing in a better way in the future. But as of today, we've not made any decisions regarding tool rental.
Thanks. Again, as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter 2014 results on Wednesday, February 25. Have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you, all, for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2014 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. I will now turn the call over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. We delivered solid results for the second quarter. Comparable sales were 4.4% with an increase in comp transactions of 3.1% and an increase in comp average ticket of 1.3%.
As expected, we recovered most of the outdoor product sales missed in the first quarter due to unfavorable weather conditions, but discretionary interior projects did not perform as well as expected. Outdoor product sales were strong with a roughly 6.5% comp for the quarter while indoor comps were roughly 3%. All 14 regions had positive comps for the quarter. Likewise, all 12 product categories had positive comps. We saw particular strength in lawn and garden during the quarter, and the outdoor living experience we discussed on our first quarter earnings call drove success in patio furniture and accessories. While seasonal categories were strong, we also saw strength in millwork, paint and tools and hardware, which were all above the company average. And we saw solid performance in line with the company average in fashion fixtures, flooring and lumber and building materials. We continue to see strength in our ProServices business, which outperformed the company average during the quarter. And I'm pleased to share that our team in Canada delivered double-digit comps in local currency for the fifth consecutive quarter. We remain focused on improving our profitability even while investing in key capabilities to drive sales growth. For the quarter, gross margin expanded 20 basis points, and we effectively controlled expenses, delivering 67 basis points of operating margin expansion and earnings per share of $1.04, an 18.2% increase over last year's second quarter. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $1.1 billion of stock and paid $183 million in dividends. As we look at the backdrop for the second half of 2014, economic forecasts suggest continued strength in the home improvement market as employment, income and consumer spending levels continue to improve. At the same time, signals from the housing market appear mixed as home values have increased moderately while existing home sales, in total, have declined this year. However, when distressed sales are omitted from the data, which we believe is a more appropriate indicator of the long-term health of our industry, existing home sales have seen a slight increase through the first half of the year, revealing a more positive and sustainable trend. In light of the positive direct trajectory of these factors, we believe home improvement spending will continue to progress in tandem with strengthening job and income growth. This also aligns with recent consumer confidence ratings in our second quarter consumer sentiment survey, which revealed that home owner's views around personal finances and home values continues to improve. Consumers are indicating stronger intentions to complete a home improvement project with most of them planning a specific project in the next 3 months. And while most of these planned projects are still small ticket, we are seeing a rise in home owners planning big-ticket projects. Plans we have in place that support our continued top line growth. Our enhanced sales and operations planning process will help us capture seasonal opportunities in the second half of the year. We also remain focused on improving our product and service offerings for the Pro in order to drive sales for this important customer. And we will continue to build customer experience design capabilities that differentiate Lowe's from other home improvement retailers. Continued improvement in macroeconomic landscape, together with our strengthening execution, strategic priorities and keen focus on productivity and flow-through give us confidence in our business outlook for 2014. Before I close, I would like to thank our employees for their hard work in achieving this quarter's solid results and for their continued dedication to serving customers while we further transform our business. Thanks again for your interest. And with that, let me turn the call over to Rick.
Rick Damron:
Thanks, Robert, and good morning everyone. As Robert shared with you, we generated positive comps across all regions and product categories as we continue to capitalize on an improving macro backdrop through our enhanced sales and operations planning process, improve relevance with the Pro and develop customer experiences and capabilities.
Our lawn and garden category experienced the strongest growth among our seasonal categories, even over strong growth in the second quarter of last year. Customers shopped our compelling offering of live goods as they took advantage of improved weather to spruce up their yards. Likewise, we grow growth in outdoor power equipment over double-digit growth in the second quarter of last year with great national brands like Husqvarna, John Deere and Troy-Bilt, supplemented with the launch of our Kobalt line of battery-powered handheld outdoor power equipment. Within our seasonal living category, patio and outdoor fashion products topped their solid first quarter results, generating double-digit positive comps and better-than-anticipated sell-through. This strong performance offset softness in the window air conditioners in the North, which has experienced cooler-than-normal summer. The strength in patio and outdoor fashion is a testament to the outdoor living experience we rolled out over 2/3 of our stores in advance of the spring selling season. We removed 15 bays of steel racking to create a showroom feel with about 35% more open space, which was made possible by our larger store format. To help customers envision and create their outdoor space, the experience in product purchasing, we displayed patio sets with coordinating rugs, umbrellas and accessories like pillows, lanterns and planters, along with grills and other outdoor products just as you would expect in your own backyard. The outdoor living experience is one example of how a dedicated customer experience design team is working with customers to better understand their purchase drivers, and based on these insights, is designing entire experiences from inspiration to purchase and enjoyment. Other categories showing particular strength in the quarter included millwork, paint and tools and hardware. In addition, fashion fixtures, flooring and lumber and building materials had solid performance, in line with the company average. Fashion fixtures, flooring, lumber and building materials and millwork benefited from customer's increasing interest in refreshing both the interior and exterior of their homes. And our in-home project specialists are simplifying the process by guiding customers through inspiration, design and installation. While we already had project specialists that focused on the exterior of the home available across all U.S. stores, we continue to expand our interior project specialist program. Customers have responded very positively to these programs and we are pleased with their performance. The paint category, particularly deck stains and exterior paints, including newly-launched Valspar Reserve, performed well as customers took advantage of better weather to refresh the outside of their homes. We introduced Valspar Reserve exterior and interior paints at the end of the first quarter to appeal to both DIY and Pro customers and our sales to both customers have exceeded our expectations. Within tools and hardware, our enhanced sales and operations planning process help us drive strong power tools performance with great holiday values, and we are improving our attachment of fastening and repair products to sales of lumber and building materials. As Robert mentioned, our Pro business continued to perform well. In fact, ProServices comps outpaced the company average for the 12th consecutive quarter. Increasing customer willingness to complete refresh projects, coupled with our strong product offering, led to notable Pro sales strength. We will continue to invest in our core product and service offering for Pros, a segment that is growing faster than the rest of the home improvement market. We are working to ensure we have the right products and brands Pros demand and the inventory depth required to help Pros complete their jobs. We also strive to provide Pros with great service that makes doing business with us as quick and as convenient as possible. So we continue to reach out to them through multiple channels, whether in-store where we have dedicated specialists to answer questions and dedicated loaders to help them get back to the job quickly; or at the Pro's place of business where our account executives help regional maintenance, repair and operations customers order and replenish products across multiple stores; or through our national account representatives who assist customers doing business with Lowe's across the country; or online where we are also committed to providing great service to Pros. During the quarter, we began the relaunch of LowesForPros.com, a dedicated platform for Pros to purchase online from Lowe's. This site will provide Pros useful functionality, such as tools to develop requisition lists and views of their purchase history, as well as customized product catalogs. And this site can be integrated with purchasing systems Pros use to manage their business to further streamline their day-to-day operations. This site is currently being tested with a select group of Pro customers and we received positive feedback on the site's flexibility and ease-of-use. We will expand our test group and continue refining the site with a goal of a broad-based release by year-end. In addition to our efforts to drive top line growth, we are focused on driving productivity and profitability, and we made good progress in the second quarter as we leveraged payroll and inventory. Just over a year ago, we added an average of 150 stores per week to the staffing model for nearly 2/3 of our stores in order to improve close rate by increasing the proportion of selling hours during high traffic weekday times. This year, we are optimizing this investment by better aligning hours with customer traffic. This allowed us to meet second quarter customer demand with only a slight increase in payroll hours relative to the second quarter of last year, resulting in roughly 10 basis points of payroll expense leverage. Similarly, last year, as part of our value improvement initiative, we reinvested our inventory to provide greater depth of high velocity items in job lot quantities. This year, we have held inventory per store roughly constant in the second quarter even while increasing comp sales. We are pleased with the progress we're making this year on productivity and operating profitability, and we will continue to look for ways to make further progress. As we have shared with you previously, our enhanced sales and operations planning process has enabled us to improve seasonal planning, including the cadence of inventory allocation, staffing, associate training and marketing. This year, the process helped us stay connected on the inventory and staffing needed to recover sales while ensuring we address key summer holidays, including Memorial Day and July 4th, and home improvement occasions, such as maintaining lawns and gardens and refreshing patios. Entering the second half of the year, we will use the same process to ensure we are prepared to address a new set of customer needs for the fall, such as planting, home winterization and exterior maintenance. Then, as winter arrives, we'll help customers refresh their homes for holiday guests, decorate and organize their home after the holidays. Over the next few months, as appropriate by climate zone, you will see us repurpose the space used for outdoor living experience to focus on products used for fall cleanup, outdoor power equipment, such as leaf blowers to clear yards, seeding, fertilizer, and ultimately, holiday decor. Our focus will be on using this space to provide the inspiration, guidance, products and service that customers need to tackle the products that are relevant for each micro-season. Thank you for your interest in Lowe's. And I will now turn the call over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the second quarter were $16.6 billion, an increase of 5.7%, driven by comp sales and Orchard Supply Hardware. Total customer transactions increased 5.6% and total average ticket increased 0.1% to $65.65.
As previously discussed, the Orchard stores have more transactions per foot, but fewer per store and a lower average ticket than a traditional Lowe's store. So while Orchard aided total sales by approximately 100 basis points and added roughly 220 basis points to our total transaction growth, it negatively impacted total average ticket growth by approximately 115 basis points. The Orchard stores are considered noncomp, but will be included in our comp sales calculation after the anniversary of the acquisition in Q3 2014. Comp sales were 4.4% for the quarter. Looking at monthly trends, comps were 4.7% in May, 4.6% in June and 3.7% in July. As a reminder, in last year's second quarter, July had the highest comp at 11.3%. For the quarter, comp transactions increased 3.1% and the comp average ticket increased 1.3%. As you've heard discussed, we recovered most of the outdoor product sales missed in the first quarter due to unfavorable weather conditions, as evidenced by a roughly 6.5% comp in exterior products categories. However, interior categories, at approximately 3% comp, performed lower than the company average. Year-to-date sales of $30 billion were up by 4.2% versus the first half of 2013, driven by a 2.8% increase in comp sales, the addition of Orchard and new stores. Gross margin for the second quarter was 34.55% of sales, which increased 20 basis points over Q2 last year and is up 62 basis points on a 2-year basis. The increase was driven primarily by Value Improvement. Year-to-date gross margin of 34.98% of sales, an increase of 42 basis points over the first half of 2013. SG&A for Q2 was 21.33% of sales, which leveraged 40 basis points. Bonus expense leveraged 28 basis points due to lower expected attainment levels relative to last year. Also in the quarter, we experienced leverage in store payroll and advertising, largely as a result of the sales increase. These items were somewhat offset by employee insurance, which deleveraged 17 basis points, primarily a result of the Affordable Care Act, which drove a 10% increase in enrollment. Year-to-date, SG&A was 22.87% of sales, which leveraged 17 basis points from the first half of 2013. Depreciation for the quarter was $375 million, which is 2.26% of sales, leveraged 7 basis points when compared to last year's second quarter as a result of the sales growth. In Q2, earnings before interest and taxes, or EBIT, increased 67 basis points to 10.96% of sales. For the first half of 2014, EBIT was 9.62% of sales, which was 60 basis points higher than the same period last year. For the quarter, interest expense was $126 million and deleveraged 6 basis points to last year as a percentage of sales. The effective tax rate for the quarter was 38.6%, which is higher than last year's 37.5%. The higher rate, which was consistent with our expectations, was a result of tax programs that expired at the end of last year. Net earnings were just over $1 billion for the quarter, an increase of 10.4% over Q2 2013. Earnings per share of $1.04 for the second quarter were up 18.2% to last year. For the first 6 months of 2014, earnings per share of $1.64 represented a 20.6% increase over the first half of 2013. Now to a few items on the balance sheet, starting with assets. Our cash and cash equivalents balance at the end of the quarter was just over $1 billion. Our inventory balance of $9.3 billion increased $209 million or 2% versus Q2 last year. The majority of the increase was driven by the addition of the Orchard stores. Inventory turnover was 3.74, up slightly over last year. Asset turnover increased 10 basis points to 1.63. Moving on to the liabilities section of the balance sheet. Accounts payable of $6.2 billion represented a 9% increase over Q2 last year, caused by the timing of purchases year-over-year. At the end of the second quarter, lease-adjusted debt-to-EBITDAR was 2.07x. Return on invested capital increased 199 basis points for the quarter to 12.61%. Now looking at the statement of cash flows. Cash flow from operations was $3.9 billion, an increase of $567 million over last year, largely due to working capital, as well as growth in the earnings. Capital expenditures were $384 million, a 2% increase over last year. Year-to-date free cash flow of $3.5 billion was 19% higher than the first half of 2013. In May, we entered a $750 million accelerated share repurchase agreement. At this point, we expect to receive approximately 15.9 million shares, but the ultimate number of shares will be determined upon the completion of the program in the third quarter. We also repurchased approximately 8.1 million shares for $380 million through the open market. In total, we repurchased a little more than $1.1 billion in the quarter. We have approximately $4.3 billion remaining on our share repurchase authorization. Looking ahead, let me share our business outlook. We expect a total sales increase of approximately 4.5%, driven by a comp sales increase of 3.5% and the opening of 10 home improvement stores and 5 Orchard locations. Our sales outlook is modestly lower as a result of our year-to-date performance. However, our improved flow-through assumptions allowed us to maintain our prior EBIT expectations. We're anticipating an EBIT increase of approximately 65 basis points and expect that the improvement will come from both gross margin and expense leverage. The effective tax rate is expected to be 37.2% for the year. We expect earnings per share of approximately $2.63 for the year, which represents an increase of 22.9% over 2013. We are forecasting cash flow from operations to be approximately $4.1 billion. Our capital plan for 2014 is approximately $1.2 billion. This results in an estimated free cash flow of $2.9 billion for the year. We expect to issue incremental debt during the year as we manage to the 2.25x lease-adjusted debt-to-EBITDAR target. Our guidance assumes approximately $3.4 billion in share repurchases for 2014. Kim, we are now ready for questions.
Operator:
[Operator Instructions] Our first question comes from Eric Bosshard with Cleveland Research Company.
Eric Bosshard:
Curious on your thoughts on market share performance. Obviously, a lot of things going on in merchandising and leadership changes within that. Curious in how you're seeing the progress there and how you expect that to play out as we move forward.
Robert Niblock:
Yes, I'll start and talk about it, Eric, and then we've got Mike Jones in the room and he can jump in as well. Certainly, there has been a lot of changes in the organization. But I really feel really good about the transition. Greg retired earlier in the year, long-tenured employee, done a phenomenal job for the organization. Mike has jumped right in without missing a beat. I think that Mike and Mike McDermott, he's now our General -- our Chief Merchant, are both working hard to try and dissect, on a category-by-category basis, where we have opportunity, where we see, particularly with where our stores are located, with the way we go to market, our ability to try and develop better customer experiences and also, as we've mentioned several times, strength that we're trying to go after with the Pro -- an opportunity with the Pro customer, opportunity to get the brands we need, obviously depth of inventory, the things we've talked about that we've improved in the past. So we see a significant amount of opportunity. As we said, Pro continues to lead the overall comp. We see through -- that continuing in the back half of the year as we continue to work with our sales and ops planning process, dive into some of the categories. We're dissecting on a category-by-category basis where some of that opportunity is and we've got plans in place to go after it. Won't fix it all within the next quarter or 2, but over the balance of the next few quarters, we've -- we think we've got a lot of things that will help drive sales. Mike, do you want...
Michael Jones:
Yes, I'd add to that. At a high level, we feel real good about continuing to drive the top line and drive growth for the company. We feel real good about the engagement of our merchandising team. We love the merchandising tools that have been deployed. We feel very good about our vendor partnerships. When we look at market share, it is category-by-category, as Robert mentioned, we do see some choppiness in the way the industry continues to get forecast. So we watch it very closely. And again, we look category-by-category to ensure that we feel comfortable that our plans are delivering growth.
Eric Bosshard:
I guess, a follow-up. When you think about the changes that you're making, and I appreciate, Robert, that it's not the next quarter or 2, but when do you think you do have sort of your best and brightest merchandising strategies in place implemented, when can we start to look for that to really be in place and gaining traction with the customer?
Robert Niblock:
Well, I'd say we've done a lot of foundational work over the past couple of years with the depth of inventory, the job lot quantities, those type of things for the Pros. We've kind of -- through that whole massive Value Improvement process, which was the original line of grievance [ph] that's where we cleaned up inventory. We've got some key things we're working on from a website standpoint to improve the functionality of our website that will be delivered in the next 12 months. And then things like our outdoor living experience that we rolled out this year. That's where you start to really see the organization come together to deliver something different and better in-store than the way we went to market previously. And they're continuing to go through and figure out, based on working with Mike and his team, where the opportunities where we can put our resources to place that will resonate in the greatest way with the customer. Obviously, for competitive reasons, we're not going to talk about what's coming along those lines. But I think when you look at what we're doing with the Pro customer, what we're doing on the brand side, the fact that we're through the line review process, I think over the next -- and what we're doing from the website, I think what you're going to see over the next 12 months you'll see some pretty significant improvements in our execution, above and beyond what we've already been working on.
Operator:
Our next question comes from Alan Rifkin with Barclays Capital.
Alan Rifkin:
So you've kept your earnings guidance the same despite taking down revenues slightly, both on a comp basis and total for the year. Bob, can you just provide a little bit more clarity as to where on both the gross margin and SG&A line you're going -- you're anticipating seeing the incremental leverage that you can maintain that earnings guidance?
Robert Hull:
Sure, Alan. So as we think about the outlook for the year, we maintained it at 65 basis points, but we do expect roughly the same level of gross margin improvement that we previously expected. We'll get a little bit better performance on expense leverage. As you've heard us talk about in prior years, we're really focused on productivity and profitability on a number of fronts. And that's showing up in 40 basis points of SG&A leverage in Q2 even with 17 basis points of headwind due to the Affordable Care Act. As we think about the second half, we'll drive further expense leverage going into the year. So we feel good about that. So really, the change is more on the expense leverage side than the margin side for the second half of year.
Alan Rifkin:
Okay. And one follow-up, if I may. Is there any discernible difference between the performance of your stores by class of the year with respect to the comp? Are more recently opened stores comping above the corporate average? Or where do we stand there?
Robert Hull:
So Alan, generally speaking, we don't see a material difference in comp performance based on year of opening. What we do see is stores within markets performing roughly similar. So it's local market economics. The local economy and the state of the local housing are more impactful to a store's performance versus the year they opened.
Operator:
Our next question comes from Aram Rubinson with Wolfe Research.
Aram Rubinson:
A couple of things. One, I'm hoping you can give us a little bit of clarity on the Australia business, where you are strategically with that and how that impacts the P&L because I'm pretty sure there are some losses that are incurred there. And then the second question is on the distribution side. Most companies that we talk to have kind of changes going on, on the distribution side, whether it's for e-commerce or for something else. You guys have always had a very established, very advanced distribution network, but I don't think we've heard a lot about it. So would you mind giving us an update to see how that's going to stay a competitive advantage for you as your peers make progress there, too?
Robert Niblock:
Yes, Aram, it's Robert. I'll start on the Australian question. I'll let Rick and Bob follow up on the distribution. On the Australia question, the -- we've got 49 Masters stores open as of the end of their fiscal year, which was the end of June. As you know, that's 49 stores. I think they've been open a little less than 3 years. So great -- getting a great foothold there. We also, as you know, we also bought another business there called Danks that now [indiscernible] are in the home, timber and hardware group that was bought about time we started the joint venture. And it really does -- distributors to a lot of the independents in the area, there's about 400 or so independent stores to distribute to. But they also have 28 company-owned stores. So we've gotten a good foothold. I think the initial receptivity of the business has been good. Obviously, as is the case any time you open up a new concept in a market, there's the competitive response that normally takes place. And just when you're taking a business from greenfield, growing up -- growing the business, making sure that you are being able to staff and grow that business. So what the joint venture decided to do is they're slowing down slightly the new store growth, to allow a little bit more maturity, and being more targeted and strategic in where those new stores will go. So that we'll have a little less cannibalization on existing stores and more in the markets that are underserved. So they're pulling back to about a 10 to 15 stores per year over the next few years. Previously, it was closer to about 20 stores a year. So we're still excited about the opportunity there. There's a lot that we bring to it with our global sourcing and brand -- private label brand capabilities. And as from a financial standpoint, the losses from that, obviously, it's an equity investment, so it runs through the P&L as a separate line item. It's not -- the operations aren't consolidated because we only have 1/3 of the operations.
Aram Rubinson:
And the dollar amounts that are run through each quarter for that?
Robert Niblock:
I don't think we speak for...
Robert Hull:
We haven't spoken directly to that, Aram. You can take what Masters report. So since we're a minority participant, we'll let a majority partner speak for the business. But you can take what they report on the home improvement business and infer what the impact to us is. It is a couple of cents per share this year.
Rick Damron:
Aram, this is Rick. I'll give you an update on the distribution teams. First, let me say extremely proud of what both our supply chain and stores were able to accomplish in the movement of goods and making sure that we had the products available for the customer during Q2, during our most volatile time of the year from a seasonal standpoint. The teams did a phenomenal model job in making sure that we had products for the customer. Second, I would say, Aram, as you've mentioned, we have a world-class distribution center that is and was stood up to supply our brick-and-mortar stores. And we have then, over the last several years, continued to look for ways to optimize that channel to really be able to deliver our omnichannel experiences. So a couple of the changes that we have made over the past year, one being our ability to offer flexible fulfillment to our customers and through our stores. Flexible fulfillment allows us the capability to ship from 35 of our -- excuse me, 54 of our stores, as well as all of our distribution hubs and nodes direct to consumer and parcel product that allows us to better leverage that inventory and drive greater flexibility there. The teams continue to work on driving productivity, both in the distribution center itself, as well as in trans, particularly in cube throughput. So as we look at Q2, the teams were able to really offset a lot of the incremental costs in fuel with greater productivity and greater cube movement through the distribution center. We continue to look for ways to optimize the -- what we stock and maintain in our network versus what we use to cross-dock and what we flow through as a cross-docking channel. And we feel comfortable that we've optimized that spend in the way that those products are flowed through the alternate channels. And then we continue to look for new ways to meet the customer's demand in the future through our -- through supply chain strategy improvements. So we have a lot going on. But we feel comfortable with where we are and pleased with the performance we're getting out of the network.
Operator:
Our next question comes from Brian Nagel with Oppenheimer & Company.
Brian Nagel:
So wanted to maybe dive a little deeper into the comment you made regarding the discretionary interior projects, which were -- somewhat weighed upon your sales here in Q2. Question, first of all, maybe describe more specifically what that is. Is it a specific product category that caters to interior? Did you see any differences geographically? And do you think it was more a function of just the overall environment competitively or something Lowe's did?
Robert Niblock:
Yes, as we said, overall, we had a lot of interior categories that performed well during the quarter. But we did see some weakness in a couple of areas. One of them, as you know, in our -- we give comps for kitchen and appliances area. When you dive down with that, within appliances, we were going up against an incredibly strong comp last year. We were high-teens comps last year in the second quarter. So when you look at our performance over 2 years, we were still average double-digit comp over that 2-year period. So that was obviously something that was a little bit of a challenge in the second quarter. It was a competitive environment out there for major appliances and tough numbers we were going up against. We also saw air conditioners with the summer, as Rick mentioned in his comments, not being as warm as what we had expected. Air conditioner sales were a little weak in July. And then just a couple parts of flooring were a little weak in the quarter. So those were some areas that we saw some weakness in from the consumer, all of which we're looking at and trying to determine how do we get better performance in those in our share of the opportunity as we head into the back half of that year.
Brian Nagel:
On the flooring specifically, the 3 you mentioned, is there something -- is that -- do you think that's more of a competitive issue? Or is it more of a function of the environment?
Robert Niblock:
Mike?
Michael Jones:
Yes, if I can jump in. Just a couple of things just to put a finer point on the appliance discussion. We saw certainly high-teens comps in major appliances, specifically, second quarter of last year. And if you take a look at our 2-year performance on major appliance, we see double digits. So it's actually performing very well. That said, we had profiled a little more strength in appliances, as well as AC certainly and I'd add flooring to that as well. To answer your question on flooring, we see very good performance in tile. We see very good performance in carpet. We see a little pressure in wood and laminate. And we think part of it's industry, we think part of it is that the competition has caught up with some of the first-to-market innovations that we launched last year. And then our merchandising team continues to look at new first-to-market innovations that we can launch going forward.
Brian Nagel:
Got it, got it. And then maybe just one follow-up. On the guidance, you modestly lowered the guidance for the year. Just to be clear, the way the press release reads, and I think your comments in your prepared remarks said too, that's really a function of sales in Q1 and Q2. I mean, your internal sales plan for Q3 and Q4 remains the same?
Robert Hull:
That is correct, Brian.
Operator:
And our next question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
Also wanted to follow up on the guidance. So in the first half of the year, you comped just under 3%. And then in 2Q, you comped 4.4% with the seasonal business up 6.5% and bring that number up. So 2 related questions. What do you think the seasonal recapture was in 2Q? And as we try to think about what the underlying comp trend is, could you give us some light to that? And then what gives you the confidence that you can hit that 4% to 4.5% implied comp in the back half?
Robert Niblock:
I'll start and then -- this is Robert and then I'll have Bob jump in with any additional color. The pickup from Q1 impact was probably about 150 basis points going into Q2. So that -- but as we did say, Q2 was our strongest comp performance last year. Particularly strong, as we just talked about, in major appliances and the performance we had with high-teen comps for the quarter in major appliances last year. We also talked about the weakness that hit the second quarter with regard to ACs and that was a little bit of a drag on second quarter, particularly in July. Our performance, as we look to the back half of the year and we normalize all of that
Robert Hull:
The only thing I would add is, so as Rick mentioned in his comments, we've seen great progress with Pros for 12 consecutive quarters. But as you've heard us describe, there's still a lot of focus in that area and we expect continued traction and momentum in the second half of the year, which gives us confidence in our second half outlook.
Christopher Horvers:
Is there something, particularly on the Pro, a certain initiative perhaps that you can point to? Or is it just sort of the continued improvement across the store in terms of close rates and more focus gaining traction?
Michael Jones:
Sure, this is Mike Jones. A couple of things. First, if you look at our 3 business areas, our building and maintenance business area was above the average, so that's very encouraging. We are continuing to see better traction. We are seeing improvements in brands and we've returned some brands back to Lowe's, heavy coatings would be an example, the expanded lineup of LENOX and IRWIN. Certainly, our Bosch brand continues to do well. DEWALT does very well. So that feels very encouraging. The team continues to work that very hard. Our depth of inventory continues to improve. And we've made the necessary inventory trade-off decisions so that as we become more relevant with Pros, you don't see the pressure in the balance sheet. So we are making those trade-offs so that we can better serve the Pros and still protect our operating performance. And then the last piece I'd say is that our Pro selling team is doing an excellent job, excellent job, out engaging our Pros and helping us to build those relationships we need to continue to grow that business. Rick spoke about LowesForPros, which is our portal designed specifically for Pros to help us transact with them, help us make doing business with us easy for them and frankly help them drive productivity in their own businesses. So we're very encouraged by the work that we see with Pros and we continue to build on it.
Rick Damron:
Chris, this is Rick. I'd just like to reiterate a point that Mike made. I think what we're continuing to see and feel comfortable with is the initiatives that we put in place over the last 18 months regarding both the organizational design to enable our stores, our field teams, as well as our national teams to really meet the needs of the customer in the way that they need service. But then, you look at the value statements that we've made, whether it be through inventory or whether it be through our contractor Pack programs the merchants are driving or proprietary value prop initiatives, continue to respond very well with the Pro. As a matter of fact, when you look at Q2, our Pro applications grew 23% over last year. So we continue to see the Pros respond very well to the initiatives that we got in place. As Mike said, we continue to work on brands and inventory depth where needed to continue to maximize that opportunity. But we feel good with where we are and we feel very good with the way the pro is responding to the actions we've taken.
Christopher Horvers:
And then just related to that. So can you talk about close rates in the store? I know you added the Value Improvement, the resets are done and fully reset. How -- and labor hours are now in there. So can you talk about close rates as well?
Robert Hull:
So Chris, we have done all of the above to focus on improving close rates. What we've seen through the first half is roughly a 100 basis point improvement in close rates. So we feel good about progress we're making, but we know there's still work ahead of us.
Rick Damron:
And Chris, I'll just add -- this is Rick again. And I think as a testament to what we've done there, if you look at the fact that we were able to leverage our payroll cost during the quarter, increasing our sales per hour by 4%. And even when you look at the first half in totality even with the soft Q1, we were still able to increase our sales per hour worked by 3.5%. So we feel the initiatives that we put in place is working. As Bob said, we're seeing roughly 100 basis points of close rate improvement. And we'll continue to refine how we schedule, how we staff our stores to make sure that we're meeting our traffic patterns and the needs of the customers as they enter.
Operator:
Our next question comes from Matt Fassler with Goldman Sachs.
Matthew Fassler:
I'd like to try to connect the dots a bit between, Robert, some comments you made about doing some work on the online piece and talking about your interior projects. Where do you think you sit in terms of customer's researching projects and leading in through online? Are you where you want to be? Or do you see that as an opportunity for the business?
Robert Niblock:
Yes, well, certainly, as I've said from the interior projects we talked about, part of that being the tough comp compare we had for major appliances, specifically, it highlighted a number of interior areas that are doing well. I think, from an overall online standpoint, we did make [ph] progress with the website. There's things like delivery scheduling and those type of things that we need to get worked on so that it makes it a better, easier experience for the customer. We are seeing great transaction growth online on the website. We're still seeing that a majority, obviously, of what is transacted online translating to either pick up in-store or the store delivering. So the kind of omnichannel aspect of it is working together really well. And certainly, obviously, the customers online, in many cases, they make the -- buy it online, pick it up in-store or they may be -- they're making it because they want to ensure that, that product is available when they get to the store. And then, in many cases, they are also shopping the store and getting add-on sales on top of that. So I think there is still -- we know that there is still a significant amount of influence sales coming from what's happening online. But the world's changing at a fast pace, technology's changing. We know that we've got to continue to improve our online experience and that's what Mike and his team are working on.
Matthew Fassler:
Got it. And then secondly, I'm not sure if you touched on this in your comments, you spoke a lot in thinking about your sales outlook, about the macro factors and the way they're evolving through the second half of the year. I guess you exited the quarter looking at July at kind of a subdued 1-year comp, but on a 2-year basis pretty consistent with where you were through the quarter, which was pretty good relative to trend. How is your quarter-to-date experience impacting your sales thinking? And is it consistent with the numbers that you have out there?
Robert Niblock:
Yes, we feel good about our start to August, and particularly, in light of the fact that when we look at, once again, from a 2-year compare standpoint, August last year is our toughest comp comparison we're going up against. So we feel good about the way we started the quarter in light of what our guidance is for the back half of the year, Matt.
Robert Hull:
Matt, one other point I'd make, as we think about the impact of air conditioners, it had about a 30 basis point negative impact for the quarter, had about a 60 basis point negative impact for July. So that's a headwind in July that won't carry towards the back half of the year.
Operator:
And our next question comes from Peter Benedict with Robert Baird.
Peter Benedict:
Just a quick question. Bob, you spoke about all the progress you're making on the expense front. How about gross margin, just an update here on the long-term view. Do you still think that kind of tops out around 35%? Or do you think you can maybe find ways to push it past that?
Robert Hull:
Yes, we haven't set any arbitrary limit on what gross margin could be. I think we know we've got some work to do as a result of the Value Improvement and we're seeing that play out in both -- in terms of gross margin improvement experienced in 2013 and 2014. As we've talked about, we created the process to bring more formality and rigor to the process. We've always done line reviews. We're always going to do line reviews. So that's not to suggest that wave 2 or wave 3 there's no benefit there. However, we also recognize that there's competitive pressures in the marketplace moving in sales by channel. So we do expect to continue to make progress with Value Improvement. Our long-term outlook beyond Value Improvement didn't suggest material increase to beyond maybe 5 to 10 basis points per year. So we haven't set any arbitrary cap and we know there's still work to be done with Value Improvement and with other areas.
Peter Benedict:
Okay. That's helpful. Fair enough. And then just a clarification, the interior project specialists. I guess, they're not available nationwide now? I guess, when do you think you guys could have that capability rolled out nationally?
Rick Damron:
Okay, this is Rick. As of this year, we originally started this process and this program a couple of years ago. We had it test in really 3 -- 2.5 regions this past year, completed in Q1 of this year. We rolled it to another 582 stores. We're looking at the rollout campaign into 2016. We see another 3 to 4 regions possibly being rolled out then and then the remainder in 2016.
Operator:
Our next question comes from Jaime Katz with Morningstar.
Jaime Katz:
My first question is on some of the medium-term goals that you have, which is EPS next year and EBIT and ROIC goals. Do you still feel confident that you can achieve them this far into 2014? And then if you are willing to comment on any of the rumors about Brazil that came out last week, I'd be glad to hear what you say.
Robert Hull:
Sure, Jaime, I'll take the long-term outlook. So we still stand by the 2015 outlook that we provided at our analyst conference a couple of years ago. As we've talked about, we're making good progress this year, specifically improvements in flow-through, an incremental point of comp to the bottom line. Other efforts in place to further those efforts, as you heard the team talk regarding product categories, continue to understand opportunities to take share Pro DIY across the merch categories. So we feel good about the outlook we provided for 2015.
Robert Niblock:
Jaime, this is Robert. With regard to the rumors on Brazil, obviously we don't comment on specific rumors of a nature like that. And I would just reiterate what we've said in the past. Our continued focus is on improving our existing operation in the U.S. and other international markets where we're at today. And in that light, we continue in both veins to look at opportunities. But with regard to commenting on specific rumors, no, we won't comment on that.
Operator:
[Operator Instructions]
Robert Niblock:
It sounds like we don't have any more left in the queue. So thanks for your interest in Lowe's, and we look forward to speaking with you again when we report our third quarter 2014 results on Wednesday, November 19. Have a great day. Thank you.
Operator:
Thank you. And this concludes today's conference. You may disconnect at this time.
Operator:
Good morning, everyone, and welcome to Lowe's Companies First Quarter 2014 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. We delivered comparable sales growth of 0.9% for the quarter, driven primarily by an increase in comp average ticket. While prolonged winter weather exerted pressure on our business, our enhanced sales and operations planning process, along with our distribution infrastructure, allowed us to align resources, such as inventory, staffing and marketing, more effectively by climatic zone. In the South and the West, where weather was more favorable, comps were in the mid-single digits. The Northeastern part of the country, which was the most impacted by poor weather conditions during the quarter, experienced negative comps and some of these regions faced additional headwinds from last year's Superstorm Sandy recovery activity.
For the quarter, 7 of our 12 product categories had positive comps. Overall, indoor products, which accounted for roughly 65% of sales, had solid performance with positive comps of approximately 2%. In fact, in areas of the country where weather was more cooperative, indoor comps were mid-single digits. However, outdoor products declined approximately 1.5% overall. We continue to see strength in our ProServices business, which outperformed the company average during the quarter. And I'm pleased to share that our team in Canada delivered double-digit comps in local currency for the fourth consecutive quarter. We remain focused on improving our profitability, even while investing in key capabilities to drive sales growth. For the quarter, gross margin expanded 70 basis points, driven by a number of factors that Bob will discuss. Additionally, we effectively controlled expenses in the quarter and delivered earnings per share of $0.61, which included unfavorable charges related to long-lived asset impairments and favorable impact of a lower tax rate for the quarter, for a net benefit of $0.03 per share. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $850 million of stock and paid $186 million in dividends. Moving on to the economic landscape for the remainder of 2014. The backdrop for home improvement industry growth remains positive despite the slow start to spring. Economic forecasts still suggest a moderate improvement in growth for the year. Growth in key indicators, such as employment, income and consumer spending have recently begun to improve from weather-affected levels earlier in the year. Although signals from the housing market are mixed, with existing home sales declining in recent months while home values continue to increase, we believe stronger job and income growth and gradually loosening credit conditions indicate that the environment for home improvement spending should remain favorable. These macroeconomic data points align with our first quarter consumer sentiment survey. According to the survey, homeowners increasingly believe that improvements made to their homes will increase their value. And consumers' views around personal finances continue to improve, as homeowners report that they are less likely to decrease home improvement spending. With these factors in mind, we believe underlying home improvement industry demand remains intact despite pressures exerted by unfavorable weather in the first quarter. In fact, performance has already improved in May. And continued improvement in the macroeconomic landscape and consumer sentiment, together with our strengthening execution, strategic priorities and keen focus on productivity and flow-through, continue to give us confidence in our business outlook for 2014. Before I turn the call over to Mike, I want to highlight a couple of recent organizational changes. At the end of April, Greg Bridgeford retired from Lowe's after providing 32 years of world-class service to the organization. Succeeding Greg as Chief Customer Officer is Mike Jones, who previously served as Chief Merchandising Officer. Mike brings extensive leadership experience, expertise in key product categories and a clear focus on the customer. In his new role, Mike will be responsible for creating experiences that better serve customers and differentiate us from our competitors. He will oversee U.S. home improvement strategy and customer experience design, merchandising and marketing and communications. Filling the Chief Merchandising Officer role is Mike McDermott. Mike has more than 20 years of experience in leading global product management and merchandising teams and driving innovation. Mike McDermott will ensure continued refinement of our improved line review and product reset process now that Value Improvement has been rolled into our base operations, and he will continue the efforts he started as General Merchandising Manager of Building and Maintenance to ensure that we have the products and brands Pro customers demand. Lastly, Mike Mabry has been named U.S. Home Improvement Strategy and Experience Design Executive. He will oversee our efforts to satisfy customers' needs with a seamless omnichannel offering and to differentiate with better customer experiences than any other home improvement provider. Both Mike Mabry and Mike McDermott report to Mike Jones. I look forward to the continued contribution from our more than 260,000 employees and like to thank them for their dedication to serving customers and for their efforts to continue building on the momentum established in 2013 as we further transform our business model. Thanks again for your interest, and with that, let me turn the call over to Mike.
Michael Jones:
Thanks, Robert, and good morning, everyone. We executed well during the quarter despite an unexpected prolonged winter in many areas of the country. While we saw reduced demand for many outdoor products, we bolstered performance in our seasonal categories by helping customers dig out from snow and ice, as we positioned truckloads of weather-relevant products at our regional distribution centers, which enabled quick deliveries to our stores in areas hardest hit by winter weather.
We also offered customers a new outdoor living experience that inspired them to buy patio furniture and accessories even when the weather didn't cooperate in parts of the country. I'll share more of this experience in a few minutes. In rough plumbing and electrical, we generated strong sales by providing ample supplies of products customers needed to repair pipes damaged by the severe cold, as well as prepare their HVAC systems for spring. Moving to interior projects. We drove strong sales in fashion fixtures, where we saw particular strength in light bulbs, driven by LED and other energy-efficient products; and in fashion plumbing products, such as bath faucets, vanities and toilets. We are providing compelling new styles and coordinated sets for customers refreshing or remodeling their bathrooms, and our in-home Project Specialists are simplifying the process by guiding customers through inspiration, design and installation. We continue to drive solid performance in kitchen and appliances, where our extensive offering of major brands, along with service advantages of next-day delivery and haul away, and in-house facilitation of repairs and maintenance, provides a best-in-class customer experience. We also drove solid performance within tools and hardware. Particularly in power tools, where our lineup of Bosch handheld power tools and accessories performed very well. We are focused this year on 3 priorities to drive further top line growth using our enhanced Sales & Operations Planning process to optimize performance in micro-seasons by market, improving our product and service offering for the Pro customer and building customer experience design capabilities. Through our enhanced Sales & Operations Planning process, we have addressed an opportunity to improve seasonal planning, including the cadence of inventory allocation, staffing, associate training and marketing. This quarter, this process helped us drive ticket growth and support traffic against an unfavorable weather backdrop. The theme for this year's spring plan was Spring is Calling! It didn't call as early as we initially expected, but when it did, we were well prepared. And where it did, we performed well. We built plans by climatic zones in order to get the most from our investment in inventory, staffing and marketing. For instance, we staggered our Spring Black Friday campaigns. The earliest rollout occurred in the Deep South in mid-March, and the last rollout took place in the North, just at the beginning of May. All occurred at appropriate times for each geography, when customers planned to clean and prep their outdoor spaces for enjoyment throughout the spring, summer and fall. Our second area of focus is to better capitalize on the Pro market, which is growing faster than the consumer market. So we are enhancing our product and service offering for this important customer. While Pros shop across the entire store, the penetration of sales to Pro customers is highest within traditional building and maintenance categories, including lumber and building materials, millwork, rough plumbing and electrical and tools and hardware. So we have grouped these building and maintenance categories together to focus on ensuring we have the types of products and brands Pros demand. For example, the mix of customers shopping electrical wire is roughly 70% Pro and 30% DIY. We are losing share in this core category, particularly with electricians. So within last year's line review, we focused on why and what we needed to change. We identified Pro purchase drivers by obtaining insights from our vendors and surveying our dedicated Pro sales team. We then validated our initial findings with Pro customers. We found that while we have an opportunity to enhance our offering for Pros working on residential jobs, we had an even greater opportunity to enhance our offering for Pros working on commercial jobs. In the end, we added to our selection of wire types, gauges and covers, as well as full rolls of wire and cable to supplement the offering of wires sold by the foot, along with Contractor Pack pricing so Pros could benefit from buying bulk rolls. We also launched our new hand tools from Southwire, a brand electricians know and trust. Of course, winning the Pros business also requires great service in an omnichannel environment to make doing business with us quick and convenient. This quarter, we will relaunch LowesForPros.com, testing it with larger Pro customers before rolling it out more broadly. This relaunch will provide a dedicated platform for Pro customers to purchase online from Lowe's, in addition to aligning Pros to access contract pricing, develop requisition lists and view purchase history. And LowesForPros will be enabled for convenient mobile access. Our third area of focus is developing a process to coordinate the elements of great customer experiences. To do this, our dedicated customer experience design team is working with customers to better understand how they think about specific home improvement projects, from planning, shopping and buying to using and enjoying. And based on these insights, this team is designing an entire experience, from inspiration and product assortment, to purchase and fulfillment.
That experience must meet 3 critical criteria:
it must be desirable to our target customer; it must be feasible, in other words, it must fit within our organization's competencies; and it must be viable, so that we can deliver in a profitable and sustainable way.
An example of what can be accomplished with this approach is the outdoor living experience we rolled out to the majority of our stores in advance of our key spring selling season. We started with research and determined that customer shopping for outdoor living products relied mostly on in-store display for inspiration. Further, while selection, price and coordination of patterns and colors are customers' top shopping attribute, brand does not index as high for this product category. Customers are looking for inspiration as they seek to create an extension of their home and to use their outdoor space during more of the year. They want to directly interact with the patio furniture to assess its comfort and to envision using it. And they want the ability to build a collection over time. With these attributes in mind, we examined our previous outdoor living area and determined that customers cannot navigate easily through aisles filled with product and that coordinating products, colors and trends was more difficult when they were not close to one another. In short, we were selling isolated products, not helping customers build their outdoor world. We then used these insights to evolve our outdoor living experience. In over 2/3 of our stores, we removed 15 bays of steel racking to create a showroom filled with about 35% more open space, which is made possible by our larger store format. To help customers envision their outdoor space, we are displaying patio sets with coordinating rugs, umbrellas and accessories like pillows, lanterns and planters, along with grills and other outdoor products, just as you would expect in your own backyard. Customers can also customize their sets. Special orders can be delivered from distribution centers to stores in 7 days or less and coordination extends to Lowes.com. Customers can find style at every price point. In fact, this area showcases several sets under $500. This new experience better positions Lowe's as a destination for outdoor living and should drive sales to more improved close rate and attachment. In this case, because we have determined brand to be a less important shopping attribute for outdoor living products, we can leverage our direct sourcing capability to buy these high-quality products at competitive costs, which should benefit both sales and gross margin. We are pleased with the performance of the outdoor living experience so far. As the year progresses, this space will provide a flexible stage to display other seasonal products, such as holiday decor. Even while we are building customer experience design capabilities, our merchandising team continues to bring exciting new products to Lowe's customers. For instance, we just recently introduced STAINMASTER PetProtect, an exclusive in the Home Center channel. This carpet is made with a new fiber specifically designed to withstand the toughest pet stains, reduce pet odor and lessen the time required to vacuum pet hair. In February, we became the authorized dealer of Progress Lighting, whose interior lighting collection has the highest market share with Pro customers. We're also excited about our recent rollout of Valspar Reserve, which will be our most technologically advanced paint formulated with a new coloring system to increase durability, scrubbability and adhesion to challenging surfaces, and to provide unparalleled hide and coverage. These are just a few examples of how we continue to work day in and day out with our vendors to bring more innovation and value to customers, even while we work to better capitalize on the Pro market and differentiate through customer experience design. Thank you for your interest in Lowe's. I will now turn the call over to Bob.
Robert Hull:
Thanks, Mike, and good morning, everyone. Sales for the first quarter were $13.4 billion, an increase of 2.4% over last year's first quarter. Total transaction count increased 2.9%, while average ticket decreased 0.5% to $64.68. As previously discussed, the Orchard Supply stores had more transactions per square foot, but fewer per store and a lower average ticket than a traditional Lowe's store. So while Orchard aided total sales by approximately 110 basis points and it added roughly 240 basis points to our total transaction growth, it negatively impacted total average ticket growth by approximately 130 basis points. The Orchard stores are considered noncomp, but will be included in our comp sales calculation after the anniversary of the acquisition in the third quarter of 2014.
Comp sales were up 0.9%, comp average ticket was up 0.8% and comp transactions were up 0.1%. Looking at monthly trends. Comps were essentially flat in February, 2.5% in March and flat in April. While the late Easter holiday did not affect comp sales for the quarter, it did impact the monthly spread. We estimate that normalizing for the timing of Easter holiday, March and April comps would have been 0.8% and 1.9%, respectively. We are encouraged that both ticket and transactions adjusted for the Easter shift improved sequentially each month of the quarter. This trend has continued into May. Gross margin for the first quarter was 35.5% of sales, a 70-basis-point increase over last year's first quarter. The increase was driven primarily by Value Improvement and the mix of products sold. SG&A for Q1 was 24.76% of sales, which deleveraged 14 basis points. Employee insurance deleveraged 18 points, primarily due to the Affordable Care Act, which drove a 10% increase in enrollment. We incurred long-lived asset impairment expense of $23 million, which resulted in 17 basis points of deleverage. These items were somewhat offset by proprietary credit, which leveraged 23 basis points due to continued growth in the program and lower operating costs. Given the sales shortfall relative to our expectations, we are pleased with our efforts to manage expenses in the quarter. Depreciation for the quarter was $373 million, which was 2.78% of sales and deleveraged 9 basis points compared with last year's first quarter as a result of the timing of information technology assets placed in service. For the year, we expect depreciation expense to be essentially flat to last year. Earnings before interest and taxes increased 47 basis points to 7.96% of sales. Interest expense, at $124 million for the quarter, deleveraged 7 basis points to last year, as total debt increased approximately $1.1 billion versus last year. Pretax earnings for the quarter were 7.03% of sales. The effective tax rate for the quarter was 33.8% versus 37.8% for Q1 last year. The lower tax rate, which aided earnings per share by $0.04 for the quarter, relates primarily to a settlement of prior year tax matters. Earnings per share of $0.61 for the quarter represents a 24.5% increase over last year's $0.49. The $0.61 per share includes both the $0.04 favorable tax rate impact and the negative $0.01 impairment impact. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $658 million. Our first quarter inventory balance of $10.5 billion increased $241 million or 2.3% over Q1 last year. The majority of the increase was driven by the addition of the Orchard Supply stores. Inventory turnover is 3.61, an increase of 4 basis points over Q1 2013. Asset turnover increased 14 basis points to 1.59x. Moving on to the liabilities section of the balance sheet. Accounts payable of $7.1 billion represents a slight increase over Q1 last year. The increase in accounts payable is lower than the 2.3% increase in inventory due to the timing of purchases in the quarter versus last year. At the end of the quarter, lease-adjusted debt-to-EBITDAR was 2.14x. Return on invested capital increased 249 basis points for the quarter to 12.02%. Now looking at the statement of cash flows. Cash flow from operations was $2 billion. Capital expenditures were $194 million, resulting in free cash flow of $1.8 billion. In the quarter, we repurchased 17.9 million shares for $850 million in the open market. We have approximately $5.4 billion remaining under share repurchase authorization. The remaining $60 million of the $910 million shown on the statement of cash flows as repurchase of common stock relates to shares repurchased from employees to satisfy statutory tax withholding liabilities, as well as the timing of share repurchase settlement across quarters. Looking ahead, here's our business outlook. We believe that we'll recover the majority of the Q1 sales shortfall. As a result, we have not adjusted our outlook for the year -- our sales outlook for the year. We expect a total sales increase of approximately 5%, driven by a comp sales increase of 4% and the opening of approximately 10 big-box stores and 5 Orchard Supply locations. We're anticipating an EBIT increase of approximately 65 basis points and expect the improvement will come from both gross margin expansion and SG&A leverage. After reflecting the favorable tax settlement from this quarter, the effective tax rate is expected to be 37.2% for the year. Given the lower tax rate and Q1 impairment expense, we expect earnings per share of approximately $2.63 for the year, versus our prior outlook of $2.60, which represents an increase of 22.9% over 2013. We're forecasting cash flows from operations of approximately $4.1 billion. Our capital plan for 2014 is approximately $1.2 billion. This results in estimated free cash flow of $2.9 billion for the year. We expect to issue incremental debt during the year as we manage to the 2.25 lease-adjusted debt-to-EBITDAR target. Our guidance assumes approximately $3.4 billion in share repurchases for 2014, spread roughly evenly across the 4 quarters. Carmen, we're now ready for questions.
Operator:
[Operator Instructions] Your first question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
My first question relates to sales and my second question or follow-up, if you will, relates to SG&A. Would it be possible for you, either to quantify the sales that you think you lost to the weather in Q1 or talk about the first half versus second half sales relationship that you would expect for 2014?
Robert Hull:
So Matt, we think the weather impacted our Q1 sales by approximately 150 basis points, that about 35% of our sales are outdoor or mix related. So it had a pretty good impact on Q1. As we said in our prepared comments, we do expect to recover the majority of that in the second quarter.
Matthew Fassler:
Okay. And as we think about the base that you would add that to, should we think about the run rate that you have in the nonweather-impacted markets and then add 1.5 points to that, or is that too simplistic of a calculation?
Robert Hull:
Probably too simplistic, since we've got tougher Q2 compares. As we indicated, our May is off to a good start. We're running at about mid-single-digit comp, driven by good balance of ticket and traffic. So we feel good about the start to Q2 and our ability to recover lost sales from Q1.
Matthew Fassler:
Great. And then on expenses, I just want to refer back to some of the color that I think you gave us after Q4, about a couple of expense items that you didn't reference. I think you had originally expected a bonus from retirement to deleverage for you a bit. You had also called out a property tax -- I'm sorry, store payroll item, in terms of significant leverage. Can you talk about what impact bonus accruals had on SG&A? And if it's possible to quantify the labor levers that you had, it would be very helpful.
Robert Hull:
So Matt, I think a couple of items we talked about were risk insurance would be unfavorable because of a unfavorable -- excuse me, to a favorable adjustment we had in Q1 '13. We actually experienced a favorable adjustment this quarter as well. But that was somewhat offset by the impairment, higher utilities and snow removal costs associated with the weather. We did think that bonus was going to leverage -- excuse me, deleverage in the quarter. It actually provided some leverage. If you think about our experience in the first quarter, we missed our sales and earnings plan. Our bonus plans are predicated on operating profitability, so the tax pickup had no impact on the bonus accruals, so we did leverage bonuses by about 9 basis points in the quarter.
Operator:
And your next question is from the line of David Strasser with Janney Capital Markets.
David Strasser:
Two questions. First of all, on the balance sheet, you had an impairment charge that you tend to take them usually in Q4. You took it in Q1 of this year. Can you just give a little background on what -- where the impairment came from and sort of why, the timing of it?
Robert Hull:
Sure. So we've got a process to evaluate the profitability and viability of store locations. That process occurs throughout the course of the year. There's a footnote in our 10-K that explains the process in some detail as we take a look at cash flows for the rolling 12 months to evaluate. There's no magic about what quarter that a trigger occurs and when impairment occurs. It does relate to 2 operating locations that gave rise to the $23 million charge in Q1.
David Strasser:
Fair. Back in February, you had -- Bob, you had made a comment that Q1 would be the best comp of the year. Obviously, the weather kind of impacted that. You're -- as you kind of -- I'm asking Matt's question a little bit differently, but as you kind of look at for the first half of the year, how substantial of a recovery do you need to sustain in Q2 to hit your first half estimate -- to hit your first half sales estimates? I mean, do you -- can you see a deceleration as that tough comp continues -- the tough comparison from last year continues through Q2 and still get to the -- your first half plan? Or is it -- or is that kind of mid-single that you talked about a kind of number that you sort of need to hit?
Robert Hull:
Yes. So on the Q4 call, we talked about Q1 being our -- coming into the year, we thought that Q1 would be our best performing comp, Q2 would be our lowest performing comp, really based on compares relative to 2013. Obviously, weather is going to push some sales from Q1 to Q2. Q2 looks like it's going to be our highest comping quarter at this point in time, even with tough compares. But having said that, the band between comp for Q2, 3 and 4 is fairly narrow.
Operator:
Your next question is from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
I was curious. Your quarter ends on Sunday, and Home Depot's quarter ends on Friday. So we were out in the stores that weekend, and it was a pretty nice weekend on the West, on the East Coast. So do you think that was some of the delta in the comp performance, because you probably had a really not a great first week in the February weather-wise, and then you had -- you missed the -- what looked like, on the East Coast and Northeast, a pretty nice weekend weather-wise in the beginning of May?
Robert Niblock:
Yes, Chris. This is Robert. Actually, what you said was that we end on Friday and they end on Sunday. So maybe that's what you meant, but I think you stated it backwards. But yes, certainly, as you think about the extent of the conversation that we've had so far today, weather was very difficult in the quarter, certainly pretty widespread. We've actually looked at the numbers and said, if we had adjusted and really looked at just the days that would have picked up that last weekend and dropped out the first weekend of the quarter, it would have made a difference on our first quarter comps of about 50 basis points favorable.
Christopher Horvers:
Okay, about 50 basis points. And then 2 expense questions. One, I might have missed it, but did you say anything about any negative impact in gross margin from proprietary credit? And then also, on D&A, when you say flat year-over-year, is that a -- that's a -- I assume that's a dollar number?
Robert Hull:
So the -- there was no negative impact, no significant impact to gross margin from the proprietary credit program and the 5% off val prop. As it relates to depreciation, we do expect dollars to be essentially flat to last year, therefore, driving some leverage that contributes to the EBIT increase of 65 basis points for the year.
Operator:
And your next question is from the line of Budd Bugatch with Raymond James.
Budd Bugatch:
Just a couple of quick ones. Pros -- Pro sales penetration in the quarter, where was it as a percentage of sales and where do think it will wind up for the year, with your new Pro programs?
Rick Damron:
Budd, this is Rick. We look at Pro as now approximately 30% of our total mix of business, and we continue to work on that daily. The thing that we've really looked at Pro, when you look at Q1, it was roughly 3x our comp number for the company. And I think we're getting some credit for the continued progress of the initiative. When you look at the Pros, they're reacting very strongly to our structure that we implemented last year of in-store specialists who really manage and handle the customers when they come inside the stores; our market account specialists, which manage the larger accounts within the marketplace; and then our national accounts program, which manages those accounts that do business across many stores across the country. That process and that program is working extremely well. Keep in mind, the investments that we made in inventory as well as the val prop proprietary credit discounts that we offer them to give them additional incentives, as well as our normal Contractor Pack pricing, which Mike spoke about earlier, as well as our other programs there to help continue to provide great value for them. We see the relaunch of LowesForPros being a significant opportunity to continue to drive share and increase penetration with that customer. As Mike said, we'll begin to test that with some customers in Q2, with the expected full launch to be in Q3 from that program as well. So we feel very good about where we are from a Pro standpoint currently. We believe they have reacted very well to our initiatives and our programs that were put in place over the last 18 months, and we continue to see that to progress into this quarter. And Mike, I'll turn it over to you, let you talk about some of the initiatives from a merchandising standpoint we're working on, from a brand and assortment standpoint.
Michael Jones:
Absolutely. The team made good progress on being more relative with Pros inventory depth, certainly critical localization, we continue to make progress on, as well as on brand. We continue to work to our brand portfolio to ensure that we have the right brands that Pros need. So we feel very good that our holistic approach of separating out those divisions that lean very heavy towards categories that have a heavy penetration of Pro. I spoke about it earlier, lumber and building material, tools, hardware, rough electric, rough plumbing, millwork, that putting them together under a single leader has helped us put more focus there. And the team continues to make progress on those areas that are critical for Pros.
Operator:
Your next question is from the line of Dan Binder with Jefferies.
Daniel Binder:
So I had a couple of questions. First was on labor training and kind of where you are with labor add-back and training. I think last fall, you had thought you needed to maybe add some more training hours, so maybe an update on that. And then on gross margin, as you know, your main competitor has essentially put a cap on where they want to see gross margin go for competitive reasons. And I'm curious what your point of view is on that as it pertains to Lowe's and where you think your gross margin should be.
Rick Damron:
Dan, this is Rick. I'll take the first part of that question, and then turn it over to Mike to answer the question around margin. From a labor perspective, we feel very good about where we were and what the operations teams with Dennis Knowles was able to accomplish in the quarter as we continue to look at payroll to provide positive leverage during the quarter during a very difficult environment from a weather perspective. It was an outstanding job on their part. And we feel comfortable that the labor that we added back in the stores last year as part of our weekday teams helped us fill that void that we had during the peak selling times of the weekdays, and we think there is no need to continue to add any incremental labor back into that environment. So currently, what we're looking at, of course, is as sales improve, we continue to add labor to match sales rate. That's the way our staffing programs and plans work. And our part-time mix gives us the flexibility to flex up and flex down to meet sales trends throughout the quarter, and that's what really helped us continue to provide solid leverage during Q1. As it relates to training, we spoke about training in Q3 from a perspective of making sure that our investment of those weekday team members was as solid as we can get, and we realized there were some training gaps there. We made some adjustments to the program to help solve that issue by placing them into specific departments versus allowing them to work in multiple departments, therefore able to provide them much better training to assist the customers in those departments. We feel good about that. The other aspect that we talk about as we continue to migrate to becoming an omnichannel retailer is to continue to develop skill sets of our employees in the stores. And we've invested a substantial amount of training time last year, making sure that they were able to address our customers when they came into the stores looking at the type of trips they were into shop, whether that be the customer is in on a specific mission trip, whether it was a project trip, or whether they were in the store seeking inspiration. We did substantial training with every associate on being able to recognize those and being able to adapt to the customer and what they wanted to focus on. So we continue to work on training. It continues to be a significant focus as we move into 2014, but we feel very good about our programs from last year, the investments we made and the results they provided. So Mike, I'll turn it over to you to answer the question on margin.
Michael Jones:
Sure, absolutely. Our 2014 outlook talks to approaching 35%, but we don't think there's a hard cap on gross margin. Let me talk about Value Improvement, because that's the process that we use to really manage how we do our line reviews, which is a huge contributor to gross margin. We have a very balanced approach with our vendor partners. We always look at growth for both us and our partners. Innovation is central in those discussions. We look at value for customers. We see these engagement opportunities as an opportunity to build partnership. And of course, cost is always a part of that discussion. But when you think about gross margin, you also got to think about line design as it impacts mix, and you got to think about the ability to find efficiencies with both us and our vendor partners so that we can drive out cost. So we think all this comes together to allow us to go after improved margin. And it's working, and it's working very well along all those fronts. So I don't know that it is a hard cap. We are continuing to drive mix, look for efficiencies and -- while improving our partnerships and going after innovation, and we're doing it in an environment and in a way that's allowing us to expand margin.
Rick Damron:
Yes, Dan, this is Rick. Just to expand on one other key point, and that's related to our Sales & Operation Planning process. One of the things that we identified as we continue to look, over the last couple of years, was our ability to attach and how do we really continue to drive that through our employees and how we merchandise our stores and get our stores prepared for events. And our Sales & Operations Planning process helps us really understand the attachment to go along with the core item, which ultimately helps us improve the basket, therefore helping us to improve the overall margin mix within the basket as well.
Robert Niblock:
Dan, this is Robert. Just to sum it up, we -- as we go to market, we will continue to be priced competitively. As Rick spoke of, it's helping, mix and margin, with attachment and the right items there. As Mike said, we've done a lot of work the past couple of years going through our Value Improvement line review process. If you recall, during that period of time, there was some disruption where we had excess product that we had to clear and mark down, and we refer [ph] to cycle through the majority of that now, so a little bit cleaner numbers are coming forward. But just so -- the underpinning for all of that is we will continue to be competitive on price in the marketplace across all channels that we compete in, so...
Operator:
Your next question is from the line of Dennis McGill with Zelman & Associates.
Dennis McGill:
You touched on a couple of regions, I think you mentioned the Southwest and Northeast. I was just wondering, how many regions do you have? And can you just maybe talk across all of them, sort of what you saw relative to the company, like comp in the quarter?
Rick Damron:
Yes, Dennis, this is Rick. We have 3 operating divisions, and that's what you heard us speak about when we talked about the Southern markets, the West and the Northeast. Within those, we have 14 regions encompassing a mix of each of those. What we saw was, as Bob highlighted in his comments, where we had solid weather or good weather, more normalized, we saw solid mid-single digit comps around each of those geo-zones, as we refer to them, Deep South and South being particularly strong. The central parts of the country performed well, particularly as we got into the latter half of the quarter. The North and the upper North was where we saw a greater amount of weather impact, and where we saw the negative comps from an overall sales environment as a result. So we feel very good in those markets from -- for the quarter from the Deep South, Southern and Central areas. The North and the upper North is what put pressure on the overall performance.
Dennis McGill:
Okay. So at the highest level, the South and West was at mid-single and the Northeast was down at the 3 divisions?
Rick Damron:
That's correct.
Robert Niblock:
Yes, and Dennis, basically, we look -- this is Robert -- we look inside the South and the West, every region in those had positive comps. When you get up to the North, the division, every region within that had negative comps. So it really does kind of [indiscernible] that we saw during the quarter, so...
Dennis McGill:
Okay, great. And then second question, just on margins. I think you highlighted the Value Improvement, as well as mix, on gross margin in the quarter. Can you separate those 2 and just maybe talk to, on the outlook, how those 2 things would trend, particularly here in the second quarter?
Robert Hull:
So of the 70 basis points improvement, Value Improvement was 45 basis points and mix was 20. As we cycle last year's Value Improvement activity, we would expect that benefit to diminish as the year progresses. The mix impact was primarily a result of selling less seasonal goods in the first quarter. We would expect that to flip in the second quarter, as we recover lost sales. It should be a slight drag in Q2 and then revert back to being flattish or neutral in the second half of the year.
Operator:
Your next question is from the line of Kate McShane with Citi Research.
Kate McShane:
I just wanted to know if we could have a little bit more detail on any changes we can expect from the changes in the merchandising team. Could we see further refinement to your merchandising strategy, and how disruptive could this be? And then just with regards to some of the refinement strategy you continue to make at the store, was there anything during the quarter that you could highlight that was particularly beneficial?
Michael Jones:
Sure, absolutely. This is Mike Jones. We don't anticipate any radical changes in our merchandising strategy. Our initiatives are very well vetted. We believe they will continue to create value for us. We love the enhanced partnerships that we have with our vendor partners. We're extremely close with our vendor partners. Our team has a very strong bench, and all of our leadership was united in our development of our functional plans. So there's no anticipated change at all. And we're confident that the changes that we've made with some of these promotions of some of our talent that's on our bench will be well received by our vendor partnerships. So we're very comfortable there. I spoke of the outdoor living set as one of the combined efforts between our merchandising team and our customer experience design team, which in particular, in areas that had pretty good weather, did extremely well, extremely well. So excited about that. As you look at the divisions that performed above the company average, you'll notice that our fashion fixtures is one of them. And if you walk our stores, you'll see a much more enhanced display of the way we do our bath sets, which is another example of how our merchandising team is working with our vendor partners to have the right products, as well as the influence of our customer experience design team as well. So we're very excited about our merchandising initiatives, we've very excited about our partnerships and we don't anticipate any dramatic changes.
Robert Niblock:
And in -- Kate, you also had a question about, was it any store refinements? I'm sorry, I didn't really catch what you -- what the intent of your question was?
Kate McShane:
Just as you continue to refine some of your merchandising strategies, were there any wins during the quarter that maybe were surprising to the upside or that were better-than-expected?
Michael Jones:
Yes, the 2 I would note would be the success that we had with our fashion fixtures, as well as our seasonal set that I spoke of.
Operator:
Your next question is from the line of Greg Melich with ISI Group.
Gregory Melich:
I have a couple of questions. First on the traffic and ticket mix. I think at the beginning of the year, you guys said about 2/3 of the comp will be ticket and 1/3 traffic. Given how the first quarter played out, do you expect that to change for the full year? And as May has recovered, is it the -- how did the traffic and ticket breakdown look like?
Robert Hull:
So as we think about our seasonal business, lawn and garden in particular is a huge driver of transactions in traffic for us. That was weak in the first quarter. That is beginning to recover in the second quarter, so that gave rise to the -- an out-of-balance performance, with almost all the comp being driven by ticket in Q1. As we get that traffic in lawn and garden business back in Q2, that is more balanced, almost 50-50 thus far in the second quarter. We think for the year, the 2/3, 1/3 ticket and traffic still holds up.
Gregory Melich:
That's great, helpful. And then on dot-com, you mentioned in several of the answers, how it's an initiative with the Pro, with the consumer and with some of the labor initiatives you have in specialist departments. Could you give us an update on where you are in that and in terms of percentage of sales, or ship-to-store or other things you got going on?
Robert Niblock:
Yes. Overall -- I'll start and have others jump in. Greg, overall, our dot-com business was up a little more than 25% in the quarter, so we're pleased with what we see there. Obviously, we're excited about adding LowesForPros in the second quarter, will really give the Pro a dedicated website to be able to transact on, with the additional functionality that Mike spoke of in his comments. We're still continuing to see about 50% of what is bought online is actually picked up in store. So the customer is using it in a -- it's really our whole strategy of being there to meet their needs whenever and wherever they choose to engage. And then on top of that, there's about another 20% that is delivered from the store to the consumers' homes. If you think about it, about 70% of what we sell online is fulfilled through that store channel. So it's -- as I said, being there whenever and wherever the customer chooses to engage. And we're happy to ship it to them, have it available in store, whatever. And we're continuing to add functionality, continuing to add the necessary products and refine the offering that we have now. Mike, I don't know if you have anything else on...?
Michael Jones:
No, I think you summarized it well. The one thing I would add is that we do have very strong dot-com businesses in some of the seasonal areas, some of the OPE, where we tend to index very highly. And as we look at the first quarter, we can see that some of the divisions that were below the company average have a pretty big footprint on our dot-com sales. And so that was a little bit of a headwind that we expect to see pick back up as we go into the second quarter. But all told, we feel very comfortable with our continued build-out of our omnichannel environment.
Operator:
And your final question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
Just a quick one to start. You said the weather impacted you by 150 basis points. If we add that back, then you would have comped at 2.4% in the first quarter, which still would be below your plan. Your plan was for the first quarter to be the highest comp of the year, which may be, well certainly above 4%. So what else missed the comp line in the first quarter?
Robert Hull:
So we've had -- we were expecting some level of deflation in the quarter. It was a little bit higher than we anticipated. The -- as we think about the estimates of comp impact, they're not precise. As Rick and Robert took you through the geography, strong performance in West and South, really challenged performance in the Northeast. So we do feel like we can recover the lost sales. We do feel like there's other activity, some of the initiatives that Mike spoke of regarding the experience design. Rick and Mike both talked to you about some of the Pro initiatives that's going to gain traction throughout the course of the year. So we feel that we'll recover the lost sales and do have other initiatives that will drive the 4% comp for the year. And the good news is, we're seeing evidence of that thus far in May.
Michael Baker:
Okay. So to follow up on that, how much did deflation hurt, and does that get better? And I guess, maybe my words instead of yours, but you said 150 basis points. I guess, what we should interpret that is that's not that precise. It could -- the weather could have been more or less than that.
Robert Hull:
Right. So we estimate it's 150 basis points. However, the West and South comped roughly positive 4%. The Northeast comped roughly negative 5%. So that tells you that's a 900-basis-point spread, so...
Michael Baker:
And what percentage of your stores are in the Northern region?
Robert Hull:
I'm sorry?
Michael Baker:
What percent of the stores are in the Northern region? Is it roughly 1/3, 1/3, 1/3?
Robert Hull:
Probably 30% of our sales. So we've got a consistent methodology to calculate weather impact. That hasn't changed. But if you take a look at just the division performance, you can see that weather could potentially be bigger than that. The deflation impact was 35 basis points. We see improvement in comparisons relative to lumber, so we see that headwind going away as the year progresses.
Robert Niblock:
Thanks, and as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter 2014 results on Wednesday, August 20. Have a great day.
Operator:
Thank you for participating in today's Lowe's conference. You may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Fourth Quarter 2013 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. Greg Bridgeford, 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. We delivered comparable sales growth of 3.9% for the quarter, with positive comps in 10 of our 12 product categories and the continued balance of ticket and transaction growth, and our ProServices business continued to perform well. We achieved this growth despite a holiday season where the retail sector experienced softer sales than anticipated.
Through continued use of our enhanced sales and operations planning process, we balanced softer sales of seasonal gift and holiday decorations with solid performance in core categories for interior refresh projects. We continue to see strength in recovery markets, with particular strength in California, Arizona and Florida, where the housing recovery is well under way. In fact, even with pressure exerted by extreme weather late in the quarter in the Northern and Central areas of the country, we recorded positive comps in all regions, except for the region most directly impacted by Superstorm Sandy recovery activity last year. I'm also pleased with our performance in Canada, where the team has delivered double-digit comps in local currency for the third consecutive quarter. Gross margin expanded 40 basis points in the quarter, driven by a number of factors that Bob will discuss. And we delivered earnings per share of $0.29 for the quarter, which included approximately $0.02 of charges related to long-life asset impairments. For the year, we delivered comparable sales growth of 4.8%, our strongest annual comp since 2005. Earnings per share were $2.14, a 26.6% increase over fiscal 2012. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $958 million of stock and paid $189 million in dividends. For the year, we repurchased $3.7 billion of stock and repaid $733 million in dividends. Looking at the landscape for 2014, economic forecasts suggest moderately accelerating growth. Stronger job and income growth should create a more favorable environment for consumer spending, which, coupled with the live benefit of the housing recovery, should generate continued growth in the home improvement industry. While credit conditions remain tight relative to the housing boom years, conditions are improving, and household finances continue to strengthen, which should also contribute to stronger growth in 2014. Also supporting the increased home improvement market growth is positive progression in consumers' views around personal finances and home values that we saw in our fourth quarter consumer sentiment survey. Homeowners continue to believe the value of their home is increasing and report that they are less likely to decrease spending. With consumers more willing to invest in their homes, the job and income growth forecasted for 2014 should provide the wherewithal for continued home improvement spending. In 2014, we will continue to capitalize on opportunities within an improving economy and we'll build on the momentum established in 2013 as we further optimize our business model. We have substantially completed our initiatives to enhance retail relevance, including value improvement, product differentiation and our store labor investment, and we will operationalize and refine these initiatives in 2014. Our top line [ph] performance improved this year as a result of our focus on cross-functional collaboration and consistent execution, along with our strategic initiatives, which allowed us to more fully capitalize on market demand. Now we are focused on improving our profitability even while investing in key capabilities to drive sales growth. Over the longer term, we remain committed to satisfying customers' needs whenever and wherever they choose to engage with us and to differentiating with better customer experiences than any other home improvement provider. Determined to be a customer-centered omnichannel retailer, we've been investing in infrastructure, both systems and processes. Our focus is on transforming our current multichannel offering in store, online, including mobile technology, in home and by phone, to an omnichannel experience with our brand. Through enhanced customer service tools, we expect to improve our associates' ability to sell seamlessly across channels, introduce new project management tools and to expand fulfillment capabilities beyond our bottom line pick-up-in-store or partial fulfillment of online orders, both of which we do today. And we will cultivate personal and simple connection with customers over and above what was accomplished to date with MyLowe's. These new capabilities are projected to be in market in 2015. We will differentiate Lowe's by delivering better customer experiences. In order to help customers visualize their home improvement projects, we will offer a cohesive group of products that provide relevant, occasion-based solutions and will present them in an inspiring manner. Greg will discuss further how we will begin building customer experience design capabilities in 2014. The commitments we made to improve for customers and shareholders require unrelenting determination. Completing the transformation we've undertaken is not like flipping a switch. It's more gradual and deliberate, like turning up the dial as we add new capabilities. I want to thank our employees for their dedication and hard work towards this long-term commitment. The momentum created by retail relevance initiatives, our strengthening execution and our keen focus on productivity and flow-through give us confidence in our business outlook for 2014. Bob will share those details in a few minutes. Thanks again for your interest. And with that, let me turn the call over to Greg.
Gregory Bridgeford:
Thanks, Robert, and good morning, everyone. We continue to drive balanced performance in the quarter, with strong execution and further momentum from our initiatives. We offset a soft holiday gift-giving environment by assisting customers in preparing their home for guests and cleaning and organizing after the holidays.
For instance, many customers were looking to replace their older appliances. Using our enhanced sales and operations planning process, we tightly coordinated advertising, promotions and inventory. As a result, we drew customers to Lowe's, and we met their needs through a broad assortment of innovative appliances, which, combined with our service advantages of next-day delivery and haul away and in-house facilitation of service calls, provides the best in customer service and simplicity. We also drove strong sales of fashion fixtures, both by making incandescent bulbs available to customers working to beat the government deadline and by providing compelling, new fashion plumbing products and sets for customers who were refreshing their bathrooms. And we know that winter weather can be unpredictable. So we are ready to respond quickly to the demand for items needed to cope with the January storms across many markets in the Northern and Central areas of the country. Customers needed snowblowers, space heaters, heating fuels, snow shovels and ice melters, as well as pipe fittings to replace those that burst from the extreme cold. Working with our vendor partners, we drove strong performance in these products using our distribution network to quickly and efficiently move them to where they were needed most. Our performance in the quarter is also a testament to the improved line designs and inventory depth resulting from value improvement. I'm pleased to share that at the end of the quarter, we had completely finished the first round of value improvement line reviews and substantially all of the associated resets. We'll continue to conduct line reviews in the normal course of business, but the annual volume of resets will be lower going forward. Examples of resets completed in the fourth quarter include core products, like pliers and wrenches; decor products, such as bathroom vanities and pedestal sinks; and seasonal products, such as house and patio plants. Value Improvement is now fully operationalized. This means that the improved line review and product reset processes are woven into our everyday business and are being used at an appropriate cadence for each of our nearly 400 product lines. Even so, we expect the initial round of value improvement resets to further contribute to our profitability in 2014, as we obtain a full year of benefits from resets completed over the course of 2013. We are now better positioned to meet customers' product needs and drive better inventory productivity. We are also pleased that we modestly leveraged payroll expense in the quarter. We have made the store labor investment more productive by refining our allocation of these hours by store and by selling department. In the quarter, we increased sales per hour by approximately 2%. As we lap the introduction of the store labor investment in the first quarter, we expect to obtain even greater leverage, which will contribute to greater 2014 operating profit. The store labor investment and value improvement are 2 of our initiatives designed to enhance retail relevance. Our third is Product Differentiation, which is intended to drive excitement in our stores through better display techniques, including our revised endcap strategy and revamped promotional spaces. Product Differentiation has been reset in 1,400 stores to date and will be rolled to the remaining U.S. home improvement stores in the first half of 2014. In addition to operationalizing our most recent initiatives, in 2014, we will focus on driving more of our revenue growth to the bottom line through expense control and disciplined execution of our plans. We will also focus on 3 priorities to drive further top line growth. The first 2 aim to capitalize on opportunities within an improving economy. First, we'll use our enhanced sellings and operations planning process to address micro-seasons by market. And second, we will improve our products and service offering for the pro customer. Our third priority will be to build customer experience design capabilities. Through our sales and operations planning process, we have addressed an opportunity to improve seasonal planning, including the cadence of product introductions, promotions and staffing. While we've always planned and executed these seasons in our stores, previous planning was completed function by function and then reconciled to minimize conflicts. Now the process starts earlier and is anchored on the customer mindset for the season.
The process more thoroughly considers detailed input from all functions to determine resource allocation, and it enables Lowe's to provide a consistent messaging experience across all selling channels:
stores, Lowes.com, contact centers and in-home selling. We also have an opportunity to better capitalize on pro market, which is growing faster than the consumer market. We'll do this by enhancing our product and service offering with this important customer.
While pros shop across the store, the penetration of sales to pro customers is highest within the traditional building and maintenance categories, including lumber and building materials, millwork, rough plumbing and electrical, and tools and hardware. So we grouped these categories under the leadership of a general merchandise manager, who is focused on ensuring we have the types of products and brands that pros demand. Of course, winning the pros business also requires great service to make doing business with us as quick and convenient as possible. So we continue to ensure we reach out to pros through multiple channels, whether in-store, where we have dedicated specialists to answer questions and dedicated loaders to help them get back to the job quickly; or the pros' place of business, where our account executives help regional maintenance repair and operations customers order and replenish products across multiple stores; or through the national account representatives, who assist customers doing business with Lowe's across the country. In the second quarter, we will relaunch LowesForPros.com, which will provide a dedicated platform for pro customers to purchase online from Lowe's. LowesForPros will also allow pros to access contract pricing, develop requisition list and view purchase history. And LowesForPros will be enabled for convenient mobile access. We also have an opportunity to more broadly enhance the customer experience. Customers already give us credit for a better customer experience, and we are strengthening that advantage. We're developing a process to coordinate the elements of great occasion-based customer experiences. To clarify, I'd like to define occasion. Customers don't simply shop for products, they shop to repair something, to replace something, to refresh a room or complete a major remodel. These are occasions. And we have the opportunity to build experience around these occasions that will inspire customer devotion, differentiate Lowe's in the marketplace and, ultimately, lead to superior business results. To do so, our customer experience design team is getting under the hood with customers, understanding how they think about home improvement projects, from planning to shopping and buying to using and enjoying, and based on these insights, designing an ideal experience with all channels in mind. Now that experience must meet 3 critical criteria. First, it must be desirable to our target customer. Second, it must be feasible, in other words, must fit within our organization's competencies. And third, it must be viable, something that we can deliver in a profitable and sustainable way. In 2014, we will begin building these customer experience design capabilities. We also -- we will also introduce a number of changes to our stores and website that will become a stage for future experiences. We'll invest in experiences that we expect to drive market share growth and solid return for investors. We expect 2014 reset expenses to be approximately flat to 2013, as declining expenses associated with line reviews are offset by increased customer experience design resets. As Robert said, we continue to turn up the dial of our transformation. Even as we focus on optimizing our business model, driving profitability and capitalizing on market opportunities within an improving economy, we are investing in customer experience and omnichannel capabilities to drive future sales growth. Thank you for your interest in Lowe's. And I'll now turn the call over to Bob.
Robert Hull:
Thanks, Greg, and good morning, everyone. Sales for the fourth quarter were $11.7 billion, which represents a 5.6% increase over last year's fourth quarter. That was approximately $100 million below our expectations, as the result of the extreme January weather Robert mentioned.
Total transaction count increased by 4.4%, and total average ticket increased 1.1% to $63.08. As discussed last quarter, the Orchard Supply smaller-format neighborhood hardware stores are located in densely populated markets and offer a product selection focused on paint, repair and backyard categories. As a result, Orchard stores have more transactions per square foot but fewer per store and a lower average ticket than a traditional Lowe's store. So while Orchard aided total company sales by approximately 100 basis points and added roughly 260 basis points to our transaction growth, it negatively impacted average ticket by almost 150 basis points. The Orchard stores are considered non-comp but will be included in our comp sales calculation after the anniversary of the acquisition in the third quarter of 2014. Comp sales were 3.9% for the quarter. As you heard from Greg, further momentum from our initiatives and improving execution drove balanced performance in the quarter. Comp average ticket increased 2.4%, and comp transactions increased 1.4%. Looking at monthly trends, comps were 3.3% in November, 6.3% in December and 1.4% in January. For the year, total sales were $53.4 billion, an increase of 5.7%, driven by a comp sales increase of 4.8%, the Orchard acquisition and new stores. For 2013, comp average ticket increased 3.2% and comp transactions increased 1.6%. Gross margin for the quarter was 34.67% of sales, an increase of 40 basis points over last year's fourth quarter. Value Improvement helped gross margin by approximately 40 basis points in the quarter. Also, sales mix and lower inventory shrink aided gross margin but these items were essentially offset by markdowns necessary to clear seasonal product and our proprietary credit value proposition. For the year, gross margin of 34.59% represents an increase of 29 basis points over fiscal 2012. SG&A for Q4 was 26.12% of sales, which deleveraged 69 basis points. The SG&A deleverage was driven by a variety of factors. In the quarter, we incurred $32 million in expense for asset impairments. This compares to $8 million for asset impairments and discontinued projects last year, resulting in 20 basis points of expense deleverage for the quarter. Risk insurance deleveraged approximately 10 basis points due to favorable adjustments experienced last year that didn't repeat this year. Property tax expense deleveraged approximately 10 basis points due to increase in property valuations and cycling a favorable adjustment from last year. The strengthening U.S. dollar caused losses in market values of forward cash positions and forward contracts, causing almost 10 basis points of deleverage. Also, building and site repair, reset and proprietary credit expenses each deleveraged about 5 basis points in the quarter. For the year, SG&A was 24.08% of sales and leveraged 16 basis points versus 2012. Depreciation expense was $370 million for the quarter, which was 3.17% of sales, and leveraged 56 basis points. The leverage was driven by the increase in sales, as well as assets becoming fully depreciated. Earnings before interest and taxes for the quarter were $627 million, which represents a 27-basis-point increase to 5.38%. EBIT was about $15 million below our expectations, driven by lower sales and the impairment expense. We're pleased with our efforts to manage expenses to mitigate these 2 items. For the year, EBIT of 7.77% represents an increase of 72 basis points over 2012. Interest expense at $128 million for the quarter deleveraged 11 basis points as a percentage of sales. The increase in interest was attributable to the $1.4 billion increase in total debt relative to last year. Pretax earnings for the quarter were 4.28% of sales. The effective tax rate for Q4 was 38.7%, which was consistent with our expectations. The higher rate this quarter, relative to the 36.7% last year, was driven by expiring tax provisions, which impacted year-over-year earnings growth by approximately $10 million. For the year, the effective tax rate was 37.8%, compared to 37.6% for 2012. Q4 earnings of $306 million increased 6.3% versus last year. Earnings per share of $0.29 for the quarter were up 11.5% to last year. The asset impairment expense resulted in an EPS drag of approximately $0.02 for the quarter. For fiscal 2013, earnings per share of $2.14 were up 26.6% versus 2012. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $391 million. Inventory at $9.1 billion was up $527 million, or 6% over last year. Approximately 30% of the increase was driven by Orchard Supply and the remainder to support of demand. Inventory turnover, calculated by taking a trailing 4 quarters cost of sales divided by average inventory for the last 5 quarters, was 3.74x, which was flat to last year. Asset turnover, determined using a trailing 4 quarters sales divided by average assets for the last 5 quarters, increased 12 basis points to 1.59x. Moving onto the liabilities section of the balance sheet. We ended the quarter with $386 million in commercial paper outstanding. Accounts payable at $5 billion was up nearly 8% to last year. The increase in accounts payable relates to the timing of purchases. At the end of the quarter, lease adjusted debt to EBITDAR was 2.23x. Return on invested capital, measured using a trailing 4 quarters earnings plus tax adjusted interest divided by average debt and equity for the last 5 quarters, increased 217 basis points for the quarter to 11.5%. Now looking at the statement of cash flows. For the year, cash flows from operations were $4.1 billion, cash used for capital expenditures was $940 million, resulting in free cash flow of almost $3.2 billion, which was a 24% increase over 2012. During the quarter, we repurchased 19.9 million shares for $958 million through the open market. Also, in the quarter, we received approximately 1.6 million shares as part of the final settlement associated with the accelerated share repurchase program executed in Q3. For the year, we repurchased almost 87 million shares for a total of $3.7 billion. I'm pleased to announce that our board has approved an incremental $5 billion share repurchase authorization. With $1.3 billion remaining on the prior authorization, we had total share repurchase authorization of $6.3 billion at year-end with no expiration date. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, economic forecasts suggest modestly accelerating growth in home improvement industry in 2014. We are optimistic about our improving execution. But with the recent slowdown in both housing activity and jobs growth, we've taken a cautious approach to our 2014 outlook. For the year, we expect total sales increase of approximately 5%, driven by a comp sales increase of 4% and the opening of approximately 15 big-box stores and 5 Orchard Supply locations. We expect to have our highest comp in Q1. This is an important quarter for home improvement and the easiest compare to last year. In addition, we expect the first half comp to be modestly higher than the second half of the year. We are anticipating an EBIT increase of approximately 65 basis points. As we've discussed in the past, 20 basis points of EBIT expansion per point of comp above 1% is a good rule of thumb for the year. However, there might be some choppiness quarter-to-quarter. Let me offer 2 items that will put some pressure on the flow-through for the first quarter. In Q1 last year, we had negative -- had a negative comp and reduced bonus accruals. This year, we plan to accrue at target levels resulting in deleverage of 20 basis points in Q1, while leveraging roughly 20 basis points for the year. Also, we will experience risk insurance deleverage in the first quarter, as we cycle favorable adjustments from Q1 last year. This item is expected to deleverage 20 basis points in the first quarter, but only 10 basis points for the year. We expect EBIT improvement will come from both gross margin expansion and SG&A leverage. Our initial focus during our transformation was on market growth. While market growth is still a priority, we are also focused on flow-through. The effective tax rate is expected to be 38.1%. The higher rate is driven by the expiration of tax provisions at the end of calendar 2013. The higher rate impacts earnings per share by almost $0.01 per share. For the year, we expect earnings per share of approximately $2.60, which represents an increase of 21.5% over 2013. Our outlook -- our 2014 outlook includes approximately $35 million of incremental expenses associated with the Affordable Care Act, or about $0.02 per share. We are forecasting cash flows from operations to be approximately $4.1 billion. Our capital plan for 2014 is approximately $1.2 billion. This results in estimated free cash flow of $2.9 billion for 2014. We expect to issue incremental debt during the year as we manage to the 2.25x lease adjusted debt to EBITDAR target. Our guidance assumes approximately $3.4 billion in share repurchases for 2014 spread evenly across the 4 quarters. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Greg Melich with ISI Group.
Gregory Melich:
I wanted to ask strategically on the store expansion, the 15 big boxes. Where are they going? And also, why add Orchard Supply stores? What do you see there and how are you thinking of using them?
Robert Niblock:
Greg, this is Robert. On the Orchard Supply stores, I think we've got 5 of them for planning up for this year. There's a lot of focus on remodeling the existing 72 stores that we purchased. As you know, those stores had not had a lot of investment put in them in a number of years, and we are seeing a nice lift in -- we are seeing a nice lift in the remodeled stores. So that's a big focus. And I think we've got about 10 remodels or so that we'll be able to accomplish this year. So and with our -- continuing to be any new stores for Orchard are really focused on dense, urban, metro areas that would have some clear air from a big box, so that you could really focus on being a community store and our go-to-market with the key categories that they focus on. Beyond that, on the other 15 stores, we've got about 6 in the U.S., about 4 in Canada and about 5 down in Mexico.
Gregory Melich:
Okay, great. And then on SG&A. I think, Bob, you mentioned the proprietary credit only hurt SG&A by 5 bps. Did your credit penetration decline or what was behind that? And in terms of the outlook, any color you could give on that test of additional labor you did last year, whether you expect to do more of that or how the traction is on that?
Robert Hull:
Sure, Greg, I'll take the credit question and let Rick speak to you about the plans for labor productivity in 2014. So credit penetration in the fourth quarter was 26.5%, which is a 160 basis point increase relative to the comparable quarter last year. As we think about the credit deleverage, it's really -- we had some favorable developments in loan loss reserves in fourth quarter last year. We had a little bit less favorable forms this year, creating some expense pressure, which drove the 5 or so basis points of deleverage from a credit perspective.
Rick Damron:
Okay, Greg, this is Rick. Regarding the labor investment. We made the decision at the end of Q3 to move the test into a permanent part of our staffing model, and completed that session this past year. We were very pleased with what we saw as our employees learned more about the store, we were able to get them into departments and get them trained. We saw greater productivity from that, which ultimately led to an improvement in close rate of 80 basis points in Q3 and Q4. So we were very pleased with the results, and we do not foresee any incremental investment required or any additional tests necessary. We're very comfortable with the investment we made, and we'll continue to drive greater leverage and productivity through 2014 with it.
Operator:
Your next question will come from the line of Laura Champine with Canaccord.
Laura Champine:
Your close rate performance was impressive. How do you measure that?
Robert Hull:
Laura, so a couple of different ways. So of late, we've been using satellite imagery. So we take pictures of parking lots throughout the course of the year. We match that up with actual transaction counts in stores. Of late, we've been actually using some technology that involves traffic counters in the stores, which gives us close rate by day, by hour, which is going to further allow Rick and the team to optimize labor going forward. We've got both methodologies for the same stores and got similar results. We're pretty comfortable with the methodology. It allows us to forecast and see actual improvement in close rates.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
I wanted to dig in a little bit on some of the investment spending you're going to do this year. So last year, you underperformed the benchmark of 20 basis points of leverage for every 1% of comp above and beyond that 1, and due in part to some of the investment spending. So I guess the expectation was there may be a little bit of catch-up this year. It sounds like you're going to perform in line with your rule of thumb. When -- at what point do you start to see the leverage? Some of those investments pull back and the flow-throughs really start to hit the P&L. Or do you have to continually invest in order to maintain that market share?
Robert Hull:
So Michael, the first part, the rule of thumb. If you take the 4.8% comp, subtract 1, that gives you 3.8 times 20 would suggest 76 basis points of EBIT expansion. We have 72, so we modestly missed the target. Remember, we guide off of GAAP, and our target's based on GAAP. There are some nonoperating fluctuations year-to-year, but it is what it is. So I would suggest we were fairly much on our rule of thumb for 2013. Greg, do you want to talk about investments and experiences relative to resets?
Gregory Bridgeford:
Sure. So as Bob was describing right now, Michael, the -- we're going forward and cycling down the massive amount of reset activity that we had through Value Improvement, which is obviously going to allow for more flow-through. But we are in the process of testing and piloting some customer experience work within the stores that we think is very important for now, for the foreseeable future. There'll be more of a balance of the total spend, when you look at the resets, re-merchandisings associated with customer experience and the decline in the large amount of resets that, for the first round of value improvement that we've seen over the last 2 years. So it somewhat balances out when you look at all the reset re-merchandising spend per store.
Michael Lasser:
Okay. And the follow-up question is on the $3.4 billion in share repurchases that you're expecting this year. That's a little bit below what you've done for the last few years. So what's influencing that part of the outlook?
Robert Hull:
So we've talked about a little cautious outlook coming into 2014. So as a result, our comp outlook of 4% is below what we would have intimated at the analyst conference in December of 2012 for 2014. If you think about 2013, our initial comp outlook was 3.5%. We delivered 4.8%. That's roughly $650 million higher versus the expected comp plan. In addition, our EBIT was about $175 million higher than planned, which is about a 26% flow-through rate. So if the market opportunity is there, we're going to capitalize on the opportunity and we're going to deliver an enhanced profitability.
Operator:
Your next question will come from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
I wanted to ask a question, this will be a quick one, just on the weather. Bob, you mentioned weather, a lot of people are talking about the weather. But is there a simple way we should think about what impact the weather had upon that comp? And what the comp would have been had it not -- had you not seen the weather? And then as a follow-up to that, what about gross margins? Was weather a positive or a negative to the gross margin for the quarter?
Robert Hull:
The $100 million that I referenced is approximately 100 basis points to comp, Brian. So it would have taken the 3.9 to approximately 4.9. And then, as it relates to gross margin, I mentioned mix had a modest positive impact based on the mix of products sold. So slight favorable impact on gross margin rate.
Brian Nagel:
Okay. Then -- and I don't know if the weather's actually turned in any parts of the country yet. I'm sitting in Nashville and it's still pretty cold here. Are there markets where you've seen the weather start to turn, and any indication that you've seen in sales in those markets so far?
Robert Niblock:
Brian, this is Robert. Obviously, that was an extreme weather, as I mentioned in my comments. Bob gave you the impact that we thought it had on the fourth quarter. But in those parts of the country where we've seen the weather improve or where we haven't been as impacted by the extreme weather, we've been pleased with the comp performance we're delivering.
Operator:
Your next question will come from the line of Aram Rubinson with Wolfe.
Aram Rubinson:
Two quick things, if it's okay. One, I'm still trying to make sure I understand this customer experience. It sounds great. But can you guys walk us through kind of for instance or 2 to make sure that it kind of clicks in my mind? And then I had a follow-up.
Gregory Bridgeford:
Sure, Aram. This is Greg. I'll be happy to. So when you go back to the question that we talked with -- Michael talked about a minute ago, with investment spend, some of the programs that we are testing right now have to do with going deep into customer research and see what's important for customers and make sure that we can start to build an experience that hit the attributes that they're looking for, both from all phases of a project, all the way from inspiration, to planning, to getting started, to getting supplies, all the way through enjoyment. We -- I mentioned to you a couple of years ago that we devoted 6 research -- consumer research analysts from our research team to the merchants to begin this process a couple of years ago. So, for instance, going on right now, and we're probably about halfway through this reset, we've looked at the fashion bath area and it was a challenge for customers to try to pull together a bath refresh project. They don't go behind the wall in a refresh, but they potentially change out -- they change out faucets, vanity tops, mirrors, lighting, a lot of details on the -- kind of on this side of the wall of the bathroom. So what they told us that they wanted was they wanted to visualize the results of this project. They wanted to bring -- they struggled to bring style and finish this together and look across the entire array of fixtures and accessories. And they want to understand what this looks like in end-use, but they also wanted to touch and feel the projects with the different products, and they wanted styles that met their taste. So what we did was we literally created pods. These are 8 foot, 16 foot pods to bring these different styles and finishes together in these categories
Operator:
Your next question will come from the line of Seth Basham with Wedbush.
Seth Basham:
I want to follow-up on that, regarding the customer experience design. That was a really helpful response, I agree, but if you could help us understand a little bit in terms of cadence of investments and then the expected benefit in 2015, that will be helpful. Then I have a follow-up on it.
Gregory Bridgeford:
These are a rotating series of programs. In '14, you'll expect -- you should expect that we'll do a lot of piloting as we learn what's working within these different tests. We'll be at trial in probably 5 or 6 categories, but it will be stretched out through the year. So we'll begin to see the payoff until '15 in virtually all of these different projects. The bath refresh, we you might see a payoff this latter part of '14. But I'd say, for the other pilots that we're doing, we'll see returns begin in '15. And when you think about the returns, in some cases, it's going to be -- it's going to come back to us in different ways. For example, if we do an outdoor living reset, and we accessorize product with the, what we call, the anchor product of a project, for example, accessorized complete patio set, one of the goals there would be to sell the set with the accessories at full price prior to the end of the season. That has significant financial implications in that category. That's different from the timing and the type of project that you're engaging if you're doing a bath refresh. In that case, it might be able to create that entire look of product and to be able to offer installation services and literally be able to offer the complete project installed for customers. So there's different financial components that will be part of the outcome, because we're trying to build these experiences around the attributes that customers are saying, "These are gaps. These are gaps or pain points in my current experience." So as we -- I said earlier that as we approach this customer experience designs, we have to make sure that we have the capabilities to offer these attributes to customers and meet them, and we also need to make sure that these produce the financial results that are sustainable. So we look -- we start with the customer. We look at the potential to re-create that experience. We look at the attributes that we're going to offer, make sure they fit our capabilities and make sure we have a clear understanding of the financial outcome. And it can be very different based on the occasions that we're trying to serve to customers to experience design.
Robert Niblock:
And just to tie back to Greg's comment and part of your question. And remember, because he talked about the amount of investment we're making on in-store resets, is we're rolling off all the line review value improvement resets that he said that the amount of reset activity would be fairly similar year-to-year, last year to this year, because we're now -- because some of the customer experience resets that Greg talked about that we'll be investing in.
Seth Basham:
That's really helpful. And just to follow-up, these investments play right into the increase we're seeing in big ticket comps relative to small ticket comps. Can you give us those metrics for the fourth quarter and tell us how you expect them to play out between 2014 and '15?
Robert Hull:
So in the fourth quarter, the tickets above 500 were 8.9% comps. Tickets below 50 were 1.2%. And the middle was, the 50 to 500, was 2.2%. As we think about the 4 comp in 2014, about 2/3 of that will be driven by ticket. 1/3 by increase in transactions. So we do expect to see continued performance in the above-500 category.
Operator:
Your next question will come from the line of Keith Hughes with SunTrust.
Keith Hughes:
Just to dig in on your last answer on the 8.9% on the greater than 500 ticket. Within the categories, were there any one that sit out there to help drive that number?
Robert Hull:
The biggest one in the fourth quarter was outdoor power equipment. We also had strength in -- which is snow throwers, largely, and then appliances and fashion fixtures. Those were the 3 categories that propelled the big-ticket growth in the fourth quarter.
Gregory Bridgeford:
And, Keith, also, flooring was a strong category. This is Greg. And it always tells you a lot about the weather when your top-selling subcategory is snow throwers. We see it hit historical highs in sales of snow throwers.
Keith Hughes:
I'm sure you had it in places where you normally don't hit those historical highs. One follow-up question. You had mentioned about more installed sales. Can you elaborate that a little more? Are there certain categories you are going to be pushing more on that or -- any detail will be helpful?
Rick Damron:
Yes, Keith, this is Rick. As we look about -- think about installed sales, we continue to see strength across all the major drivers of our programs this past year. As Greg mentioned, flooring performed extremely well and we continue to see growth in that category as customers look to update flooring in new styles and new trends. The other components of that, Keith, that we have invested in over the past couple of years have been our in-home selling models. As we talk about our strategy to be able to meet customers anytime, anywhere they like, we realize that in-home was a major component of that. So we now have our project sales exterior specialists in all stores and in all markets across the country. We also have our interior specialists programs, which we had significant test for the past couple of years in 2 regions and some other geographical areas. We're continuing to roll that out in 2014, and we will grow that into 5 additional regions in this upcoming year.
Operator:
Your next question will come from the line of Kate McShane with Citi Research.
Kate McShane:
My question is on gross margins. I'm just wondering how you're thinking about managing this going forward. Will you continue to push the gross margin higher? And if so, will that be reinvested or flowed-through?
Robert Hull:
So, Kate, if you think about our outlook back from the analyst conference December of '12, we talked about 1/3 of the EBIT improvement coming from gross margin, which is about 90 basis points. In 2011 and 2012, our gross margin fell roughly 84 basis points. So really, we're just talking about recovering back to 2010 levels. Once we do that, we don't expect significant margin expansion on an annual basis after that. It's more of a maintenance mode.
Gregory Bridgeford:
Kate, this is Greg, I would also say that the work we do in sales and operations planning, I think, tries to create that proper balance between driving transaction, driving ticket. And in doing so, we try to drive basket builds so that the out -- the gross -- the out-billing gross margin is something that is accretive for us. So it's a good mix that we've been getting better and better, I think, over the last 18 months, since we've instituted this process of making sure that what we direct customers to through our advertising and through our in-store merchandising creates the gross margin outcome that we want as we drive the entire basket of attachments and anchor items.
Operator:
Your next question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
Two questions. So since you keep referencing that December 2012 outlook, I think about outlook you talked about at 9.7% operating margin. Even with the 65 basis points that you talk about in 2014, you'll be a ways away from that. Can we still expect 9.7% by 2015, which would imply a pretty big jump in 2015 versus '14?
Robert Hull:
So, Mike, as we think about the rule of thumb of 20 basis points of EBIT expansion per point of comp, hopefully, we'll see strength in 2014 and be able to over-deliver both the sales and EBIT plan in 2014, which would suggest a much lesser increase required in 2015. So simple math, if you take a look at the rule of thumb, that would just suggest 20 basis points per point of comp above 1; a 5.5 comp in 2014 and 2015 gets you there. However, if there's a more modest comp and there's an opportunity to further focus on expense productivity, there might be another way to get there. So we do have line of sight to drive market growth and enhance profitability. Whether that's through line design and building baskets, as Greg described, or as Rick talked about, further optimizing the labor investment we've already made in our stores, we're really focused on that.
Michael Baker:
Okay. So that was my longer-term question. The short-term one. So first quarter is guided above 4%. Is that what you're seeing in February? Or is it more of a function of March is -- it was, I think, last March, was down 10%, so very easy comparison coming. But then again, of course, April was a tough comparison. So where are you, I guess, relative to that 4% -- higher than 4% planned for the first quarter?
Robert Hull:
So we did have a negative comp in the first quarter last year. The first 2 weeks of February were tough. Trends have improved significantly since then, and we are very comfortable with our outlook for the first quarter and for the year.
Operator:
Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Can you provide any more color in terms of what you're seeing on the pro or contractor front? And frankly, I don't know how granular you can get, but what kind of the impact do you expect as you start to expand the services and products for the pros that you previously referenced?
Rick Damron:
Okay. I'll take the first part of that. Then I'll let Greg jump in on the categories and products. Scot, we have been very pleased. As you know, we've been focused on the pro essentially for now through about the past 18 months, looking at how we went to market and the opportunities for gaps that we saw that we needed to close to continue to gain share and be more relevant with the pro. We've completely redesigned our operating model regarding the pro this past year, which really took place in January, in how we went to market from a service perspective with the pro. And Greg referenced that this morning, as we talked about our in-store specialists meeting the needs within the local market. Then we also redefined our account specialists in the market to really go after the larger MRO accounts and contractors within the market to give us the ability to meet them on their job sites or in their places of business. And then also, we established our national accounts team, which focuses on those pros who deal with us across many states and many stores and make it much more simple for them to shop with us. The other components of that, that we've really took and really made -- sort of we continue to evaluate was the value proposition. As you know, we -- the pro received 5% value prop discount on anything on proprietary credit. That continues to resonate well with the pro, as well as our "the close program" on very large orders. And then also, the value that our contractor pack program provides, which is really purchasing bulk quantities within the stores. So we think we really addressed that with looking at how we went to market from a service standpoint. Also, providing great value every day to the pro. And then, quite frankly, we're extremely excited about the relaunch of LowesForPros, which will happen late Q1, early Q2 this year, which provides them much greater access to product, as well as to purchase history and to purchase information. So, Greg, I don't know if you want to talk a little bit about pros.
Gregory Bridgeford:
Thanks, Rick. I think Rick really described very well the -- our ability to deliver, enhance the delivery system against expectations for the pro. And so the key is -- that I want to talk about is what do we have to deliver? What's the content? So we spent -- if you go back in the last 2 years, we spent a significant amount of value improvement, process improvements on looking at the categories that are extremely relevant and have a high penetration of pro sales, whether that's hardware tools, rough plumbing, rough electrical, power tool accessories, handheld power, hand tools, building materials. And we've tried to make sure that from an -- and as you know, we've also tried to make sure -- so we get our cost structure right, try to make sure from an inventory standpoint that we had the proper inventory. We've worked hard. We've been very overt about what we've been doing with inventory, specifically focused on the categories. Earlier in 2013, we said we need even a greater focus on this. So we subdivided merchandising. When Mike Jones came in, one of the first things he did within 3 months was subdivide the merchandising divisions and put a heavy focus on what we call the building and maintenance categories, with a new GMM. That's provided the kind of longer-term strategy and shorter-term tactics that we think we need to meet the needs of the pro and to address all the attributes that's important for them. So we've got a very, very heavy focus on it right now, what's the proper offering for this discrete type of pro customer, for this segment, whether it's an MRO customer, whether it's an R&R customer, and are we meeting those needs. And we're using research. We're going back to the basic approach with experience design, even in building and maintenance, and saying, "Okay, what are the experience attributes that are important for these subsegments?" So armed with that, we're building longer-term strategies to be important for that customer and shorter-term tactics that we think can optimize this great category, this great business, one of the best businesses in Lowe's and one that we have a long, long history in. And when Rick and I joined Lowe's, sales to pros were 60% in terms of our sales mix. So we both are dedicated to seeing relevance in this category.
Operator:
Our final question will come from the line of Peter Benedict with Robert Baird.
Peter Benedict:
A couple of questions here. First, a week or so ago, you guys outlined your spring seasonal hiring plans. I think you said like 25,000 associates this year. That was down pretty materially from last year. Just could you give us some color as to what drove the decrease?
Rick Damron:
Sure, Peter. This is Rick. As it relates to the announcement from last year, keep in mind some of the changes that we implemented last year. The weekday team that we hired was a component of that announcement last year, or the 40,000 hires that we announced last year versus the 25,000 hires this year. As I said earlier, those positions moved from temporary or seasonal into regular, part-time positions throughout the year. So when you look at that, we were able to maintain a much higher base of level of employees this year compared to the previous year, which, frankly, helps us from a training perspective and on-boarding perspective. And we were able to carry those employees throughout the year versus having to go so heavily into the spring hiring process. We were able to continue to manage our full-time and part-time mix to give us much greater flexibility and help us manage payroll in a -- during Q4, especially in the latter half, when the weather really turn bad, gave us the ability to use that flexibility to continue leverage payroll, but also maintain our existing employee base. So we were carrying many more employees through the winter, and then the addition of the weekday teams also helped us to be able to pull that number down.
Peter Benedict:
Got it. That makes sense. And then just 2 quick ones for Bob. Bob, you mentioned that the reset expense for '14 will be flat relatively with 2013. Can you remind us, and I apologize if you mentioned this already, how much reset expense was incurred in 2013? And then on the depreciation line, obviously, D&A was down around 10% in the fourth quarter on a year-over-year basis. Can you help us understand what your outlook for 2014 assumes in terms of D&A on the income statement?
Robert Hull:
Yes. So depreciation should be flattish from a dollar perspective, 2014 versus 2013, which drives some modest leverage as a percent of sales. As we think about the reset expenses, we haven't broken out the specific aspect of resets. We've talked about maintaining our stores, giving them the updates they need, whether that's the physical property or the updates to the products based on the customer experience that Greg described. So that's kind of embedded in our operating model going forward as part of maintenance CapEx, if you will.
Robert Niblock:
Okay. Thanks, Peter. And thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2014 results on Wednesday, May 21. Have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2013 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. Greg Bridgeford, 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.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. I'm pleased that we've delivered another solid quarter, driven by balanced performance. Comparable sales for the quarter were 6.2%, once again, driven by balance of ticket and transaction growth. We grew positive comps in 11 of our 12 product categories in the quarter. In fact, outdoor power equipment, the only outlier, was achieving solid positive comps into the last week of the quarter when faced with a substantial headwind from the sales of generators, the result of Superstorm Sandy. We also saw strength in all regions of the country, with double-digit comp performance in Florida, as well as particular strength in California and Arizona.
Markets for the housing recovery is well under way. And our ProServices business continued to perform well across the country. Our balanced performance is a testament to our enhanced sales and operations planning process, applied to the stronger base we've been building with value improvement, product differentiation and our store labor investment. I'm also pleased with our performance in Canada. We have a new leadership team in place, and for the second consecutive quarter, they've delivered double-digit comps in local currency. Gross margin expanded 26 basis points. We effectively controlled expenses, and we delivered earnings per share of $0.47 for the quarter, a 34.3% increase to last year's third quarter. Delivering on our commitment to return excess cash to shareholders, in the third quarter, we repurchased $761 million of stock and paid $191 million in dividends. As I mentioned, we've enhanced our sales and operations planning effort, a process that is led by our customer experience design team within Greg's organization. The intent is to better understand and anchor around the consumer mindset season-to-season and to change the way we go to market through coordinated planning across channels that binds together every function on our organization. That cross-functional effort has produced a comprehensive and coordinated view of the path ahead, allowing us to leverage resources to drive sales and margin. Greg will provide more details in a few minutes, leveraging our All for Fall campaign as a tangible example of this effort. Now looking to consumer landscape going forward. Our most recent consumer sentiment studies suggest that consumers are adopting a more resilient mindset and as a result, embracing a broader perspective. During the recession, consumers had a very focused perspective, the result of household budgetary constraints. Their primary concern was how to adapt to what felt like a free fall. That perspective has started to broaden as consumers have gained a foothold, and we're seeing it play out, strengthening home improvement affinity metrics, an increasing number of installed sales leads, as well as in the strength of large project category performance. So despite the recent government shutdown and falloff in home affordability, the home improvement industry is poised for persisting growth in the fourth quarter. As for our year-to-date performance and outlook for the balance of the year, we've raised our fiscal year 2013 guidance. We expect further acceleration of industry growth next year. Stronger job and income growth, improving household financial conditions and the lagging benefit of the recovery in home buying will be key drivers. In closing, our sales and operations planning process, applied to the stronger base we've been building with value improvement, product differentiation and our store labor investment, together with our associates' hard work and continued dedication to serving customers, has improved our level of execution, allowing us to more fully capitalize on market demand in 2013. Thanks again for your interest. And with that, let me turn the call over to Greg.
Gregory Bridgeford:
Thanks, Robert. Good morning, everyone. Our third quarter performance reflected our improving collaboration and execution within a strengthening home improvement market. We performed particularly well in large project categories such as flooring and kitchens and appliances. The strength of these large project categories reflects an emerging willingness among consumers to finally replace items that are worn or outdated or to make significant enhancements to their homes.
Large project discretionary spending is still far below prerecession peaks, but we are seeing steady improvement. We also performed well in fashion fixtures and paint, as we were well prepared with the right products and advice to assist customers as they spruced up their interiors in advance of the holidays. We're pleased that our improved performance is enabling us to take advantage of home improvement market growth. This is due in large part to our enhanced sales and operations planning process. Through this process, we have addressed an opportunity to improve seasonal planning, including the cadence of product introductions, promotions and staffing. We've always planned and executed these seasons in our stores. Previous planning was completed function by function and reconciled to minimize conflicts. Now the process starts earlier and is anchored on the customer mindset for the season.
The process more thoroughly considers detailed input from all functions to determine resource allocation and it enables Lowe's to provide a consistent message and experience across all selling channels:
stores, Lowes.com, contact centers and in-home selling.
Our recent All for Fall campaign, which ran from late August through the end of October, is a great example how the enhanced process works. Our planning began earlier than it would have under the legacy process. And instead of each function separately developing its own plan to achieve our comp and margin targets, we started with 2 key customer mindsets for the fall. First, customers wanted to complete fall maintenance projects, such as prepping the lawn for next spring, planting and sealing windows and doors to save energy during the winter. And then they transitioned to make their homes' interior more inviting to holiday guests. We anchored in the mindsets to determine the projects customers would complete, the key products needed, which of those products should be promoted to drive traffic, what product should be merchandised nearby as project completers, helping to build the basket, how much inventory would be needed, when it would need to be available, and what staffing and training was needed for each store department. Then, we staged the introduction of new product and sets based on climatic zone. This planning process, while capturing input from many different teams, was centrally managed by Bob Gfeller's customer experience design team. Bob's team communicated the final plans, both the underlying insights and the implementation steps. This approach drove better understanding of each function's role in the plan's success and consistency of execution across channels. This season's theme, All for Fall, was also clearly and consistently messaged across all media and was used in theme store displays built across merchandising. We believe that our particularly strong performance in fall interior project categories, like flooring, kitchens and appliances, fashion fixtures and paint, is evidenced that our coordinated All for Fall campaign resonated well with customers. And remember, this enhanced sales and operations planning process is made more effective by other elements of our transformation undertaken since 2011, including the organizational changes we made last year, our product differentiation initiative, which drives customer engagement through better display techniques and facilitates the smooth execution of seasonal themes and product introductions, and our value improvement initiative, which is providing the right product assortments and inventory depth by location. All these elements work in concert to improve the customer experience. Having just mentioned value improvement, I'd like to take a moment to update you in the progress of this initiative. At the end of the third quarter, we had completed resets, representing approximately 80% of our business, and we expect to substantially complete the initial round of resets in 2013. As a reminder, the financial benefit of value improvement is greatest once we have reached stabilization, that is, when we are past clearance and selling only new assortments. We estimate that roughly 2/3 of our business was at this stage at the end of the third quarter. Value improvement is captured in our improved comp performance, and we continue to obtain average gross margin rate improvement of roughly 100 basis points for product lines that have reached stabilization. Beginning in 2014, value improvement would be fully operationalized and no longer separately tracked as an initiative. Examples of resets completed in the third quarter include core products like thermostats and electrical tools; decor products such as wall sconces and decorative shelving; and seasonal products such as leaf blowers and fireplace gas logs. In addition to the value improvement resets, we are investing to improve the customers' in-store experience. One example of our implementation -- is our implementation of mobile functionality that helps customers locate products in our stores. Customers can create a shopping list and plan their route before arriving at the store. While there, they can check items off the list as they shop, ensuring they get everything they need accurately and efficiently. We'll share further plans to improve our customer experience as we enter 2014. Likewise, we continue to invest in inventory. Using intelligence provided by value improvement together with our sales and operations planning process, we are leaning into increasing demand as we bolstered job-like quantities to benefit pros, increase overall in-stock service levels and present compelling end cap displays. We expect that these incremental inventory investments will be completed this year, and we'll be positioned to achieve greater inventory productivity. We've also invested in additional weekday labor hours to improve close rates. As a reminder, we added an average of approximately 150 hours per week to the staffing model for nearly 2/3 of our stores. These hours were allocated to interior areas of the store supporting key fall projects identified within the sales and operations planning process. While we realized improving benefits from this program in the third quarter, this incremental investment caused payroll deleverage, as expected at this point in the program. We continue to monitor this initiative's performance and will make adjustments as necessary. Finally, I am pleased to share that through the first 3 quarters, approximately 87% of our U.S. stores have qualified for a service and sales employee initiative, or SSEI, payment. As a reminder, SSEI is our profit-sharing program for hourly associates. Thank you for your interest in Lowe's. And I'll now turn it over to Bob.
Robert Hull:
Thanks, Greg, and good morning, everyone. Sales for the third quarter were $13 billion, which was an increase of 7.3%. Total customer transactions increased 5.7%, and total average ticket increased 1.5% to $64.07.
As you know, we acquired 72 Orchard Supply Hardware stores on August 30. Orchard's smaller format neighborhood hardware stores are located in densely populated markets and offer a product selection focused on paint, repair and dockyard categories. As a result, Orchard stores had more transactions per square foot but fewer per store and a lower average ticket than a traditional Lowe's store. So while Orchard aided total sales by approximately 75 basis points and added roughly 175 basis points to our transaction growth, it negatively impacted average ticket growth by almost 100 basis points. The Orchard stores are considered non-comp and will be included in our comp sales calculation after the anniversary of the acquisition in Q3 2014. Comp sales were 6.2% for the quarter. Looking at monthly trends, comps were 7.3% in August, 5.6% in September and 5.8% in October. For the quarter, comp transactions increased 3.6%, and comp average ticket increased 2.5%. As Robert noted, our sales and operations planning process, applied to a stronger base we've been building with value improvement, product differentiation and our store labor investment, allowed us to more fully capitalize on market demand. Additionally, inflation added roughly 25 basis points to the comps, while last year's hurricanes, Sandy and Isaac, were a headwind of approximately 45 basis points. Year-to-date sales of $41.8 billion were up 5.8% versus the first 3 quarters of 2012, driven by a 5.1% increase in comp sales, new stores and the acquisition of Orchard Supply Hardware. Gross margin for the third quarter was 34.58% of sales, which increased 26 basis points over Q3 last year. The biggest driver of the increase was value improvement, which helped gross margin by 52 basis points. Our estimate of the improvement net the clearance impact of the resets against the benefit of the stabilized lines. This improvement was offset somewhat by the following items. First, our proprietary credit value proposition negatively impacted gross margin by 14 basis points. This is driven by higher penetration of our proprietary credit program, which reached 26.6% of sales, an increase of 145 basis points over Q3 2012. The negative margin impact was more than offset by expenses leverage associated with the program, which I will comment on in a moment. Also, competitive pressures in the market impacted the level of appliance promotions, which reduced gross margin by an estimated 10 basis points. Lastly, the mix of products sold modestly hurt gross margin in the quarter. Year-to-date gross margin of 34.57% of sales is an increase of 27 basis points over the same period last year. SG&A for Q3 was 24.56% of sales, which leveraged 47 basis points. In the quarter, we incurred long-lived asset impairment and discontinued project expenses of $10 million. This compares to $52 million in similar charges last year, resulting in 35 basis points of SG&A leverage in this year's third quarter. Risk insurance leveraged 35 basis points in the quarter. We are self-insured for certain claims related to workers' comp and general liabilities. Due to the duration of the claims, we discount our liability. As discussed in Q3 of last year, we reduced the discount rate applied to incurred but not reported claims, which increased Q3 2012's insurance expense by $33 million and was the primary driver of expense leverage this year [ph]. Also, we experienced 31 basis points of leverage associated with our proprietary credit program. The leverage was driven primarily by lower operating costs, including costs associated with promotional financing. Contract labor leveraged 20 basis points, as we cycled against an elevated level of spending for information technology projects in Q3 last year. These items were somewhat offset by incentive compensation expense, which deleveraged 41 basis points as a result of higher expected attainment levels relative to last year. During the quarter, store payrolls deleveraged 16 basis points. Payroll dollars were up approximately 9% versus Q3 last year, which includes the additional weekday hours investment. Resets and remerchandising expense deleveraged 16 basis points, driven by the efforts Greg described to improve customer experiences. Year-to-date, SG&A was 23.52% of sales, which leveraged 39 basis points versus the same period last year. Depreciation for the quarter was $373 million, which was 2.88% of sales and leveraged 20 basis points compared with last year's third quarter as a result of the sales growth. In Q3, earnings before interest and taxes, or EBIT, increased 93 basis points to 7.14% of sales. Year-to-date EBIT was 8.43% of sales, which was 85 basis points higher than the same period last year. For the quarter, interest expense was $125 million and deleveraged 2 basis points to last year as a percent of sales. Total expenses for Q3 were 28.41% of sales and leveraged 65 basis points. Year-to-date total expenses were 26.97% of sales and leveraged 54 basis points versus last year. Pretax earnings for the quarter were 6.17% of sales, the effective tax rate was 37.6%, which was essentially flat to last year. Net earnings were $499 million for the quarter, an increase of 26% over Q3 2012. Earnings per share of $0.47 for the third quarter were up 34.3% to last year. The $0.47 were roughly $0.05 per share higher than our expectations. Year-to-date earnings per share of $1.84 represents a 29.6% increase over the same period last year. Now, to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.1 billion. Our third quarter inventory balance of $9.6 billion increased $598 million, or 6.7%, versus Q3 last year. The increase was driven by higher inventory levels to support demand and the addition of 72 Orchard Supply stores. Inventory turnover, calculated by taking a trailing 4 quarters cost of sales divided by average inventory for the last 5 quarters, was 3.71, a decrease of 4 basis points versus last year. Return on assets, determined using a trailing 4 quarters earnings divided by average assets for the last 5 quarters, increased 98 basis points to 6.72%. Moving on to the liabilities section of the balance sheet. Accounts payable of $5.8 billion represented a 6.6% increase over Q3 last year, which was consistent with the increase in inventory. In the third quarter, we issued $1 billion of unsecured bonds. The bonds were split between 10- and 30-year issuances, with a weighted average interest rate of 4.44%. At the end of the third quarter, the lease adjusted debt to EBITDAR was 2.17x. Return on invested capital, calculated using the trailing 4 quarters earnings plus tax adjusted interest divided by average debt and equity over the last 5 quarters, increased 187 basis points for the quarter to 11.26%. Looking at the statement of cash flows. Cash flow from operations was nearly $3.9 billion, an increase of $351 million over last year, largely due to the earnings growth. Capital expenditures were $610 million, a 36% decrease from last year. As a result, year-to-date free cash flow of nearly $3.3 billion was 27% higher than last year. In August, we entered into a $500 million accelerated share repurchase agreement. At this point, we expect to receive 10.5 million shares, but the ultimate number of shares will be determined upon completion of the program in the fourth quarter. Also in the third quarter, we repurchased 5.5 million additional shares for $261 million through the open market. For the quarter, we repurchased a total of $761 million. We have approximately $2.2 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several items detailed in Lowe's business outlook. Based on our year-to-date performance and our outlook for the fourth quarter, we've raised our 2013 guidance for the second time this year. We expect total sales to increase by approximately 6%, primarily driven by comp sales increase of approximately 5%. We expect to open 9 stores for the year. We're anticipating an EBIT increase of approximately 75 basis points. The effective tax rate is expected to be approximately 37.8%. As a result of these inputs, we're expecting earnings per share of approximately $2.15, which represents an increase of 27% over 2012. For the year, we are forecasting cash flow from operations to be approximately $3.8 billion, our forecast for capital expenditures is approximately $900 million. This results in estimated free cash flow of $2.9 billion for 2013. Our guidance assumes approximately $3.7 billion in share repurchases for 2013. For the year, we expect that lease adjusted debt to EBITDAR will be at or below 2.25x. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
Bob, can you give us any more details on what the impact that Orchard had on the quarter, specifically on gross margin and SG&A? And I know you listed out some items already on SG&A, but I'm particularly curious on that line item.
Robert Hull:
Scot, so Orchard had relative modest impact. I gave you the sales impact, which is 75 basis points. Orchard's gross margin is modestly higher than the company's. But remember, we only had 2 months of activity in the 3-month quarter. From an SG&A perspective, not much impact other than we had roughly 5 basis points of deal-related expenses included in the quarter. That, obviously, was included in our guidance for the quarter but would not have been included in Q3 last year.
Scot Ciccarelli:
And then the compensation that you noted, the 41 basis points, that's executive compensation? Is that separate from the incentive comps of the stores? Can you just give us more clarity on that and kind of the way to think about that part going forward?
Robert Hull:
So, Scot, that is all incentive compensation. That would include the SSEI that Greg spoke of that is entirely store-based, that would be the store manager program, that would be DCs and that would be the corporate office. By far, the largest share of that expense is stores. Also, recognize that there's some timing involved in the accruals for incentive compensation. So while it's up 41 basis points to last year in the third quarter, it's only supposed -- expected to be up roughly 15 basis points to last year for the year. So you have to think about the rate of accrual this year versus last year. But it did have a pronounced impact in Q3 this year.
Operator:
Your next question comes from the line of Dennis McGill with Zelman & Associates.
Dennis McGill:
I was wondering if you could just talk about how you're thinking about the pace of growth transitioning from 3Q into 4Q, if you take the approximate 6% comps this quarter and then the pace down to, I guess, 4-ish implied by the guidance.
Robert Niblock:
Well, Dennis, I'll start. Certainly, there's a couple of things that we spoke about. Certainly, cycling against Hurricane -- Superstorm Sandy last year and the sales associated with that. So that's, obviously, a headwind in the quarter. As you know, in most years, the fourth quarter's probably our most weather-susceptible quarter. And so, certainly not knowing what the weather is going to hold last year, if you remember, the month of January had extremely favorable weather. So we are cycling up against, even if it's not unfavorable weather this year, we are cycling against a fairly favorable weather last year. So we took all of that into account. And so it's just a case of always wanting to be somewhat conservative closer to the end, knowing that it's out there. So I think all of those would be implied into the top line in the comp guidance, which was in our updated outlook.
Dennis McGill:
Okay. And just based on that last comment of conservatism, is it fair to say that November so far is running above that guidance?
Robert Niblock:
Yes, I don't think you would sense there, Dennis, that we feel more comfortable with our outlook for the balance of the year.
Dennis McGill:
Okay. And then just secondly, can you elaborate a little bit more on the appliance promotion headwind that you talked about in the quarter?
Robert Niblock:
Greg?
Gregory Bridgeford:
Yes, Dennis. This is Greg Bridgeford. I'll be happy to elaborate on that. It is a -- relative to larger-ticket categories and appliances is the key one. It is more of a promotional environment out there, and there's a lot of media out there. And we've indicated early on in the year, we're going to drive it as what we believe to be an effective blend of traffic-driving promotional activities and especially through the sales and operations planning process, make sure we are coordinated across the channels and across the messages we were sending, and especially in store. And that's what we did in Q3. It was as promotional as we expected it to be, and there is a -- this is a peak period for appliance sales pre-Thanksgiving. So we did see -- we performed well in appliances, one of our best-performing categories. And we're excited, the addition of LG this year has meant a lot to be a leader in innovation in appliances, with both LG and Samsung promoted and highlighted on our floors.
Operator:
Our next question will come from the line of Mike Baker with Deutsche Bank.
Michael Baker:
So you talked about the large-product discretionary sales still being below past peak. Can you talk about -- can you sort of quantify that, where you are versus past peak and also the trough after the recession? And I didn't hear -- maybe I missed it, but I didn't hear you talk about growth in tickets less than $50 or greater than $500 as you sometimes talk about.
Robert Hull:
Mike, we have those figures, and we'll come back to that. But let me start by giving you some context. We've done that 2 by 2 that you've seen so often, about small ticket/large ticket, nondiscretionary/discretionary. And in the discretionary large ticket category, it really hasn't moved appreciably. We are seeing in sales some movement, but we think it's from a -- it's relatively a small segment of the market right now that has the income that feels confident to spend on some discretionary categories. But overall, we still think it's a slow build because as we've tracked this through the last 6 years, we're still seeing that large discretionary spend inch up as opposed to make some significant leaps. Bob, do you want to talk about that, too?
Robert Niblock:
I got it. Mike, this is Robert. On the slides that we provided for you, that detail is in those slides, on 2 of the slides, but I'll give it to you. Less than $50, up 3%; $50 to $500, up 5.6; and greater than $500, up 8.6%.
Michael Baker:
I haven't seen the slides yet. The -- one other question, just this quarter, there were some incentive comp and other things. But can you remind us the kind of comp that you feel like you need to leverage your SG&A, excluding all onetimers that show up?
Robert Hull:
So like we've talked about, generally speaking, we need a one comp to get to a flattish and then beyond that 1 point of comp drives roughly 20 basis points of EBIT growth. Obviously, my response to Scot's question, I mentioned there is some fluctuations quarter-to-quarter in how incentive compensation's accrued relative to last year. So that's a pronounced impact this year. Also, in both Greg and my comments, we talked about reset and remerch activity. Think about that as preparing for next year's sales. We're including -- that included resets and customer experiences separate ad events since Q4 and beyond. So that's not necessarily a periodic expense, more of an investment for future sales.
Michael Baker:
But generally, we can keep that rule of thumb for -- on an annual basis.
Robert Hull:
Generally speaking, yes.
Operator:
Our next question will come from the line of Peter Benedict with Robert Baird.
Peter Benedict:
Just one thing on the third quarter. You said that the earnings were $0.05 better than your plan. I assume that the sales were favorable. But can you break it down a little bit, how much of it was sales and then gross margins, presumably a little less than you had anticipated, just a little more color around that.
Robert Hull:
Sure, Pete. This is Bob. Our sales were roughly $300 million higher than our implied guidance for the third quarter. The margin rate was modestly worse, largely due to the impact of the credit value proposition. The performance and the customer take on the program continues to be above our expectations, which is a good thing. As I noted, we had more than offset by lower promotional financing costs within SG&A. And then we only added roughly about $20 million of SG&A higher than our implied guidance. So that really drove the $0.05 beat.
Peter Benedict:
Okay, that's helpful, Bob. And then, a bigger picture question. Just trying to understand your current store portfolio and how it compares to how the company looked back in 2005, when you guys had your peak sales productivity and operating margins. I mean, you've added about 500 stores since then. Can you help us understand that bucket of stores and how they're performing right now relative to the rest of the business? Are they in line? Are they noticeably better? Are they lagging? What can you tell us about that?
Robert Hull:
So relative to 2005, our average sales since 2005 were roughly $37 million. The traditional big-box stores this year will do just a hair below $30 million. So to a degree, all boats have fallen based on what happened to housing in prior years. As we think about store performance, age of store is less of a predictor. It's more about location of the store and the local market performance and the state of housing. Yes, there were some stores that were opened in the 2006, '07, '08 timetable that underperformed. Some of those closed in 2011. But as we culled the pipeline and reduced the number of new store openings, the productivity of those stores has been really, really positive over the past couple of years.
Operator:
Your next question comes from the line of Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to get a little more color on the Pro customer. I know you mentioned the ProServices were solid. But can you just give any more color on maybe how the trends were, percent of sales, any incremental changes that you're noticing, and maybe what they're buying, are they making bigger purchases on the trips or not?
Gregory Bridgeford:
Joe, I'll start, and then I know Rick is going to add in. We've seen -- as we've mentioned, we've seen that particular segment of our customer base outperform any other segment. And that is intuitive, given the strength of commercial sales in the marketplace today under -- as you look at any third-party research. We have a number of Pro initiatives going on. I'll start in merchandising. We've actually restructured our merchandising group to make sure that we have -- are providing relevant commercial assortments, project-based assortments, that both have the breadth of product and the depth of product that we needed. Thus, the inventory investment we made earlier this year. It was targeted to what we call the center of our store, which is rough plumbing, rough electrical, hardware, power tool accessories, some of those categories that are key to commercial customer supply. Rick may want to add in some comments on Pro.
Rick Damron:
Yes, absolutely. When you look at this, Joe, when you look at our Pro sales, we had strong performance across all operating divisions. And as Greg mentioned, the sales of Pro continue to outpace our DIY consumer, and did so again in this quarter. Our average ticket increased by $2.38 year-over-year, driven primarily by ticket size and transaction. But ticket was the primary grower/driver of the performance, growing at 8.2 -- 8.9%, when you look at it from that way. We saw traffic increase in all ticket buckets, with the greatest amount being driven in the medium-range ticket growth area.
Joseph Feldman:
Got it. That's great. And then another kind of similar question. I know you mentioned that all regions were positive. I was kind of curious. Again, if you kind of look at what was selling in the various regions, are you seeing any big differences beyond the normal, like maybe the housing markets that are recovering a little faster at the moment, is what they're spending on different than some of the slower-recovering markets?
Robert Niblock:
Yes, this is Robert, Joe. I mean, we're seeing, obviously, as we said, widespread strength across the country. Certainly, I've talked about California, Florida, Arizona, areas where we're seeing housing recover. As we've said is that -- one of -- we feel good about now the recovery is taking place out there in housing. We expect that to continue through the fourth quarter and obviously into 2014. And one of the big drivers is where home values are increasing, consumers are feeling better about moving gradually into larger and larger projects. So whether that's -- in some markets, that may be windows, when they're doing work there. At other times, it may be refreshing the inside of the home, the bath, those types of things. Obviously, we -- how I end up a lot of the categories, when you think about flooring, kitchen appliances, paints, all of those being above average for the company where you're seeing the consumer reinvest in the home. So we saw a nice balanced strength across the country, and we expect that to continue as housing values continue to recover.
Gregory Bridgeford:
Joe, this is Greg. To layer on to Robert's comments, where we've seen some particular category strengths in some of the areas where we're -- where housing is on quite an upturn is in the fashion fixtures category in kitchens and appliances. And it's really interesting because it's more of a refresh than a remodel activity. So you're seeing some delayed -- in some cases, it's projects that may have been delayed for 4 years in particular parts of the country where housing values have been on a rise for the last 18 months and the last 12 months. So we're -- our focus is on bath refresh and kitchens and appliances, where the opportunity is available. And that's -- that did very well for us in Q3.
Joseph Feldman:
Perfect. That's really helpful. And if I can indulge one more question. The buyback trend seems a little bit slower than, I think, what we had initially thought. Any color you can provide there?
Robert Hull:
No, I think, Joe, coming into the year we said the buyback would be roughly pro rata across the 4 quarters. It's modestly lower in the third quarter, but we're still targeting $3.7 billion for the year, which is up $100 million from our thinking 90 days ago.
Operator:
Your next question comes from the line of Budd Bugatch with Raymond James.
Budd Bugatch:
I guess I have 2 questions. First, on Orchard Supply, what's implied in the guidance for Q4 and will it be accretive? Or how do you think about that?
Robert Niblock:
I'll start just with overall. Just remind me and I'll have Budd, then I'll have Bob jump into the guidance. As you know, we bought assets at 72 locations. We didn't buy the entire company. So coming out of bankruptcy, we bought the assets of 72 locations. That's why they're not comped. We don't have prior districts built in the numbers. So it's just from the performance of those 72 locations from the August 30 date going forward. And so, Bob, what's built into our guidance?
Robert Hull:
Yes, I think, as we think about fourth quarter, Budd, should add about $125 million in sales or about 110 basis points to sales growth. For the year, Orchard is going to be modestly dilutive, about $0.01 per share, which does include the deal cost I mentioned previously.
Budd Bugatch:
And just on that, just making sure, what was it in this quarter? Was it the $0.01 in this quarter or would the $0.01 be in the fourth quarter, or is it a half and half?
Robert Hull:
Half and half.
Budd Bugatch:
Okay. And my second question really goes to appliances. You talked about 10 basis points of margin degradation. Appliances are about 10% of your overall business, if it's still true as it was in 2012. That implies that the overall appliance margin was down about 100 basis points on the appliance sales. What's the outlook for Q4? How does that impact overall gross margin? Are you going to get any help from the vendors? Maybe you can go into a little detail of what's implied in your guidance and how we should think about all that.
Gregory Bridgeford:
Yes, Budd, I'll start. This is Greg. The focus on our work in Q4 is that -- is to make sure that we continue the sales momentum. And I think we're always adjusting the balance of promotional activity from ticket to traffic-driving and basket-building. And that's the work of that process I talked about today called sales and ops planning. So as we move past Thanksgiving, we move into seasonal categories. We move into gift-giving opportunities, like tools and hardware. We move into home fashions. We move into cleaning and home organization. So we're in a -- we have to drive against those occasions appropriately, and we're watching that balance very, very carefully. We're continuing to work on value improvement, which we're moving further down the cycle, virtually completing all the resets at the end of this quarter and moving to stabilization on a significantly larger portion of the business. We have resets going on in value improvement in Q4 because we have capacity to reset, particularly in December. So when you put that body of work together, we're -- we recognize that there is opportunity in the appliance category right now. We're trying to manage it appropriately through sales and ops planning. We also have lots of other opportunities on the occasion, and we will carefully manage and lead the blend of that business.
Operator:
Our next question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I'd like to start out by asking about the labor investment and just get a sense from you as to the return on that labor investment that you think you extracted this quarter and how that compares to your big picture expectations for that program.
Robert Niblock:
Matt, I'll start just a little bit and turn it over. Obviously, everything we're doing, we're talking about value improvement, product differentiation, labor, all of those things, I think, come together to see some of what you're seeing in the comp performance that we've had out there. We're starting to see an improvement on our close rates. So I think the investments are, I think, resonating with the consumer. Certainly, as you know, our average customer doesn't shop every day. So when we went into this, we knew with the incremental labor investments that it is something that we recognize the customer would build over time. So -- and I think we talked about, in prior calls, that it takes a little while to get the jobs filled with the right people, ensure with everybody that they work permanent weekday positions. We feel really good about where we're at now, and we're starting to see the benefits of that. But no, we knew it would be a drag at this point, because, as we said, we're making an investment, really, to build that experience that will build over time, so -- Rick?
Rick Damron:
Absolutely, Matt, one of the things, I think, that we learned as we move from the first half of the year into the back half of the year is how we allocate those hours across the store. We communicated in the initial rollout that they were used as flex moving across the store, interacting with customers throughout. As part of the sales and operation planning focus during the second half of the year, we've allocated those hours into the departments, as Greg highlighted, that we expect to drive incremental traffic to. So we're redeploying them more specifically into areas, therefore being able to provide greater depth of training into the areas that we'll be focused in this quarter. As Robert highlighted, the hours investment along with value improvement, product differentiation go-to allow us to capitalize on the market that is being driven in the marketplace. We went into the second quarter, we talked about gaining momentum coming out of the quarter. Pleased to say that momentum continued throughout Q3 and drove approximately 200 basis points of close rate improvement in Q3 compared to last year.
Matthew Fassler:
If I could just follow up, I guess, on expenses more broadly. The incremental operating margin that you drove this quarter, clearly, I think it was a bit lighter than where the Street was. I guess many of us looked at the numbers excluding the impairments last year. I know those are real dollars, but we don't really build them into our base. And I guess, the labor investment and the incentive comp were probably the 2 outliers, I would guess, to Street numbers. So, Bob, if you think about the -- whether you view this quarter as sort of an outlier from an expense growth perspective or whether this is sort of the run rate that you think we should consider, would be very helpful color for us for the go-forward.
Robert Hull:
Sure, Matt. So you mentioned potential outliers from where the Street were, and 2 items you mentioned were incentive comp and labor investments. The third item I would give you is the reset and remerchandising expense. So as we think about our business, they're not all periodic expenses. As Robert mentioned, with the labor hour investment, just because you add somebody in a department today doesn't mean the customer shows up the same day and they're able to interact with that associate. So some things do take time. As I mentioned with the incentive comp, it's lumpy based on the rate of accrual going forward. I think, Matt, in prior conversations, a lot of discussion regarding Lowe's ability to capitalize on the market, how well are we doing from a comp sales perspective, how well are we doing from a market share perspective. For the first 3 quarters of 2013, we are growing with the market, something we couldn't have said in prior years. We feel good about that. As we think about investing in our business, we expect to generate returns on these investments, whether it's SG&A or inventory, it just doesn't show up in the same quarter.
Matthew Fassler:
And consequently, the dollar growth rate, would you expect it -- I mean, clearly, incentive comp is lumpy, but as you think about the end impact for labor for the next couple of quarters, should that persist and just sort of wait for the business to build?
Robert Hull:
The labor will persist until we cycle the investment last year. As was described previously, as we think about the training and classification and positioning of those employees to better match up with the seasons and the sales and ops planning process to ensure that their positioned for how likely to incent with customers and generate a return.
Operator:
Your next question will come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
Two questions. First of all, I think within the numbers that, if I remember right, the October improved a little bit from September. And I know October is when the Sandy compare began. I'm just wondering if you could give a little bit more color on the month of October. In light of that, were there other areas that improved in October that might be sustainable? Or was more of your Sandy influence showing up later into November?
Robert Hull:
Eric, relative to last year, we did have Sandy improvement, sales associated with Sandy towards the tail end of Q3 last year, obviously, all hitting in October, not a substantial amount of money. As I think about the rate of growth, I think we saw some improvement in some of the bigger-ticket categories in October relative to September. And Greg can probably...
Gregory Bridgeford:
Yes, we did, Eric. And that was -- one of the keys was that some of the big-ticket categories related to prepping home for the holidays began to kick in, in October, real strength in flooring, strength in kitchens, strength in appliances, strength in fashion fixtures and, most specifically, fashion bath. So those were -- that was some of the impact that you saw sequentially from September to October.
Eric Bosshard:
Great. And then, secondly, if you could give us a bit of an update of, as you're working through the line review process and wrapping that up here shortly, what the next phase of that might look like, how that is continuing or evolving from the first effort, given the pace of what you're doing in those areas as we move into '14 and beyond relative to what you've experienced over the last 12 or 18 months.
Gregory Bridgeford:
Yes, absolutely, Eric. The -- what you're seeing in the fourth quarter now is a completion of the resets of what we would call the first round of accelerated product line reviews or value improvement category programs. In some categories, we are actually in round 3. So this is an ongoing process. But we have taken a step back, and we did this beginning 9 months ago. And we reset kind of the cadence of the process about 6 months ago and said, "Here's the categories that we're going to go through full line reviews on at least an annual basis." And as you know, in some categories, appliances, for example, because of new product introductions and staying on top of innovations, we actually have to review categories, in some cases, more than annually on a cadence. In other categories, we said we're going to review those on a mini basis in excess of more than -- in excess of a year, 18 months or 24-month basis. And in some categories, we're going to go in and do some tweaks, some business reviews in those categories. On kind of a constant basis, we probably could be on a 3-year rotation. So we really stratified the 400 categories into what's appropriate for those categories and where -- and but again, it's an ongoing process. The key is that if you -- and we all tend to forget the focus of why we're doing it. We're doing it to create values from using the insights and the information that customers give us about the buying occasions that these categories are represented in and to drive better line design, and therefore, drive better productivity out of that. So that's helped us quantify what's the timing of each of these. Does that make sense?
Eric Bosshard:
Yes, and within the timing -- I appreciate that. Within the strategy in implementing or executing this, is it fair to say that similar to sort of the earlier part of today's discussion, that it's a little bit more balanced than achieving market share progress in comps or with margin and inventory progress? How is the balance of that different in the second or third version of this relative to the first?
Gregory Bridgeford:
I think it is. What we're actually trying to drive through the ongoing improvements to this category that Mike Jones is leading in merchandising, is to go back and make sure we've utilized the consumer insights and research. Because line design, as the primary focus of, we think has -- we've hit the marks in a fairly large percentage of the reviews, but we still have some improvements to make there. If we do that, we get that better balance. We get better productivity out of the lines. We do it each share, but we achieve better, what I would call, operating margin flow-through.
Robert Hull:
This is Bob. Just 2 points back to your first question on monthly comp progression, looking back at Q3 last year, we did a 3.4% in September and a 1.3% in October. It's a little bit easier comparison in October. As it relates to storm activity, in Q3 last year, we saw sales associated with Isaac and Sandy in Q3 '12, roughly offset by Irene sales in Q3 '11. So storm activity was relatively flat for Q3 last year.
Operator:
Your final question will come from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Two questions. So big picture, you mentioned the 20 basis points of EBIT margin expansion per point of comp above 1. But to your point, Bob, as you think about next year, you get the major reset expenses behind you. You're going to lap the incremental labor that you put into the stores. And there should still be a lag benefit from -- to the gross margin line from the reset activity. So shouldn't that 20-bp rule look a bit better as we get this stuff behind us?
Robert Hull:
As we think about 2014, and we'll certainly provide a lot more color on 2014 on our Q4 call. As we think about what's next beyond value improvement and the works of Bob Gfellar's organization in the sales and ops planning process, there will be some other investments in customer experience design. Some of that is taking place in Q4 of this year. And then the second thing, as we think about 2014, Chris, is our prior outlook regarding '13, '14 and '15 did not have any expenses associated with the Affordable Care Act. We have open enrollment at this point in time, as we think about the individual mandate, and the number of employees that are on our insurance plans in '14 relative to '13 is still unknown. So we'll certainly provide more color on that and other initiatives on the Q4 call.
Christopher Horvers:
And then more as it relates to the fourth quarter. Just to check my math, based on what you said about the incentive comp pressure for the year, about 15 basis points, it looks like -- does that imply about 5 basis points or so of incentive comp accrual pressure year-to-year in the fourth quarter? And should the reset benefit to gross margin improve sequentially, given the number of categories through stabilization?
Robert Hull:
So yes, as we think about the reset benefit, that should be greater because greater lines stabilize in Q4 relative to Q3. Having said that, Greg noted, this is peak time for appliances. When we think about Black Friday morphing into Black November, there's some risk on the margin line there that we're proceeding with caution. As it relates to expenses, Chris, I'll give you some color on pushes and pulls for expenses for Q4. The biggest delever is reset and remerchandising. Call that 40 basis points; risk insurance about 20 basis points, largely because we had huge favorability Q4 last year; credit about 20 basis points. Again, huge favorability Q4 of '12. And then similar deleverage in operating salaries because of labor hour investment offset by incentive comp leverage of roughly 10; some contract labor impairment; and legal benefits in the 5- and 10-basis-point range.
Robert Niblock:
Thanks again for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter 2013 results on Wednesday, February 26. Have a great day.
Operator:
Ladies and gentlemen, this concludes today's call. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to the Lowe's Companies Second Quarter 2013 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 most directly comparable GAAP financial measures and other information about them as well as reference slides pertaining to second quarter results posted on Lowe's Investor Relations website under Investor Documents. 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. Once again this quarter, we have provided slides on our Investor Relations website to supplement our call. While we do not plan on speaking directly to the slides, we encourage you to download them to facilitate your review of our results and to use as a reference document following the call.
After my remarks, Rick Damron will review operational performance and Bob Hull will review our financial results in detail. But first, I'll provide some highlights of the quarter, as well as our view on the economic landscape for the second half of the year. Comparable sales for the quarter were positive 9.6%, driven by healthy balance of ticket and transaction growth. As expected, we recovered most of the outdoor sales we missed in the first quarter from unfavorable weather conditions. And we also capitalized, as planned, on consumers' natural mindset shift during the second quarter from lawn maintenance early on to outdoor enjoyment in the mid to latter part of the quarter. Our Time to Shine campaign resonates with customers looking forward to spending time outdoors and celebrating summer with family and friends. While outdoor categories were strong, we also saw strength in indoor categories. In fact, all 12 product categories had comps at or above 5%. Likewise, all regions had positive comps in the quarter, and our ProServices business continue to perform well. We're focused on improving our core business through cross-functional collaboration and consistent execution in-store and across other selling channels. I'd like to thank our employees for their hard work and continued dedication to serving customers. Home improvement demand was strong during the quarter, and the teams improving execution allowed us to capitalize on it. Gross margin expanded 42 basis points in the second quarter, as we made further progress with our Value Improvement initiative. We also continue to effectively control expenses and deliver earnings per share of $0.88 for the quarter, a 37.5% increase to last year's second quarter. Delivering on our commitment to return excess cash to shareholders, in the second quarter, we repurchased $1 billion of stock and paid $174 million in dividends. I'm also pleased that we made further progress with our previously announced bid for Orchard Supply Hardware. The government antitrust review has concluded. And yesterday, the Bankruptcy Court approved our bid for the 72 stores that we chose to include in the transaction. We expect the deal to close at the end of August and to be funded with operating cash flow. Strategically, the transaction will provide Lowe's with an attractive opportunity to increase our footprint in California, where we're currently under-stored, to a neighborhood format that is complementary to our strength in big-box retail. Orchard's hardware and backyard stores have a loyal customer base and are situated in high-density prime locations. We see significant potential for Orchard as a stand-alone business within Lowe's portfolio, and we look forward to the opportunity to participate more fully in California's economic recovery. Now looking at the landscape in the second half of the year. The stronger-than-expected pace of home improvement industry growth so far this year was fed by modestly stronger gains in housing turnover and job growth than originally forecast, further offsetting the negative effects of higher taxes. The industry outlook for the second half hinges on the impact of steep increases and mortgage rates expansion over the last few months. The rate increases will likely take some sting out of the recent housing market rebound, but shouldn't derail it as long as job gains persist, homes continue to appreciate and rates rise more gradually going forward. The macroeconomic transition from recovery to sustainable expansion, together with our initiatives in improving operational collaboration, give us confidence in our business outlook for 2013. Bob will show those details in a few minutes. Before I turn it over to Rick, I'd like to share why I'm enthusiastic about Lowe's long-term prospects. Our business is sound and our brand is strong. We're the second largest player in home improvement market, which provides tremendous buying power and economies of scale. Additionally, we are generating solid cash flows even as the economy emerges from the worst housing downturn in generations. We will use that cash flow, first, to make strategic investments in our core business and other opportunities that draw on our ability to serve, developing home improvement markets; second, to pay dividends; and third, to repurchase shares. Thanks, again, for your interest in Lowe's. Rick?
Rick Damron:
Thanks, Robert, and good morning, everyone. As Robert shared with you, our performance for the quarter was balanced across categories, where our comps range from mid-single digits to double digit and across regions where our comps also range from mid-single digit to double digit. Additionally, ticket and transaction growth contributed evenly to our overall performance. We also saw a balance throughout the quarter, with comps above 8% every month. Finally, we were pleased that this top line sales performance was accompanied by continued improvement in gross margin rates.
We achieved this balanced growth by executing well within the second quarter, strengthening home improvement market and ensuring we were ready to sell outdoor products as customers responded to the warmer spring and summer weather. In fact, our outdoor product comps increased approximately 13% in the second quarter compared to a decrease of 7% for the first quarter, resulting into an outdoor comp of 3.5% positive. We achieved very strong second quarter growth in products needed to improve and maintain the yard. Tools and outdoor power equipment and lawn and garden were among our best-performing product categories in the quarter. However, strong growth wasn't limited to outdoor categories. Kitchens and appliances also outperformed in the quarter, driven by robust growth in appliance sales as the LG line gained further traction after its first quarter roll-out. We are excited about the innovation that LG adds to an already strong lineup of national brands and the most extensive in-stock offering of appliances in the home center channel. In fact, this month, J.D. Power and Associates ranked Lowe's highest in appliance retail customer satisfaction for a fourth consecutive year. We were also pleased by strength in the core of the store, where categories such as hardware, paint and fashion electrical not only achieved mid-single-digit comps, but did so with solid growth in gross margin rates. This balance of sales and gross margin rate improvement within these categories reflects the progress we're making in our Value Improvement initiatives. At the end of the second quarter, we had completed resets representing approximately 70% of our business and we expect to substantially complete the initial round of resets in 2013. Examples of resets completed in the second quarter include core products, like plumbing tools and wall plates, and décor products, such as blinds and shades, ceiling fan accessories and hardwood flooring. A recent example of how Value Improvement was used to more effectively assort a product grouping was in power tools sandpaper, where the team created a clear price point progression and enhanced inventory productivity. They eliminated price point and design duplications and established exclusives within the mass retail channel, with the Gator Grip and Shopsmith brands. Gator Grip offers opening price points and the Shopsmith line offers premium film-backed, ceramic grain sandpapers, which are more aggressive and durable and appeal primarily to the pro customer. As a result, the financial benefit of Value Improvement is greatest once we have reached stabilization that is when we are passed the clearance and selling only new product assortments. We estimate that roughly 50% of our business was at this stage in the second quarter. We continue to expect average mid-single-digit comps and roughly 100 basis points of improvement in gross margin rate for product lines that have reached stabilization. As I mentioned earlier, our performance in the second quarter was not only balanced across categories, but across regions as well, with all regions achieving mid-single-digit comps or above. Those regions that struggled from cooler and wetter weather in the first quarter, including most of the East Coast and Midwest, recouped most of those sales in the second quarter. In our North division, we achieved our strongest performance in the upper Midwest, which suffered from droughts last year and experienced a delayed spring this year. Additionally, we estimate the stores most affected by Superstorm Sandy contribute approximately 30 basis points to our total comps. Housing recovery markets on the West Coast and Florida and healthy markets along the Texas Gulf Coast continue to show high-single to double-digit comp improvement. We expect to see continued strength in these markets and further improvement along the Southeast coast and in the Midwest, where the recovery is now taking root. Looking at payroll. As expected, strong second quarter sales growth generated solid payroll leverage across all regions of the country as we leverage the fixed component of store labor hours. As a reminder, we added approximately 150 hours per week to the staffing model for nearly 2/3 of our stores. These additional hours are dedicated to the interior sales floor. We continue to monitor performance and make adjustments as necessary. As Bob will share with you, our expectation for year-end inventory is approximately $200 million higher than we had forecasted last quarter. Part of this increase is due to air conditioners and ceiling fans. The cooler and wetter summer to date has greatly reduced our sales of these items. We expect to sell into the end of the summer, but we will carry over the remainder to sell next year. The greater part of this inventory increase reflects our commitment to further lean into increasing demand, as we bolster job lot quantities to benefit pros, increase overall in-store service levels and present compelling endcap displays. We expect that these incremental inventory investments will be completed this year and that we will be positioned to achieve greater inventory productivity in 2014. Before I hand it over to Bob, I am pleased to share that for the first half of the year, approximately 80% of our U.S. stores have qualified for a service and sales employee incentive, or SSEI payment. As a reminder, SSEI is our profit-sharing program for hourly associates. This quarter payment will be the highest we have made since the start of this program. Thank you for your interest in Lowe's, and I will now turn it over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the second quarter were $15.7 billion, which was an increase of 10.3%, driven by positive comp sales and new stores. In Q2, total customer transactions increased 5.3% and total average ticket increased 4.7% to $65.60. Comp sales were 9.6% for the quarter.
Looking at monthly trends, comps were 9.5% in May, 8.5% in June and 11.3% in July. For the quarter, comp transactions increased 5% and comp average ticket increased 4.4%. With regard to external factors, we estimate that the recovery of lost Q1 sales from a delayed spring aided second quarter comps by approximately 120 basis points. Also, lumber inflation and sales-related to Superstorm Sandy recovery efforts added roughly 60 and 30 basis points to comps, respectively. Our internal efforts, including Value Improvement, Product Differentiation, Lowes.com, proprietary credit value proposition, outside selling positions and the weekday labor hours investment drove approximately 250 basis points of the Q2 comp. The balance of the comp growth, 5-or-so percent, we believe is driven by improving execution and strengthening industry demands. Year-to-date sales of $28.8 billion were up 5.1% versus the first half of 2012, driven by a 4.6% increase in comp sales and new stores. Gross margin for the second quarter was 34.35% of sales, which increased 42 basis points over Q2 last year. The biggest driver of the increase was Value Improvement, which helped gross margin by approximately 55 basis points. Our estimate of the improvement nets the clearance impact of the reset against the benefit of the stabilized line. For the quarter, the percentage of resets completed increased from 50% to 70%, while the percentage of resets stabilized increased from 30% to 50%, which was consistent with our plan. Also, more effective promotional activity relative to Q2 last year aided gross margin by an estimated 20 basis points. This improvement was offset somewhat by the following items: First, our proprietary credit value proposition negatively impacted gross margin by approximately 15 basis points. This is driven by higher penetration of our proprietary credit program, which reached 24.7% of sales, a 90-basis point increase over Q2 2012. Also, the mix of products sold negatively impacted gross margin by 14 basis points. Lastly, lumber inflation negatively impacted gross margin by relatively 10 basis points. Year-to-date gross margin of 34.56% of sales is an increase of 26 basis points over the first half of 2012. SG&A for Q2 was 21.73% of sales, which leveraged 53 basis points. During the quarter, store payroll leveraged 30 basis points. Payroll dollars were up approximately 7% versus Q2 last year, which includes the additional weekday hours investment that Rick noted. While payroll grew in the quarter, it was at a lower rate than the sales, resulting in expense leverage. Similarly, insurance, both casualty and employee, advertising, utilities, rent, profit taxes and other costs leveraged, as a result of the 10.3% sales increase. Also, expenses incurred last year for the voluntary separation program resulted in roughly 10 basis points of leverage this year. These items were offset somewhat by incentive compensation expense, which deleveraged 31 basis points as a result of higher expected attainment levels relative to last year. Year-to-date SG&A was 23.04% of sales, which leveraged 36 basis points to the first half of 2012. Depreciation for the quarter was $367 million, which was 2.33% of sales and leveraged 26 basis points compared to the last year's second quarter as a result of the sales growth. In Q2, earnings before interest and taxes, or EBIT, increased 121 basis points to 10.29% of sales. For the first half of 2013, EBIT was 9.02% of sales, which was 82 basis points higher than the same period last year. For the quarter, interest expense was $110 million and deleveraged 2 basis points to last year as a percentage of sales. In Q2 2012, we settled various tax matters that resulted in lowering interest accruals by $22 million, causing the interest expense deleverage in this year's second quarter. Total expenses for Q2 were 24.76% of sales and leveraged 77 basis points. Year-to-date, total expenses were 26.31% of sales and leveraged 52 basis points to last year. Pretax earnings for the quarter were 9.6% of sales. The effective tax rate for the quarter was 37.5%, which is down slightly from Q2 last year. Net earnings were $941 million for the quarter, an increase of 26% over Q2 2012. Earnings per share of $0.88 for the second quarter were up 37.5% to last year. The $0.88 per share compares with our plan of $0.83, was a $0.05 beat driven primarily from higher-than-planned sales. For the first 6 months of 2013, earnings per share of $1.36 represented a 27% increase over the first half of 2012. Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.1 billion. Our second quarter inventory balance of $9.1 billion increased $407 million or 4.7% versus Q2 last year. The increase was driven by higher inventory levels to support demand, inflation in lumber building materials, as well as the air conditioner and ceiling fan carryover that Rick noted. Inventory turnover, calculated by taking a trailing 4 quarters cost of sales divided by average inventory for the last 5 quarters was 3.73x or essentially flat with last year. Return on assets determined using a trailing 4 quarters earnings divided by average assets for the last 5 quarters increased 114 basis points to 6.38%. Moving on to the liabilities section of the balance sheet. Accounts payable of $5.7 billion represented an 11% increase over Q2 last year, caused by the timing of purchases this year relative to last year. At the end of the second quarter, lease adjusted debt to EBITDAR was 2.05x. Return on invested capital, measured using a trailing 4 quarters earnings plus tax adjusted interest divided by average debt and equity for the last 5 quarters, increased 201 basis points for the quarter to 10.62%. Now looking at the statement of cash flows. Cash flow from operations was $3.4 billion, an increase of $560 million over last year, largely due to the timing of purchases that contributed to the higher accounts payable balance, as well as growth in net earnings. Capital expenditures were $376 million, a 40% decrease from last year. As a result, year-to-date free cash flow of $3 billion was 37% higher than the first half of 2012. For the quarter, we repurchased 24.4 million shares or a little bit more than $1 billion. Also in the quarter, we received approximately 2.7 million shares as part of the final settlement associated with the accelerated share repurchase program executed in Q1. We have approximately $3 billion remaining under share repurchase authorization. Before getting into the details of the Lowe's business outlook, I'd like to note that the income statement impact from the Orchard Supply acquisition is not expected to be material, and except for deal-related expenses, is not include in these figures. Also, I wanted to note that our outlook for the second half of the year is unchanged from our prior outlook. Our 2013 outlook combines the above-planned sales and earnings performance in Q2 with our previous assumptions for the second half of 2013. Now to our outlook for 2013. We expect total sales to increase by approximately 5%, driven by comp sales of approximately 4.5%. We expect continued momentum for our internal efforts tampered by moderating home improvement industry demand. We expect to open approximately 10 stores for the year. For the fiscal year, we are anticipating an EBIT increase of approximately 65 basis points. The effective tax rate is expected to be approximately 37.9%. As a result of these inputs, we're expecting earnings per share of approximately $2.10, which represents an increase of 24% over 2012. For the year, we are forecasting cash flows from operations to be approximately $3.9 billion, which is lower than our prior forecast, due to the higher inventory levels that Rick described, offset somewhat by higher earnings. Our 2013 forecast for fixed assets acquired is approximately $1 billion. The decline from our prior expectations relates to spend rationalization, lower expected cost and project timing, primarily related to information technology. This results in an estimated free cash flow of $2.9 billion for 2013. We expect to close the Orchard transaction in the quarter. Our guidance assumes approximately $3.6 billion in share repurchases for 2013, which is lower than our prior expectation as a result of the $205 million Orchard purchase price. For the year, we expect that lease adjusted debt to EBITDAR will be at or below 2.25x. We continue to execute against the long-term strategy that we outlined during our Analyst Investor Conference last December. Our initiatives are gaining traction, and we are pleased with our results for the first half of 2013. In addition, housing is turning. So for the first time in a while, both internal and external forces are moving in the right direction. We will not be holding an Investor Conference in 2013, but look forward to updating you on our strategy in mid-2014. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of David Strasser with Janney Capital Markets.
David Strasser:
Bob, I just wanted to follow up on a conversation or a comment you made as you were talking about the guidance, about the moderating home improvement demand. I mean, July was -- it seemed like the strongest category. It seemed like it was -- it seems accelerating throughout the quarter.
Robert Hull:
So as we think about Q2, I talked about some improving execution. So we had implemented some procedures, specifically sales and operations planning that allows us to work on behalf of the customer in a more collaborative and coordinated fashion, so that's aiding this year's performance. But if you think back to Q2 last year, we had a lot of moving pieces as it relates to the value of voluntary separation program, the change in commission for some of the sales folks in the store floor. We had some reset challenges, the execution of resets related to Value Improvement. We had inconsistent promotion activity in Q2 last year. So some of the benefit in Q2 was specific to recovery of some disruption in Q2 last year. Also as you think about the external factors I described, the recovery of the lost sales from Q1, lumber inflation and Hurricane Sandy, 200 or so basis points, largely doesn't continue into the second half of the year. And then lastly, Dave, I'll talk about interest rates. We're seeing positive momentum in housing, but the wildcard is interest rates and the impact it has on housing affordability. So we're kind of watchful of that potential impact.
David Strasser:
I guess, along those lines, one follow-up question here. Yesterday, Best Buy and Home Depot talked about really strong appliances. You're talking about really strong appliances out there. Is there something in the industry that's happening that's driving sort of just such dramatic demand in that space? Each person had incremental brands and so on, but it just does seem like the category has expanded fairly dramatically recently. I'm just trying to understand a little bit more about what may have driven that.
Robert Niblock:
Dave, I'll start, and then I'll have Greg jump in. This is Robert. Yes, I think part of it is underlying economic fundamentals we've talked about, which we attribute part of the increase in the quarter to. That as home prices started to move up, I think it does have homeowners feeling gradually better about willingness to spend, particularly as you get to big-ticket durables. And I think some of the appliances, some of those things are probably some of the purchases that consumers have otherwise delayed during the downturn because they could get better clarity with regard to where the value of their home was moving. So I think part of that is coming into -- you're seeing part of that come into play. It's no different than what you're seeing in the auto industry and other places where you're seeing consumers have a willingness to move towards some of those big-ticket durables, as they're feeling gradually better about things. But specific to appliances and what we're seeing, Greg, if you want to add something.
Gregory Bridgeford:
Sure. Dave, I agree with Robert, from a kind of household economic trend standpoint. I think we are seeing the impact of what's been delayed spending now coming into our favor. And what's important for us and what drove our share increases in Q2 was innovation. The launch of LG continues to provide a lot of momentum for the category. Also, new innovative products from Samsung, innovative products from Bosch, some new rollouts from GE and Whirlpool. That's been -- have been driving our sales in appliances. And I think we've gotten into the cadence, Bob mentioned it earlier. I think we've gotten into the cadence of the proper balance of traffic, driving promotions and ticket building promotions, too. So that's been a big hit in terms of driving sales and driving margin simultaneously.
Operator:
Your next question will come from the line of Budd Bugatch with Raymond James.
Budd Bugatch:
I guess my first question comes on the penetration of the pro business. Typically, I think it's been around 20% for you. Can you give us some flavor and comment on what you're seeing in the pro, and maybe how that penetration is moving?
Rick Damron:
Budd, this is Rick. We continue to see good growth in the pro for the quarter. Our pro business outperformed our sales totals, our comp totals. You look at it, overall, it's roughly, we say, approximately 25% of our total volume at this point in time. If you think back to several initiatives that we launched midyear last year, we're gaining tractions with those. When you look at the focus that we've got on the MRO, the maintenance and repair customers when they come into the stores, as well as the reorganization that went through and talked about, our account executive of ProServices in the field, getting them focused on building strong relationships with our core customers and really pulling that together as a cross-functional program across the organization to make sure that we're really doing the things that benefit the pro. I talked a little bit about it in our opening comments. The job lot, the job lot inventories, making sure we have the right depth of inventory. Being able to present those effectively to the pro customer has really benefited. You look at Northlake and our product differentiation aspects and the freeing up of endcap space have allowed us to present our contractor pack of value offerings to the pro customer, which is a way to give them discounts on multiunit purchases. And then the every day value proprietary credit has also really benefited that category. So we've been extremely pleased with the programs the teams have built, the progress that we're making and traction we're making as the pro continues to rebound in the marketplace.
Budd Bugatch:
Okay. And my follow-up really has to do with the air conditioner issue. Did I hear you correctly that you're going to pack away about $200 million worth of air conditioners? And just my question is do you risk -- what risk of obsolescence do you have? And have you done this before? And what risk is there in this particular strategy?
Robert Hull:
So Budd, this is Bob. The $200 million relates to many factors, not just ACs. So it does relate to, as Rick described -- as we think about going through the lines, we're adding greater depth of inventory to the products that are -- the 8 items, the highest velocity items, so greater in-stock levels there. Also, we do have some seasonal -- so that's the bulk of it. We do have some carryover for both air conditioners and ceiling fans. As we think about seasonal product, we evaluate the quality of that product, whether it makes sense to mark it down at that point in time or carry over. AC is a category where there's not much change year-over-year. So as we think about carrying over air conditioners, there's really no impact to the 2014 line. There's no risk to the line. There's no risk of damaging the product as we carried over through the season. So yes, we have done that before and feel comfortable with that decision.
Operator:
Your next question will come from the line of Laura Champine with Canaccord.
Laura Champine:
I understand the air conditioner and ceiling fan issue. But given those strong sales trends in Q2, how are your in-stock positions as we move into Q3?
Robert Niblock:
The overall -- Laura, this is Robert. I think we feel really good about our in-stock positions. A lot of the cross-functional work that we've talked about, certainly our strength with our extensive logistics and distribution network that we have out there has allowed us to stay very comfortable with in-stock positions that we have. And we've said, the seasonal categories, the air conditions, from a follow-up on the last question, yes, we've still time to sell a big part of that and it's an easy product to carry over to next year. So we feel really good about in-stock. But Rick, I'll let you.
Rick Damron:
Yes. Laura, this is Rick. As you think about inventory in general, I think it's important to go back and realize some of the changes that we've made to our strategy this year. That is helping us impact our in-stock levels in the stores today in what we're continuing to do. We talked about previously, as we'd looked at opportunities for inventory moving into 2013, that we saw some opportunities to improve our in-stock positions. Actions that we took were greater than the job lot inventory, meaning that we have greater depth of inventory available for our pros and our DIY customers when they come into the stores to complete those projects. We also increased our in-store targeted service level across many items, particularly those that have gone through the Value Improvement line initiatives to drive greater in-stock levels of those -- of that inventory when those categories come out of that line review. So that has helped us meet those demands as well. And then as it relates to Q2, related to seasonal categories, remember, we talked about in Q1, the way that we built our inventories, more aggressively to hit those high seasonal peaks and demands for the consumer allowed us to capture that upside -- and that initial spike when the consumer was ready, and that allowed us to proactively flow that inventory for the remainder of the season. So I think collectively, all of those initiatives have played out very well and have us in a good position going into the second half of the year.
Gregory Bridgeford:
And Laura, this is Greg Bridgeford. The only thing I'd add to Rick's comments would be that when you look at the top 4 categories that had above average performance for the quarter. 3 of the 4 are what we call flow-through and sell-out categories. And one of the keys to the quarter was really a tremendous performance on the part of our vendors, our logistics teams and our store operations teams from being able to flow through that much inventory and putting in the hands of the customers, whether it's an outdoor power equipment, live goods, lawn and garden, hardlines or appliances. That was one of the keys to the quarter.
Operator:
Your next question will come from the line of Brian Nagel with Oppenheimer.
Brian Nagel:
I'm going to ask the same question. I asked this to Home Depot yesterday, too. But you called out in -- as part of your outlook, some concern or maybe in the Q&A, some concern with respect to potential for rates to climb higher. The question I have is interest rates have already ticked higher by a bit here. I mean, have you seen any indication yet in your business that this is having an effect? And given the histories you have with Lowe's, I mean, how would you think -- if interest rates continue to climb higher, how could that impact Lowe's business in the coming quarters or a year or so?
Robert Niblock:
Brian, I'll start. This is Robert. Certainly, if you look at any of the numbers out there with regard to refinancing or new home sales, housing turnover, those type of things, certainly, you're seeing the impact of interest rate starting to show up in some of those numbers. As I said earlier, I think, however, the biggest impact that we have seen so far -- positive impact, we think, on the business to date has been the fact that overall, from macro environment, home price is starting to move up and the strong housing turnover job gains that we've seen to date, we think that, that's contributed to what we've seen in the business. Yes, interest rates, I think, over the past -- since May or something are up about 110 basis points or so. So it is starting to have an impact on refinancings, those type of things. As long as it kind of stays in this area, moves up a little more gradually, we think, has some impact, but we're not overly concerned about it. If you start seeing interest rates that were to -- yet to move north of the 6% interest rate for a 30-year mortgage, we think that, that would probably start to have some impacts that we would start feeling in the business.
Brian Nagel:
Got it. And then maybe just a quick follow-up, and I apologize if you addressed this in your prepared comments. But any update on the remerchandising and resets? And what lift you're seeing in your comps, the areas of the store you touched?
Robert Niblock:
Greg, you want to address that?
Gregory Bridgeford:
Sure. Brian, as we discussed, we're -- as Rick discussed, we're making a lot of progress with Value Improvement. We did perform a normal amount of resets for the second quarter and provided the bulk of the -- when you look at the lift that Bob detailed, 55 basis points attributed to Value Improvement. It's -- we continue to see progress being made in, what I'd call, the interior categories, which is in the center of the stores. As we execute resets and refresh the lines, that's provided a strong basis for the business because you saw a very balanced performance across the categories for Lowe's. And then going into the season, obviously, we performed line reviews preseason for categories, such as the lawn and garden. And we actually do line reviews about twice a year on the appliance categories, as new models and innovations roll out, so continue to be a major foundational factor in our performance. And it's at a point now, as Rick mentioned, with 50% of lines reaching a form of stabilization, where it is becoming part of our business. And it's a solid foundation to our business.
Operator:
Your next question will come from the line of Michael Lasser with UBS.
Michael Lasser:
On the 150 labor hours that you added to the store, how much do you think that you have opportunity to maybe push a little further on that, increase service levels even more? And what sort of benefit might you be able to see from that?
Rick Damron:
Yes. Michael, this is Rick. I'll take that. Right now, we're comfortable with the program that we have in place and executing against that 150 hours. I think it's -- when you go back and you look at the analysis that we did when we put those numbers, put those sales hours back in, we felt confident that, that would get us back to where we were from a service level and an hours level to meet the sales needed for the quarter. So we feel confident in that program. We're still making adjustments to that program as we move into Q3, and looking at how we allocate the hours, what departments we allocate the hours into and how we mix them across the floor. But we're still comfortable that the 150 hours is the appropriate number. We don't see, at this point in time, a need to increase those hours.
Michael Lasser:
Okay. And my follow-up question is on your outlook. I'm curious about the level of conservatism that you've baked into your outlook. Can you kind of frame how you see the upside, downside? And potentially, what type of momentum have you carried into the current quarter from that very strong July?
Robert Niblock:
Michael, it's Robert. I'll start, and then Bob may want to jump in on the details of the outlook. But if you think about it, if you remember back, Michael, at the end of the first quarter, when we fell short of what our internal plan was, we didn't really change our guidance because we anticipated that with the impact we saw from a delayed spring, we would make up the majority of that in the second quarter. In the second quarter, we actually covered most of those sales and then had actually performance above what our internal plan was. So our thought process has been we'd take the amount that we exceed our internal plan for the second quarter, roll that into the annual guidance, combined with what our plan was basically for the second half of the year. So we've got good momentum going into the third quarter, so that gives us additional confidence. There are some headwinds out there, as Bob outlined in his comments, including some unknowns out there, with things like interest rates that we just went through and the impact that, that could potentially have on the industry. So we feel good about our -- the outlook for the second half of the year. But that's kind of how we got to building the revision to our guidance for the year. So Bob?
Robert Hull:
Yes, so 2 comments. One related to your guidance question, Michael. So you asked about where we were so far. So if you think about our 4.5% comp for our outlook for the year relative to the 4.6%, that implies a comp of 4%, 4.5% in the second half of the year. I will tell you that August to date, we are running somewhere between that 4% to 4.5%, and the 11.3% we ran in July. So a nice big range for you. The other point I'll make, Michael, really ties together your question on payroll and the prior questions on inventory. So as we think about the second quarter, we saw a ramp in industry demand that we haven't seen for quite some time. In fact, reported our highest quarter comp in almost 10 years. So we were focused on capitalizing on the opportunity. As you heard from Rick, we'll focus on the inventory productivity that we outlined in 2015. We'll get there, but we didn't want to lose sight of the opportunity that was in front of us in this quarter.
Michael Lasser:
Okay. That's a pretty wide range. I think you can drive a sledgehammer through that. Maybe, no chance you could narrow that a little bit for us?
Robert Hull:
You can build your model as you see fit, Michael.
Operator:
Your next question will come from the line of Greg Melich with ISI Group.
Gregory Melich:
I wanted to talk a little bit about guidance, but rather the top line on the flow-through. Specifically, on the margin guide, you basically only increased the guide by 5 basis points, even though second quarter was up 100 bps. So I'm just wondering, why that was. Is there something going on with the flow-through from the resets that's maybe a little different than you thought? Or on the SG&A side, if comps decelerate, help us understand the difference based on whether that deceleration is traffic or ticket in terms of the leverage.
Robert Hull:
So following up on Robert's response to Michael's question. Our outlook for 2013 is a function of taking our year-to-date performance, plus our prior expectations for the second half of the year. So yes, it looks like on a 1% sales increase to EBIT, only goes up 5 basis points. We didn't change our second half outlook. We do expect the 4% to 4.5% comp in the second half to be balanced across ticket and traffic. We do have some expense pressures that we talked about previously, the 10 basis points from additional labor hours. Reset expense is actually 20 basis points. We talked about 10 basis points previously. It's now 20 basis points for the year in incentive comp. We modeled the year at -- performance at target given where we are to date. Sales and earnings are forecasted above our plan, which means that we're accruing a bonus above target, which is another 10 or so basis points. So we've got some expense pressures that are probably resulting in the flow-through rate looking less than what we've guided in the past, which is the 20 basis points for each point of comp. That's what's taking place in the second half of the year.
Gregory Melich:
Okay. And then if I could, Bob. On the D&A, that's been pretty choppy and bouncing around. Should we use this quarter as the right run rate? Or how should we think about that?
Robert Hull:
I think you can use a number of about $1.5 billion for the year.
Gregory Melich:
As an average, and then just accept that it's bouncing around a little bit more?
Robert Hull:
It should be more steady going forward. As we think about the nature of timing of asset adds, the last big store ramp was Q4 of 2005, a lot of the 7-year assets become fully depreciated or ramping up a couple of years ago, some IT, which is 3-year lives, that caused some of the lumpiness that we saw in 2012. I think we'll see more consistent depreciation going forward.
Operator:
Next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I have one follow-up question on guidance and then one question on demand. My question on guidance, just sort of phrasing it in another way, it looks like the implied operating margin guidance for the second half of the year would be up about 10 basis points. And that's actually a little less than you did in the first quarter, with a 1% comp decline. And obviously, you levered much more in the second quarter on a much bigger comp decline, despite throwing a lot of money into expenses, probably a lot more than you had initially intended. Are the expense pressures, those discrete pressures you discussed, sufficient to limit operating leverage to 10 bps, if you do comp 4 or so? Or could that be a conservative number in the event that the top line gets to that level?
Robert Hull:
Yes. I guess, I'm not sure where the 10 basis points comes from. We're at 82 for the first half of the year and expect 65 for the second half, so the 10 basis...
Matthew Fassler:
I guess, I was looking on a non-GAAP basis. That might be the difference.
Robert Hull:
We report on GAAP and guide to GAAP. So...
Matthew Fassler:
Fair enough, understood. So all right, we can move on from there. I guess, the second question relates to kind of visibility of big-ticket sales. If you could talk about some of the projects that have sort of longer life cycle from the consumer's initial visit to completing the project, what is traffic in some of those categories looking like today? And what can you glean about the sustainability of demand from your interactions with consumers in your stores?
Gregory Bridgeford:
Matt, I'll start. And then anyone else want to add in, but what we've seen is, again, probably the most, one of the most balanced performances that I've ever seen from a category performance. So we saw strong demand for the bigger ticket project categories in a way that we haven't seen in recent time periods, whether it's kitchen cabinets, whether it was appliance sales or whether it was fashion plumbing sales. We're seeing strength in those categories and interest and traffic in those categories that we haven't seen in previous quarters. So as we look at the focus of a lot of our VIP [ph] work over the last 9 months, we're coming in somewhat of a sweet spot as we get into the second half of the year because 60% of all project sales come from flooring, paint, bath and appliances. And we put a lot of effort in those categories to make sure that we're able to capture that customer demand. As I mentioned before, we're really working hard to execute and maintain a good cadence of promotional activity that is margin accretive, is foot traffic driving, builds basket and is margin accretive in the process. And that's part of this plan as we head into the second half of the year.
Operator:
Your next question comes from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
Looking at the benefits from the Value Improvement Program, the gross margin was a bit higher than the math would suggest based on the percentage of resets completed and through clearance and so forth. So that was a little bit better there. Was that a sort of catch-up from the first quarter? And then thinking about the math both on a comp and the gross margin into the back half, I mean, should that normalize back to what the basic math of the percentage completed and through reset and times or percentage, the mid single digit and 100 bps comp lift?
Robert Hull:
So Chris, your first question was on the 55 basis point improvement relative to the 50% of lines stabilized?
Christopher Horvers:
Right.
Robert Hull:
Yes. So it's really somewhat of a function of the lines that are reviewed and the timing of the reviews within quarter. As Rick outlined in his comments, we still believe and still are seeing the average mid-single-digit comp increase, 100 basis points of gross margin stabilize. So nothing that would indicate that we'd see anything different in the second half.
Christopher Horvers:
Okay. And then thinking about the acceleration during the quarter and looking at 2-year stocks accelerating during the quarter, clearly, the seasonal business peaks in the Memorial Day to July 4th timeframe. So can you talk about the texture of demand within July? How much was the moisture levels, maybe carryover impacted July versus what you would consider more core and sustained demand as you look to the back half?
Gregory Bridgeford:
I'll start, Chris. This is Greg Bridgeford. We did see probably more moisture on a nationwide basis in July, more moisture in the ground than we've seen in years, maybe a decade. And it did drive the opportunity for sustained live goods sales, bagged goods sales and in particular, outdoor power equipment sales, as the normal dryness that hits in July and August didn't retard the growth of grass. So I think we had a very strong performance in the outdoor power equipment categories, in particular. And we were able to execute against that because we were ready.
Robert Hull:
Chris, this is Bob. You mentioned 2-year comps in Q2. Given that we had some shift in demand between Q1 and Q2, I'd encourage you to take a look at the 2-year stack for the first half, which is 5.6%. And then you take a look at the outlook for the second half, basically assumes that our 2-year comp would be in the 5.5% to 6% range. So we do have tougher comparisons in the second half of the year. But on a 2-year comparable basis, we're expecting relatively the same performance, second half versus first half.
Christopher Horvers:
Understood. And one final one, as you think about sort of the disruption last year around sort of the promotional variation throughout the quarter and things that were successful and not successful, did that impact -- was that more of a June issue last year impacting comps? Or was that more of a July issue?
Robert Hull:
A little bit of both. I think, specifically, as we talk about last year, we have probably 2 lighter promotions for Memorial Day, didn't get the attachment rate. We responded by larger big-ticket promotions. We didn't get the unit movement. So I think it's a little bit of impact all across the quarter.
Gregory Bridgeford:
Yes, I'd say I agree with Bob, Chris. It was a May issue, May to mid-June issue, and then a separate issue in the latter half of the second quarter. The cadence and the integration and the collaboration that we're executing through our sales and ops planning process today is helping to drive the balance performance that you saw in Q2. We intend to improve on this process and it's really driving -- it's really enabling us to meet expectations in terms of our performance.
Operator:
Our final question will come from the line of Eric Bosshard with Cleveland Research.
Eric Bosshard:
I wondered if you could give a little color, I heard you -- I understand you're talking about adding some inventory to the business. But curious of how the progress, the focus that you've had on margin, and now it seems like there's a -- you're having obviously very good success with sales, but how you're thinking about sales and market share performance relative to margin and how that's playing out in the strategy and how you're executing the strategy. What's changed or what's evolving within that, if you can speak to that.
Robert Niblock:
Eric, I'll start and get others to jump in. Certainly, as we've talked about with our sales and ops planning, I think we're doing a much better job approaching the business on a cross-functional basis, which is helping getting the promotional cadence right, helping with the lines, helping -- making sure that we responded to demand that we saw in the second quarter. And certainly, with the resets, the Value Improvement, those type of things, we think we'll start to hit our stride, so that we're moving through those. We've got a good cadence to them, continuing with the markdown and clearing of the older inventories, as the offsets get more normalized. After we've done that sell-through, we're starting -- continue to see the margin performance that we anticipate. And so we're optimistic about the path we're on, and as we've indicated, expect most of those -- majority of those resets to be done by the end of the year. So we feel good about that and the ability to be able to deliver our margin goals for the second half.
Rick Damron:
Yes, Eric, this is Rick. I would just add a couple of things to that. First being -- and this references back to the sales and ops planning that Greg spoke about. Dennis Knowles and the store teams have done an outstanding job this year in driving attachment items to the project item, much better than we've done in the past, increasing the basket size, so that we're able to add those higher margin components onto the total transaction from a store standpoint. That goes back to a lot of the training that he and the leaders of store operations rolled out in the past year of selling at Lowe's, getting the stores to really understand attachment. And assisting the customer throughout the entire project has really been beneficial to helping us drive that margin. And again, that goes back to a lot of the sales and ops planning that Greg spoke about earlier. The other thing I think that we've done a great job from -- on is understanding the reset activity itself. We talked about a lot of missteps when we first started rolling this out last year, going back into understanding the flow of the reset, making go, no-go decisions based upon preset guardrails and criteria before we allow it to hit the store, driving a better overall reset for the store to execute against, and the consumer when they come in, helping us manage the amount of nonproductive inventory to a greater degree, so we're not seeing that have a bigger drag on us as we did last year at the same time. Greg, I don't know if you have anything else you'd like to say.
Gregory Bridgeford:
Yes. And probably the last element, Eric, would be our big-ticket categories. So we perform very well the balance of driving sales and driving margins. So as you can tell from the categories that performed above average, we -- you wouldn't see that kind of margin performance unless we manage those very well. And it was a great execution, I think, on the part of the teams. On the sales floor, we're able to be able to deliver these big-ticket projects and items to customers with a good margin outcome.
Robert Niblock:
All right. Thanks, Eric. And as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our third quarter 2013 results on Wednesday, November 20. Have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference. Thank you all for joining, and you may now disconnect.
Operator:
Good morning, everyone, and welcome to the Lowe's Companies First Quarter 2013 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 most directly comparable GAAP financial measures and other information about them as well as reference slides pertaining to first quarter results posted on Lowe's Investor Relations website under Investor Documents. 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. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Robert Niblock:
Good morning, and thanks for your interest in Lowe's. Let me start by expressing our sympathy for those impacted by the devastating storms in Oklahoma and throughout the Midwest and Plains. Our team members stand ready to assist the affected communities in the days and weeks ahead. And as we've done in the past when natural disaster strikes, Lowe's stores around the country as well as Lowes.com, will 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.
Following my remarks, Rick Damron will review our operational performance in the quarter, and Bob Hull will review our financial results in detail. But first, one housekeeping note. For the first time, we're providing slides on our Investor Relations website to supplement our call. We encourage you to download the slides to facilitate your review of our results and to use as a reference document following the call. Now, for some highlights of the first quarter. Our plan assumed normal weather based on historical multiyear averages. But as you know, temperatures were cooler and precipitation greater than normal for much of the quarter, resulting in a delayed spring selling season. As a result, comparable sales for the quarter were negative 0.7%, driven by a decrease in comp transactions. The month of March was particularly soft with a roughly 10% comp decline, but April improved significantly resulting in positive comps of approximately 10%. We have maintained that positive comp momentum through the first few weeks of May, and I'd like to thank our employees for their hard work and continued dedication to serving customers. For the first quarter, 7 of 12 product categories had positive comps. But as you might expect, seasonal categories such as lawn and garden and seasonal living fell short of our expectations. In fact, comps for indoor products were positive approximately 3% while comps for outdoor products declined approximately 7%. Our West division, particularly the upper Northwest and California, delivered the strongest performance in the quarter but we also saw strength along the Gulf Coast. While weather was certainly more cooperative in those regions of the country, they are also benefiting from sustained demand created by the housing recovery. We continue to benefit from Superstorm Sandy recovery efforts in the Northeast, and our ProServices business outperformed the company average. Gross margin expanded 10 basis points in the first quarter. While our Value Improvement Program contributed to sales and gross margin, the delayed spring impacted the full realization of the benefits we expected. We continued to effectively control expenses in the quarter and delivered earnings per share of $0.49. Delivering on our commitment to return excess cash to shareholders, in the first quarter we repurchased $1 billion of stock and repaid $178 million in dividends. The team continues to focus on improving our core business through cross-functional collaboration and consistent execution in-store and across other selling channels. One proof point is our level of preparedness for the spring selling season, the result of a more coordinated planning effort. The organization worked together to build store level inventory earlier in the season to create a compelling marketing campaign from messaging to signage, to promotional events and to ensure that staffing levels were adequate and timely. We rolled our spring plans by climatic zone in an effort to match resources to spring's expected arrival across the country. In addition to a more coordinated planning effort, we're diligently working on Value Improvement. The goal is to enhance line designs and maintain better in-stock positions, as well as simplified deal structures that allow us to offer competitive prices everyday. We're also leveraging compelling displays and enhanced merchandising flexibility from our Product Differentiation program. Finally, in the first quarter, we made an incremental investment in store labor during peak weekday hours to increase the proportion of selling hours relative to tasking and begin to address the weekday close rate opportunity that we've previously identified. Now looking at the balance of the year from an economic perspective. The housing market continues to show convincing signs of life. However, growth in other key indicators, particularly employment, slowed in the first quarter. We expect growth to remain modest through midyear as consumers adjust to higher taxes and the fiscal drag intensifies. However, we do expect that the lag effect of recent gains in housing will benefit home improvement demand as the year progresses. The macroeconomic transition from recovery to sustainable expansion, together with our initiatives and improving operational collaboration, give us confidence in our business outlook for 2013. Bob will share those details in a few minutes. Thanks again for your interest, and I'll now turn it over to Rick.
Rick Damron:
Thanks, Robert, and good morning, everyone. During my time, I will provide some additional product and geographic color surrounding our results, and update you on our additional investment in weekday selling hours and our Value Improvement Program.
As Robert pointed out, our indoor products, accounting for approximately 2/3 of our first quarter business, comped roughly 1,000 basis points higher than our outdoor products. We performed particularly well in large decor products. Well-designed promotions, along with the introduction of the LG line drove strong comps and margin dollar growth in kitchens and appliances. Flooring benefited from strength in hardwoods, laminates and ceramic tile, which finished a Value Improvement reset last year, introducing trend-relevant designs, including larger sizes, rectangular formats and wood plank looks. We also saw solid positive comps in interior products within core categories such as plumbing, millwork, paint, tools, lumber, building materials, hardware and fashion electrical. Many products benefited from improved line designs and deeper inventory in key items after having completed their Value Improvement resets. Strength in these products is also consistent with strong performance in our ProServices business, which continued to outcomp our DIY business, especially within higher tickets as we continue to apply a particular focus on building stronger relationships with our largest Pro customers, both in-store and through our field-based ProServices team. While we had solid performance from our indoor products, our outdoor products did not meet our expectations. We were well prepared for the spring selling season, but we expected the season to be normal in terms of timing, precipitation and temperature. We built seasonal inventories earlier and deeper in our stores to be fully prepared whenever spring arrived, particularly in products such as mowers, string trimmers, grills and fertilizers. We also added seasonal labor to the stores and staged Spring Black Friday events by 3 climatic zones just in advance of the expected arrival of spring in each of these zones. At the beginning of the quarter, we expected headwinds from the unusually warm and dry conditions experienced in last year's first quarter. However, this year, it was colder and wetter than expected throughout the Northeast, Southeast, Midwest and Plains states, which we estimate further impacted our comps by nearly 200 basis points. In fact, in areas where conditions were more favorable, such as the West Coast, Texas Gulf Coast and Florida, we recorded solid positive comps. In the Northeast, the negative impact of weather was somewhat offset by sales associated with Superstorm Sandy recovery efforts, which aided first quarter comps by approximately 45 basis points, down from 70 basis points in the fourth quarter but consistent with our expectations. Approximately 27 stores have seen a prolonged surge in demand as they meet the recovery needs of the most severely impacted communities. Three categories, comprised mostly of outdoor products, drove our negative comps for the quarter. Lawn and garden was double-digit negative; and seasonal living, which includes grills, patio and seasonal cooling was high single-digit negative. Lower lawnmower sales drove low single-digit negative comps in the outdoor power equipment category. These categories recorded strong comps in April and also, thus far, in May. In the second quarter, we expect to recover most of the outdoor sales we missed in the first quarter due to unfavorable weather conditions. As you think about the types of sales we will recover, it is helpful to divide our outdoor products into 2 groups. The first includes products to take now [ph], only to be used within a narrow window of time when weather is favorable, preemergent fertilizers and spring flowers, for example. The second group includes products that customers will want to use throughout the spring and well into the summer months. Examples include grills and patio furniture. Customers will be willing to buy these products as long as enough time remains during the summer to enjoy them. Most of our outdoor products fall into the second category. With the entire summer ahead of us and the improvement in weather we have seen in recent weeks, we expect to recoup a significant amount of outdoor sales in the second quarter. As Greg discussed last quarter, there is a gap between the percent of customers who know what they want to purchase when they visit our stores and our close rate. We are addressing this opportunity to improve close rate by investing in more customer-facing hours during peak weekday times and through our Value Improvement Program. We have added an average of 150 hours per week to the staffing model for nearly 2/3 of our stores, entirely apart from our typical seasons -- seasonal staffing increase. Previously, weekday and labor hours were heavily skewed toward tasking and we have identified an opportunity to better serve customers and close more sales during those hours by increasing the assistance available in our aisles. We completed hiring of these part-time employees in the first quarter. As these employees progress up the learning curve, we expect these hours to contribute to sales growth. We will continue to monitor the performance of this program and make adjustments as necessary. The Value Improvement Program remains our most important 2013 initiative. Through this initiative, we are improving our line designs, making them more relevant to each of the markets we serve, easier for our customers to shop and more efficient for our associates to maintain. This includes reducing duplication of features and functions within price points and reinvesting the inventory to increase in-stock levels, especially in key high-velocity items customers expect us to have on hand, including job lot quantities needed to complete large projects. We are also working to lower unit cost by reducing funds set aside by vendors for promotional and marketing support and by negotiating lower first costs. We continue to make progress. At the end of the first quarter, we had completed resets representing over 1/2 of our business. Examples of resets completed in the first quarter include seasonal products like planters, patio furniture and grills and year-round products like kitchen cabinets and garage door openers. We expect to finish the initial round of resets in 2013. As Greg mentioned last quarter, the financial benefit of Value Improvement is greatest once we have reached stabilization. That is, when we are past clearance and selling only new assortments. We estimate that roughly 30% of our product lines were at this stage in the first quarter. We continue to expect average mid-single-digit comps and roughly 100 basis points of margin improvement rate for product lines that have reached stabilization. From an operational perspective, these resets are now flowing across our stores with minimal disruption. Greg and I are committed to continuous learning and collaboration and we expect the same from our organizations. As we monitored the execution of Value Improvement resets during the first half of last year, we identified opportunities to minimize disruption by managing the reset process at a more granular level. We now plan the clearance of old inventory, the arrival of new inventory, the arrival of displays and signage on a store-by-store basis versus at a regional level. And before we proceed with any reset, a team, including members from merchandising, store operations and logistics, meet to ensure all elements of the reset are ready. If not, we delay the reset until they are. These steps have helped us to eliminate out of stocks and minimize disruption in our stores. As you can see, our commitment to continuous learning and collaboration supports our focus on increasing close rates. We expect to get better everyday at meeting customers' needs through improved service and product offerings, which is why we have added customer-facing hours during peak weekday times, and we continue to enhance our product assortments through our Value Improvement Program. We look forward to sharing our progress with you in the coming quarters. Thank you for your interest in Lowe's, and I will now turn it over to Bob.
Robert Hull:
Thanks, Rick, and good morning, everyone. Sales for the first quarter were $13.1 billion, which represents a decrease of 0.5% from last year's first quarter. Comp sales were negative 0.7%. Comp transactions were negative 3.7% while comp average ticket was up 3.1% to last year. As you heard from Robert, exterior categories were negatively impacted by weather early in the quarter but began to rebound as spring finally reached most of the country.
In planning for the quarter, we expected a 300 basis point headwind associated with last year's great spring weather. However, we estimate that the cooler and wetter spring this year caused comps to be almost 200 basis points below our expectation. This cooler, wetter weather impacted our seasonal business, which was a driver of the negative comp transactions in the quarter. Gross margin for the first quarter was 34.8% to sales, a 10 basis point increase over last year's first quarter. The gross margin increase was driven by Value Improvement, which helped gross margin by approximately 25 basis points. Our estimate of the improvement nets the clearance impact of the reset against the benefit of the stabilized line. For the quarter, the percentage of resets completed increased from 30% to 50%, which was consistent with our plan, while the percentage of resets that reached stabilization increased from 20% to 30%. The progress in completing resets was greater than product lines reaching stabilization as a result of the delayed spring. The financial benefit of Value Improvement is greatest once we have reached stabilization. We are comfortable that with recent trends, the percentage of stabilized resets will improve and we will achieve the anticipated margin expansion for the year. This improvement was offset by our proprietary credit value proposition, which negatively impacted gross margin by approximately 20 basis points or about 10 basis points higher than we expected. This was driven by higher sales penetration of our proprietary credit program, which reached 24.7% of sales, a 190 basis point increase over Q1 2012. SG&A for Q1 was 24.62% of sales, which leveraged 3 basis points. While the leverage was modest, there are a number of expense lines worth discussing. Casualty insurance leveraged 31 basis points as a result of favorable actuarial adjustment. On our fourth quarter call, I shared 3 cost pressures in our 2013 plan, one of which was casualty insurance. With this favorable adjustment, we now expect this item to be essentially flat to last year versus our prior expectation of deleveraging 10 basis points for the year. Incentive compensation leveraged 19 basis points as sales and earnings came in below expectations compared with higher attainment levels in last year's first quarter. Last year, we recorded $17 million in expense associated with the voluntary separation program, resulting in 13 basis points of leverage this year. As Rick noted, in addition to the normal spring hire, we added incremental hours during peak weekday periods. As a result of the additional payroll and delayed spring, store payroll deleveraged 30 basis points. We also experienced deleverage in store repair and reset expenses of 9 and 5 basis points, respectively. The store repair was driven by planned repair and maintenance activity while the reset deleverage was caused by the higher volume of resets relative to last year. Depreciation for the quarter was $352 million, which was 2.69% of sales and leveraged 12 basis points as compared with last year's first quarter as a result of assets becoming fully depreciated. Earnings before interest and taxes increased 25 basis points to 7.49% of sales. Interest expense at $113 million for the quarter deleveraged 8 basis points to last year as a percentage of sales as last year's bond yield occurred in mid-April versus a full quarter's interest expense this year. For the quarter, total expenses were 28.17% of sales and leveraged 7 basis points. Pretax earnings for the quarter were 6.63% of sales. The effective tax rate for the quarter was 37.8% versus 38% for Q1 last year. Earnings per share of $0.49 for the quarter represents a 14% increase over last year's $0.43. Now to a few items in the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.1 billion. Our first quarter inventory balance of $10.3 billion increased $488 million or 5% over Q1 last year. The increase is primarily attributable to delayed spring selling season. Inventory turnover, calculated by taking a trailing 4 quarters cost of sales divided by average inventory for the last 5 quarters, was 3.57, a decrease of 11 basis points from Q1 2012. Return on assets, determined using the trailing 4 quarters earnings divided by average assets for the last 5 quarters, increased 23 basis points to 5.68%. Moving on to the liabilities section of the balance sheet. Accounts payable of $7 billion represents a slight increase over Q1 last year. The increase in accounts payable is lower than the 5% increase in inventory, which relates to the timing of purchases in the quarter versus last year. At the end of the quarter, lease adjusted debt-to-EBITDAR was 2.17x. Return on invested capital, measured using a trailing 4 quarters earnings plus tax-adjusted interest divided by average debt and equity for the last 5 quarters, increased 56 basis points for the quarter to 9.53%. Now looking at the statement of cash flows. Cash flow from operations was $2 billion, which was down 19% from Q1 2012 due to working capital. Capital expenditures were $196 million, a $141 million reduction from last year. As a result, first quarter free cash flow of $1.8 billion was down 16% versus last year. In February, we entered into an accelerated share repurchase agreement to repurchase $1 billion of the company's common stock. At this point, we expect to receive about 25.9 million shares, but the ultimate number of shares will be determined upon completion of the program in the second quarter. Also, in the first quarter, the company repurchased approximately 300,000 shares of its common stock for $10 million through the open market. Through the quarter, we repurchased a little more than $1 billion. We have approximately $4 billion remaining on our share repurchase authorization. Looking ahead, I'd like to share our outlook for the year. In 2013, we expect total sales increase of approximately 4%, driven by a comp sales increase of 3.5% and the opening of approximately 10 stores. For the fiscal year, we are anticipating an EBIT increase of approximately 60 basis points. We expect the majority of the improvement in EBIT will come from gross margin, majority meaning more than half, but not 100% or more of the 60 basis point improvement. The effective tax rate is expected to be 38.1%. For the year, we expect earnings per share of $2.05, which represents an increase of 21% over 2012. We're forecasting cash flows from operations to be approximately $4 billion. The reduction relative to our prior outlook is due to higher forecasted inventory at year end. The higher inventory levels relate to investments in target service levels. Our capital plan for 2013 is approximately $1.2 billion. This results in estimated free cash flow of $2.8 billion for 2013. Our guidance assumes approximately $3.8 billion in share repurchases for 2013 spread roughly evenly across the 4 quarters. For the year, we expect lease adjusted debt-to-EBITDAR will be at or below 2.25x. Regina, we are now ready for questions.
Operator:
[Operator Instructions] Our first question will come from the line of Greg Melich with ISI Group.
Gregory Melich:
I wanted to get a little more detail on the comp trend. You said it got better, and May was similar to the April numbers. Does that mean it was actually at April number or better or worse, or you just think the trend is such that you're going to get that acceleration for the full quarter?
Robert Hull:
Greg, this is Bob. The May trends to date are approximately the same as what we've experienced in April.
Gregory Melich:
Got it. And then I wanted to follow up a little bit more on the margin side of the equation. Clearly, it looked like there was a little bit of delay in getting the Value Improvement in, but also some hit from mix and some of the weather issues. Could you help us understand that seasonal products that you missed, what does that do to the mix? Is it -- is lawn and garden higher margin because you own the inventory or help us out a little bit on that side.
Gregory Bridgeford:
Greg, I'll start. This is Greg with -- Greg Bridgeford with the val prop, that -- I mean the Value Improvement impact. We reset -- we completed the reset of about 80 categories in Q1. And as Bob detailed, that reset process brought us to over 50% of the categories. But with the weather impacts and a slow sales environment, many of those categories that are seasonally oriented did not reach stabilization, and therefore, moved through their clearance inventories so we could appreciate the margin gains from the new sets. And so with that delay in weather, we saw the impact of the clearance obviously hit our margin line without the benefit of having the lines reset and the margin accretion from the new cost structures and the new category set. So we certainly have seen that turn around as the weather turns around, so that gives us some confidence that we can -- we're going to achieve our 100 basis points improvement after stabilization in categories in the mid-single-digit comps.
Robert Hull:
And to follow on that, Greg, so we think about the mix of products. Mix had a slight negative impact on margin for the quarter, largely driven by lumber and the inflation that we're seeing in that category, resulted in it being a greater proportion of our business relative to Q1 last year. The seasonal products themselves have a margin rate consistent with the company average, so not really a mix impact. But as you think about the slowdown in March, created the delay in clearing through the clearance activity, therefore delaying the sale of products at full margin after the reset. So we estimate that a combination of Value Improvement about 10 basis points lower than our expectation and the value prop was another 10 basis points, resulting in gross margin coming in about 20 basis points lower than our expectations for the quarter.
Gregory Melich:
Great. That's super helpful. And Rick, I just -- given the initiatives to put those extra labor hours during the week, did you at least get the close rate up as expected even if you didn't have the traffic given the weather?
Rick Damron:
Yes, Greg, I'll answer that in 2 ways. One, as we put the incremental staffing labor into the weekday teams, we approached that in the same way we did the Spring Black Friday events by going by climatic zones. So in the Southern markets where those hours were implemented first, we were able to get the teams on board, get them through the training required to be as efficient and effective as we like to see. We saw better results there than we did as we moved farther north later in the quarter with finalizing the implementation of those hours in early April in the Northern market. So as we progressed up the climatic zones, we did see improvement there. If you look at overall close rate, it was basically flat to last year due to a lot of the mix issues we saw with seasonal inventory typically driving a higher close rate in the spring selling months than our interior category. So while looking at that, I'm very comfortable with the results that we saw even though the close rate remained flat for the quarter because of the timing of those reset or the timing of the seasonal business and the close rates that historically come with those.
Robert Hull:
Again, let's put a little color, Greg, on Rick's remarks. When with seasonal business we do find that to be more of a destination shopper for items bedding plants, fertilizers, grass seed, soil amendments. And so that is you do see stronger close rates. So as the weather didn't improve in some of the northern regions that's where -- as Rick described, we didn't see the close rate improvement, but where we did see the weather improve, we're seeing improvement.
Operator:
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
Two questions, if I could. The first revolves around the resets, and that's just getting clarity on when you expect those lines to cross, i.e., the progress starting to outpace the disruption. And I guess related to that on this topic, you talked about a couple of categories that have been through resets like paint and millwork and you talked about a 500 basis point delta versus the company average. I think those comped more in line with the chain this quarter, so I'm not sure if there was anything in particular that weighed on those. Now that we have some categories done, just want to make sure that we can align sort of the expectation with reality and make sure that those sync up.
Gregory Bridgeford:
Matt, this is Greg. As Bob described, we -- our expectations post reset is 100 basis points improvement impact by category. So what we have seen, and this is really important, is as we've seen weather improve and we see some of these seasonal categories that were reset and completed the reset in Q1 but hadn't stabilized, we're beginning to see the impact of that. We're seeing the basis point improvement that we expected to see. And as Bob said, our expectation was 10 points higher from the impact of the stabilized categories from a margin impact. So that's our expectation moving forward. That's a sequential increase over where we have been seeing and that's the kind of progress that we're expecting to make as we move through to see more categories stabilize at roughly 30% right now, and we're seeing -- we expect to have all categories stabilized by the end of the year.
Rick Damron:
I would add one thing to Greg's comment as it relates to the sales aspect of the categories, particularly in paint. I think you look at paint with the same phenomenon as you did seasonal with the mix of interior and exterior paints making up a driver of the average performance. You see the same relationship in paint as you saw in the rest of the categories, with the interior paint categories far outpacing the performance of the exterior categories due to the unseasonable weather.
Matthew Fassler:
Got it, that's very helpful. So is it like kind of third quarter or fourth quarter when you actually start to see this being a firmer gross margin driver across the business?
Robert Hull:
Yes, so we do expect gross margin to improve throughout the course of the year. As we talked about, we're at roughly 30% stabilization. As stabilization improves, we'll see improved margins throughout the course of the year.
Gregory Bridgeford:
Yes, Matt, we expect to see the impact of clearance inventory taper down as we move through the third quarter into the fourth quarter.
Matthew Fassler:
And just a quick follow-up for Bob. We've seen a little bit of volatility on the depreciation line and I know it's not kind of a focus on the operating front, but the Q4 to Q1 move was pretty dramatic. What kind of number would you expect to see for the year that's depreciation on the P&L? Is this a good base to build off of or should that number still be bouncing around a little bit?
Robert Hull:
The movement you see in depreciation is largely just timing of assets brought on board. So depreciation from those. If you think about the shorter duration IT equipment adding some offset, and really more than offset, by assets becoming fully depreciated. If you think back to a number of years ago when we were opening up 150 stores and CapEx was north of $4 billion, we've got some of those assets becoming fully depreciated, which causes some of that quarter-to-quarter volatility. I think the run rate that we saw in Q1 are a little bit higher than that because of the assets being added this year is probably a good number to use.
Matthew Fassler:
So if last year the average through the year was something in the $375 million, $380 million per quarter run rate, we're at $350 million this quarter, it sounds like somewhere in between those 2 numbers on a quarterly basis?
Robert Hull:
I think that's right.
Operator:
Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli:
I guess my question is regarding some of the merchandise resets. What you've told us so far is that when merchandise is being fully reset and you're experiencing a mid-single-digit comp gain once all the old merchandise is cleared out, et cetera, can you give us an idea of what the range on these results are? I'm assuming it's not just a steady 5% kind of level. And then related to that, has the extra labor you've been adding to the stores been concentrated towards those areas where you've had the resets?
Gregory Bridgeford:
Scot, I'll start. This is Greg. It is quite a range. And I'll tell you in some of the categories, the hardlines category that we reset early on, we've seen strong response to new values especially as we've market assorted. And I guess there are categories within some of our paint departments, plumbing departments that are seeing double-digit comp increases. But included in the Value Improvement line reviews are categories like plywood and dimensional lumber. We're not seeing double-digit comp increases because in reality those categories are open market and you literally -- if we did see those kind of increases, I'd be very suspicious. So it is a mix and it is a range. And where we have had the categories stabilized, it takes -- it does take a while, depending on the traffic hitting that category, for the customer to encounter those values, to encounter the new ranges and the market assorting impacts, but we are seeing the impact.
Rick Damron:
Yes, Scot. This is Rick. I'll discuss the extra payroll for a moment. The thing to keep in mind as we talk about the incremental investment to the weekday teams was that was in addition to our normal seasonal build of temporary labor to handle the normal seasonal ramp-up. So the focus of the weekday teams is on the core categories, which is where the predominant number of the resets have taken place thus far through the program. So the seasonal temporary labor is still skewed to the outdoor lawn and garden department and seasonal departments. The weekday teams are focused on the interior core categories, which line up very well with the activity around the Value Improvement initiative.
Scot Ciccarelli:
So I guess my question -- I guess my follow-up question on that is just on the labor front, are you seeing any kind of direct correlation to sales improvement when you add the extra labor?
Rick Damron:
When you -- Scot, I think when you look at that, we talked a lot about the close rate into the first quarter performance. The thing to keep in mind with incremental labor, and I think we'll be able to provide you probably better clarity into the performance into Q2, is the impact of weather across the country when we talk about the incremental labor investments where we are. The thing to keep in mind, like I said earlier, is we rolled out that incremental labor not at onetime in the beginning of the quarter, but we staggered that reset to time better with when we thought the actual weather would be cooperative in adding that labor throughout the country. So we did it in 3 stages in the southern markets, the central markets and then the northern markets. So we treat it that way. The thing to keep in mind is the fact that in the southern markets where we first rolled the labor investment out, we have been pleased with the results that we've seen as the employees have become up-to-speed on training and through our orientation processes and got acclimated to the stores. And we're seeing the second tier perform better than the third tier. So a lot of it has to do with the timing that we brought the incremental labor hours on, as well as timing through the normal seasonal build process. So we'll be able to give you more clarity into the exact results hopefully at the end of Q2. But like I said earlier, we are happy and pleased we what we've seen as we progress through the timing of the incremental hours investment.
Robert Niblock:
Just to add on that. As Rick said, the weekday teams primarily were focused on the interior of the store on core categories throughout the interior store. We did layer it on by climatic zone as traffic is starting to build. If you go back to my comments, I did reference that on our indoor product categories we saw a 3% positive comp; on exterior categories we had a 7% negative comp. Part of that's obviously due to weather, but I think obviously part of it is probably attributable to where we did have the weekday teams in place. As Rick said, they weren't there for the entire quarter. And to layer on Rick's comments, once -- as customers are in there and they're starting to see, I think, a greater level of service in the aisle, I think certainly that'll help with our close rate and will pay dividends for us in future quarters as those customers make return trips to the store. And also, we get those employees up the learning curve as we have to do with any new employees.
Operator:
Your next question comes from the time line of Colin McGranahan with Bernstein.
Colin McGranahan:
Just in terms of 1Q, a couple of markets that maybe didn't have weather extremes, can you talk a little bit about what the performance looked like in those markets?
Robert Niblock:
Yes, Colin, this is Robert. I think we talked about -- and I'll have Rick and the others chime in. We talked about, one, a couple of things, recovering markets. We also talked a little bit about the West Coast, and whether you're talking about California, whether you're talking about Florida, whether you're talking about Arizona, whether you're talking about Nevada, we saw nice strong positive comps in the majority of the stores in those markets out there.
Colin McGranahan:
And Robert, just to -- maybe I understand those are the markets that took the biggest hits during the housing and are fully in recovery mode, but is there any market you can point to that's kind of a more normal market that would reflect what the business looks like not in hard-hit markets and not in weather-impacted markets and I'm kind of scratching my head if that's like a Tennessee or something?
Robert Niblock:
Yes, well, if you look at -- across our southern tier where we had better performance, better weather, we certainly saw much better performance. Positive comps across kind of the deep south southern tier when weather broke and we had more opportunity to capitalize on seasonal business across those markets.
Rick Damron:
Yes, Colin, this is Rick. I'd just add when you look at a lot of the markets, Tennessee as an example, was impacted tremendously by the weather swings. I would say the Gulf Coast is probably more reflective of more normalized markets that performed very well as far as the Southern markets go in comparison to the rest of the country. That gives us confidence in what we've seen from Value Improvement initiatives, as well as our investments back into store labor and inventory. As Robert said, California performed extremely well being our highest comping state for the quarter. And then we saw good performance across the other markets, particularly the West Coast and Florida as those markets continue to rebound.
Colin McGranahan:
And then in May -- and I'm probably thinking of this because it's obvious there's a lot of noise in the quarter, trying to understand what you're doing and how weather impacted it. But it May, how are the indoor categories performing or the non-weather-impacted markets?
Gregory Bridgeford:
Colin, this is Greg. We've not seen a fall-off in performance of the indoor categories. They're doing well. They actually benefit from the foot traffic that's brought in from the seasonal business. And as Rick was describing earlier, you see, actually see an impact. The penetration rates aren't as great, obviously, as you move from winter months into -- toward summer months. But in the interior paint categories, you see interior -- all the interior paint categories, sundry and accessories, benefit from the foot traffic that's driven in by the exterior categories that are now taking off as we've seen weather turn around from South to North.
Colin McGranahan:
Okay, that's helpful. Final quick question just on the credit proposition, 20 bps the margin impact versus expected 10, higher penetration. Are you getting a commensurate lift in sales and benefit to the comp, and are the returns what you expect at this point?
Robert Hull:
Yes, we still -- Colin, we still see improvement in top line so as we think about the 190 basis points, roughly 1/4 of that would be incremental and the balance of that would be tender shift, so we are seeing some incrementality. In addition, as we think about switching from other forms of tender, yes, we do have a 5% off on the proprietary credit that's in lieu of promotional financing that they might have taken us up on otherwise, so it's a reduction in expenses for the program. It's also a reduction of bank card fees that they might have -- we might have incurred. So we are pleased with the continued progress of the credit program.
Operator:
Your next question comes from the line of Dan Binder with Jefferies.
Daniel Binder:
You talked a lot about the labor add-back and the cadence of that. I was curious if you can give us a little bit of color on what kind of training you're putting behind the added labor if there is a bigger concentration on -- in-the-aisle training or online training? And how you're using that additional labor? I know it's 2 full-time equivalents, but is it being split up across different parts of the store so that you get 4 different bodies in there at different times? Any color on that.
Rick Damron:
Sure, Dan, this is Rick. As it relates to training, I'll address that first, we have very specific training for these individuals as they come on board in addition to our normal orientation training programs that we put them through. Our training is both in, out and online through our Lowe's learning courses that we do with the employees. The thing to keep in mind with these employees is the training is very concentrated. As we talked about, these employees are focused on the interior categories, so it could be very structural training such as paint, how to mix paint, how to engage customers in the paint aisles or in specific areas throughout the store that we have them assigned to. As it relates to how they work across the store, we take and have them focus on 2 very particular time frames that the stores are allowed to use these incremental hours and those time frames were based upon when we saw the highest concentration of customer traffic throughout the day. So they are scheduled either in mid-morning time frames or in early to late afternoon time frames to hit those peak customer traffic times throughout the day. And we also schedule them in ways to make sure that we're taking advantage of our sales planning processes, understanding where the business is being dictated, where the business is coming through so that we're able to schedule them in accordance to where we think we will be drawing traffic into the store and make sure that they're prepared and ready to engage our customers there. So it is a very holistic approach and the hours is not -- they're not being just disseminated across the store. It is very focused, very structured, which lines up to -- which enables us to train them more in depth and also allows us to target them into areas where we know the customer traffic will be more concentrated throughout the day and the week.
Daniel Binder:
And as a follow-up, what is the next areas for the resets in the coming season?
Gregory Bridgeford:
Where the next area is, Dan, in terms of categories?
Daniel Binder:
Yes.
Gregory Bridgeford:
We still have, from a reset standpoint, 1/2 of our categories to go, so there's about 100.5 left so it's quite varied. I mean, I think there'll be less obviously seasonal as we move into summer. They'll be more hardline focused and more -- probably more focused in some of the areas of plumbing, fashion electrical, some in millwork that I'm aware of. But it is spread across the store and as you get into fall, you'll see some more seasonal resets come back. And obviously as you move through towards the Christmas season, you'll see trim-a-tree.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
When you look back at the first quarter, why do you think that either you are more impacted by the weather than the broader home improvement category and your largest competitor, or alternatively maybe you didn't benefit as much from the strength in the indoor category as much in the market?
Robert Niblock:
Well, my understanding is I think that both of us were certainly impacted by weather. And I think that was what they also said on their call yesterday. So I think it's not about being more or less impacted by weather on seasonal categories. I think part of it is, one, for example, we talked about the strength in the West Coast, particularly areas like California where we don't have as many stores. So to the extent that you have those markets that had favorable weather, yes, we benefited from the favorable weather, but as a percentage of our total base, obviously, we don't have as many stores there. And then the other thing, I think, I would point to is we don't have a strong -- as strong of affiliation as a percentage of our business with that professional customer. I think that would be something to look towards. I think if you look in the Hurricane Sandy market, we don't have as many stores in that immediately affected area as obviously they would. And then the last thing, Michael, I would point to would be just what we've talk about on the call today that we still have a lot of disruption going on as we go through the reset process, the transition of the lines, those type of things and selling through existing inventory. Even though we're getting good sell-through on that inventory and we're pleased with the margins we're getting on it compared to what we normally sell our nonproductive inventory through at, you're still selling units at less than what would otherwise be a full retail value. Obviously, you're selling unit and that's having an impact on your top line comp performance as well. So I would point to that as maybe some of the differences, not saying that weather impacted one of us more than the other.
Michael Lasser:
No, that sounds --- I guess I was being a little too cute in how I was asking my question. And Robert, if the penetration of the Pro business is a little lower at Lowe's, how do you think you can -- will you be able to fully participate as that customer segment becomes fully reengaged in the business, and what can you do to increase your penetration there, and share?
Robert Niblock:
Well, we've got a number of initiatives and I can have Rick speak to those as well. But once again, as you look at where recovery is taking place, in many cases it is in some of those -- the early recovery and rebuilding effort from, I'll say, new construction standpoint is in some of those markets, Florida, California, those places, Arizona where we're so heavily hit during the economic downturn. And once again, those are areas where we're out-stored. So we've got some things we're working on to try and obviously garner our share of business in those markets, but we've got some overall initiatives that we've got working on to -- in those markets and across all markets to be able to continue to improve our relationship with the commercial customer. Anything from the things like we talked about last year or so ago adding value prop to that commercial -- to what we offer to that commercial customer, to a lot of other things.
Gregory Bridgeford:
And Michael, I'll chime in, and Rick has some notes, too. But it's an important opportunity for us. As you have heard, and this is consistent in Q1, our sales to the Pro customer, the commercial customer outpaced our sales to the consumer from a growth rate standpoint and we need to take advantage of what the market will provide us. So from 2 critical points, as we restructure our lines through Value Improvement and you go into categories like hardware, rough electrical, rough plumbing as you address the opportunity in tools. And we've purposefully made sure that we, whether it was in particular brands and especially quantities and depth of inventory, we've reset those lines with that in mind. With the investment that Rick helped drive in inventory at the onset of the year, we've been able to provide much greater on-hand depth in some of those key categories as we reset these categories through Value Improvement. That's crucial, because with that customer time is so important. So that's -- we're seeing the benefit of that depth of inventory. We're seeing the benefit of lines that are structured against that opportunity, and Rick, you may have a few more comments.
Rick Damron:
Yes, Mike, this is Rick. I just wanted to highlight a couple of things, and Robert touched a few of those, that I think will add tremendous value to the professional customer as we continue to work toward building stronger relationships with that group. I think a couple of things that we need to talk about. One is what we're doing to showcase value to this customer differently that we have in the past. And as Robert mentioned, we introduced val prop, our value proposition, to the customer last year giving this customer the 5% off for all purchases on proprietary credit through our vehicles there. And we've seen tremendous adoption of that from a consistency point of view in what we're offering from a value perspective to those customers every day in every market. Second to that is also we've talked about last year changes we've made to our inventory investments as part of the Value Improvement initiative. Particularly in increasing targeted service levels across all items in the stores, which really help us build greater depth in key product categories that are relevant for our pros that shop us every single day, to make sure that we have that inventory available in stock across the store. Particularly focused on improving our depth of what we call job lot items, those items that pros need in multiple quantities every single day to be able to complete the jobs. And we've invested greater depth of inventory into those specific items in a very targeted way, to make sure that we're able to meet the demands across the store in those areas where we know they have particular quantity needs on a day-to-day basis, to invest in that area. The third component of this is what we've talked a lot about from Product Differentiation and our ability to begin to show this product differently to these customers than we ever have in the past. One of the key items there that I'll highlight is our Contractor Pack program, which offers these customers quantity discounts for quantity purchases on those items. Whether it be electrical boxes, switches, whether it be dry wall repair or whatever those items that we've identified. We're able to present those on the endcaps in a collective way to the consumer in that area of the store differently than we have in the past by freeing up those incremental endcaps to be able to show these customers different value whether it be in Contractor Pack quantities or whether it be in that national brands or proprietary brands that are relevant for them. So those things, I think, are adding tremendous value and are leading to helping us to have the pro customer segment outcomp our DIY segment for the last several quarters since we've launched those. The third -- the fourth component of that we introduced last year being our reorganization of our outside sales teams to focus on building those relationships with our largest customers. Where we know that we have a tremendous opportunity to gain share with them and to take a greater share of their spend and we're working to continue to refine that organization. It was implemented the end of Q4, taking place in Q1. So we feel very comfortable and very good about that we're seeing that organization being able to do long term. So when you look at this, I think it's a holistic approach in what we're doing from showing value, to how we show product, to building an organization that helps us strengthen relationships across that category.
Operator:
Our final question will come from the line of Dennis McGill with Zelman & Associates.
Dennis McGill:
I was wondering if you guys could maybe talk a little bit longer term. Once you get past some of the investment you're making in the store payroll this year, and the resets and repairs and things that maybe fade away as the recovery takes hold. How would like us to think about fixed cost leverage or SG&A leverage with the rising comp environment in '14 and '15?
Robert Hull:
Dennis, this is Bob. I think the framework that we've provided in the past, which is basically 20 basis points of EBIT improvement for each 1 point of comp still holds true. Obviously, there might be some fluctuations quarter-to-quarter. But on balance beyond -- kind of '13 and beyond, that's what we would expect.
Dennis McGill:
And is that inclusive of changes in D&A and gross margin as well?
Robert Hull:
It is.
Dennis McGill:
Are you're assuming that's flat within that? So how much -- what would the SG&A component of that look like?
Robert Hull:
So the majority of it, the movement would be in SG&A as you think about fixed cost leverage. Similarly, we get leverage on depreciation as sales improve. And then once we get past the Value Improvement process, our expectations for gross margin improvement are modest, around 10-or-so basis points per year. So the majority of that is going to come from SG&A first, depreciation second and then gross margin third.
Dennis McGill:
Okay, great. And then separately, if we were to look at the 7 categories that you flagged as being above average, I was wondering if you could put maybe some absolute numbers behind some of those? Were there any categories that were up, let's say, 4% or better in the quarter?
Robert Niblock:
Yes, this is Robert, Dennis. Yes, we had categories were up that much. We're not going to go and give you the details category-by-category. But yes, we saw that wide of a spring -- that wide of a swing in categories.
Dennis McGill:
Okay. And those will be led by where you've had more stabilized resets?
Robert Niblock:
Well, it was, like I said, it's the interior categories that we said, overall, were up 3%. But yes, I mean, those that we would have some -- we've either invested the depth of inventory or we've had some of the reset activity certainly would have contributed to that performance.
Okay, great. Thanks, and as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter 2013 results on Wednesday, August 24 -- 21. Have a great day.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you all for joining, and you may now disconnect.