Lowe's Companies Inc

NYSE:LOW

Earnings Call Transcript 2018-Q1

[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. Rick Damron, Chief Operating 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, Chairman, President, and Chief Executive Officer]

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 reigns. I am 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 am 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 are fortunate to have a strong leadership team who’s 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 six of 14 regions, while two regions were essentially flat. We posted the positive comps in five of eleven product categories, while one 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 Pro services team, and we continue to see strong customer response in the 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, 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 increase 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 the solid macroeconomic fundamentals such as strong employment and income gains will sustain home improvement market expansion and as 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 persists amidst steady job gains.

We'll continue to focus on and invest our resources in what is most relevant to engaging customer 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'd like to thank our more than 310,000 outstanding employees for their commitment to serving customers, serving our 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, Chief Customer Officer]

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, 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 leveraged 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 branch 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 business assortment informed by digital line reviews and optimized search capabilities to meet customers' evolving expectations. 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 at 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 projects this quarter.

As noted on our February call, we are focused on strengthening our day to day execution. We are working diligently to improve traffic conversion by accelerating associate revenues and knowledge through our training programs and providing even more restricted scheduling to better align staffing to customer traffic. Not only by department but also around key marketing and promotional campaigns. We are also reengineering key processes. Project quoting, our paint service model and our pickup 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 have 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 have recently rolled out our improved paint service model, separating tasking and selling activity. 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 have advanced our pick-up in store experience with convenient reserve parking spaces, dedicated spacing stores with clear signage to direct customers to the pickup location and optimize processes to ensure that product is staged and ready for pickup within two 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 five minutes of arrival.

Central quoting, our paint service model and our pickup in store experiences are examples of actions we have taken within the core 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 have identified additional opportunities as well. For example, in high touch categories, such as flooring, millwork and kitchen, we will improve instore responsiveness and lead time 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 overtime.

As we work to better capitalize on traffic growth, our supply chain transformation efforts are also key to better serving customer expectations and improving conversion in the short and long-term. We are 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 in saleable position for the customers.

For example, we’re currently testing ways to improve the flow of products 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 products on shelves. And given the increased demand for in-home delivery, we're highlighting a segmented delivery network for appliances and other booking products through a network of both 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 margins. 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 Lowe's costs.

Looking forward to Q2, we're encouraged by the strong sales momentum we've seen as weather has improved. Given that spring as an event to expand 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 in 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 brand 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 tools sets, tools storage, garage organization, flashlight 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 aren’t to be the exclusive destination in the homes 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 projects.

We’re also excited about our expanded partnership with Sherwin-Williams. As we work together to deliver a simplified line event, 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 outlets for interior and exterior paints, including the Valspar and HGTV Home brand. Under this expanded strategic partnership, Lowe’s is the company only national home center to offer top selling brands Krylon, Minwax, Cabot and Thompson's Water Seal as well as the top paintbrush brand Purdy.

In summary, we’ll continue to improve our execution, while accelerating the investments that will improve our ability to serve rapidly evolving customer expectation, strengthen our competitiveness and position Lowe's to capitalize on sold project demand now and into the future.

Thank you for your interest. And I'll now turn the call over to Marshall.

[Marshall Croom, Chief Financial Officer]

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 the 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 account decreased 2.8%. Adoption of the new revenue recognition standard provided a 76 basis points benefit to sales growth. Comp sales were [six tenths of a percent] driven by an average ticket increase of 4.3% offset by transaction decline to 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% to 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 clients, gross margin has been impacted from both the mix and rate perspective. We were also lacking competitive actions taken the 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 shrink an 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. An 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 a $1.19 for the first quarter a 15.5% increase over last year's adjusted diluted earnings per share of a $1.3.

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 had $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 3.8 times, 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 a $199 million or 2% increase over first quarter last year. And at the end of the first quarter lease adjusted debt to EBITDAR was 2.23 times. Return on invested capital was 19.4%.

Now looking at the statement of cash flows. Operating cash flow was $3.4 billion, 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’ve 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 like to address several items detailed in our Lowe’s business outlook. As Robert and Mike indicated, spring is the first half event, we expect to recover the majority of our first quarter sales miss over the next two 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 the total sales to 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 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, the capital expenditures of approximately $1.7 billion. This is expected to result in 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 are now ready for questions.

[Operator]

[Operator Instructions]. Our first question will come from the line of Seth Sigman with Credit Suisse. Please go ahead.

[Seth Sigman, Credit Suisse]

Thanks. Good morning, guys, and Robert best of luck to you. There has 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 as 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, Chief Operating Officer]

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 have begun 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 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 this spring season, the most ready for the season that we've been in recent memory with both the associates staffed and the readiness of their development under our 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 non-selling 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 non-selling 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 for their dedicated paint associates.

Other activities that we've had under way include what Mike talked about in terms of test 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 the role, they didn't feel -- gotten the feedback from our store associates, been able to talk to many of our best customers, there are two 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 DIY customer. Our focus is now shifted to, how Marvin Ellison.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 specialist 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 non-selling tasking activity.

Ultimately over time, Seth is 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.

[Seth Sigman, Credit Suisse]

Okay Richard. Thank you very much for that color. Appreciate it.

[Operator]

Your next question comes from the line of Seth Basham with Wedbush Securities. Please go ahead.

[Seth Basham, Wedbush Securities]

Thanks a lot, and good morning. 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 get a better sense of what the underlying trend is?

[Richard Maltsbarger, Chief Operating Officer]

Yeah, 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 about 35% of our business in the first quarter, that was the primary driver there.

[Seth Basham, Wedbush Securities]

Yeah as we think about, go ahead?

[Robert Niblock, Chairman, President, and Chief Executive Officer]

Just 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 were would spread across the lower buckets as well.

[Seth Basham, Wedbush Securities]

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 see like they're well positioned there or are there challenges in smaller-ticket categories as well?

[Richard Maltsbarger, Chief Operating Officer]

I believe we're well positioned in smaller ticket categories across the 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 inspirational all the way 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 takeaway categories.

[Seth Basham, Wedbush Securities]

Thank you very much.

[Operator]

Our next question will come from the line of Eric Bosshard with Cleveland Research. Please go ahead.

[Eric Bosshard, Cleveland Research]

Good morning. One of the initiatives you've 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?

[Richard Maltsbarger, Chief Operating Officer]

Yeah as Marshall highlighted, gross margin increased by 23 basis points, revenue recognition provided 58 basis points of net benefit. Obviously, we're lapping the competitive actions we took in 2017 partially offset by continued value improvement activities as we work closely with our vendor partners to deliver value in the marketplace and reduce first off.

And I'm really excited about the positive momentum I'm seeing particularly around these installation, improved competitive analytics and pricing optimization tools as we widen our visibility to the market gives us the ability to effectively manage the trade-offs required to both remain competitive and stabilized gross margins. And we saw 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, Cleveland Research]

And then one follows up if I could. Robert, I'm just curious your thoughts as you pass the baton to Marvin, what might be different, what might be the same if you have any thoughts or perspective you could provide us on that?

[Robert Niblock, Chairman, President, and Chief Executive Officer]

Well certainly Eric, we are excited to have Marvin now join the team, as you know he is an experienced retail CEO, significant experience in the home improvement industry, so I think that’s very exciting for us to have him join our call. 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’ll be available for anything I could do to assist in a smooth and early transition. I think Marvin will be become and look and see to view our strategy with plans we have in place, initiatives that we are working on in areas that you have seen no the call today, where we have outlined opportunities for improvement and I think he wants to dive in and be able to add his thoughts to what the team's already working on to see how we continue to make progress and take care, then do better job of taking care of customers' needs.

[Operator]

Our next question will come from the line of Scot Ciccarelli with RBC. Please go ahead.

[Scot Ciccarelli, RBC]

Good morning guys. 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 all have a feel for what’s happened to your stores from a pure traffic perspective?

[Richard Maltsbarger, Chief Operating Officer]

The traffic continues to be positive for both up stores and lowes.com. We continue to see positive yield from the start of Lowe’s campaign to driving better awareness, great value perception, engagement and ultimately traffic. I think we are striking the right balance the right occasion of digital and mass media. Optimizing our spend and delivering targeted personalized messages. So, I think we are really connecting with the customer in a very positive macroenvironment, and we continue to engage customers with trusted brands, great values and promotions and strong assortment. So, a lot of things working for us on the traffic front right now.

[Scot Ciccarelli, RBC]

Okay, then hopefully just a quick for Marshall. On the monthly cadence you guys provide us are there any calendar shifts we need to be aware of? Thanks.

[Richard Maltsbarger, Chief Operating Officer]

[4-5-4] we were four, five forward on calendar [4-5-4] basis, there wasn’t any meaningful shifts in the calendar for the first quarter.

[Scot Ciccarelli, RBC]

Got it, thanks guys.

[Operator]

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

[Simeon Gutman, Morgan Stanley]

Thanks, good morning. I want to talk about the guidance and your 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 of a third. Is that the same in terms of profit flow through and is there any less investment that you are 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, Chief Financial Officer]

We are anticipating recovering majority of the sales missed in the first quarter, so that’s what we’re expecting to flow through in Q2 and in Q3, so that’s what we were 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 have got again the staffing the inventory and efforts to really how are we improving our customer experience, the shopability of the stores, with shoppable inventory. A lot of the associate investments that we are 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, Chairman, President, and Chief Executive Officer]

Simeon, this is Robert. Also, as we get through the balance of the year, we’ll start to lapse some of the marketing additional serves we had up from last year as well as you’ve already seen some of the early signs of the gross margin stabilization work that Mike and his team are doing and certainly that will 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 first quarter.

[Simeon Gutman, Morgan Stanley]

Okay. So just to clarify, so, no less a 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 that 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, Chief Financial Officer]

I think one, we’re continuing to leaning into the investments as planned for the year. Again, to Robert’s point, there are certain things, competitive actions, ramp up in advertising, certain things that we ramped up beginning last year that will lap. But with some of the efforts underway, right now, I would just say that we're encouraged, but more to come as we get traction on some of the tests and pilots that we’ve gotten underway. So, we're comfortable with our guidance as it is.

[Simeon Gutman, Morgan Stanley]

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?

[Richard Maltsbarger, Chief Operating Officer]

Yeah, I would tell you that Simeon, we continue to feel very good about our appliance business obviously, continued double digit growth in that category would run 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 progress in some Pro related categories, rough plumbing and electrical, for example we continue to grow share in 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 with leverage as they do their work for customers and expand penetration with the plumbing and electrical Pro, plumber 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 in our associate engagement with the Pro is paying off key brands like Marshalltown, Norton Abrasives, the recent launch of [indiscernible] striking tools and we really feel good that double-digit comps in subcategories like tools storage and mechanics tools will continue to complement the launch of Craftsman. So, they are the categories I’m feeling pretty good about and continue to see a great progress with our pro customer base.

[Operator]

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

[Michael Lasser, UBS]

Good morning. Thanks for taking my question and best of luck Robert. So, as we allocate the 300 basis points of contract that you called out due to the weather all to your traffic, with your traffic down closer to 12.7%. You have a pretty easy comparison this quarter, so the two-year traffic spend was noticeably degraded even on that basis, down 2.2% or so. Why would have the traffic gotten that much worse even adjusting for the weather. 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, Chief Financial Officer]

Yes. When you think of the 300-basis points impact from weather impacting lawn and garden or 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 five points that Richard laid out, talk about associate guidance etcetera, with the opportunities we have with execution within the stores.

[Michael Lasser, UBS]

Outside of the weather, did conversion gets worse this quarter from where it has been?

[Michael McDermott, Chief Customer Officer]

No Michael, outside of the weather the pattern that we saw in the conversion challenges last year has stabilized in the Q1 period. And now the intensity of focus is on working away back to all that.

[Robert Niblock, Chairman, President, and Chief Executive Officer]

Michael it's Robert. Just keep in mind, when we look at the 300 basis points drag, I also think about we talked about the strong seasonal business we built the 35% in the first quarter of our sales. So, it does kind a have disproportion effect given how tough the weather was this quarter.

[Michael Lasser, UBS]

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've talked about it extending through the third quarter. So, what makes you believe it's going to be always through the third quarter given that you've already seen double digit comp trends maybe quarter-to-date?

[Richard Maltsbarger, Chief Operating Officer]

Michael what we're seeing is a balanced transaction and ticket through the first couple of weeks of May, we take a look at our promotional alignment, our product assortment. The momentum that we 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.

[Operator]

Our next question comes from the line of Greg Melich with MoffettNathanson. Please go ahead.

[Greg Melich, MoffettNathanson]

Hi thanks. Just to maybe dig a little deeper on Pro and make sure I 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 it was working there what do you think you're going to lean into to sort of drive that the rest of the year. And then Marshall I had a question on the guidance follow up.

[Michael McDermott, Chief Customer Officer]

So, I would say that Greg that we have had strong performance with the Pro but not yet ready to go beyond our 30% penetration number.

[Greg Melich, MoffettNathanson]

So, stick with that. And then make sure I got the math right on this. And Robert, thanks for all the help over the year, also please enjoy your retirement. I think it's important to say that here.

The guidance now given the shifts in accounting, if EBIT dollars were down 6% in the first quarter, but we’ll still be up a little bit if I take the mid-point of your guidance for the year, is it fair to assume that EBIT dollars will be positive, the last three 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. Thanks.

[Marshall Croom, Chief Financial Officer]

Again, we are looking to recover, again the majority of the sales so that obviously we’ll have a flow through impact, so that’s going to play out over Q2 and Q3, that we have that as recovery opportunity in the year. So that’s how we’re thinking about, how we would recover sales and EBIT.

[Greg Melich, MoffettNathanson]

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 the second quarter, it’s a second quarter but if ends up being more the third quarter, it will be done.

[Marshall Croom, Chief Financial Officer]

Correct. And again, the accounting changes does not impact sales or operating income.

[Operator]

Our next question will come from the line of Elizabeth Suzuki with Bank of America Merrill Lynch. Please go ahead.

[Elizabeth Suzuki, Bank of America Merrill Lynch]

Great, good morning guys. You mentioned that storm related activity helped lumber. Can you call out any particular hurricane related benefits or quantify that in anyway?

[Marshall Croom, Chief Financial Officer]

Yes Elizabeth, it was about a 100 basis points benefit in the quarter from hurricane related activity from what we experienced last year. Again, that was the 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 you can anticipate over the back half of the year.

[Elizabeth Suzuki, Bank of America Merrill Lynch]

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 and outdoor living in lawn and garden. So, presumably kitchen and flooring were probably comping negative. Can you just talk about what’s going on in those categories?

[Marshall Croom, Chief Financial Officer]

Sure Elizabeth, paint I think had a significant weather impact. If you think about exterior stains and exterior paint, in the first quarter weather certainly hurt us there. When you think about flooring and kitchen as Richard highlighted got a lot of work underway we’ll improve our conversion rate in those categories, not just through the selling experience but also managing our installer base and reducing time in the phase from the moment a customer makes his 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.

[Elizabeth Suzuki, Bank of America Merrill Lynch]

Great, thank you.

[Operator]

Our next question comes from the line of Chuck Grom with Gordon Haskett. Please go ahead.

[Chuck Grom, Gordon Haskett]

Hey, thanks, good morning. 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, Chief Financial Officer]

Correct, in the first quarter it was 58 basis points, we were guiding to flat gross margin before the adoption of the revenue recognition standard. So yes.

[Chuck Grom, Gordon Haskett]

Okay and just as a follow-up to that. I think you said when you provided the guidance earlier in the year and that you expected the front half to be lower and the second half to be better, is that still the case?

[Marshall Croom, Chief Financial Officer]

Yes, that’s still primarily the case again lapping some of the actions that we took in Q2 and Q3 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 we lapse some of those actions.

[Chuck Grom, Gordon Haskett]

Okay. And you guys are not going to restate last year, did you say it earlier?

[Marshall Croom, Chief Financial Officer]

We adopted the modified retrospective method. So that does not require you to restate that, highlighting the impact and basis points on sales, gross margin in SG&A.

[Chuck Grom, Gordon Haskett]

Yeah, okay. Thanks. 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 elastostatic benefits that you've seen so far?

[Michael McDermott, Chief Customer Officer]

So, we continue to see positive improvement and it relates to moving 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 results we're seeing and the benefits it’s having to our gross margin.

[Chuck Grom, Gordon Haskett]

Okay. Thank you very much.

[Operator]

Your next question comes from the line of Daniel Binder with Jefferies. Please go ahead.

[Daniel Binder, Jefferies]

Thanks. 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, Chief Customer Officer]

Yeah, this is Mike, again. Look, we had another strong quarter with our digital properties, delivering at 20% comp. We continue to build out our capabilities to support the overall omni-channel experience and 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, continue to drive traffic, optimizing our assortment through digital line reviews and certainly we 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 Lowes.com business will continue to grow and digital capabilities will enhance the omni-channel experience. So, we're in a good place.

[Marshall Croom, Chief Financial Officer]

And Dan, this is Marshall, I’ll just add to that. When we had the question about continued investment in digital platform and capabilities, it’s certainly something that we continue to lean into and invest. We've got a new Chief Digital Officer on board, he’s been here about four 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% last year, so our 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 omni-channel strategy.

[Daniel Binder, Jefferies]

And then as a follow-up, adjusting for any weather impact there may have been on the Pro growth sales, Pro sales growth as you 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?

[Michael McDermott, Chief Customer Officer]

Dan, it's a relatively similar pattern and continued strong we do believe based of 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. Please go ahead.

[Matthew Fassler, Goldman Sachs]

Thanks so much, Robert. All the best to you after all these many years. On the start by talking briefly about February. So, February did not seem to be a weather call out in terms of the impact the way in March and April were. The February monthly number on a one-year basis or two-year basis are still representative of a bit of a stepdown from where we've been. So, was it really the last two months of the quarter that were light or was the how was the first month difficult as well?

[Marshall Croom, Chief Financial Officer]

Yeah, I would say that the bigger crunch that we had were March and April from a sales and transaction impact.

[Robert Niblock, Chairman, President, and Chief Executive Officer]

Yeah if you look at certainly the volume. As you know Matt, the business grew dramatically between February by the time we get to the end of the quarter. So, the impact from those higher volume leases is much significant than it would be in a month like February.

[Matthew Fassler, Goldman Sachs]

Got you. second question related to expenses. You actually came in a bit below the number from a dollar perspective adjusted for the accounting changes and all that. A bit below our forecast there. I know that you held on to the labor investment that you had maybe 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, Chief Financial Officer]

No, we actually were pretty pleased with our results in the first quarter. So, we had some productivity efforts that help provide an offset even with the investment in labor. So, we'll continue to keep that as a focus as we lean into the year where else do we have productivity efforts on that front. And so, while we have that as the focus we're also keenly focused on sales productivity opportunities as we move forward.

[Matthew Fassler, Goldman Sachs]

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 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 up from those efforts.

[Michael McDermott, Chief Customer Officer]

Yeah Matt, we look at value perception pretty regularly. And our value perception metrics continued to be consistent with where that been since we took the competitive action in the second quarter of 2017. We remain competitive, we see a rationale environment right now as it relates to the competitive pricing front. We've got a wired 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 got to make the right trade off to maintain gross margin. So that's our focus. And what we seen so far are positive results.

[Matthew Fassler, Goldman Sachs]

Got you. Thank you so much guys.

[Robert Niblock, Chairman, President, and Chief Executive Officer]

Thanks. And as always thanks to 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.