Lowe's Companies Inc

NYSE:LOW

Earnings Call Transcript 2018-Q4

[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, President and Chief Executive Officer]

Thank you, Regina. Good morning, everyone. Overall we're pleased with the progress we're making in our business and most of the intense work over the past six months to transform our company has been preparation for an improved spring season in fiscal 2019. Therefore, we're encouraged by the customer's response for our assortment and service changes in Q4 and with the results we're seeing in early spring categories.

This progress was evident and 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 and is 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 recess. We believe this will be huge 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 US comps improved by 2.4% delivering a positive 5.8% comp in January. We're also very pleased with a comp progression which we believe further reinforces that our retail fundamental focus was in place and doing well in the quarter.

In US we delivered comps in 11 or 14 geographic regions and at Tampa, Houston markets faced tough comparison from Hurricane Irma and Harvey. The US we delivered positive comps in eight of 11 product categories and great offers in tools and hardware delivered comps above the average supported by strong cost 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 in Black Friday weekend. These challenges are reminder of the upside opportunity we have in our online business. However coming out of 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. 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 Halloween market combined with ongoing integration of Ronna [ph] exerted pressure on the business. We also reported $952 million non-cash pretax goodwill impairment charge associated with our Canadian operations. We anticipate weakness in the Canadian housing market which is a growing pressure on our outlook for that business over the near term. However we remained confident in our market position in Canada and over the long-term potential of this business.

We reported a 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 wide home improvement products with the best service and value across every channel and community that we serve. And will achieve this mission by winning in four key areas; driving merchandising excellence, transforming our supply chain, delivering operational efficiency and intensifying customer engagement.

Note that our strategic focus has been changed, but we've modified the tile of our second focus area since our Analyst Investor Conference from omnichannel to supply chain transformation. This better described via initiatives - need the including fulfilment and delivery optimization. In fact all four 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 US home improvement industry should continue to benefit from several factors including income growth, lower federal tax rates, gains on household formations and continued home price appreciation. This growth is further supported by an ageing housing stock, as home prices are increasing consumers were staying in their homes longer and the cost of their improved financial position they're investing in their homes. All of these factors drive investments in home improvement project.

To capitalize on this supported macro environment we'll 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 three inconsistencies we're beginning to see improvements in key areas. So let me take a moment to share with you five 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 team or MST pilot 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 for 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 five areas of progress give us confidence in our business outlook for 2019. They also demonstrate that we're focused on the right initiatives to achieve our long-term target.

Before I close, I'd like to thank our 300,000 associates for embracing change and for the renewed competitive spirit and for their commitments, our most important initiative, serving the customer. With that, let me turn the call over to Bill.

[Bill Boltz, Executive Vice President, Merchandising]

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're very excited about our new partnership as the official home improvement retail sponsor of the National Football League.

This exclusive multi-year sponsorship grand flows 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're also working to deliver an outstanding 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're beginning to see signs of improvement. For example, we're seeing positive signs from our Merchandizing Service Team or MST pilot. These teams are funded by our vendors and they add an average eight full time employees per store. These teams are responsible for the day-to-day maintenance of the day presentations in our stores, responsible for setting and maintaining endcaps and helping to execute off shelf displays.

The MST teams are critical to improving our execution at store level as they take these [technical difficulty] consuming tasks off the shoulders of our red vest associates, so that they could 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 base service per hour. We expect to complete the staffing of our MST teams enrol the program nationwide in the first quarter of 2019.

As we've 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 debts 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 skews and select test markets and we saw an increase in both pro comps and pro sales penetration. Following the successful pilot, we're now expanding our investing in job lot quantities and we're rolling out nationwide in the first quarter. We're also leveraging our improved reset process to better position us for the spring selling season.

We're transitioning in the season more efficiently and we're setting our stores earlier. All of this to ensure that we have submission, seasonal inventory on hand that we're positioned to capture the spring demand when the season breaks. We're pleased with early results in the south and Deep South where we're seeing strong comps in our seasonal and lawn and garden categories.

And other area of excitement for spring is the continued roll out of Craftsman. Our data shows that approximately 60% of 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're very proud to be the exclusive destination of Home Center channel for this iconic brand.

We've gained market share in each Craftsman categories since introducing the brand and we're excited to add Craftsman outdoor power equipment as part of our spring offering. Throughout the spring, we'll also continue to rollout mechanics tools, hand tools, power tools and tools for range across the chain. In addition, for the first time this spring Lowe's will have the top three brand in John Deere, Husqvarna and Craftsman.

In addition to our assortment and 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 Monrovia plant program, a Home Center exclusive in lawn and garden and expanded offerings from Weber and Char-Broil the top two brands in outdoor grilling. In fact, earlier this month, at our store managers meeting the merchants let every store manager in the company through a product lot 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 merchandizing productivity through the rollout of our field merchandizing teams. These teams will focus on meeting the needs of the customers to 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 skews out of our stores and onto our website to improve inventory return.

We're excited about the opportunities there 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.

[Joe McFarland, Executive Vice President, Stores]

Thanks Bill and good morning, everyone. I'd like to discuss the steps we're taking to improve customer service in-stock and better optimize our labor spend. The first step to improve customer service was to streamline communication in past at the store level. Therefore in fourth quarter, we moved to simplified weekly playbook that focuses to teams and top priorities, key metrics and critical deliverables. Since then, we've seen a significant increase in odd time task completion in the stores, as our associates are now more focused on activities that drive sales and improved customer service.

In addition, we instituted a regular crack down 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 improved by 15%. To assist with our supply chain, replenishing [ph] algorithms and keeping pace with sales demand. We gave our store managers limited autonomy to reorder appropriate quantities of low risk, high velocity skews 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 book 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 the 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 the trend 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 will complement this training by rolling out smart mobile devices to our stores. No longer will associates will 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 at 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 in peak traffic, providing better department coverage and customer service, while also ensuring that we're using our labor hour 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're 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 in 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 at dedicated loaders so that the pro customer can consistently rely on us to help them level 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 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.

[Dave Denton, Chief Financial Officer]

Thanks Joe and good morning, everyone. Let me begin this morning with housekeeping notes and review the major charges that we incurred during the quarter. First there's 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 cost. Cost related to the delivery of products from the company to the customers are now included in cost of sales versus SG&A and B&A [ph]. This reclassification resulted in a decreasing 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 reported $952 million non-cash 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 it's 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've 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 $2.59 through the open market. So in total, we will purchase $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 were 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 $1.6 billion in pretax charges we've recognized in the fourth quarter adjusted diluted earnings per share was $0.80 and 8.1% increase over the 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 for the adjusted diluted earnings per share was in line with our expectations as we effectively manage expenses and drove store payable 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 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 US home improvement comp was 2.4% for Q4. While comp transactions declined for the quarter we've built 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 effective cycling the hurricane season was an approximate 80 basis point drag on comp sales. Headwinds from Hurricanes Harvey and Irma were partially offset by demands 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 US 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 comparable non-GAAP basis. Adjusted gross margins for the fourth quarter was 31.5% of sales, a decrease of 56 basis points from Q4 last year. The adoption of 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 skews as well as an accelerated clearance activity for holiday inventory, in order to better position us for the spring selling season.

We're raising bar on serving our customers. Therefore these actions are necessary to mitigate in efficient planning lead into the holiday season. We also experienced 45 basis points of pressure from supply chain cost. As we added new facility to network that are still ramping up to full capacity coupled with ongoing increases in transportation costs 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're working diligently to mitigate the pressure from tariffs through a portfolio approach. We're 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 25 basis point negative impact on gross margins for the quarter. Adjusted SG&A from Q4 was 23% of sales which delivered 77 basis points.

Adoption again of the new revenue recognition standard resulted in 108 basis points of SG&A deleverage. This is partially offset by leverage from operational expense management. Adjusted operating income decreased to 106 basis points to 6.4% of sales and adjusted effective tax rate was 24.3% compared to 39.1% of versus LY. This significant improvement is largely the result of tax reform. $12.6 billion inventory increase, $1.2 billion or 10.3% versus the fourth quarter of LY. This is largely driven by earlier spring buys, the anticipation of additional Craftsman reset 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 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 take this one step further and new 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 the 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 reported as an adjustment to beginning repaying 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 approximately 3%. We expect adjusted operating margin increase of 85 to 95 basis points. A primary driver of operating margin expansion beyond sales growth is expected to come from SG&A leverage. Store labor productivity as well as the adoptions and advertising cost for 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're forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.6 billion. This prospective result and free cash flow were approximately $4.9 billion for 2019 and our guidance assumes approximately $6 billion to $7.5 billion in shares repurchases for the year. We remain extremely excited about the future of our business and are focused on taking necessary actions to drive returns and long-term shareholder value.

So with that, operator we're now ready for questions.

[Operator]

[Operator Instructions] our first question comes from the line of Christopher Horvers with JP Morgan.

[Christopher Horvers, JP Morgan]

Can you talk about the improvement in January obviously, you called that out in press release and on the call. it's a small month, so was curios have you seen any particular categories, was it driven by particular regions, how did it look in DIY and pro and was there any other clearance activity that you saw pressure gross margin provided a benefit to the January comp?

[Marvin Ellison, President and Chief Executive Officer]

Chris this is Marvin. Overall, we saw improvement in both pro and DIY and whether it is sequential comp improvement was driven by quite a few factors. First we saw transaction in pro and DIY and I think Dave'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 investments job lot quantity, the supervision and staffing improvements. Basic things like the loading and just a broader service operation that we put in place.

We also feel very good about the early set to spring. I think Bill mentioned in his comments and so did I, where we actually had stores that found last year that in the seasonal area, they were still managing through clearance holiday product and so the simple fact, we're able to get what will be relevant spring product in some of these normal weather markets, pay a big dividend. In addition that, we've talked about the Craftsman response by a customer was also important.

Yes I'll let Bill add any additional color but the good news for us. It was widespread, it was not either DIY, pro or 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 on that?

[Bill Boltz, Executive Vice President, Merchandising]

You hit on most of them. I think the comments that were made in your early 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 south as I said in my prepared remarks. Where just by saying 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, President and Chief Executive Officer]

Chris, the only caveat I'll provide is, we're not declaring victory. We've a lot of work to do, there's still areas of the business that I mentioned that we're still seeing pockets of inconsistency. But we believe that the whole retail fundamental is focused that we all talked about is paying dividends, the longer we're able to embedded in our merchandizing philosophy, in our operational processes and that's why we believe we sequentially improve throughout the entire Q4 period.

[Christopher Horvers, JP Morgan]

Thank you. And then as a follow-up, Dave as you look for, can you talk a little bit about the cadence around the quarters or the haves anything on the comp and the margin structure? And as you look forward do you think the inventory is clean such that and the stores are closed. So do you think that the gross margin pressure from clearance are behind us and the accounting charges as well?

[Dave Denton, Chief Financial Officer]

So maybe keep that couple questions in there. First from a comp perspective, as I think about 2019, is it 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. But first half I think we're very nicely positioned for seasonal and I think the seasonable drive our performance a bit in the first half, as 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 about it as the year shapes us. I do think largely our inventory liquidation work is behind us, as a retailer we're always in this business. We always look at non-productive inventories. So we'll continue to focus on that. But we don't see any major program from that perspective going forward.

[Christopher Horvers, JP Morgan]

Thank you.

[Operator]

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

[Simeon Gutman, Morgan Stanley]

My first question is on 2019 guidance, I think it was mentioned at the - 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?

[Dave Denton, Chief Financial Officer]

Yes so, think about this in two ways. One, when we gave guidance at our analyst investor conference. We baselined it off of - we baseline 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 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 re-baseline numbers. So if you step back and you do the compare to re-baseline numbers versus our adjusted that will bridge that gap. So essentially our 2019 outlook has not changed as we sit here today.

[Simeon Gutman, Morgan Stanley]

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, the 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 gage the sensitivity within each of your lines whether it's gross margin or SG&A and determine, if there's high degree of any or not?

[Dave Denton, Chief Financial Officer]

So I'll take the first fees [ph] as what was I'll say somewhat unexpected and gross margin as we cycled in the 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 a right thing to do from a customer perspective. And then secondly, we made during the quarter a proactive change to our plan, to liquidate seasonable more aggressively and earlier to get ourselves better positioned from a spring perspective recycled into 2019. So those were probably not - completed expected, but we actively managed that from our standpoint.

[Marvin Ellison, President and Chief Executive Officer]

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 timeframe. So it was a real accelerated process to understand where we were entering springs set base and alike. And to Dave's point, there's a traditional process that I'm accustomed to and Joe and Bill are accustomed to heading into the holiday period. Would - is that is go through the half to make sure that you have a different 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.

Don't I get it? It would have margin impact, but as Dave as stated, it's right thing for the customer. In addition to that, as I mentioned it was not uncommon going into week three, four and five for Lowe's to be still managing through holiday mark downs 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.

[Simeon Gutman, Morgan Stanley]

Thanks.

[Operator]

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

[Michael Lasser, UBS]

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 not only that going to extend into the upcoming year, but we'll also be more aggressive to reengage customers with your store.

[Marvin Ellison, President and Chief Executive Officer]

Michael, we don't see any material changes to our promotional cadence in 2019 versus prior year. We think we have a great brand. We're excited about products that we're bringing to market and we think that's going to allow us to get the traffic and then do a much better job of converting that traffic.

[Michael Lasser, UBS]

Okay and I want to follow-up the outlook for 2019 because you did embed income tax rate that 100 basis points below what you would previously expected. So what prompted that change and how did that flow through the rest of the model?

[Dave Denton, Chief Financial Officer]

Clearly we're constantly looking at our income tax status and I think we'll just continue to tweak that as we look at our expectations for 2019, so nothing dramatic there.

[Michael Lasser, UBS]

Okay, thank you very much.

[Operator]

Your next question comes from the line of Brian Nagel with Oppenheimer.

[Brian Nagel, Oppenheimer]

The first question I have, you discussed a lot of what's happening in the stores and obviously some initial positive results. How should we think about, what you've done the stores initiatives, how far into this process are you? And then, also is there a way to look at particularly with the comp sales acceleration through the fiscal Q4. Is there a way, we've got data to sort of say isolate, areas where you have touch versus areas you haven't. So we could see evidence of the progress you make in the stores with some of the initiatives.

[Marvin Ellison, President and Chief Executive Officer]

Brian's it'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've 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 low as late in the summer and it just didn't give us the proper time to make the necessary adjustments to - the categories we want to impact, the buys we'd like to make and the supply relationships that we would like to formulate.

Having said that, we're very, very proud of the work, of the teams. And we're very proud of the change management acceptance that we've seen in the stores, on the merchandizing side of the supply chain, really a product - 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 talked, I'm going to let Bill provide a little more specifics. But our highlight is paint.

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 four 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 supply partner and Sherwin-Williams has agreed, that we felt we could.

And so we immediately addressed that and we feel great about the progress that we're making and we felt like this, the progress was more of a micro chasm 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, what about this year, to try to get the same level of improvement.

[Bill Boltz, Executive Vice President, Merchandising]

So I think, a couple of things. First of all just to kind of finish the comment around paint. There is 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 pokers [ph]. 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 market and that includes job like quantities soon, products like five gallon paint. Training, we put a whole new paint department in front of our customers last year. We didn't do any training. So now we're going through training all of our associates.

We're leveraging relationship as Marvin touched on 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, paint in the way that we need to.

From a marketing perspective, we've got only marketing coming out this spring. We're very excited about that and work that the teams' done. In addition to pricing and loyalty programs that we're testing to be able to put out their - for pro paint. And then as I touched on already in the seasonal categories. The work that we, were quickly able to do at the latter part of last year between the store team, the supply chain team and merchant teams.

To look at spring, to look at loadings, to look at the prep needed in order to be ready for the spring when the season breaks, is 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 give us little bit of encouragement in regards to the stuff that we're focused on, is working as Marvin said you've got areas inside of store that are longer putt for us, we 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 just going to take longer for us to get cleaned up and to get addressed.

[Marvin Ellison, President and Chief Executive Officer]

Brian, one other thing as you think about the - where we're at from this recovery we've been talking about and new department supervisors in place, that's just happening in January. I talk 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. Actually feel good about where we're at today and feel really good about the plans we have moving forward.

[Brian Nagel, Oppenheimer]

That's helpful. And thank you. One - maybe real quick follow-up. You obviously called out January and the five, eight comp there. Any commentary how the business is tracked to into February?

[Marvin Ellison, President and Chief Executive Officer]

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 on anecdote. I was in the store recently. The stores are performing really well from a comp perspective and we have a 21-year manager that in the building. I pulled him aside and wanted to get his assessment of how did we feel about spring versus last year.

And we were standing in the area with new Craftsman outdoor power equipment and with 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 things that we're doing is outrageously strategic.

It's retail fundamentals, setting product into timeframe that customers will like to buy it, having great brand, improving service, having product available. But the key thoughts for February is just a timing. Meaning having the product in the store online, when customer is interesting in buying 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.

[Brian Nagel, Oppenheimer]

Thank you.

[Operator]

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

[Scot Ciccarelli, RBC]

Given the improvement that you saw in the process specifically in January. I guess I'm wondering how are you guys generally thinking about pro trends for 2019 as yet job lot quantities and some of the other changes that you're making, that's number one. 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? Thanks.

[Marvin Ellison, President and Chief Executive Officer]

So Scott I'll give a high level answer to pro and then Joe, believes there's any other specifics he can jump in. but we think our pro-business improved in - and our actual pro comp in the month of January outperformed the total company comp. so pro really had a strong flows to the quarter. But when you look at it fundamentally it's just some basic things. It is getting the job lot quantities in the stores and both Joe and Bill mentioned we're not yet complete, that we should have all stores with job lot quantities investments by the end of this quarter.

Is doing basic things like adding dedicated loaders to every store. Joe mentioned the fact that we put pro department supervisors in position for 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 are 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'll be coming a second, if not its first option for customers then it literally stop shopping us because we didn't have adequate inventory level. We have high expectations for pro, but we have a lot of work to do. I mean, we're by no means checking the box that we've kind of solved. This very important customers 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.

[Joe McFarland, Executive Vice President, Stores]

The only thing I'd add is, we brought in a few tenured leaders for our pro-business and they have depth of experience servicing the pro, 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 a larger share of wallet. So we're - again as Marvin said, we're early stages in pro, but we feel very, very good about the focus we have.

[Marvin Ellison, President and Chief Executive Officer]

And Scott, don't think [indiscernible] well it's too early to determine if it's new customers, existing customers. We're looking at all as you can imagine, but our philosophy is very basic here. We want to improve our overall service in 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 pro will improve transactions, it will improve ticket and it will improve overall productivity from a sales and square foot perspective and so it's a balance approach serving both of those very important customer segments.

[Scot Ciccarelli, RBC]

Appreciate the help, thanks guys.

[Operator]

Your next question comes from the line of Steve Forbes with Guggenheim Securities.

[Steve Forbes, Guggenheim Securities]

I wanted to start with the adjusted EBIT margin guidance for 2019. 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 headwinds, right you called out impacting you in the fourth quarter. How should we think about those impacting you in 2019?

[Dave Denton, Chief Financial Officer]

Steve, this is Dave. I would look at gross margin and think about that as essentially flat for the year for the most part. We're going to get an operational leverage really through SG&A as we focused on both store productivity, but importantly as we focused on advertising effectiveness. And I feel like that, much of with what we had occurred in Q4 of 2018 is kind of behind us and baked into our plan going forward is essentially that flat outlook.

[Steve Forbes, Guggenheim Securities]

And then a just quick follow-up regarding the capital deployment plans for the year. Any color 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?

[Dave Denton, Chief Financial Officer]

I can't give you too much on that. 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 the best assumption that you should use just from a modeling perspective is to think about share repurchase more or less equal throughout the year. Obviously that will ebb and flow based on how we actually go to market. The best probably good starting point for you.

[Steve Forbes, Guggenheim Securities]

Thank you.

[Operator]

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

[Eric Bosshard, Cleveland Research]

Two things. First of all in terms of online curios for your outlook in terms of when the results there start to improve. It seems like the execution at the stores is better but online continues to lag. I'm curios for the outlook for progress there and then also if you could explain within that change in your strategic focus, which maybe 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 clearance and holiday out earlier. Thank you.

[Marvin Ellison, President and Chief Executive Officer]

So Eric I'll take the first part online question and then I'll let Bill give some color to online and I'll let David jump in on the question regarding clearance. First and foremost, we know a modern day retail 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 a decision to just go out recruit someone who had a specific background in this to just kind of supercharge our focus and have a much more aggressive approach and as Mike Amend joined us in January as I mentioned in my prepared comments and he's going to work Seemantini, our new Chief Information 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 two leaders in position one with deep learning and proven 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 in the merchandizing, is critical because we want the merchants to have a broad view not a store view, not an aligned view, but an omni view.

So I'll let Bill talk a little bit about kind of his additional thoughts on, on what the expectations are in that business for 2019 and beyond.

[Bill Boltz, Executive Vice President, Merchandising]

Thanks Marvin, so couple of things. First of all we're not sitting still in online, so as we've strengthened the leadership team and merchandizing side for online. Underneath Mike, we're aligning those folks so that they're tied to the core merchandizing team. So we can pull through those strategies, but we're really looking at it focused on three separate areas. So from a customers' perspective making sure that it's easier to shop, easier to navigate and that we have more products available on those type of comp.

And then for our associates, it's building out the muscle of the endless island [ph] inside of our stores. So utilizing lowes.com is a tool in their toolbox and getting that rigorously as we work through the smart channelling that Joe was talking about, it's about been able to leverage lowes.com is a solution for our customers inside of our stores.

And then the third part of it is, our vendor partners, right? Been able to get this few additions online, the product availability, making sure that we're forecasting and ruling out the rigor around those businesses just like we inside of our store. Improving the A plus content and then improving our drop capability and fulfilment abilities that we have on those .com. so that's what we're focused. We got a lot of work to do. We know that we've had some struggles there, but I think we're very confident that the leadership team that we have in place there, that we'll see significant progress in our lowes.com business in 2019.

[Marvin Ellison, President and Chief Executive Officer]

And Eric, before handing to Dave. Just one other data point, even with some of our challenges today 60% of our online order that picked up in the store and 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 over side and the strategic direction that Bill is providing and we're looking forward to coming back in subsequent earnings calls to update the investor community on kind of the progress, we're making. I'll let Dave talk to you about clearance.

[Dave Denton, Chief Financial Officer]

Eric, your last comment around the clearance affecting January. Clearance did not drive any material inflows. It had very immaterial influence on sales in January. So that was not a driver of our performance in the month.

[Eric Bosshard, Cleveland Research]

Great.

[Dave Denton, Chief Financial Officer]

Thank you. With that, we'll take one more question. Thank you.

[Operator]

Our final question will come from the line of Peter Benedict with Baird.

[Peter Benedict, Baird]

Hi guys, pressures on here I guess. So I'll start with the question just around the supply chain transformation Marvin that you called out kind of that second strategic focused. Can you give us a sense of where you're today? And milestones which you think about in terms of where you want to be 12, 24 months from now with respect to fulfilment and delivery? That's my first question.

[Marvin Ellison, President and Chief Executive Officer]

Well, Peter I would say, earlier today we talked about at the analyst investor conference that we just opened our first direct performance 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 Whitford [ph] and it's very manageable, not very efficient, effective and we transitioned from that to something that's much more state-of-the-art. With plans to open the second facility on the West Coast.

We're also focused on this year is transitioning a lot of deliveries will 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 customer's home more effectively. At 30,000 feet Lowe's have 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 product to the consumers 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 customers' 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, Baird]

Okay, that's helpful and then 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. Thank you.

[Bill Boltz, Executive Vice President, Merchandising]

Yes so I'll take that. so first of all, I think we're - 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've 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 [indiscernible] lot of them just as we've [indiscernible] lot of change in our organization and they've responded very favorably. So we're just like what we talked about the 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, President and Chief Executive Officer]

And Peter the only two comments I'll 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 entity 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 deep understanding of home improvement product and category knowledge, he also brings the 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 made ourselves available quite a few strategic meetings. We've had some very positive and very and practical discussions and we think it's going bear more fruit in the long run thus far.

[Peter Benedict, Baird]

Great, thanks so much guys. Good luck.

[Marvin Ellison, President and Chief Executive Officer]

Thank you.

[Operator]

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