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Lowe's Companies, Inc. (NYSE:LOW)
Q4 2017 Earnings Conference Call
Feb. 28, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning everyone, and welcome to Lowe's Companies Fourth Quarter 2017 Earnings Conference Call. This call is being recorded. Please note if you press *1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press *1 again to enter the queue. 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 if they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer; Mr. Richard Maltsbarger, Chief Operating Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Mike McDermott, Chief Customer Officer.

I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.

Robert Niblock -- President, Chairman, and Chief Executive Officer

Good morning, and thanks for your interest in Lowe's. Fiscal 2017 represented the highest sales in net earnings in our company's history. In the fourth quarter, we delivered comparable sales growth of 4.1%, exceeding our expectations, through compelling consumer messaging, strong holiday event performance, and integrated omnichannel customer experiences. Our U.S. home improvement business delivered a 3.7% comp for the quarter with positive comps in 13 of 14 regions. From a product view, we posted positive comps in nine of 11 product categories while one category was essentially flat. Appliance led product category growth with another quarter of double-digit comps. We achieved above-average comps in tools and hardware, rough plumbing and electrical, and lumber and building materials.

Internationally, we delivered another strong quarter with high single-digit comps in Mexico and mid single-digit comps in Canada, both in local currency. We've made significant process integrating RONA, delivering double-digit online sales growth, rolling out appliances to approximately 100 locations, completing five RONA big-box conversions, driving strong growth in our affiliated dealer business, and further optimizing shared supplier partnerships and procurement efforts. We're pleased with the strong momentum we've built throughout the year, culminating in RONA posting its highest comp in 13 years. We believe that we're well positioned for continued growth and remain on track to double operating profitability in Canada by 2021.

For the quarter, we delivered adjusted diluted earnings per share of $0.74. Delivering on our commitment to return excess cash to shareholders in the quarter, we repurchased $133 million of stock under our share repurchase program and paid $341 in dividends. And our Board of Directors recently authorized an incremental $5 billion of share repurchases which further underscores our commitment.

Turning now to our progress against our strategic priorities. I'm particularly proud of how we've grown sales with pro customers by focusing on breadth and depth of inventory, our portfolio of brands, localized assortments, and enhancing LowesForPros.Com as evidenced by our pro growth rate outpacing DIY for both the fourth quarter and the full year. The integration of Maintenance Supply Headquarters and Central Wholesaler remains on track and provides a compelling opportunity to improve and expand our ability to serve multi-family property management customers.

On Lowes.Com, we saw strong customer response to our enhanced shopping experience and marketing efforts with comp growth of 28% for the quarter and 34% for the year. We continue to enhance our in-home selling program, providing customers the ability to now request services online, and we are centralizing our process for providing installation quotes, allowing for greater efficiency in a more consistent customer experience. Our project specialists represent a critical element in our omnichannel offering and a differentiated capability in capturing and serving project demand for the do it for me, or DIFM, customer.

Though we are pleased with the strategic milestones we achieved this year, we recognize that we still have an opportunity to improve execution to ensure greater success in the future. Richard will speak to our efforts to improve conversion, gross margin, and inventory management in a moment.

Looking ahead, the home improvement industry is expected to see solid growth supported by job and income gains which should drive increases in both disposable income and consumer spending. And we expect continued housing tailwinds, including favorable trends in household formation despite near-term pressure on housing availability.

In 2018, we plan to capitalize on this strong macroeconomic environment and see an opportunity to invest much of the incremental cash flow from corporate tax reform to accelerate our strategic priorities, including investments in our people. We are focusing our resources on what is most relevant to engaging customers in the moments that matter and improving the capabilities our employees need to serve customers. In 2018, we will focus on leveraging analytics to know the customer better, changing how we engage, expanding our fulfillment options, delivering compelling product experiences, growing sales with the pro customer, and differentiating with services. These strategic areas of focus and investment will be instrumental to further strengthening our competitiveness and enhancing our position as the omnichannel project authority. Richard will provide additional details on each of these focus areas in a moment.

And of course, as we look at our results, along with the additional investments we're making, it warrants reevaluating our long-term targets. Marshall will address those in a moment. But let me be clear that our entire leadership team and board are focused on working together to continue to analyze our performance and business expectations, and we are moving forward with urgency to improve our results.

Before I close, I would like to express my appreciation to our employees for their dedication to serving customers and living our purpose-driven mission to help people love where they live. We recently announced plans to expand our employee benefits and a one-time bonus of us to $1,000.00 for our more than 260,000 hourly employees in the U.S. Our employees are the foundation of our success, and we are investing in them to support our bright future and reward them for their unwavering commitment to serving customers in the communities where they live and work. It's their dedication that makes this company great.

Thanks again for your interest, and with that, let me turn the call over to Richard.

Richard Maltsbarger -- Chief Operating Officer

Thanks, Robert. Good morning, everyone. As you just heard, we've achieved some important milestones this year and identified actions necessary to drive future success. First, we refined our marketing strategy, successfully launching a new campaign, start with Lowe's, which has captured mind share and improved measured campaign effectiveness. We've also continued our evolution from analog to digital marketing, delivering more personalized, targeted messages. And we've optimized our messaging content, driving critical improvements and value perception. Together, with our incremental marketing investments, these improvements have increased awareness leading to robust traffic growth.

Second, we capitalized on customer excitement for the holiday season. We provided cohesive decorating solutions as well as compelling gift ideas across our product assortment, connecting our in-store display with digital access such as Pinterest, Facebook, Instagram, and YouTube, and delivered a seamless shopping experience on Lowes.Com. In fact, we drove double-digit comps in appliances, leveraging our investments in customer experience both in store and online as well as our best-in-class selection of leading brands and our services advantages of next-day delivery, haul-away, and facilitation of repairs and maintenance.

As cold temperatures and winter storms hit, our never-out strategy ensured that we were in a strong position to serve demand for critical items customers needed. Combined, our strong holiday performance and never-out strategy drove above-average comps in tools and hardware and rough plumbing and electrical. We also continued to execute on our strategic priorities, driving comp growth of 28% on Lowes.Com, the result of strong customer response to our enhanced online shopping experience. We have optimized functionality and displays for touch-screen devices to support a better mobile experience, improved product content recommendations, refined search algorithms, improved click-to-chat capabilities, and optimized our assortment informed by digital line reviews.

And we have releveraged our MyLowe's platform to drive brand loyalty and build deeper relationships with customers, important because MyLowe's members spend approximately 35% more on average than non-members. In 2017, we added more than 4.5 million new MyLowe's members, and we used the platform to simplify our military recognition program, allowing active-duty personnel and veterans to register through MyLowe's and receive 10% off their purchase every day.

However, not all the actions we took during the year delivered on expectations. While we were pleased with our traffic growth, we are actively working to improve conversion and gross margin while better managing inventory. Earlier in the year, we recognized a need to improve our sales floor coverage, especially during key weekend and holiday events. We made an investment in Q3 to bolster conversion rates but did not realize the full value of this investment in the second half of 2017. We ultimately determined that while necessary, payroll actions alone will not deliver the conversion rates we expect. Therefore, we must accelerate associate readiness and knowledge through training programs and reengineer key processes in order to better serve customers.

We must also stabilize gross margin by leveraging new pricing and promotion analytics tools to ensure that we are competitive on highly elastic traffic-driving products while driving profitability across less elastic items and through our continuing value improvement efforts, work closely with our vendors to improve first costs. Finally, we've made the required inventory investments to support key categories such as appliances, flooring, and tools, as well as depth and breadth in critical pro categories. Now we must drive greater working capital efficiency.

We enter 2018 with a plan to address these challenges and accelerate the investments that will improve our execution and our ability to serve rapidly evolving customer expectations. As Robert outlined, there are six planks to this strategy. First, we are working to know customers and their homes on an even deeper level, understanding their plans and designing better solutions to help navigate their project journey. We're integrating our analytics capabilities, bringing together terabytes of customer data, connecting many different touch points throughout our omnichannel platform, supplementing that data with third-party information and leveraging our talented global workforce to translate this information into actionable insights.

Second, we're changing how we engage, connecting with customers and associates through relevant tools and messages. We'll deliver more refined, personalized messages to customers through our enhanced marketing management platform that went live in Q4, and we'll better empower associates by deploying more user-friend interfaces, beginning with our Point of Sale upgrade in Q1 which will allow our associates to better serve customers with a touch of a button. Later in the year, we'll significantly improve our associate connectivity, expanding the functionality of our in-store handheld devices to improve the efficiency of our order staging and management, daily tasking, and inventory processes.

Third, as customers demand an increasingly broad set of fulfillment options, we're transforming our supply chain to better service their needs and expectations. We're investing in a new direct fulfillment center which we expect will be operational in the third quarter of 2018, allowing for the expansion of our online product offering and faster parcel shipping. We're also investing in delivery capacity to meet increased demand, and we're advancing our pickup in store experience during Q1 to allow customers and our installation service providers to pick up product within five minutes of arrival.

Fourth, we'll continue to deliver compelling product experiences to provide inspiration and personalized choice through a combination of strategic brands and differentiated in-store experiences. We previously announced the introduction of Craftsman in store and online in the second half of 2018. Today, we're proud to announce our expanded partnership with Sherwin Williams. Paint continues to be a top home improvement project, and we will partner closely with Sherwin Williams to deliver a simplified line design that makes it easier for customers to select the right product for their painting needs. Sherwin Williams will now be the exclusive national supplier to Lowe's U.S. retail outlets for interior and exterior paints, including the Valspar and HGTV Home brands. Sherwin Williams is one of the most recognized brands in paint, highly respected for quality products by both homeowners and pros. Under this expanded strategic partnership, Lowe's will become the only U.S. national home center to offer top-selling stain brands, Minwax, Cabot, and Thompson's WaterSeal, as well as the top paintbrush brand, Purdy. We are excited to bring consumers more of the top brands they trust for their next paint or stain project.

We're also investing in our paint service model to improve the associate and customer experience across the entire paint project. We are rolling out a new paint desk experience in select stores beginning in the first quarter, with plans for a nationwide rollout in the second half of 2018. The improved experience will include an updated project selector display, as well as a simplified and streamlined service model to make it even easier for customers to work with associates to find a color, pick a paint or stain, quickly have it mixed, and begin a project.

Fifth, while our pro penetration has grown over the last five years, we have further opportunity to continue growing sales to pro customers and expanding our market share. To that end, we're investing to improve the pro experience. We're building on our strength in the MRO space by optimizing our Maintenance Supply Headquarters business, launching a streamlined product catalog this spring, followed by branch expansion beginning later this year. We're also testing improved pro jobsite delivery in select urban markets with an expectation of rolling out the best concept nationwide in the second half of the year. And in order to build a stronger generation of skilled trade professionals, we are launching our Track to the Trades program, a new workforce development initiative that provides innovate career alternatives and financial support for our employees as they pursue a skilled trade.

Finally, as the DFIM opportunity continues to grow, we're providing a differentiated services offering, delivering complete home improvement project solutions through our in-home sales platform which we are proud to note has grown to over $2 billion in sales annually. Across all project types, our installation services team completes approximately 60,000 in-home installations each week, and we continue to push forward in this space where we are currently testing the commercialization of Lowe's Vision Pro with our in-home project specialists, allowing customers to use augmented reality to visualize their kitchen or bathroom remodel and feel confident proceeding with their project. Through this and other work, we have earned recent recognition by Fast Company as the most innovative company in augmented and virtual reality.

Together, these six planks build upon our strong foundation and further strengthen our competitiveness, positioning us to continue capitalizing on helping project demand. Thank you for your interest in Lowe's, and I will now turn the call over to Marshall.

Marshall Croom -- Chief Financial Officer

Thanks, Richard, and good morning, everyone. Let me start by reminding you that last year's results included an extra week, which contributed approximately $950 million in sales. That extra week also caused a calendar shift this year which had no impact on comp sales but negatively impacted fourth quarter total sales growth by approximately $1 billion, or 7%.

Sales for the fourth quarter were $15.5 billion, a decrease of 1.8% compared to last year's fourth quarter. Total transaction count decreased 7% while total average ticket increased 5.2% to $73.44. Main Supply Headquarters contributed 40 basis points of growth in the quarter, while new stores contributed 60 basis points. Comp sales were 4.1% driven by an average ticket increase of 4.9%, partially offset by transaction decline 0.8%.

Looking at our monthly trends, comps were 1.1% in November, 7.7% in December, and 3.4% in January. Hurricane recovery efforts in Texas and Florida aided fourth quarter comps which offset the impact of cold temperatures and winter storms across the country in the latter part of the quarter as well as the comparison to Hurricane Matthew and Louisiana flooding last year. We estimate that the net benefit of weather in the quarter was approximately 65 basis points. For 2017, total sales were $68.6 billion, and comp sales were 4%. Gross margin for the quarter was 33.73% to sales, a decrease of 68 basis points from the fourth quarter of last year. Two-thirds of the decline was attributable to rate while the balance was mix and shrink. As we've grown our market share in appliances, gross margin has been impacted from both the mix and rate perspective. We also continue to take competitive actions, which were partially offset by the benefits from value improvement as well as early results from pricing optimization efforts.

SG&A for the quarter was 24.28% to sales which deleveraged 29 basis points. In last year's fourth quarter, we recorded severance-related costs for organizational changes, which drove 53 basis points of leverage this quarter. In the fourth quarter of '17, we experienced 21 basis points of leverage related to employee insurance, and 32 basis points of leverage related to incentive compensation due to lower attainment levels versus last year. Offsetting these items were the one-time cash bonus for eligible hourly employees in the U.S., which resulted in 42 basis points of deleverage, as well as 21 basis points of deleverage in delivery costs due to increased demand from continued growth in appliances.

We also had 14 basis points of deleverage in advertising, primarily as a result of our efforts to amplify our consumer messaging. And lastly, the 53rd week in the fourth quarter of 2016 drove approximately 65 basis points of deleverage this quarter.

Depreciation and amortization for the quarter was $367 million or 2.37% to sales flat to last year. Operating income declined 97 basis points to 7.08% of sales. The 53rd week in the fourth quarter of last year drove approximately 90 basis points of deleverage this quarter.

Interest expense for the quarter was $154 million which leveraged three basis points. The effective tax rate for the quarter was 41.3% compared to 40.3% last year. The higher rate this year was driven by tax reform. The change in our Federal statutory rate triggered remeasurement of our deferred tax assets and liabilities resulting in a charge in the fourth quarter.

Earnings per share was $0.67 for the fourth quarter. The tax reform negatively impacted earnings per share by $0.02 while the one-time cash bonus reduced earnings per share by $0.05. Adjusted earnings per share was $0.74, a 14% decrease compared to last year's adjusted earnings per share of $0.86. Last year's extra week contributed approximately $0.08 to last year's quarter which negatively impacted adjusted earnings-per-share growth this year by 9%. For 2017, earnings per share was $4.09 while adjusted earnings per share was $4.39.

Turning to the balance sheet, cash and cash equivalents at the end of the quarter was $588 million. Inventory at $11.4 billion increased $935 million or 8.9% versus the fourth quarter of last year. This is primarily driven by investments in key categories as Richard mentioned, such as appliances, flooring, and tools, as well as investments across pro categories. Part of the increase is also attributable to the acquisition of MSH and new store growth.

Inventory turnover was 3.9 times, a decrease of 15 basis points over last year. The extra week in 2016 negatively impacted inventory turnover by approximately six basis points. Asset turnover increased five basis points to 1.9 times. Accounts payable of $6.6 billion represented a $61 million or 0.9% of a decrease over fourth quarter of last year. At the end of the fourth quarter, lease adjusted debt to EBITDAR was 2.33 times. Return on invested capital was 18.8%.

Now looking at the statement of cash flows, we generated strong operating cash flow of nearly $5.1 billion and free cash flow of $3.9 billion. In the fourth quarter, we paid $341 million in dividends and we repurchased approximately 1.7 million shares of stock for $133 through the open market. For the year, we paid $1.3 billion in dividends and repurchased $3.1 billion of stock for the year.

In January, our board of Directors authorized a new $5 billion share repurchase program. The new program has no expiration date, therefore, our combined purchasing power under the share repurchase program, we have a total authorization of approximately $6.9 billion.

Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert and Richard indicated, we've made meaningful progress this year against our strategic priorities. While we are pleased with the strategic milestones, we do recognize that we have an opportunity to improve execution to ensure greater success in the future. We are focused on improving conversion, gross margin, and inventory management. In addition, customer expectations in the retail landscape are rapidly evolving, and corporate tax reform provides incremental cash flow. As a result, we are accelerating our investments to enhance our ability to serve customers.

We'll be taking the necessary actions to transform our supply chain, better empower our associates, and continue to deliver compelling product experiences. In 2018, we expect a total sales increase of approximately 4% driven primarily by comp sales increase of approximately 3.5%. We do anticipate opening approximately ten stores. On a GAAP basis, we are expecting operating margin decline of approximately 30 basis points. While we expect flat gross margin for the year as we improve execution, incremental expenses associated with our strategic investments will pressure SG&A.

Factoring in the benefits of tax reform, which are approximately $750 million in 2018, effective tax rate is expected to be 25.5%. For the year, on a GAAP basis, we expect earnings per share of approximately $5.40 to $5.50. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.7 billion. This is expected to result in estimated free cash flow of approximately $4.8 billion for 2018, and our guidance assumes approximately $2.5 billion in share repurchases.

As we look at our results, along with our decision to accelerate strategic investments, we are reevaluating our long-term targets. We plan to provide a full update on our business strategy and long-term outlook at our analyst and investor conference in December. Until that time, I'd like to share some parameters that we're applying as we reevaluate our long-term targets. First, the outlook for the home improvement industry over the next few years remains solid. As such, we continue to expect an average annual sales increase of at least 4%. Second, we expect operating margin to improve after 2018 even while we continue to invest in the business and we are diligently working to improve productivity in order to provide greater confidence in the operating margin targets we plan to communicate in December. Finally, we remain committed to our current shareholder distribution target, returning approximately $14 billion to shareholders through 2019.

...

Regina, we're now ready for questions.

Questions and Answers:

Operator

To ask a question, press *1 on your telephone keypad. To withdraw a question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one followup.

Our first question will come from the line of Brian Negal with Oppenheimer. Please go ahead.

Brian Negal -- Oppenheimer -- Analyst

Hi, good morning. A couple of questions. First off, with respect to the investment plan or the strategic plan you laid out on the call, how should we think about, as we go through 2018, the sort of -- the investment, the cadence of investments along those lines and the potential benefits in terms of sales and other metrics? How should those line up?

Marshall Croom -- Chief Financial Officer

I'll take the top line first. This is Marshall. Basically as we think about our sales progression and comps, we would slightly expect sales to be higher in the first half of the year. As you recall, first quarter was our easiest comparison as we head into '18. So first half sales will be slightly higher than second half. But as far as capital expenditures and expenses throughout the year, we'll be leaning that throughout the year. But excuse me, we do expect -- so, we manage to stabilize gross margin that not only the capital expenditures but the expense associated with some of these initiates will put pressure on SG&A.

Richard Maltsbarger -- Chief Operating Officer

And Brian, as noted during my comments -- this is Richard -- a few of the nationwide rollouts that we have such as the paint service experience, as well as some of the enhancements to the digital tools in the hands of our associates are back-loaded.

Brian Negal -- Oppenheimer -- Analyst

Got it. Then the second question, more of as a followup, if you look at the cadence of comps through the quarter, it was weak to start, weak to end, and stronger in the middle. Is there something that explains that, that basically what we saw through the quarter?

Richard Maltsbarger -- Chief Operating Officer

Yes, it's largely function of the holiday sales that we experienced. So as we mentioned, we were pleased with the appliance sales growth. A majority of our appliance sales are scheduled to be delivered. They're not take-with. As a result, a lot of those sales over Black Friday and that holiday period were delivered in December, and it's not until they're delivered or customer takes possession that we recognize that revenue. So that creates some lumpiness of the 1.1 comp in November to the 7.7 in December.

Brian Negal -- Oppenheimer -- Analyst

Is there a way that -- just that one piece, can we quantify it, the shift between those two months?

Richard Maltsbarger -- Chief Operating Officer

Yes, Brian. As another way to think about it, is you look at the comp progression not including the impact of deferred sales. It was roughly kind of mid-three comp in November and January and roughly mid-four comp in December.

Brian Negal -- Oppenheimer -- Analyst

Got it. Thanks a lot. Good luck.

Operator

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

Eric Bosshard -- Cleveland Research -- Analyst

Thank you. Sorry about that. Thank you. Sorry about that. Two questions for you. First of all, the 4Q margin I think was below the guidance you had given 90 days ago, so just curious if you could summarize again the moving pieces with the MAT. And then secondly, excited to hear about the incremental investments to grow the business in '18, and you talked about taking advantage of the tax savings of $750 million, but I wondered if you could just quantify the amount of incremental investment that you're making in 2018.

Mike McDermott -- Chief Customer Officer

Eric, this is Mike McDermott. I'll touch on the gross margin question. In the fourth quarter, we meaningfully exceeded our expectations in the appliance category, growing significant market share. As a result of that, that had an impact on both our mix and our rate from a margin perspective. The other thing we did, as you recall, in the second quarter of 2017, we focused on getting more competitive and improving our value perception to make sure that we could take advantage of the available market opportunity. Those actions continued in the fourth quarter, and yet we're only partially offset by our value improvement initiatives, working closely with our vendors on first cost, and some early price optimization benefits as we're in early innings of rolling out analytics tools and capabilities to drive that optimization. As we look into the new year, I think we're in a solid competitive position to continue to offset the impact of any competitive pricing actions through the rollout of those tools that I mentioned a moment ago, and we'll continue to work on value improvement with our vendors, ultimately delivering flat gross margin in 2018.

Marshall Croom -- Chief Financial Officer

Eric, this is Marshall. Just one other factor for fourth quarter gross margins is as we were going through out integration process with RONA, we did have some accounting harmonization that impacted gross margin in the quarter. So that was just another small factor of the pressure we experienced there. To your second question on the incremental capital that we plan to expend in 2018 as a result of tax reform, it's about 85% of that we will be investing in 2018. So we recognize this as an opportunity, and largely where we're spending that, if you think about our capital expenditures going from roughly $1.1 billion in '17 to $1.7 in '18, 45% of that $1.7 billion will be on strategic initiatives. That's almost triple of what we spent in 2017. So again, the opportunity to lean into the omnichannel capabilities that we need to build to expand customer reach and relevancy, and to further drive the six planks that Richard spoke to earlier.

Eric Bosshard -- Cleveland Research -- Analyst

Great. And then just one last question if I could circle back with Mike McDermott. How do you think about the balance between the incremental promotional spending, getting a bit more aggressive on price and effective, and then the market share performance? And I know that, you know, looking at you relative to Home Depot is just one way to look at it, but how do you -- how do you look at the incremental spend and then the market share performance?

Mike McDermott -- Chief Customer Officer

Well, Eric, look. When I take a look at incremental spend, I look at both price as well as traffic. And we had some incredible performance as it relates to our efforts to improve our customer awareness as well as drive traffic and engagement through that awareness through optimizing our marketing spend and better balancing our digital and mass media approach to make sure we're engaging customers at the right time with the right content. As it relates to both promotional and pricing spend, we simply have to be competitive, and that is our focus. The opportunity to continue to drive optimization is what we see ahead of us in 2018.

Robert Niblock -- President, Chairman, and Chief Executive Officer

Eric, this is Robert. I would just add on that I think we're pleased with the work that Mike and his team have done from a promotions standpoint. The additional traffic has driven the consumer awareness, those types of things, as Richard and I both outlined. Opportunity is to take that traffic and drive a greater conversion. And that's what Richard and his team are working on with some of the strategic investments that he talked about with focusing on investing in our associates to make sure that they have all the tools, the training, the capability. We have the right coverage for day part hours, those types of things, to ensure that we're then converting that traffic into sales. So that's a big focus area that we're -- that Richard and his team are focused on as we head into 2018.

Eric Bosshard -- Cleveland Research -- Analyst

That's helpful, thank you.

Operator

Your next question comes from the line of Christopher Horvers with JP Morgan. Please go ahead.

Christopher Horvers -- JP Morgan -- Analyst

Thanks, and good morning. Can you talk about the appliance category? It sounds like you did extremely well in that category. Any further quantification of what double-digit growth is? Is that closer to the 20 than to ten? And somewhat related to that, traffic was down in the fourth quarter. What do you think the drivers of the down-traffic were?

Richard Maltsbarger -- Chief Operating Officer

I'll just reinforce that we had double-digit comps in appliances and feel good that the combination of our messaging, our assortment, our brand partnerships, and our product offering continue to resonate very, very well with the customer. We are the leader in that space and continuing to drive leverage as a result of that leadership position with fantastic displays and great engaged associates. So I continue to see runway in the appliance space as we lean into that market share opportunity that exists.

Robert Niblock -- President, Chairman, and Chief Executive Officer

Chris, this is Robert. Just to clarify, it was not traffic that it was down, it was transactions that were down. As I just indicated in my followup with Eric on the earlier question, we're driving the traffic. It's the conversion of that into transactions. And as we mentioned, as Richard said in his comments, we put the labor there. We realize we've got to put more than just the labor there. So we've made the labor investments. Now we need to make the incremental investments to ensure that we convert that traffic into transactions.

Christopher Horvers -- JP Morgan -- Analyst

Understood. That's a great segue. As you think about the labor model and the change that you've made, are you thinking about structurally changing how you allocate labor whether it's full-time versus part-time, the algorithms that you've put in place with the new system last year. How does the overall labor strategy shift going forward?

Richard Maltsbarger -- Chief Operating Officer

This is Richard. The reality is that over the last couple of weeks, I've had the opportunity to go into stores across five different states, speak directly with our associates, understand some of the challenges that are happening in our aisles every day, and the emphasis I would put on are a few areas. First and foremost, it's really the mix of our selling and tasking hours. How do we go about getting the work done in our stores every day to enable our red-vest associates to be in front of the customer when it's time to serve. Second focus we have on, as Robert noted, is having the labor hours in the store necessary, having associates ready through our training and our knowledge programs to be ready to serve is just as necessary. So reinvestments in actions that we are taking right now during spring hiring to bolster that area. Third, reengineering some of our key processes as noted during my comments and Robert's. Our pick-up in store experience as an example. We have an upgraded experience both in the physical layout as well as in staffing and training model going out in Q1 as well as to Robert's comment on centralized quoting, an opportunity to speed up our process by centralization and greater support for our in-store associates to allow them more time to serve the customers that are with them every day. And then finally, upgrading our digital management tools, giving a chance for our associates to get more productive with the hours that we invest into tasking. So when you look across those investments from the mix of tasking to selling to our associate readiness to reengineering key processes to better empowering our associates with the right tools, those are some of the initial focus areas as we move into the year.

Christopher Horvers -- JP Morgan -- Analyst

Thanks very much.

Operator

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

Seth Basham -- Wedbush Securities -- Analyst

Thanks a lot, and good morning. My question is a followup on the conversion issue. If you could just give us a sense of how conversion trended through 2017 and how much of an improvement you expect in 2018, and what the biggest driver of that is going to be. Is it the training and knowledge programs or something else? Thank you.

Richard Maltsbarger -- Chief Operating Officer

Absolutely. As I just noted, the challenges we have had from conversion have steadily been a challenge as we move throughout the year. In fact, it really is an opportunity, as we have driven the traffic, we know that the customer is interested in our offer. There is the demand for what we're bringing to the marketplace. Really, the conversion challenge has grown as the traffic has grown. We have begun to address it, and the steps that we had to take necessarily in the payroll action in the back half of the year, and now it is simply a matter of ensuring that our associates are more ready to field that traffic.

Seth Basham -- Wedbush Securities -- Analyst

And a followup on that. In terms of the readiness, is the fact that you had a lot of employees that weren't quite qualified for their jobs or weren't trained for their jobs, or were in the wrong places?

Richard Maltsbarger -- Chief Operating Officer

The biggest focus that has come from my conversations with our teams in the field right now is greater role clarity and greater understanding of who's going to field what particular aspects of the project cycle and being able to improve the execution of that.

Seth Basham -- Wedbush Securities -- Analyst

Thank you, and good luck.

Operator

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

Matt Fassler -- Goldman Sachs -- Analyst

Thanks a lot. Good morning. I want to follow up on gross margin. So, gross margin I think was down all four quarters of this year, and I know there's been some mix issues and Canada coming into the mix earlier on probably impacted that as well. But given the commitment to deliver a comp that's level with what you've been putting up in a pretty strong backdrop, and given the fact that value improvement has been part of the agenda for quite some time, why the confidence that with mix moving against you and with the desire to continue to hold or gain market share, at this moment, the gross margin is -- can stabilize while you achieve everything else you're trying to get done here?

Mike McDermott -- Chief Customer Officer

Hey, Matt. This is Mike McDermott. Obviously we have seen gross margin decline throughout 2017. Most of the actions we put in place started in the second quarter of '17, so we're going to have the ability to lap those activities. We've been working to optimize throughout the year to improve our promotional effectiveness and reduce our spend while continuing to drive traffic. We've seen some pretty good results in the third and the fourth quarter there. And then we've got some new tools to really focus on price and promotional optimization that would give us the ability to offset any inflation impacts that we're experiencing primarily in the lumber and building material space while at the same time making sure that we remain competitive and minimize the spend to do so. Value improvement is an ongoing initiative of us working closely with our vendor partners to make sure that we've got the most efficient and effective way to deliver value to our customers moving all the way through our supply chain to the prices and promotions that we offer to close the sale. I think the combination of all of those activities give me confidence that we'll deliver flat gross margin in 2018.

Matt Fassler -- Goldman Sachs -- Analyst

And just a quick followup on that. You know, obviously inventory has the potential to be a factor here, and inventory growing faster than a fairly health sales rate I know doesn't make it any easier to drive gross margin improvement. So can you talk about your expectations for inventory growth relative to sales growth over the course of the year and whether working that down will require any measures that would impact gross margins as well.

Richard Maltsbarger -- Chief Operating Officer

Absolutely, Matt. This is Richard. I'll talk about some of the actions we're taking to manage inventory and then allow Mike if he wants to weigh in further with any estimated impact. But as noted in our guidance, right, we are going to focus on the improvement of our inventory management. We believe we've made the investments in the inventory, in our system, to support the strong sales growth we're seeing in categories such as appliances and tools. Right? Now the onus is on me as I get into the role to continue working with our teams to understand what changes in the flow of our supply chain, what changes in the interactions between our supply chain and our stores, and what changes in specifically having inventory in a shopable position for customers when they come in to demand the purchase are necessary to continue to manage at roughly a flat to slightly up inventory that is less than our rate of sales growth during 2018.

Matt Fassler -- Goldman Sachs -- Analyst

Much appreciated, guys. Thank you.

Operator

Your next question comes from the line of Mike Baker with Deutsche Bank. Please go ahead.

Mike Baker -- Deutsche Bank -- Analyst

Hi, guys. Wondering if you could tell us how you measure traffic and conversion and share some trends on that metric over the year?

Richard Maltsbarger -- Chief Operating Officer

Yeah, absolutely, Mike. This is Richard. We leverage video analytics and the tracking of the movement of customers into our stores and measure that up against the transactions that we are able to execute through our registers and the rest of our activities with customers.

Mike Baker -- Deutsche Bank -- Analyst

So can you share some metrics on that? So you're saying traffic was up. Frankly, we don't see it in the data that you provide in terms of the number of transactions. So again, if you could help give us confidence in that metric and then also what that would imply for conversion, how that has changed throughout the year.

Richard Maltsbarger -- Chief Operating Officer

Not at this time, Mike.

Mike Baker -- Deutsche Bank -- Analyst

Okay, then I'll ask just one more quick followup. Marshall, you talked about CapEx going from 1.1 to 1.7, then you said 45% of that is on initiatives. Is that 45% of the incremental $600 million or 45% of the total $1.7 billion?

Marshall Croom -- Chief Financial Officer

It's 45% of the total $1.5 billion. The 85% was reference to kind of the proportion of the tax reform benefits that we're going to see in 2018.

Mike Baker -- Deutsche Bank -- Analyst

Understood. So if it's 45% of the total and then that's up three times versus last year, so the incremental CapEx accounts for most of that 85% of the tax reform, I guess then my question is, is there an SG&A component? Why would SG&A be down 30 basis points on a 3.5% or 4% comp, or sales growth number, where, you know, you'd otherwise expect that to be up with the typical leverage that you get?

Marshall Croom -- Chief Financial Officer

With a lot of these programs and initiatives, there are expense components to deliver some of the strategic initiatives that we do have going on in 2018. So that's just noted pressure that we would expect in SG&A.

Mike Baker -- Deutsche Bank -- Analyst

Above and beyond the investment in CapEx from the tax reform?

Marshall Croom -- Chief Financial Officer

Yes, there's a CapEx component and an expense component.

Mike Baker -- Deutsche Bank -- Analyst

Understood. Okay. Thank you.

Operator

Your next question comes from the line of Scott Ciccarelli with RBC Capital Markets. Please go ahead.

Scott Ciccarelli -- RBC Capital Markets -- Analyst

Good morning, guys. Are you -- have you made any chances in your terms with any of your vendors? I guess I'm trying to understand the payable and inventory ratio a little bit better.

Richard Maltsbarger -- Chief Operating Officer

There's no significant changes. Part of this was just due to timing, kind of comparing this year to last year. We're still looking at terms and where it makes sense to extend terms where we can. But it's all part of the balance that we have with our value improvement process and ongoing vendor negotiations. We do expect to improve that in '18, but it was just really a matter of timing of some of the seasonal build and buy toward the end of the year.

Scott Ciccarelli -- RBC Capital Markets -- Analyst

So one of the things that I know that kind of gets negotiated between vendors and retailers is, you know, kind of pricing or gross margin targets, if you will, coupled with kind of payment terms. Is there any change in thought process regarding what is a more important aspect or metric to Lowe's?

Richard Maltsbarger -- Chief Operating Officer

Not at this point in time. We'll always kind of factor in net what we think is beneficial for us and beneficial for our ongoing relationships with the vendors.

Scott Ciccarelli -- RBC Capital Markets -- Analyst

Okay, got it. Thanks guys.

Operator

Your next question comes from the line of Gregory Melich with MoffettNathanson. Please go ahead.

Gregory Melich -- MoffettNathanson -- Analyst

Hi, thanks guys. I just had two questions. One was on the reinvestment of the tax savings, just to make sure I got that right. It sounds like there's maybe 30 BIPs on the income statement which would be about $200 million, and then a portion of the CapEx of that increase from 1.1 to $1.7 billion is because the tax reform has given you more money. But it probably -- CapEx probably would have gone up at least several hundred million anyway. Is that a fair way to think about it?

Marshall Croom -- Chief Financial Officer

Yes. I mean, you know, first and foremost, as we think about our capital allocation philosopher is to first invest strategically in the business to maintain the run and improve and enhance the business. So that is always going to be the first pillar. So one is we're reflecting on where we were in the marketplace, the initiatives we need to get under way. This provided a good backdrop to be able to enhance and ramp and accelerate our capital investment as we lean into 2018.

Gregory Melich -- MoffettNathanson -- Analyst

So it sounds like out of that $600 million increase in CapEx this year, a portion of it, you know, maybe half of it, was related to the tax reform, and you would have been doing a lot of these things anyway, you're just accelerating things that were coming? That's fair?

Marshall Croom -- Chief Financial Officer

Yes. Correct. Accelerating as actually it was about 85% of the tax reform benefit that we're going to see in '18 that is helping fuel the incremental CapEx.

Gregory Melich -- MoffettNathanson -- Analyst

Got it.

Marshall Croom -- Chief Financial Officer

But yes, we would have accelerated the CapEx spend to get after our strategic initiatives.

Gregory Melich -- MoffettNathanson -- Analyst

Regardless. Perfect. So then the second question was on RONA. I think Robert you had mentioned in the beginning that the integration is going well and that, you know, doubling the profitability goal over the next four or five years is still there. Could you help us understand how much RONA improved or helped corporate margins last year in '17 and what is in your guidance for this year in '18 in terms of RONA Improvement?

Robert Niblock -- President, Chairman, and Chief Executive Officer

Yeah. Like I said, you know, things are going well at RONA. We're pleased with the performance from how it blends in from margin standpoint. Marshall?

Marshall Croom -- Chief Financial Officer

Yeah, we should be cycling from a gross margin standpoint as we anniversaried the acquisition. We did have some -- just again, some minor cleanup that put some pressure in the fourth quarter, but we are on a good trajectory to doubling the profitability of RONA or Canada by 2021.

Gregory Melich -- MoffettNathanson -- Analyst

Got it. And then last, just to make sure I understand --

Richard Maltsbarger -- Chief Operating Officer

I was going to say Greg, this is Richard. Not being too far removed from the old job yet, RONA was not a significant improvement to operating margin in 2017, nor was it planned to be. However, 2018 is when we begin to see more significant movement on the operating margin.

Gregory Melich -- MoffettNathanson -- Analyst

That's great to hear. And then last, just gross margins flat this year, and on the sales standpoint, you guys think the first half is stronger. It sounds like the SG&A investments won't really build until the second or third quarter?

Marshall Croom -- Chief Financial Officer

Well, it's just slightly higher in the first half, but from a capital expense standpoint, again, we are trying to accelerate our investments throughout the year.

Robert Niblock -- President, Chairman, and Chief Executive Officer

And part of the sales is because you think about we didn't have a strong spring last year, so being cycling against weaker numbers.

Gregory Melich -- MoffettNathanson -- Analyst

Got it. Thanks. Good luck, guys.

Robert Niblock -- President, Chairman, and Chief Executive Officer

Regina, I think we have time for one more question.

Operator

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

Michael Lasser -- UBS -- Analyst

Good morning. Thanks a lot for taking my question. So arguably, you made some investments over the last several quarters in areas like labor and promotions, and they produced somewhat mixed results. Now you're accelerating investments in different areas. But how do you ensure that you produce a suitable return that will be attractive to your P&L as you accelerate those investments?

Robert Niblock -- President, Chairman, and Chief Executive Officer

I'll start, Michael. Certainly you mentioned a couple of things, labor and promotions. I think we've looked from the promotional aspect, I think we've been pleased with the investments we've made. As I said, driving the traffic, the brand awareness, those type of things. Certainly as we motioned, we have challenges from the conversion standpoint that we're working on. As Richard mentioned -- and he can further elaborate -- we've made the investments in labor. Now it is going in and supplementing those investments that we've made to make sure we have the training, the tools, the other components that are necessary so that we have the associates in front of the customer there ready to buy. And Richard, I'll let you ...

Richard Maltsbarger -- Chief Operating Officer

Michael, all I would add to that is several of the things that we talked about investing further in in the back-half of the year for nationwide rollouts we've had under test over the past several months or weeks to be able to get the early signs of success, and that really is the approach that we're going to take. A great example is the pick-up in store experience that's currently rolling out in Q1. We've had -- actually had that and a team dedicated to that since last August testing it in a handful of stores slowly going to a greater level of investment and iterating along the way to ensure that we're getting the maximum value out of the investment we're going to make prior to going to a nationwide rollout. In fact, the iteration that is going to currently roll out is the fourth iteration of that test already in the past six months in order to make sure that we're maximizing the return from all components to physical space change, to training of the associates, to shifts in the processes, to reengineering of how we do that, and the dedicated labor before we decided to take it to a nationwide rollout during the latter part of March and April.

Michael Lasser -- UBS -- Analyst

And my followup -- yeah, please.

Marshall Croom -- Chief Financial Officer

I'm going to pile in with one more comment. It just want to make it clear that the leadership team is aligned and focused on the areas that we've highlighted on the call. You think about stabilizing gross margin, improving conversion, improving inventory management along with getting after it from the six strategic planks. So I think that's just something that I do want to reemphasize and that we are working with a sense of urgency along all of those fronts.

Michael Lasser -- UBS -- Analyst

My followup question is that I think we all appreciate the commentary you made around the longer-term guidance, and it was helpful. So if we assume kind of sales remain where they are, flat-ish gross margin, can you give us a little sense of the operating leverage in the business now with all the different changes that are going on and all the different changes that have taken place over the last few years. It's become harder to understand the way the leverage point of the business is, or in a normal run rate environment, how fast your expenses grow relative to the rate of your sales growth.

Richard Maltsbarger -- Chief Operating Officer

At this point in time, we're given the high level of sales growing at least 4%, the total shareholder distributions sticking to the $14 billion there, and then just really the improvement of operating margin from 2018 levels. We expect those to improve from where we're setting that target in '18. That being said, we do plan on updating longer-term guidance when we get to our December investor and analyst conference.

Robert Niblock -- President, Chairman, and Chief Executive Officer

And Michael, I would just add -- I would just add on that if you think about one, the investments that we're making in the business. Two, some of the investments we made last year as Richard has spoken, him and Mike are working together, diving into the investments we've made, trying to figure out how can we get better performance out of those and then ensuring, as we're doing the test and learn before rollout that they're working on, as we head into 2018. You know, before we go out and commit to additional targets like that, we want to give time for them to be able to continue to dive into the business, understand the opportunities for improvement, and be in a position to really be prepared as we get to December to provide you guidance, longer-term guidance that we think we'll have great confidence in. So at this point, we just don't want to get ahead of ourselves.

Michael Lasser -- UBS -- Analyst

That makes sense. And if I could ask more maybe qualitatively, Robert, are you looking on all these investments and in the changes in the six pillars with the lens that you're looking to take the business to be more efficient and maybe produce more leverage over time as you do grow sales?

Robert Niblock -- President, Chairman, and Chief Executive Officer

Absolutely, yeah. Yeah, we know that certainly we've got some investment we've got to make in the business. We've talked about the supply chain investments we're making. We know that as the businesses continue to move, consumer expectations have moved, so we've got investments we're making in our supply chain. Some of those will pay dividends in 2018, some of them will be further into the future. But yeah, absolutely. That's what we're wanting to do, is making sure that we're as we're investing in the business have the right people in front of the customer at the right time, supporting that with supply chain, supporting it with technology, that we're getting greater leverage points to be able to drive improved operating margin in the future. That's what we're after. Focused on diving into that in '18 so that we can be in a good point to provide you exactly how we're going to get after it and where it's going to be delivered when we get to our analyst conference in December.

Michael Lasser -- UBS -- Analyst

Thank you so much.

Robert Niblock -- President, Chairman, and Chief Executive Officer

Great. Thanks, Michael. As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2018 results on Wednesday, May 23rd. Have a great day.

...

Operator

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

Duration: 62 minutes

Call participants:

Robert Niblock -- President, Chairman, and Chief Executive Officer

Richard Maltsbarger -- Chief Operating Officer

Marshall Croom -- Chief Financial Officer

Mike McDermott -- Chief Customer Officer

Brian Negal -- Oppenheimer -- Analyst

Eric Bosshard -- Cleveland Research -- Analyst

Christopher Horvers -- JP Morgan -- Analyst

Seth Basham -- Wedbush Securities -- Analyst

Matt Fassler -- Goldman Sachs -- Analyst

Mike Baker -- Deutsche Bank -- Analyst

Scott Ciccarelli -- RBC Capital Markets -- Analyst

Gregory Melich -- MoffettNathanson -- Analyst

Michael Lasser -- UBS -- Analyst

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