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Lowe's Companies, Inc. (NYSE:LOW)
Q2 2018 Earnings Conference Call
August 22, 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 second quarter 2018 earnings conference call. This call is being recorded. Please note, if you pressed *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 that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission.

Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer, Mr. Mike McDermott, Chief Customer Officer, and Mr. Marshall Croom, Chief Financial Officer. I will now turn the call over to Mr. Ellison for opening remarks. Please go ahead, sir.

Marvin Ellison -- President, and Chief Executive Officer 

Thank you, Regina, and good morning, everyone. It's an honor to be here today as the President and CEO of Lowe's. Before I get started, I'd like to take a moment and acknowledge the many contributions of Robert Niblock during his 25 years of service, including 13 years as Chairman and CEO.

Running a large public company is never easy, and Robert led Lowe's through some impressive periods of growth, doubling the size of the company and navigating through an important era of transformation in retail. I'd like to personally thank Robert for his service and his commitment to the hundreds of thousands of men and women who work for this great company.

Now, let's turn to our second quarter results. We capitalized on a delayed spring demand to drive strong growth in seasonal businesses and achieve comp sales above the company average in lumber and building materials, appliances, rough plumbing and electrical, and delivering a comparable sales growth of 5.2% overall.

Our US home improvement comp was 5.3%, with positive comps in all 14 geographic regions and 8 of our 11 product categories. We drove an 18 comp growth at Lowes.com. Diluted earnings per share were $1.86 and adjusted diluted earnings per share were $2.07, an increase of 31.8% from the same period a year ago.

Taking a step back, our second quarter results represent three broad themes. Theme number one, resilience -- despite significant organizational changes during the quarter, the associates and the leaders of this company remain focused and resilient. I'd like to personally thank the more than 310,000 associates for their hard work and commitment.

Theme number two, great marketplace -- after spending almost four years in the apparel sector, it's obvious to me that the home improvement marketplace is among the most robust in retail. We anticipate continued growth in the home improvement sector, where there is a strong demand for our products and services from a diverse group of customers motivated to invest in their homes.

The final theme is we have work to do. Despite delivering a 5.2% comp and $2.07 adjusted EPS for the second quarter, we have a lot of opportunity as a company, specifically, we're significantly behind in our supply chain strategy, our in-store technology is dated, overall execution is impaired by complexity, we have a large number of out of stocks in our stores that must be addressed, and we need to increase the rigor with which we evaluate capital investments.

Although it's never good to be behind, our current position presents significant upside potential for Lowe's and for Lowe's shareholders. So, the question is how do you realize this potential? Over the past 12 weeks, we've hired some of the best leaders in retail to help us address these shortcomings and I'm excited to see how great we can be as a company when we have these retail fundamentals corrected.

Although I've only been in the position for seven weeks, my opinions on the current state of the business have been formed by the following. First off, detailed business reviews with all of our functional leaders. I've spent time with suppliers. I've engaged our customers around the country and conducted numerous town halls of our associates and visited stores in all 14 US regions.

My aggressive travel schedule has given me the opportunity to learn from those closest to the customer. In fact, my greatest learning thus far is just how outstanding our associates are. Our frontline teams find ways to serve our customers despite some of the competitive disadvantages we've created for ourselves. Without question, our associates are our greatest asset and we must give them better tools to compete.

Simply stated, at Lowe's, we desire to be a great omnichannel retailer. While we have the foundational elements of an omnichannel network, we need to better connect and align our systems and processes to create a truly integrated ecosystem. But fortunately, I've been down this road before and I have a clear understanding of the steps and processes required to build a world-class omnichannel environment.

In addition, to drive value for our customers and shareholders, we must simplify the business to produce better results and more consistent results. The company has unfortunately become distracted over the past few years and specifically, we chased initiatives that did not add value and were not core to our retail business. Spending time on these non-core initiatives shifted capital, people, and attention away from being an operationally sound home improvement retailer. These distractions also created a complex environment for our frontline associates.

We recently steps to simplify organizational structure and my experience has taught me that a simplified organizational structure is the first step to create operational excellence and allow for faster decision making.

We also made several important leadership appointments. I'm pleased to welcome Bill Boltz as our Executive Vice President of Merchandising, Joe McFarland as our Executive Vice President of Stores, Don Frieson as our Executive Vice President of Supply Chain. Earlier today, we announced the addition of David Denton to the team as our new Chief Financial Officer. David currently serves as the EVP and CFO of CVS Health, where he's held that position for over eight years. We're very excited to welcome David to the Lowe's team.

All of our new executive vice presidents have a strong retail pedigree and proven track records of success. Combined, Bill and Joe bring over 50 years of home improvement experience and Don and David will bring a deep technical knowledge from their related fields of supply chain and finance. All four leaders will be instrumental in helping us to establish the necessary building blocks to create a world class omnichannel environment. When you combine proven leadership with disciplined capital allocation, great things can happen.

We're also working aggressively to fill our open Chief Information Officer position and expect to have a leader name in short order. In addition to implementing a new leadership structure, simplifying the business also means that we will shift our focus away from less effective projects. As we announced this morning, we announced a strategic reassessment of the business, which has already led us to make a series of decisive moves to refocus our financial and intellectual capital in running a great retail business.

First, we decided to exit our Orchard Supply Hardware operations to allow us to focus on our core home improvement business. We expect to close all 99 stores, which are located in California, Oregon, and Florida, as well as one distribution facility by the end of Fiscal 2018. To ensure an orderly wind down process, we plan to conduct store closing sales and have partnered with Hilco Merchant Services to help manage the process to ensure a seamless experience for our customers. Closing stores is always difficult and we'll take all possible steps to find positions for our displaced associates in nearby Lowe's stores.

Second, we are eliminating approximately $500 million in planned capital projects for 2018. Specifically, we are eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates, and did not meet our hurdle rate. Instead, we will reallocate that $500 million to our share repurchase program. We believe this will deliver more value to our shareholders.

Third, I've charged a new leadership team to develop an aggressive plan to rationalize our store inventory to remove clutter and reduce lower-performing inventory. This will enable us to invest in improved job-lot quantities for Pro and increase our depth of inventory in our top 2,000 high-velocity SKUs.

None of these actions are easy to take. However, they are the right decision for our company and our shareholders. This will allow us to position our core home improvement business for continued growth. The company's strategic reassessment is ongoing as we will evaluate the productivity of our real estate portfolio and our non-retail business investments. Going forward, our goal is simple. We plan to deploy both human and capital resources to our highest and best use.

Finally, as we work to create more value to our shareholders, we must create a true expense reduction culture here at Lowe's. No longer will we throw payroll at each problem. Instead, we will rigorously scope out the issue and implement technology to improve our processes. This will ensure that we deliver better sustained expense discipline and more effective capital allocation that will drive improvements in our return on invested capital.

So, to summarize, our short-term priorities at Lowe's are the following. We'll simplify organizational structure, recruit outstanding leaders, improve our reset execution, rationalize store inventory while improving our in-stock position, invest in high-velocity SKUs for our Pro and DIY customers, implement more rigor into our capital allocation process, intensify our customer engagement, and develop a true expense reduction curve.

This is what I define as sharpening our focus on retail fundamentals. I look forward to sharing more details on our long-term strategic plans at our analyst and investor conference on December 12th. With that, I'll turn the call over to Mike.

Michael McDermott -- Chief Customer Officer

Thanks, Marvin and good morning, everyone. It has been a pleasure to serve Lowe's over the past five years. Though we have a lot of work to do, I believe the business has great potential for success going forward. As Marvin shared with you, we capitalized on delayed spring demand in the second quarter, posting comparable sales growth of 5.2%. We drove increased traffic to our stores and Lowes.com and grew transactions six-tenths of a percent while increasing average ticket 4.5%.

We leveraged holiday events designed to take advantage of seasonable project demand with strong messaging, attractive offers, more personalized marketing, and our continued shift into digital and localized marketing channels. We were positioned with seasonal inventory in place and staffing trained and ready to help customers complete their projects. In fact, we kicked off the quarter with significant outdoor recovery, driving comparable sales growth of 8.2% in May.

For the quarter, we achieved double-digit comps in lawn and garden, driven by broad-based strength in lawn care, live goods, and landscape products. We delivered high single-digit comps in seasonal and outdoor living, with double-digit comps in cooling, where we were pleased with the results of our transition to GE air conditioning products.

And we delivered double-digit comps in outdoor power equipment, driven largely by strength in battery-powered cordless products, as well as double-digit comps in pressure washers, following the introduction of Craftsman to the category. We drove market share gains across all major categories where we introduced Craftsman to our lineup.

In the second quarter, we also saw continued strength in categories such as lumber and building materials, appliances, and rough plumbing and electrical. We achieved high single-digit comps in appliances, as our omnichannel offering, together with leading brands, breadth of assortment, competitive pricing, and service advantages continued to propel our performance.

Pro demand as well as inflation drove strong comps in rough plumbing and electrical and lumber and building materials. In order to continue growing our sales to pro customers, we'll further strengthen our portfolio of pro-focused brands.

Today, we're proud to announce the introduction of Mapei to all stores, the leading brand in tile-setting materials. We're also excited to announce the addition of Zoeller, the number one brand in pumps and a retail exclusive. Lowe's will be offering the full line of Zoeller products, including well, sump, submersible, and utility pumps.

As we look forward, we're focused on capitalizing on the opportunity presented by a strong home improvement sector. We'll work to sharpen our execution, as Marvin noted, by simplifying the business and focusing on core retail fundamentals, improving our in-stocks, and reducing the time our associates spend on tasking so that they may focus more on serving our customers.

We'll also streamline and simplify our reset process to improve our execution and reduce disruption for our stores. Reset challenges adversely impacted our performance in fashion fixtures, specifically light bulbs, and in paint throughout the quarter. We're working diligently to address those issues.

We'll also continue to make advancements in our supply chain, opening our first direct fulfillment center this fall to allow for expansion of our online product offering and more efficient delivery for our customers. We're testing predictive delivering scheduling for our stores to allow them to better plan for shipment arrivals from our regional distribution centers.

We're excited about our continued rollout of Craftsman in the second half, including individual mechanics and hand tools, power tools, and fall outdoor power equipment. Given the strong response we've seen in category introductions thus far, we're thrilled to be the exclusive destination in the home center channel for this iconic brand, offering some of the best tools, storage, and outdoor power equipment in the industry.

We'll also leverage our expanded strategic partnership with Sherwin-Williams, one of the most recognized brands in paint, highly respected for quality products by both homeowners and pros. With this partnership, Lowe's is the only national home center to offer top-selling stain brands, Minwax, Cabot, and Thompson's WaterSeal.

Moving beyond the reset pressure we saw in Q2, in the second half of the year, we'll deliver a simplified line design. That makes it easier for customers to select the right product for their painting needs, with exclusive HGTV Home by Sherwin-Williams and Valspar interior and exterior paints, as well as the top paintbrush brand, Purdy. We're excited to bring customers more of the top brands they trust for their next paint or stain project.

We're also rolling out a new paint desk experience, including an updated product selector display, as well a simplified and streamlined service model, to make it even easier for customers to work with an associate to find a color, pick a paint or stain, quickly have it mixed, and begin their project. We're excited about the second half of the year, with great brand introductions, exciting marketing plans and events to drive traffic, and a focus on core retail fundamentals, we will capitalize on strong demand in a healthy sector.

Thank you for your interest in Lowe's and I'll now turn the call over to Marshall.

Marshall Croom -- Chief Financial Officer

Thanks, Mike. Good morning, everyone. It has been a great experience for me to serve Lowe's for the past 21 years in many different capacities. I'm excited to see what the future holds for this great company.

As a reminder, in the first quarter, we adopted the new revenue recognition accounting standard. As a result, we reclassified certain items within operating income. The most significant of which was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales.

The adoption of this standard had no impact on operating income and no impact on comparable sales. It was adopted on a modified retrospective basis, so the prior year has not been adjusted. Sales for the second quarter increased 7.1% to $20.9 billion, supported by a 1.3% increase in total transactions and total average ticket growth of 5.8% to $75.53.

Adoption of the new revenue recognition standard provided a 74-basis point benefit to sales growth. Comp sales were 5.2%, driven by an average ticket increase of 4.5% and transaction growth of six-tenths of a percent. Looking at monthly trends, comps were 8.2% in May, 4.2% in June, and 3% in July.

As Mike indicated, we capitalized on delayed spring demand, leveraged our strength in appliances, and drove strong comps in lumber and building materials and rough plumbing and electrical. Gross margin for the second quarter was 34.46% to sales, an increase of 25 basis points from Q2 of last year.

Adoption of the new revenue recognition standard provided a 55-basis point benefit to gross margin. Product mix shifts negatively impacted gross margin by 20 basis points and higher transportation costs negatively impacted gross margin by 20 basis points. SG&A for the quarter was 22.45% of sales, which deleveraged 229 basis points.

As Marvin noted, we performed a strategic reassessment of Orchard Supply Hardware during the quarter, which led to non-cash charges of $230 million and a decision to exit the business. These non-cash charges drove 110 basis points of SG&A deleverage. Adoption of the new revenue recognition standard resulted in 64 basis points of SG&A deleverage.

In last year's second quarter, we recorded a $96 million gain from the sale of our interest in the Australia joint venture. This resulted in 49 basis points of deleverage this year. While increased demand from continued growth and appliances drove 16 basis points of deleverage and customer delivery costs, it was offset by 21 basis points of payroll leverage in the quarter.

Depreciation and amortization for the quarter was $345 million, which was 1.65% of sales and leveraged 18 basis points. Operating income decreased 186 basis points to 10.36% of sales. Interest expense for the quarter was $153 million, which leveraged 7 basis points. Effective tax rate was 24.4% compared to 36.2% last year as a result of tax reform. Diluted earnings per share was $1.86 for the second quarter, compared to $1.68 in the second quarter last year.

Excluding the non-cash charges as a result of the strategic reassessment of Orchard, adjusted diluted earnings per share was $2.07, a 31.8% increase over last year's adjusted earnings of $1.57.

Now, to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $2.3 billion. Inventory at $11.9 billion increased $478 million or 4.2% versus the second quarter last year. Inventory turnover was 3.85 times, a decrease of 15 basis points versus Q2 of last year.

Moving on to the liability section of the balance sheet, accounts payable of nearly $9 billion represented a $335 million or 3.9% increase over Q2 last year. At the end of the second quarter, lease-adjusted debt to EBITDA was 2.23 times. Return on invested capital was 20%.

Now, looking at the statement of cashflows -- operating cashflow was nearly $5.8 billion and capital expenditures were $543 million, resulting in free cashflow of $5.2 billion. In the second quarter, we paid $338 million in dividends. In May, we entered into a $550 million accelerated share repurchase agreement, which settled in the quarter for approximately 5.6 million shares.

We also repurchased approximately 5.8 million shares for $550 million through the open market. In total, we repurchased $1.1 billion of stock in the quarter. We have approximately $5.1 billion remaining on our share repurchase authorization.

Looking ahead, I'd like to address several updates we made to Lowe's business outlook. From a macroeconomic perspective, we maintain our positive outlook for the home improvement industry. We expect to see solid sector growth driven by gains in employment, which should boost disposable income and consumer spending. We expect housing will remain a positive driver as solid housing demand and continued home price appreciation supports home improvement spending.

However, while we recovered approximately half of the seasonal miss in the second quarter, assortment issues in flooring, inventory out of stocks, and reset disruption continue to exert pressure on sales growth. As a result, we now expect a total sales increase of approximately 4.5% for the year, driven primarily by a comp sales increase of approximately 3%. We anticipate opening approximately nine stores.

As Marvin shared, we are developing plans to aggressively rationalize or store inventory to remove clutter and to allow for investments in job-lot quantities for the Pro and overall depth of high-velocity SKUs. These actions may put up to 55 basis points of pressure on operating income in the second half of the year.

Also, our business outlook reflects the $230 million non-cash charges we incurred in the second quarter related to long live asset impairments and discontinued projects for Orchard, as well as the expected $390 million to $475 million of additional charges expected in the second half of 2018 as a result of our decision to exit this business. On a GAAP basis, we now expect an operating margin decline of approximately 180 basis points.

Effective tax rate is now expected to be approximately 25%. For the year on a GAAP basis, we now expect diluted earnings per share of approximately $4.50 to $4.60. As Marvin mentioned we lowered our capital forecast for the year by $500 million, eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates, or didn't meet our hurdle rate.

We are now forecasting cashflows from operations of approximately $7 billion and capital expenditures of approximately $1.2 billion. This is expected to result in estimated free cashflow of approximately $5.8 billion for 2018. Due to the lower capital expenditure forecast, our guidance now assumes approximately $3 billion in share repurchases for 2018.

Regina, we're now ready for questions.

Questions and Answers:

Operator

To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from the line of Christopher Horvers with J.P. Morgan. Please go ahead.

Christopher Horvers -- J.P. Morgan -- Analyst

Thanks, good morning. Welcome, Marvin. Welcome back to home improvement. Two questions -- first question, you spent a lot of time in the field. I want to get your thoughts on the opportunity to improve the Pro performance, as it appears that this is where the strength of the market is and where the performance gap has widened. So, you're attacking in-stocks first, but what's your other early diagnosis point of areas that you can see improvement in and try to drive improved comp on the pro side of the business?

Marvin Ellison -- President, and Chief Executive Officer 

Okay. Thanks, Chris. Pro is a huge opportunity for us. Today, we have roughly 30% of our overall sales penetration from the Pro segment. If you think about the pro for a second, they are a very important customer, but they have some very simplistic expectations on what it takes to get their business. Really, it starts first with service. We've heard often times that pros think time is money. So, they want to get in and out quickly. We'll invest more emphasis on simple things like loading, staffing the desk, and making sure we improve our delivery processes.

Secondly, they just want to have the product there. So, I've discussed in my prepared comments how we're not only rationalizing inventory. We're also investing in job-lot quantities. That is primarily for our pro customers. Pros need to be able to walk in to see a depth of inventory that they can complete their jobs. We are very inconsistent in that today.

The next thing that we have to do -- and Bill Boltz, our new EVP of merchandising is already working on this -- we need the brands. Pros resonate to certain brands. So, we're working to look at our assortment in our pro and building materials area and asking the question what brand gaps do we have in assortment that we need to attack. That is already under way to try to make sure we are responding to the feedback that we receive on certain and specific brands that we need to add to the assortment.

The last thing that we feel really good about is credit and our relationship with Synchrony and how we've worked with them to create more of an emphasis around our pro customer. These are really the short-term priorities that we're going after. As you noted, it's a huge opportunity for us. We can impact this side of the business without distracting or disenfranchising our DIY customers on the garden, on the décor side. It's something that we're going to spend a lot of time on. Joe McFarland, who is our new Executive Vice President of Stores, has a deep understanding of this segment and we're excited about the short and long-term potential.

Christopher Horvers -- J.P. Morgan -- Analyst

Understood. As a follow-up, you mentioned reviewing non-retail investments. I'm curious as to what they are, exactly. As you think about the long-term here, you mentioned a culture of expense discipline. How do you think about the ability to drive operating margin expansion versus the need to invest in things like in-store technology, labor, and supply chain? Thank you.

Marvin Ellison -- President, and Chief Executive Officer 

I think from a non-retail investment, if you look across some of the decisions we made from a capital perspective over the course of the last three to five years, we've dabbled in quite a few investments in non-retail types of formats and non-retail types of synergies and systems and services.

So, without getting very specific because it's still really early, we're just assessing everything. We're looking at our entire real estate portfolio and looking at every capital investment where we are spending the shareholders' money asking the question, "Are we getting an appropriate return?"

Equally as important -- is it consistent with our strategic long-term view of where we think Lowe's should be as a world-class omnichannel retailer. So, I'm expecting when we gather for our December investor conference, we're going to have much more specificity on where we see the future going, where we will invest and investments we're going to kind of par back. I want to just wait until that time frame before I'm going to be more specific on what opportunities or possibilities we're going to shift it from.

Relative to operating income, it really comes down to a couple of fundamental things. We need to generate more sales per square foot productivity in our stores. If you look at where we are in the past and focus on our end caps, as an example, our end caps have been more leaning toward innovation and driving productivity.

It's really not the merchants' fault. The merchants' have simply been following the companies' strategic plan. What we're going to do is shift away from innovation if innovation isn't driving revenue. So, we have to drive more improved productivity. While we're doing that, we have to be more disciplined on our SG&A. We have to be more disciplined on our investments of expense and capital.

So, I mentioned in my prepared remarks that we're going to no longer through payroll at problems. In the past, when we could have what we deemed conversion issues in the stores, we indiscriminately added payroll to try to solve it without really identifying the root cause. That is not how you run a business this size. So, instead, we're going to be more prudent on getting to root cause, redefining process, and not just thinking every solution is a solution where you just kind of through more headcount at it because that's not sustainable.

So, improving productivity on our sales per square foot, being more diligent and disciplined around SG&A, making sure that we have more rigor in our capital allocation process is going to improve our EBIT performance, operating profit, and have more sustainable EPS growth.

Christopher Horvers -- J.P. Morgan -- Analyst

So, does that mean you think there's an expense reduction opportunity outside of driving the actual productivity of the business?

Marvin Ellison -- President, and Chief Executive Officer 

I would say there's more to come on that. We are spending a lot of time looking at our strategic process around where we invest and where we cut and how we can drive productivity in our stores. As a recollection, one of the things that I am significantly focused on is how we can drive improved productivity in our stores while continuing to leverage operating profit. We can do both. We can improve service. We can improve productivity and we can also create a more profitable environment.

That is a correlation of understanding more process discipline in addition to making the right investments. As one specific example, we have very few, if any, engineering standards in our stores. What I mean by that is that typically, for a retailer our size, there are very engineered processes on things like how you unload a truck and how you flow product from the receiving to the sales floor to drive in stock.

We have no standards for that. It's a very random process where our stores are kind of fending for themselves trying to make it happen. That is how you destroy productivity. So, if you simply go in and build engineered processes consistent across all types of stores and volumes, you can drive increased productivity without having any kind of staff reduction action. It's just more of a process efficiency.

So, we're going back right now to create engineering standards for everything we do, from unloading the truck to stocking the shelf to every other process. We know that's going to reap significant benefits.

Christopher Horvers -- J.P. Morgan -- Analyst

Thank you.

Operator

Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead.

Simeon Gutman -- Morgan Stanley -- Analyst

Thanks. Good morning. Welcome, Marvin. My first question is given your experience, Marvin, in this segment, you used to compete a lot against Lowe's. I'm wondering at that time how you thought about the productivity advantage that Home Depot had over Lowe's, whether it was real estate-driven, whether it was operating execution driven, any thoughts that you share from your time last in the segment of why Lowe's wasn't operating at the same level as Home Depot.

Marvin Ellison -- President, and Chief Executive Officer 

Well, Simeon, I can remember back in early 2000 where it felt like every quarter we were getting beat pretty significantly by Lowe's with those same structural disadvantages we currently have. I think for us, it's less about looking at the competition and it's about looking within and asking the questions, "Where can we be better?"

Now, obviously, relative to our largest competitor, we have a disadvantage in real estate locations from a metro area, specifically in the Northeast and the West Coast. However, we believe that if we can find a better balance between serving the do it yourself customer and our pro, we can start to chip away at any competitive gaps that we have. Mike McDermott and I both mentioned in our prepared remarks about the challenges we face with our recent execution.

That is an example of what I call a self-inflicted strategic wound that we've done to ourselves because structurally, how we execute resets puts our team at a tremendous disadvantage. From a merchandise planning standpoint, that is kind of living in the merchandising side and the actual reset execution is in-store operations. So, you have two teams working on the same process and that creates inconsistency and communication problems. So, there are process improvements that we'll make to fix areas like resets.

In addition to that, we talk about our dotcom performance and how we delivered roughly 18% comps. Within that number is a significant systems issue where we tried to create better inventory visibility. By doing that, we drove a significant number of order cancellations that had a dramatic impact on the overall sales number of our dotcom business. That's another self-inflicted issue that created a lack of performance for us during the quarter. I also mentioned a significant number of out of stocks that we're dealing with in our stores that we have to fix.

So, as we look within and we ask the question where can we be better as a company to drive improved productivity, improved sales performance, improved operational leverage, we think that there are a lot of things that we can correct ourselves because there are certain structural disadvantages that we cannot overcome, but what we can overcome is poor execution. That is where our focus will be.

We think as we improve within these areas, we're going to see that gap start to close because we're going to be focused more within our own company versus looking across the street at our competitor.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay. That's fair. My follow-up, I respect that it's early days, but if you're willing to share your instinct, especially given your experience in the segment and now knowing both players, whether there is some type of under-spending that had been taking place at Lowe's and whether that necessitates some type of big catch-up in order to drive those results that you're talking about or if it's more on process than it is infrastructure.

Marvin Ellison -- President, and Chief Executive Officer 

Well, I don't think it's necessarily over-spending as it was the strategic choices we made on what we spent money on. As we announced today, we're going to be moving away from our Orchard investment. In retrospect, you can argue that may not have been the most prudent use of capital. So, I think it's less about total spending and more about the strategic rationale regarding the spend.

So, what we're doing as a team now is we're taking a really hard look at capital spending and asking a question where should we invest. Obviously, we're going to invest in supply chain. We have a very clear line of sight of exactly what we want our supply chain to look like. We recruited Don Frieson, who spent time at Walmart and Sam's Club and he brings a wealth of knowledge.

So, we'll make the right investments and we feel very confident that we can create a modern supply chain over the short and long-term. It's an iterative process that you can't do overnight. I mentioned we're looking for a new Chief Information Officer to help us understand how we continue to modernize our in-store technology. We have the capital to spend and we have a pretty good line of sight of what we need to spend it on and now, we're going to bring a leader in that's going to build out a multi-year plan.

So, I guess my short answer to the question is it's not a lack of spending. It's the prioritization of what we spend it on. We're going to focus on retail fundamentals. Now, it doesn't mean that we're going to think short-term.

While we're fixing these fundamental issues like out of stocks and reset issues and customer engagement and being more specific around serving the pro, we're going to be building out our supply chain, improving our IT infrastructure, and also creating this omnichannel environment where we can leverage these wonderful stores to be more in tune to serving customers that they want to serve both in-store and online.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay. Thanks, Marvin.

Marvin Ellison -- President, and Chief Executive Officer 

Thank you.

Operator

Your next question comes from the line of Michael Lasser with UBS. Please go ahead.

Michael Lasser -- UBS -- Analyst

Good morning. Thanks a lot for taking my question and welcome, Marvin. The first question I have is Marvin, how are you going to define success, especially in light of the fact that the company has grown in earnings the last few years and benefited from what's been a fairly healthy home improvement cycle that now looks like it's in the later stages.

Marvin Ellison -- President, and Chief Executive Officer 

Well, I think for us, like any large public company, we're going to define success in a couple of ways. First, we're going to look at are we gaining market share? We're going to be very purposeful around taking share in key categories. We're going to look at our financial performance, look at our sales growth relative to our competitive set. We're going to look at our bottom line, how are we performing from an EBIT and an EPS perspective and are we continuing to deliver value for our shareholders.

The thing that we're going to do, Michael, which is not a surprise is that we're going to be really customer focused. We have some very impressive competitors in this space. We're not denying that. But we understand that we also have to be focused on our customers. We can serve our customers at the highest possible level. We think that we're going to take market share. We think that we will see the proper levels of comp sales growth and we'll drive that sales productivity that I mentioned and you'll see overall bottom line improvement.

There are areas that we know we can do a much better job on relative to operating profit, which will be driven through more disciplined SG&A execution, overall operating expense, but keenly focused on driving improved sales productivity in our stores. We know that we can do that. So, those are kind of the basic fundamental things we're going to look at. It's going to be really more about are we serving our customers at a level that's driving loyalty and return visits.

Michael Lasser -- UBS -- Analyst

My follow-up question is can you frame the upside and the downside you're guiding for the back half of the year? Was there any thought to a new team coming in, let's provide a downside case or a really conservative outlook to provide breathing room for some of the changes that we're going to have to make, especially in light of the fact that there have already been some execution challenges that we're going to have to confront as we begin this journey?

Marvin Ellison -- President, and Chief Executive Officer 

Well, Michael, I'll give you my thoughts. I'll hand it to Marshall and he'll provide you any more specifics. I think the simple answer is we have a lot of moving pieces as the earning release outlined, with our decision to liquidate Orchard and our decision to rationalize inventory. Also, we made, I think, a very prudent decision to take $500 million in CapEx and shift it to our share repurchase program.

So, based on all of that, specifically Orchard in the inventory rationalization, we felt it was prudent to update our guidance. We feel as though we were conservative, but we wanted to also make sure that we did not under-perform what we believe the numbers should be for the second half of the year.

With that, I'll hand it to Marshall and he may provide some more specifics.

Marshall Croom -- Chief Financial Officer

Michael, when we started the year, we were guiding to 40 basis points of pressure on our operating margin. We expanded that to 180 basis points. That's 140 basis points. Again, to Marvin's point, largely driven by Orchard, the decision to exit that business as well as taking a hard look at our inventory rationalization process that we're getting under way. So, those two items combined drive that. Again, the right thing to do so we can redeploy capital so we can invest it where necessary, but it's those two big pieces that are driving the operating margin pressure.

Michael Lasser -- UBS -- Analyst

Marshall, just to confirm, those two pieces that are what we're seeing the difference between the old guidance and your new guidance or was there pressure factored in to the operating profit margin above and beyond other factors as well?

Marshall Croom -- Chief Financial Officer

Those were the two key drivers. Again, taking a hard look at the inventory rationalization, I felt that we needed to plan for an aggressive approach to that.

Michael Lasser -- UBS -- Analyst

Thanks very much.

Operator

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

Eric Bosshard -- Cleveland Research -- Analyst

Good morning. I'm curious, Marvin, as you think about -- you're doing a good job of listing out the investments that are needed, the prioritization of what you're doing -- but I'm curious as you think about the resets in customer engagement and the pro-service in building out the supply chain and IT and also identifying the productivity opportunities, is your mindset and discipline to invest first in these areas to strengthen the future or is your discipline to self-fund these things along the way and measure out and meter out the implementation of these things? Which path are you more apt to go down?

Marvin Ellison -- President, and Chief Executive Officer 

Eric, I think it's a combination of both. The best way to describe it is I think we have to work very aggressively to address what I call a lack of retail fundamentals. I mean, just basic things like reset execution, in stock improvement, sales productivity on end caps, addressing out of stocks and job-lot quantities, having more engagement with customers and not overriding and tasking versus engaging customers and understanding how we serve our pro via improved service and brands that they respond to. Concurrently, we'll be investing in a multi-year plan in supply chain.

Concurrently, we'll be investing in a multi-year plan from an IT infrastructure improvement, and concurrently, we'll be building out our omnichannel investments in our stores so that we can continue to leverage our 2,300+ physical locations with our digital platforms. So, I think it's a combination of addressing retail fundamentals plus we think the short-term benefit is there.

Again, you can't be a great retailer if you're not fundamentally sound, while making the strategic investments that will make us viable for the short-term and the long-term. So, it's a combination of all those things.

Eric Bosshard -- Cleveland Research -- Analyst

That's helpful. Secondly, I'm curious in terms of the timing we should be expecting regarding payback on the sales line. You talked about the importance of considering sales growth and sales per square foot and even your market share performance. When is it reasonable to expect the efforts that you're making to start to change the performance in those areas?

Marvin Ellison -- President, and Chief Executive Officer 

Eric, what I would say to you is as you can imagine, we're spending a lot of time getting our new leaders assimilated to the company. The good news is both Joe McFarland and Bill Boltz bring a combined 50 years of home improvement experience, which I think is really important for us on the merchandising and the stores side, but they have to get assimilated. Don Frieson brings over 18 years with Walmart and Sam's Club, but he needs to get assimilated. We just announced David Denton this morning as our new Chief Financial Officer.

So, when we come together at the investor and analyst conference in December, it is my expectation that we're going to have a high-degree of specificity around where we see the business going, not only for 2019, but over the course of the next two to three years. We'll be able to lay out those strategic investments that we're going to make that's going to deliver upon that. We're going to have probably a degree of detail that hopefully will give comfort to everyone who thought through this in a very specific fashion.

So, I would kind of postpone answering that question more directly until we have a chance to get all these leaders assimilated and we can get together and lay out that all-inclusive strategic plan.

Eric Bosshard -- Cleveland Research -- Analyst

Great. Thank you.

Operator

Your next question comes from the line of Zach Fadem with Wells Fargo. Please go ahead.

Zach Fadem -- Wells Fargo -- Analyst

Hey, good morning. Welcome, Marvin. Congrats on the new role. I'm curious if you can talk about your initial conversations with vendors and suppliers. Where do you think those relationships are today versus maybe what you expected? Where do you see the opportunities to improve these relationships either via expansion or consolidation of your offerings where appropriate and any additional improvement efficiencies? Thanks.

Marvin Ellison -- President, and Chief Executive Officer 

Well, Zach, the first thing is I want to just give Mike McDermott and his team a lot of credit. There are some significant partnerships that they've created the last couple years that I think have long-term benefits, specifically if you think about being the exclusive big box home center channel for Craftsman. What an iconic brand.

The brand is exceeding expectations of the team. We're just getting started. And also with Sherwin-Williams, another iconic brand -- having the ability to have their products, whether it's Thompson's WaterSeal or Purdy brushes in addition to their paint, this is something that we think we're just scratching the surface on the potential.

So, I would say overall, I've been very pleased with my engagement with the suppliers I've had a chance to spend time with. Obviously, with Mike's transition and Bill Boltz coming on board, we're going to be spending more time not only with existing suppliers, but we'll be spending time with suppliers that we currently don't work with to see if there is a realistic possibility that we can add additional brands to the assortment that will resonate with our DIY and Pro customers.

I would say overall, it's been very positive. I think they've been very encouraged by some of the changes that we've made because they now know that we're getting refocused on being a fundamentally sound home improvement retailer, which opens up the opportunity for them to drive more revenue within their own companies.

Zach Fadem -- Wells Fargo -- Analyst

Got it. Also, just to marry up your current outlook with the plans outlined at the beginning of the year, Marshall, you had called out about $140 million of tax reform reinvestment spending for things like labor, technology, some other items. To what extent are these investments still incorporated in the current outlook today? Is there any planned reallocation in that spend being contemplated?

Marshall Croom -- Chief Financial Officer

Zach, again, taking a look at the reduction of capital, there are expenses associated with those that's actually providing a little bit of offset in the back half of the year, but again, net-net, the incremental pressure of 140 basis points from our original guidance on operating margin.

Zach Fadem -- Wells Fargo -- Analyst

Got it. Appreciate the time, guys.

Operator

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

Steven Forbes -- Guggenheim Securities -- Analyst

Good morning. Maybe to start with the full-year comp guidance, are you assuming any flow through benefit from your inventory rationalization efforts that you mentioned today in the back-half or from the remaining seasonal recapture? I think you mentioned on the call that you got about half of it back in the second quarter. Then on the topline guide for the back half in general, can you help us quantify what you think the out of stock impact is to the business today, sort of like the run rate of it?

Marvin Ellison -- President, and Chief Executive Officer 

So, Steve, I'll take the out of stock question. I will let Marshall take the remaining components of the question. It's hard for us to determine the upside potential of the out of stocks. Having said that, having been in retail for over 30 years, I'm keenly aware that if we have increased traffic and improve in-stock, we should see some level of sales productivity from that. So, we are optimistic that we're going to be able to drive sales improvement when we get our in-stock position improved.

Now, the reality is that you just can't flip a switch and have inventory in your stores on the shelves. We are going to be very prudent in how we exit out and rationalize inventory that we think needs to exit the assortment, but we're going to be equally as prudent on making sure that we are selective and surgical on what we bring in. It's really more about timing than anything.

Once we get this process completed, we're very confident we'll see sales productivity. The question is how quickly can we get it done. That's the unopen question that I have that makes it very difficult to answer your question more precisely. So, with that, I'll let Marshall take the rest of your question.

Marshall Croom -- Chief Financial Officer

Steve, just on the inventory rationalization efforts, again, in the back half, primarily, that's being driven in the third quarter and we are anticipating about 55 basis points of operating margin pressure, again, just to allow for what we believe will be an aggressive approach to remove some of the clutter of inventory in the store and potentially an effort to reinvest into job-lots for the pros and some higher turning SKUs, our future sales productivity as the company moves forward.

Steven Forbes -- Guggenheim Securities -- Analyst

And then just a quick follow-up -- I think there was a $1 billion increase in the free cashflow guidance for the year, 2Q over 1Q. Half of that, obviously, is the $500 million reduction in planned CapEx for the year. Where is the other half coming from, the other $500 million? Then just touch on where you think inventory ends up being at the end of the year.

Marshall Croom -- Chief Financial Officer

So, the question on where does the incremental $500 million of operating cashflow come from, it's from the liquidation efforts of Orchard and the actions we are anticipating taking in the third quarter taking with inventory rationalization. So, that's really the two drivers to that piece. Was there another part to that question?

Steven Forbes -- Guggenheim Securities -- Analyst

What do you think inventory is at the end of the year as far as the balance sheet on a per store basis?

Marshall Croom -- Chief Financial Officer

Right now, we're looking at total inventory to be roughly flat for the year.

Steven Forbes -- Guggenheim Securities -- Analyst

Thank you very much.

Marshall Croom -- Chief Financial Officer

Regina, we have time for one more question.

Operator

Our final question will come from the line of Seth Sigman with Credit Suisse. Please go ahead.

Seth Sigman -- Credit Suisse -- Analyst

Thanks a lot and good morning. A couple follow-up questions -- first, just in terms of Orchard Supply, any more insight into that decision to exit that business and the historical financial contribution to that business. Then I'm just curious your views on Canada and Rona specifically. Do you view that as core to the go-forward strategy? Thanks.

Marvin Ellison -- President, and Chief Executive Officer 

Well, I would say Canada and Rona first has been a very positive benefit for the company. The good news is that the overall integration is happening well. The introduction of unique and different categories for Rona like appliances has been met with really strong response from the customers. We feel very, very good about the Canadian business performance and, again, that overall acquisition of Rona. We think that it's exactly where we want it to be, if not exceeding expectations from the original performance.

Relative to Orchard, as the old saying goes, hindsight is 20/20. But I think there were some strategic decisions made that if they had to be done over would be different. The good news is that 86% of the Orchard stores that are closing are within a 10-mile radius of a Lowe's store. So, we're very optimistic that any associate who is an Orchard associate that's looking for a home at Lowe's, we should be able to find them a position. We're going to prioritize those individuals.

But the business was just not running well. As we started to do the strategic assessment of where we wanted to invest our capital and where we wanted to be focused, it became really clear to me and to the leadership team that we want to be focused on our core retail business. We could grow Orchard into the most dominant, small box specialty home improvement channel in America and it will be very minimal positive impact from an EBIT, from an overall revenue standpoint to the Lowe's business.

So, the question is do you continue to invest financial and intellectual capital in an initiative that will have very small benefit to the shareholder. We decided that we would not. So, we're going to take the intellectual and the financial capital that we would have been investing in that business and invest it in the core of Lowe's business and we think that's a better return for the shareholder.

Marshall Croom -- Chief Financial Officer

Seth, I had one other point just as a frame of reference. Orchard for 2017 generated about $600 million in sales and it was a negative $65 million in EBIT.

Seth Sigman -- Credit Suisse -- Analyst

Okay. Thank you for that. That's helpful. My last follow-up is just around e-commerce and your assessment of the gap versus the competitors in this space. I guess in general, how are you thinking about investments required to address those gaps? Thank you.

Marvin Ellison -- President, and Chief Executive Officer 

The good news is a lot of the investments are under way. We are building a very, very impressive team of experts that are coming in from a lot of different backgrounds and some of our very impressive competitors. I think our greatest opportunity is fundamentally making sure that our site is a lot more user-friendly, from a search, from a navigation, from a checkout. There's a very specific roadmap that is being built and being executed to deliver on all of those things.

The second big component is how do we more seamlessly connect our digital and our physical footprints together? The great news for us is that we're in a space of home improvement, where customers still like to come to the stores. They enjoy engaging with our associates because they want some level of consultation on a purchase. In addition to that, we have products that are big, bulky, and hard to ship. Having the ability to leverage our digital and our physical stores is important.

The good news is if you look at our business today, roughly 60% of our e-commerce transactions were picked up in a store. That's incredibly powerful even though we have a significant list of opportunities that we are addressing. That's telling me that our customers are already resonating with our omnichannel philosophy and being able to connect digital and physical. We just need to make it more seamless. So, the investments required are really already under way. The roadmap is already built and we're continuing to tweak it, but we see nothing but positive upside in the space.

Seth Sigman -- Credit Suisse -- Analyst

Thank you. Best of luck.

Marvin Ellison -- President, and Chief Executive Officer 

Thank you. So, just a few closing remarks -- I want to make sure that I just take a moment and thank both Marshall Croom and Mike McDermott for their loving commitment to this company. More importantly, these gentlemen have been extremely professional and very, very helpful for me throughout this transition. So, I'll be eternally grateful to both of them for their support of me in this transition, their love and support of the associates of this company. I wish them Godspeed and many blessings in the next chapter of their lives and careers.

Thank you. We look forward to speaking to you on our November 20th earnings call.

Operator

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

Duration: 64 minutes

Call participants:

Marvin Ellison -- President, and Chief Executive Officer 

Michael McDermott -- Chief Customer Officer

Marshall Croom -- Chief Financial Officer

Christopher Horvers -- J.P. Morgan -- Analyst

Simeon Gutman -- Morgan Stanley -- Analyst

Michael Lasser -- UBS -- Analyst

Eric Bosshard -- Cleveland Research -- Analyst

Zach Fadem -- Wells Fargo -- Analyst

Steven Forbes -- Guggenheim Securities -- Analyst

Seth Sigman -- Credit Suisse -- Analyst

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