Lowe's Companies Inc (LOW) Q2 2019 Earnings Call Transcript

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Lowe's Companies Inc (LOW 1.49%)
Q2 2019 Earnings Call
Aug 21, 2019, 9:00 a.m. ET

Prepared Remarks:

Operator

Good morning, everyone. And welcome to Lowe's Companies' Second Quarter 2019 Earnings Conference Call. This call is being recorded. [Operator Instructions].

Also, supplemental reference slides are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the Company's results and to be used as a reference document following the call.

During the call, management will be using certain non-GAAP financial measures. The supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the Company can give no assurance that they will prove to be correct. Those risks are described in the Company's earnings release and in its filings with the Securities and Exchange Commission.

Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. David Denton, Chief Financial Officer.

I'd now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir.

Marvin R. Ellison -- President, Chief Executive Officer and Director

Thank you, Regina. Good morning. Our total company comp sales grew 2.3% in the second quarter. Our US home improvement comps were positive 3.2% exceeding expectations, despite lumber deflation and unfavorable weather. In fact, we saw broad-based growth across all 15 geographic regions generating positive comps. Three of our top four performing regions were in the Western Division. In addition to the Western regions, we also had great performance across the following regions that outperformed the total company comps, Atlanta, Boston, Charlotte and Tampa.

Weather was particularly challenging early in the quarter, exerted approximately 195 basis points of top line pressure, in the month of May. And as weather improved, we saw broad-based sequential improvement in US console, a positive 0.7% in May, positive 4.2% in June, and positive 4.7% in July. Commodity deflation exerted approximately 110 basis points of pressure to comp sales in the quarter, however unit growth, and impacted departments such as lumber and building materials remained strong.

For the quarter, comparable transactions grew at a positive 0.3% and average ticket grew at a positive 2%. We executed very well during key holiday events and converted strong foot traffic into sales. Once again, Pro comp significantly outpaced DIY during the quarter and our strong Pro performance was particularly driven by investments in job lot quantities coupled with our improved service model.

As Joe will detail, we continue to make progress to better serve our Pro's and we received very favorable feedback on our improved in-store experience with our customer service scores increasing 900 basis points. Overall performance in the quarter demonstrated continued momentum executing our retail fundamentals framework. And with the initiatives we put in place we continue to make steady deliberate progress to better serve customers, position our business for long-term success and improve our results in categories that have historically underperformed.

Bill will discuss some of those categories in a moment. On Lowes.com, we posted comp growth of approximately 4% in the second quarter. There are a couple of key items that contributed to this underperformance.

First, we intentionally slowed the number of new SKUs that we added in the quarter, while we addressed systems and process issues that negatively impacted our stores productivity. These systems and process issues were resolved in early Q3. Second, we took steps to improve the quality of our online business by eliminating certain programs, which were unsustainable from a profit perspective. In taking these steps, we knew that we would stun our short-term growth. However, we took the necessary actions to position ourselves to grow our online business for long-term sustainable success.

In addition to solving these process and systems issues, we're taking aggressive steps to improve the technology foundation of Lowes.com. We replatformed the entire site to Google Cloud. At the beginning of this year our dot-com site was only a decade old platform. So we expect to have the entire site on the cloud in the first quarter, which will improve our agility as we redesigned the customer experience from search and navigation to checkout.

Omnichannel is a tremendous growth option for Lowe's, and we have a very detailed transformation plan to modernize our platform and dramatically grow Lowes.com sales in the future. Our goal is simple. We want to serve customers [indecipherable] shop and we look forward to updating you on our progress on future calls. In fact, our commitment to having a world-class technology team is reflected in our announcement to open a new global technology center to 2000 additional technology professionals in Charlotte. Construction of this new facility began this month, with plans to open the center in 2021.

The global technology center underscores our commitment to recruiting world-class talent and becoming the best-in-class omnichannel retailer. But in the meantime, we are utilizing a temporary space in downtown Charlotte for the technology professionals that will ultimately be based in our new global technology center.

In Canada, we posted negative comp sales for the quarter. Our negative comps was driven in large part by our ongoing RONA integration. After a strategic reassessment of the Canadian business, we decided to make adjustments to the original RONA integration strategy. Although, we remain confident in the long-term potential of this business, this shift in strategy has [indecipherable] slow growth. But once again, we're sacrificing short term growth to position ourselves for long-term success. And I look forward to providing you additional updates on future calls.

Diluted earnings per share were $2.14 for the quarter and adjusted diluted earnings per share were $2.15, supported by solid top line growth and expense leverage. Now let's take a moment to provide an update on the progress to deliver gross margin improvement in 2019. The improvement since the first quarter reflects immediate benefits from the actions that we've taken. In fact, we realized compounding benefits as we moved through the second quarter with marked improvement in gross margin for the second half of the quarter as compared to the first half.

Our second quarter performance coupled with actions still to come give me confidence that we're on the right path to sequential gross margin improvement in the third and fourth quarters. Although we're pleased with the progress we made in Q2 to recover gross margin dollars, we have additional work to do to modernize our systems and our pricing tools. Therefore over the next 12 months, we'll be focused on two major initiatives to deliver this monetization. Our first initiative is focused on the deployment of our new price management system, which will allow us to better systemically analyze, prioritize enough significant retail pricing actions. This new system will create a single repository of pricing to provide better visibility for the merchants to understand the impact of our pricing decisions.

This new pricing management system will be in place by the end of the year and will get us to compare to currently with most retailers. Our second initiative is focused on fully integrating our acquisition of the Boomerang retail analytics platform. Integrating this platform will allow us to incorporate Boomerang's technology into our core retail business, both to a strategic data driven pricing and also allow us to make better merchandising decisions across the business from an assortment perspective.

This Retail Analytics platform will be fully integrated with our price metrics during the first half of 2020 and will provide us with a best-in-class pricing analytics system. We're confident in our strategic initiatives as we enter the back half of the year and we expect to continue our strong top line performance while delivering margin improvement. And we'll also begin to manage down our inventory to more sustainable levels.

So now, allow me to take a moment to discuss the inventory in more detail. This year, we invested in inventory to support offers such as earlier season to load-ins, CRAFSTMAN resets, increased presentation minimums and job lot pf Pro's. These strategic investments in inventory helped us to deliver improved sales performance in Q1 and in Q2. And although our inventory has increased year-over-year, we have a very minimal seasonal inventory, which limits our risk of unplanned markdowns.

In the back half of the year, we will refine our in-stock expectations and began to reduce inventory in certain categories. One key initiative tied to our supply chain transformation strategy is rollout of predictable deliveries in our stores. This more predictable product enable us to lower safety stock across many SKUs. In addition, we will execute a list of strategic initiatives in the back half of the year that will allow us to strategically manage down inventory while protecting our in-stock position and our margins. Though we made great strides and we are pleased with our second quarter results, we're not taking victory laps. We have a lot of work to do and we're fully committed to driving top line growth, improve our gross margin, intensifying our commitment which fits the management. We're very excited about the upside potential of our company and we believe we are on the right path to generate long-term profitable growth.

And lastly, I want to take a moment to thank our associates for their hard work, dedication and commitment to each other and commitment to serving customers. And with that, I'll turn the call over to Bill.

William P. Boltz -- Executive Vice President, Merchandising

Thanks, Marvin, and good morning everyone. We were pleased with our second quarter performance, as we capitalized on the continued spring demand and strong event execution. We posted a US comparable sales growth of 3.2%, exceeding our expectation. On a two-year stack, US comp sales accelerated from 4.7% in Q1 to 8.5% in Q2. During the quarter, we leveraged our successful Memorial Day, Father's Day and July 4th events, taking advantage of the seasonal project demand. And we also drove traffic with our compelling values, relevant assortments and our continued shift into digital marketing channels.

We were well prepared for our holiday events with excellent coordination and alignment between store operations, supply chain and our marketing teams. Our success in driving spring sales was supported by the improved service model in our stores and better in-stock execution. Joe will share more of that in a moment on how well our associates delivered in the aisle. Our continued focus on retail fundamentals drove strong performance in areas of [technical issues] strength and more importantly, help deliver improved performance in categories which has historically underperformed.

In fact, we had seven departments perform above the company average in the quarter. For example, we began the implementation of our retail fundamentals framework in the Paint department two quarters ago. Prior to that implementation, Paint had delivered comps below the company average for 10 consecutive quarters. This quarter, because of an improved service model and better in-stock position, along with compelling offers, paint led the merchandising department growth with the strength coming from both interior and exterior paint products. All of that being done despite some weather pressure early in the quarter.

This marks the first time in 10 years that Paint has led the merchandising department comp growth. We will continue to invest in this important area given that paint is a traffic driving category and that painting is the number one DIY project. We are working closely with our suppliers to rollout an improved propane offering. And we see a significant opportunity to drive an increased Pro penetration in paint, all of this by better serving the repair, remodelers who need paint to complete a larger project such as a kitchen or bathroom remodel.

Prior to our implementation of retail fundamentals, our core department had performed below the company average for 12 of the last 13 quarters. In Q2, we drove mid single-digit comps in the core with double-digit comps coming in blinds and shades. The improved performance was largely driven by job lot quantity investments and our improved product offerings in both our private and national brands.

Millwork is another merchandising department that has historically underperformed. In 11 of the past 12 quarters, Millwork had posted comps below the company average. This quarter with a heightened focus on the Pro and improved in-stock position, a refresh department and investment in job lot quantities and some new product introductions, Millwork delivered comps above the company average.

For the quarter, we also continue to achieve strong comps in areas of historical strength for Lowe's. In Tools, we delivered strong mid single-digit comps and continue to see market share gains as a result of our craftsman resets. The strength in craftsman came from categories such as power tools, tool storage and mechanics tools. We're excited to now have completed the CRAFTSMAN resets this quarter and we're proud to be the exclusive destination in the home center channel for this iconic brand.

During the quarter, we also leveraged key programs such as the Dewalt, the number one power tool brand in the industry. Along with the introductions of other new and innovative products from Bosch, Spider and Metabo HPT, all to help drive strong comps in Tools. Within our Appliance department, we drove solid mid single-digit comps building on our leading market share position with our top brands and breadth of assortment. In Hardware, we posted solid mid single-digit comps with strength coming from our family hardware and our fastening categories. The investment we made in job lot quantities and new product introductions help deliver the results in these two categories to support the Pro demand in hardware.

And lastly we again delivered above average comps and saw market share gains in seasonal and outdoor living, led by double-digit comps in pressure washers as well as riding lawn mowers where we continue to leverage the top three brands in riding equipment with John Deere, Husqvarna and CRAFTSMAN. We continue to be pleased with the results that we are seeing from our new merchandising service teams or MST. These teams are supported by our vendors and they're responsible for day-to-day bay maintenance, the resets in our stores, setting and maintaining our end caps and executing our off shelf displays. The MST teams are a critical component to improving our merchandising reset execution at the store level, as they continue to take tasking activities off the shoulders of our selling associates, so that they can be freed up to dedicate more time to serving our customers.

The early results of our MST program are positive and these teams have shown a reduction in out-of-stocks and improved sales productivity and an increase in bay service per hour. Now as we look ahead to Q3, we remain focused on our retail fundamentals and driving profitable sales with our upcoming Labor Day and fall harvest events, leveraging additional target events throughout the quarter that will take advantage of the fall micro seasons, continuing to drive the strength of the traffic power of CRAFTSMAN. Building on the responsibilities are our field merchandising team who will be instrumental in driving the localization in our stores along with executing our seasonal transitions, continuing the focus on the Pro categories as we continue to capitalize on our investments and our focus on this important customer segment.

And lastly, we look forward to leveraging our new NFL partnership including -- introducing new exclusive products and events that will help drive a strong connection with both the DIY and our Pro customer. As I've shared on previous calls, we are in the process of implementing our category management strategy. This cohesive strategy is going to be critical to driving merchandising productivity by ensuring that we are allocating our resources to the areas of greatest opportunity. The merchandising team is committed to aggressively driving top line sales while growing gross margin dollars.

Thank you and I would like to turn the call over to Joe.

Joseph Michael McFarland -- Executive Vice President, Stores

Thanks, Bill. And good morning everyone. Our commitment to improving in-stocks and customer service along with intensifying our commitment to the Pro customer were integral to our stronger event execution and comp growth in the second quarter. I'm pleased to be accumulating benefits we've seen from actions we took in the first quarter to further improve assisted engagement and drive store simplification. We recently deployed the new mobile devices for our store sales, we call smartphones, the acronym smart represents our customer service philosophy.

Our new smartphones are designed to reduce tasking hours by providing real-time data without ever stepping up the sales floor. In the second quarter, we added our standardized performance scorecards to the smartphones. We also deployed store walk application to allow for more efficient, strategic store review process. These applications allow our store managers to drill down and evaluate productivity by department and by associate to manage their store more strategically. These new mobile devices are an example of how we can leverage modern technology to make significant advancements in the capabilities we make available to our associates. Putting the new mobile devices in the hands of our managers and supervisors is a significant step toward revolutionizing how we deliver sales and operational productivity in our stores.

Our investment in over 600 assistant store managers and 5500 department supervisors paid dividends in Q2. On average, we've added 120 customer facing hours per store per week while still leveraging store payroll. Because of this investment, we are to provide better departmental coverage and expertise as well as coaching for our associates in delivering excellent customer service.

With the addition of department supervisors, we ensured that we have proper coverage for strategic areas of focus such as Pro and Paint, and it is no coincidence that both Pro and Paint were two top performing areas for the second quarter. All said, our commitment to improving both store efficiency and customer experience drove 600 basis point increase in overall Q2 customer service stores.

As Marvin indicated, we're very pleased with our Pro business performance in Q2, with Pro comp significantly outpacing DIY. We're also pleased with the Pro customers willingness to grow their business with us. We continue to leverage our investments in job lot quantities and product presentation in key areas such as Pro Canopy and end caps, improved store level service including dedicated loaders and preferred parking under the Canopy. To ensure we can get our Pro customers in and out faster and staffing our Pro dedicated associates working a consistent schedule, dedicated department supervisors for Pro areas, a consistent volume pricing message and our redesign field structure with 15 new regional Pro directors and experienced leaders to focus our in-store and outside Pro sales.

We're already seeing great results from this team with double-digit comps this quarter. We also continue to leverage key brands to grow our Pro business such as Little Giant Ladder Systems, Lithonia commercial lighting along with Bosch, Metabo HPT, and Dewalt. And our merchant teams continue to work at more key Pro items to our assortments, including the new exclusive Dewalt 12 volt cordless extreme brushless platform launching this quarter.

We're proud to be the destination for this platform offering extreme power and a compact lightweight design that allows Pro's to work more efficiently in tight spaces. We are seeing positive results from our actions with increased Pro customer service scores. Once again this quarter we invited customers in to see our improved environment with another very successful Pro appreciation event, which allowed us to grow our Pro accounts.

In fact, we opened over 35,000 new Pro accounts in the quarter. Although, we are pleased with Pro performance in Q2, we are in the early stages of our transformation. Therefore, we are pursuing additional opportunities to deepen our relationship with the Pro including our upcoming propane test in select markets focused on improving our staffing and training model to better serve the needs of this key customer. We have additional initiatives on our Pro roadmap and I look forward to keeping you updated on future calls.

As we look to the back half of the year, we're working to improve staffing and better leverage our payroll spend with the national rollout of our new customer centric labor scheduling system. We have deployed the system in four geographic regions and will complete the rollout to our remaining 11 regions by the end of the fiscal year. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic to provide better department coverage and customer service, while ensuring that we're using our labor hours efficiently and reducing payroll expense.

This new system will replace our current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. We're also deploying a new one task team to ship task work from our selling associates to one centralized team that will be responsible for completing non-selling task during the evenings and overnight hours. The centralized team will drive more consistent execution of tasking, streamline non-customer facing payroll and allow for cross trading. Though we are pleased with the changes we've made and excited about the results we're seeing, we are very focused on the hard work ahead to drive further improvements and transform Lowe's into one of the most operationally efficient retailers in the world.

Thank you, and I'll now turn the call over to Dave.

David M. Denton -- Executive Vice President and Chief Financial Officer

Thank you, Joe, and good morning everyone. I'll begin this morning as I often do with a brief review of our capital allocation program. In the first six months of 2019, we generated $3.1 billion in free cash flow and through a combination of both dividends and share repurchases, we've returned over $3.5 billion to our shareholders. In the second quarter alone, we paid $382 million in dividends and our dividend payout ratio currently stands at 37% over the trailing four quarters.

Now given the dislocation of our stock price coming out of Q1, we ramped up our share repurchase activity and bought back nearly $2 billion of our stock at an average price of approximately $100. Early in Q2, we entered into a $990 million accelerated share repurchase agreement retiring 9.9 million shares. And additionally, we repurchased 9.7 million shares in the open market for $974 million. This brings our year-to-date share repurchases to $2.8 billion with a plan to repurchase $4 billion for the year. We also have approximately $11.2 billion remaining on our current share repurchase authorization. We continue to invest in our core business with a focus on high return programs designed to drive long-term shareholder value. In Q2 we had capital expenditures of $321 million.

Now turning to the income statement, we generated GAAP diluted earnings per share of $2.14. On a comparable basis, we delivered adjusted diluted earnings per share of $2.15, an increase of 3.9% compared to adjusted diluted earnings per share of last year. Sales for the second quarter increased 0.5% to $21 billion, supported by total average ticket growth of 3.2% to $77.97. This was partially offset by a 2.7% decline in total transactions.

On our comp sales basis, we were up 2.3% driven by a comp transaction increase of 0.3% and an average ticket increase of 2%. Our US comp was 3.2% for Q2. Looking at monthly trends, total comps were negative 0.3% in May, positive 3.4% in June and positive 4% in July. Additionally, monthly comps for our US business were positive 0.7% in May, positive 4.2% in June and positive 4.7% in July.

Gross margin for the second quarter was 32.1% of sales, a decrease of 85 basis points from Q2 of ROI. But 65 basis points better than Q1. The improvement since the first quarter reflected immediate benefits from the actions we've taken including retail price adjustments that had minimal impact to units. It pivot to more strategic and targeted promotions and greater vendor support from key promotional activities. We are very pleased with the progress we made to improve our gross margin performance.

The actions we implemented are gaining traction but there is additional work to be done on this important area for the balance of the year. This quarter we experienced approximately 50 basis points of rate pressure. As expected we experienced approximately 15 basis points of pressure from supply chain cost. We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery costs. Product mix shifts and inventory shrink each ahead at approximately 10 basis points negative impact on gross margins during the quarter.

SG&A for Q2 was 19.3% of sales, which levered a 170 basis points. It's worth noting that in last year's second quarter, we recorded a non-cash charge of $230 million related to the strategic reassessment of Orchard Supply Hardware. This resulted in approximately 110 basis points of leverage this year. We drove approximately 50 basis points of leverage and retail operating salaries in the quarter and approximately 15 basis points of leverage to improved advertising efficiencies.

Operating income increased 98 basis points to 11.34% of sales. The effective tax rate was 24.2% compared to 24.4% to LY. At $13.7 billion inventories increased $1.8 billion or 15.5% versus the second quarter of last year. But it's down $1.3 billion versus Q1.

As Marvin indicated, this increase was driven by strategic investments in the first half of the year to drive sales, such as an earlier seasonal load-in, CRAFTSMAN reset, increased presentation minimums and investments in job lot quantities for the Pros. In the back half of the year, we will refine our in-stock expectations and began to strategically reduce inventories in certain areas, while protecting our in-stock position as well as sales and margins.

Before I close, let me address our 2019 business outlook. The underlying macroeconomic fundamentals in the US remains supportive as demonstrated by the solid pace of job growth. The home improvement sector should continue to benefit from several factors including strengthening wage growth, gain in household formation and rising home prices that encouraged homeowners to engage in discretionary projects.

Additionally, the aging US housing base is driving ongoing maintenance and repair spending across the nation and despite a strong financial performance in Q2, which exceeded our own expectations, and a solid underlying economic outlook for the remainder of 2019, we've elected to maintain our current 2019 business outlook. We are still recovering from a disappointing first quarter margin performance, but we have assembled the very talented management team and we are aggressively implementing initiatives to improve our business. Therefore, we feel prudent to maintain this intense focus on retail fundamentals throughout the remainder of this year.

And as we've said many times, we are in the early days of our transformation. We expect a total sales increase of approximately 2% for the year driven by comp sales increase of approximately 3%. We expect an adjusted operating margin increase of 20 basis points to 50 basis points. The effective tax rate is expected to be approximately 24%, and we now expect adjusted diluted earnings per share of $5.45 to $5.65.

We shared previously that our business outlook includes the waive of trading tariffs. We have a value-weighted waive for A, and have concluded that we can manage through that limited impact in the second quarter of this year within our existing guidance range. We are forecasting operating cash flows of approximately $4.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio stands at 2.75 times and our guidance assumes that we complete approximately $4 billion in share repurchases for this year. So in closing, we remain extremely excited about the future of the company and its ability to deliver significant shareholder value over the long term.

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

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan.

Christopher Horvers -- JPMorgan -- Analyst

Thanks, good morning. First, a question on Dave, your comments on the guidance and your decision not to raise it. So I appreciate your comments on being prudent, because there is a lot of uncertainty in the turnaround and it's now early stages, but is there anything in any area or any initiative in particular that causes gives you that pause or any area that P&L, and your guidance where you see more risk versus other areas?

David Denton -- Chief Financial Officer, Executive Vice President

No, listen. We're really extremely pleased with the progress coming out of Q2 . We are very confident in our outlook for the balance of the year. Keep in mind, as I said in my prepared remarks, we've worked, we've committed ourselves to retail fundamentals and improving our financial performance recycling of the back half of the year. But as you know, we've launched many broad cross-functional efforts touching almost all areas of our core business. Thus, creating a little bit of a fluid environment in our business model. Having said that, we feel very confident in where we stand today and our outlook for the balance of the year. So there is nothing on that horizon that we see that is a disappointing news coming forward from that perspective.

Marvin R. Ellison -- President and Chief Executive Officer

Hey, Chris, this is Marvin. The only additional comments that I'll make, Bill outlined in his prepared comments some of the key initiatives for the third quarter and the back half of the year. We have a lot of confidence in our strategy. Q1 was a disappointment, and we are still candidly digging out of that. But as we look forward, I mean we're very confident in our ability to drive the business. We just think it's prudent to just focus on retail fundamental execution to get this still relatively new team or time to continue to get our arms around every aspect of the business and then we'll evaluate guidance as we continue to progress through this quarter and beyond that.

Christopher Horvers -- JPMorgan -- Analyst

Understood. And then just a question on the margin front. So SG&A dollars are down in the first half of the year, and if you look at on a per foot basis, it's up about 0.5% year-to-date with 2Q better than 1Q. So how are you thinking about SG&A as we proceed through the year and lap the store closures? Should the SG&A dollars be down in 3Q and then, and then up modestly in the fourth quarter on a year-over-year basis as you get through the store closures in 4Q?

David M. Denton -- Executive Vice President and Chief Financial Officer

Yeah, let me just take it first half, second half, I think we continue to make really nice progress from an SG&A perspective. I think the second half -- we won't leverage nearest March in the second half driven by the fact that many of our initiatives from a project perspective are continuing to ramp into the back half of the year. And so you will see those expenses show up back half of the year.

Christopher Horvers -- JPMorgan -- Analyst

Understood. Thanks so much. Best of luck.

David M. Denton -- Executive Vice President and Chief Financial Officer

You're welcome.

Operator

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

Simeon Gutman -- Morgan Stanley -- Analyst

Thanks, good morning everyone. I wanted to ask about gross margin. If we look back, I think, the right base on a rebase basis is around 33% for this business before some of the one-time issues occurred. Is there any reason that you shouldn't recoup and get back to those levels and you mentioned this modernization. Do you need the modernization to recoup what you lost in Q1 or does this enable you to even get past that 33% level over time?

David Denton -- Chief Financial Officer, Executive Vice President

Yeah, this is Dave. Maybe I'll start. Clearly, if you look at the long-term algorithm of our business model, as we said, to get to our 12% operating margin over time is that, we would think about gross margin, they are substantially flat if you will over time. I don't think there's anything on the horizon that we've seen our business model that would change that expectation. Clearly, as we go through the years to come, we need to do two things. We need to increase our performance from a sales perspective, thus leveraging SG&A flowing through a higher profit margin through that algorithm and through that approach. So I don't think there's anything from a margin perspective that gives us pause at this point.

Marvin Ellison -- President, Chief Executive Officer and Director

Simeon, the only thing I'd add, this is Marvin is, from a technology dependencies we don't have high dependencies on technology specifically for the back half of this year, when I talk a little bit of detail about our price management system and leveraging the Retail Analytics platform that we acquired from Boomerang, we're going to have a new product management system in position in the fourth quarter. That will get us to a competitive parity and now candidly, we're quite a bit behind what a modern large retail would be from the ability to leverage a pricing and to have agility pricing in local markets in-store and online.

We're going to get build a team just better visibility and just single repository which believe or not, this company has never had. Within the first half of next year, we're going to merge the price management tool with the Retail Analytics platform that we acquired and we think that's going to unlock the ability to meet the expectations that they've laid out and that is relatively flat gross margin. Our operating income store is going to really be about flat gross margin in driving continued SG&A leverage by implementing technology and taking task out and putting more labor on the floor to serve customers and so that's going to be more of an ongoing year-over-year process.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay. And then for my follow-up, I'll stay on the same topic. I mean there is some big events, you're going to be lapping first and the third quarter with the write down and then next year's first quarter. Is there any reason today that you see that you couldn't recoup in what was lost in the write down, it should have been a one-time event. Is there any reason we don't get back that amount coming in the third quarter and then through the first quarter, a lot of the issues from this prior year's first quarter should be resolved?

David M. Denton -- Executive Vice President and Chief Financial Officer

Well, clearly that's within our plans. Our guidance assumes that we're going to lap that in the back half of the year and as you look at the continued performance of our business, both from a sales perspective and a margin perspective, we're actively managing up against that fight, there is no -- there is no doubt that we would sequentially continue to make progress from a margin perspective for the balance of the year.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay, thanks. Good luck.

David M. Denton -- Executive Vice President and Chief Financial Officer

You're welcome.

Operator

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

Zach Fadem -- Wells Fargo -- Analsyt

Hey, good morning. So, Marvin, you called out strong execution on holiday events. Curious, if you could talk a little more about what you're doing differently there both in terms of just the execution and merchandising assortment, but also the traffic driving initiatives like the paint promotions that you ran and how that's impacting your take rate?

Marvin R. Ellison -- President, Chief Executive Officer and Director

So Zach, I'll take the first part and then I'll let Bill add some additional color. When you look at the home improvement business the one thing that we brought from a strategic standpoint is the importance of the event execution because you have certain DIY customers that will traditionally to shop you about four times a year. So it's really important that you start the year off really effectively and in the past, Lowe's has kicked off their spring Black Friday types of events and they've been out of stock at some degree of services. So you disappoint customers and those customers just don't come back for that second, third and fourth shopping occasion later in the year.

So we put in enormous emphasis on great execution, product load-in, in-stock great value for spring Black Friday, understanding that customers who may have been disenfranchised by shopping at Lowe's in the past, would come in to shop Lowe's because the values were compelling but the goal was to create such a great service experience that they would come back on that second, third and fourth occasion this year. And so what we, what we believe we're seeing in Q2, as we're seeing that second shopping occasion because of the great event execution and spring Black Friday that led to continual execution in Father's Day and 4th of July, etc, etc. And so it starts with great product and great value, it starts with compelling marketing message. Again the stores have to take it from there to turn that foot traffic in to sales. And so we've done a really nice job of that and it's been a collective team effort.

So I'll let Bill talk about what some of the values that drove our success and kind of what we're going to be leaning into as we think about the rest of this quarter.

William P. Boltz -- Executive Vice President, Merchandising

Yeah, I think just to add to Marvin's comments, a couple other things. The investment that we made propping up our MST team as well as our field merchant team certainly started to take hold in Q2 and we're able to pull a lot of this event recovery, event execution off the shoulders of our selling associates and really recover faster inside the stores and that was a big -- that was a big difference this year versus last year.

And then the marketing teams and the merchant teams did just, I thought a superb job of coming with just great values that we drive traffic into the store and drive the basket and your comment around paint was we know that that's a traffic driving category. We know it's the number one DIY project and by being able to strategically look at our overall promotional strategy inside the store we were able to do something disruptive in paint that drove some unprecedented traffic into that category for Q2.

So we're excited about what's happened, we're excited about where the learning we've received, it will help aid certainly as we go into the back half of the year and more importantly, in to 2020.

Zach Fadem -- Wells Fargo -- Analsyt

Got it. And then on some of the merchandising efforts, you removed from the SKU rationalization, could you talk about the success of that initiative. Whether the replacement SKUs have have been more productive from a volume and margin perspective and then with your inventory up over 15% in Q2, how should we think about the timing potential for further inventory rationalization initiatives ahead?

Marvin Ellison -- President, Chief Executive Officer and Director

So Zach it was less inventory rationalization and more of the removal of non-productive inventory. So that sounds like a nuance but this is a different because the steps we took in the second half largely was that basically just identify all the age inventory that had been sitting and not turning and just take aggressive action to exit it from the business. We didn't in many cases go back in and replace it with more productive SKUs. We just tried to create better presentation of our most productive SKUs. So what we build is in the process of doing now is identifying what we described as slow turning SKUs and as we stabilize e-commerce, what really efficient retailers are doing, they're taking the slow moving SKUs off the shelf in their brick and mortar location and putting it online, and these will have it and the handful of powerful fulfillment centers didn't have it in 1700 stores. So that work is just beginning for us.

But as we take a lot of inventory and as I said in my prepared comments we made a strategic decision to invest. If you take a look back at Lowe's historically, Lowe's had wanted to ever since our acquisitions of any major retailer and to be quite candid, it was actually worse than what we anticipated when we started to take actions to get in-stock. So as we think about kind of the timeframe around kind of getting our inventory to more what I'll describe as rebalanced, we're going to have some supply chain initiatives that are going to be happening right now. I've mentioned predictable delivery. That's really important for us because we're so out of stock and our delivery and supply chain process were so inefficient that we had excessive amounts of safety stock in stores just to compensate for late and slow deliveries. Now that our supply chain has become much more efficient, this more predictable delivery will allow us to reduce safety stocks. So we'll have more frequent flow of products. That doesn't sound like a big deal, but in our environment it's going to be a big deal and that's going to be one of the most significant initiatives that we're going to take to get our inventory rebalanced.

We think this is going to be a multi-quarter initiative, we'll be updating externally more at the end of this quarter, but we're going to see how our process goes this quarter. Again, we'll have a better perspective on when we think we'll be in a position that will be most comfortable. And the only caveat to that would be we are committed to staying in stock, we're committed to driving sales and we're committed to protecting margin. So we're not going to swing this pendulum from one digit to the other, and so it's all about finding balance. But we feel comfortable that the quality of our inventory is really good, we have a small amount of seasonal inventory. So we don't have risk of taking excessive markdowns. So we feel like we have time on our side to get us in order.

William P. Boltz -- Executive Vice President, Merchandising

One other thing I would add that the merchant teams now getting their feet on the ground as they've all come together. Along with our planning replenishment teams on the supply chain side SKU rationalization, is an ongoing effort right, it goes on all the time. So that's part of the rhythm of what they do, always looking at making sure you've got the most productive stuff inside the store.

Zach Fadem -- Wells Fargo -- Analsyt

Got it. Appreciate the time.

Marvin R. Ellison -- President, Chief Executive Officer and Director

Okay, thank you.

Operator

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

Michael Lasser -- UBS -- Analyst

Good morning. Thanks a lot from taking my question. It seems like you went to a deeper level of promotion on the Paint category than the industry has seen in the past. So how does that inform your view on what you might do in other categories? Would you try the same strategy in other products?

Marvin R. Ellison -- President, Chief Executive Officer and Director

No Micheal, it's a fair question. So let me, let me just kind of take a step back and just give you kind of a broad view of the strategic approach that we were taking. One of the first observations that Bill made to me upon arriving is that we have too many category wide promotional events, and so it is our intent and expectation that we will become less promotional not more promotional. What we're trying to do with our promotions is to be more strategic and make them more event base, [indecipherable] that's something we're going to slowly line ourselves out of and be more event based.

Having said that, we're going to strategically choose categories that we believe our product starters, project starters and they drive traffic. But when we lean in to something like they we're going to be pulling back from other areas, so the net effect will be less promotions but more effective promotions and so new paint was the first attempt at that. We are very pleased with the results. Obviously for competitive purposes, we are not going to telegraph what our next strategic move will be, but philosophically I think the message is we're going to lean into certain categories that we think provides a broader strategic gain, will pull back the models and we're going to be more SKU focused on promotions than overall category.

And that's going to allow us to drive price perception to drive value perception would do it while protecting margin more effectively and Bill I don't know if you have anything to add to that.

William P. Boltz -- Executive Vice President, Merchandising

No, I think just it was also an area where we looked at a lot of disruption a year ago when we came in and we have struggled really through the balance of the second half of last year to try to get paint stabilized. So really 2019 gave us an opportunity to try to do something different and that was an opportunity that we had to be able to mix it up a little bit.

Michael Lasser -- UBS -- Analyst

And I have one follow-up and two parts on that. So if you're going to pursue a similar strategy in other categories. Do you see the risk or is there a risk of potential ripple effects across the industry as others might be forced to follow suit. And then as part of that are you using some of the pricing actions that you're taking as you described in the first quarter to use that as a source of funding to go out and make some of these investments in promotional activities within certain categories. Thank you so much.

Marvin R. Ellison -- President, Chief Executive Officer and Director

Yeah, Mike, we think, again, the net effect is going to be fewer promotions and more targeted promotions. So we don't see this as a risk. I mean, as a matter of fact, we see it as a benefit because it's going to create an even more rational promotional atmosphere than what we have right now. And we think we have a relatively rational sector from a promotion standpoint. We're in the process of redefining how we go to market. Anytime you have lost a market share and lost relevance over a 5 year to 7 year period like Lowe's had done prior to 2019, you can't just run the same play over and over again and expect that you're going to get a different result. And so, we believe, one of the reasons why in Q1 and Q2, we've grown sales and taken share is because we've taken a more strategic approach to how we go to market.

Having said that, we have no intentions on being more promotional, we have no intentions on doing anything that's going to ratchet up the promotional environment. This is an environment that competitors do special buys, all the time and a special buy not really described as a promotion is described as taking advantage of a specific category during a specific event period. So you'll see us do a lot of those different things, but we have no intention of being more promotional. We will be less promotional, less or low with a lot more strategic.

Michael Lasser -- UBS -- Analyst

Thank you.

Operator

Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli -- RBC Capital Markets -- Analyst

Good morning, guys, thanks for the time. Do you guys have any -- we talked about supply chain and inventory and some of the changes happening there, Marvin. Are there any examples of categories where you've been able to pull back on the amount of inventory in the category without it actually adversely impacting your comp growth?

Marvin R. Ellison -- President and Chief Executive Officer

Well Scot, I would say that we try to test and learn in everything that we do. And so I would say that from this whole predictable delivery process that we're rolling out, part of that has been in cooperations with the stores and with supply chain. So because of that we have taken a few items, we are not, for comparative purpose, we are not going to kind of lay everything out there, but short answer is yes, we have and as we roll predictable delivery out to the entire company, we are evaluating safety stock levels by SKU by store. So that we can understand what level of safety stock will be required for us to maintain the proper in-stock position, the proper presentation minimum, while driving sales and then that ties to the frequency required from the supply chain. So it was all predictable delivery model in large part driven by test with the operations team on how effective we can do this while still hitting our financial targets.

Scot Ciccarelli -- RBC Capital Markets -- Analyst

And just to clarify, I mean you've made some, let's call it adverse comments previously on some of the legacy systems that the current team kind of inherited. Do you have the analytics in-house to be able to make sure you're not adversely impacting your comp growth when you make some of those inventory changes on the delivery side?

Marvin R. Ellison -- President and Chief Executive Officer

Yeah, yeah, that's what -- testing and learning, Scot, is the way you do it. I mean, and that's just really the environment we put in place. We're not going to roll anything out chain wide, and we're not going to test that first. So the short answer is, we have the analytics, we have the process design and anytime when we roll something chain wide, you can be assured that we are pretty confident of what the outcome is going to be.

Scot Ciccarelli -- RBC Capital Markets -- Analyst

Got it. Thanks a lot guys.

Operator

Your next question comes from the line of Laura Champine with Loop Capital.

Laura Champine -- Loop Capital -- Analyst

Thanks for taking my question. I'm just wondering if you can help quantify all the comments that you've made on your inventory management and the changes you expect to make? So by the end of this year, would we still be likely to see inventories up, call it high single digits or because you need to reset levels to keep your in-stocks in good shape? Or should we start to see inventories growing in line with sales growth?

David Denton -- Chief Financial Officer, Executive Vice President

This is Dave. I don't think you're going to see much movement in inventory levels this year. I do think we'll, as we indicated earlier, we're going to strategically rationalize inventory in certain areas, but this is probably a multi-year journey, as we make sure that we have the right analytics in place, we have the right supply chain in place, and we've really thought through by category, what's the right assortment. And that's a multiple quarter or multiple year journey to get us back to that. I'll say that's the optimal level of inventory.

Marvin R. Ellison -- President, Chief Executive Officer and Director

The only thing I'll add to that is to reinforce the point that I've made a couple of times this morning. We have very minimal seasonal inventory, so we don't have markdown risk of excessive inventory that we just have to work out of the system in a certain timeframe. The good news about the home improvement sector is when you load in job lot quantities and in Pro-related categories, these are year-around SKUs, and when you look at presentation minimums, if you're doing it on core SKUs, you have a limited markdown risk.

Having said that, we're still going to be working quarter-over-quarter to make sure that we are getting our inventory more in line with our rate of sales. We will learn a lot in the next two quarters and we'll have a much more efficient and clear point of view as we head into 2020.

David M. Denton -- Executive Vice President and Chief Financial Officer

And I think also as Marvin and I said, listen, it's really important, we're going to be focused on our in-stock levels, we're going to make sure that we're supporting our sales plan and we're going to be supporting our margin plan. So we have all three of those kind of working in tandem and we don't want to harm our business, we got to make it more efficient over time. But right now those things are -- those three elements are pretty important to us.

Laura Champine -- Loop Capital -- Analyst

Understood. Thank you.

David M. Denton -- Executive Vice President and Chief Financial Officer

You're welcome.

Operator

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

Brian Nagel -- Oppenheimer -- Analyst

Hi, good morning. Thank you for taking my questions. Nice quarter.

Marvin R. Ellison -- President, Chief Executive Officer and Director

Thanks, Brian.

Brian Nagel -- Oppenheimer -- Analyst

So the first question, I just want to, I guess, bigger picture on the Pro, you've guess, you've discussed success you're having lately with the Pro. We talked a lot here about better in-stocks which is obviously an effort that would help both Pro as well as DIY. Marvin as you look out, you may be further and to continue to really better serve this professional customer what are some of the next initiatives we should be thinking about that that Lowe's undertake.

Marvin R. Ellison -- President and Chief Executive Officer

Hey, Brian. It's a good question. I'll take the first part and I'll hand it off to Joe who spent quite a bit of time on this. So let me first take a step back and give a more strategic overview of why Pro is important. I think one of the strategic missteps over the last seven years here is not really understanding what the Pro customer does to the overall productivity of the business. I mean our stores operate with a -- in some cases, fixed expenses and variable expenses and so, as you drive more productivity through those boxes, it just creates and unlocks a lot of value. And so as we lean in the Pro, our strategic rationale for this was how you take a box that has a certain amount of expenses allocated to it and exponentially increased volume, which makes it more productive and so we're pretty confident that our sales momentum over the last two quarters, our improvement in transactions in our Pro improvement in sales per square foot in large part is driven by Pro. So the strategic rationale for Pro is traffic, transaction, sales per square foot productivity and just unlikely more value in every location. And so based on that, I mean, we're committed to it, I'll let Joe kind of provide kind of some what's on the horizon that we think will allow us to continue to build on this very important customer.

Joseph Michael McFarland -- Executive Vice President, Stores

I would, Brian. Thanks for the question. So the first phase of our journey to win the Pro business, we're setting up the proper retail fundamentals which we've been discussing and we largely feel we're completed with that in the first half of the year. As we look out in our Pro roadmap, we have a lot of initiatives coming, when we think about having that foundation in place, we can now lean into better Pro marketing, focus on things like customer acquisition, driving awareness and it was different at Lowe's, the future focus, key segments, national accounts, our outside sales team, integration of MSH, a better job site delivery. We have a laundry list of improvements that will continue to make for the Pro customer. And we're very, very encouraged by what we're seeing across the total store from a Pro standpoint.

Brian Nagel -- Oppenheimer -- Analyst

That's helpful. Thank you. Then my follow-up question, shifting gears a bit. I just wanted to discuss again gross margin and maybe more for -- I guess for Dave. But Q1, you have the inventory, the systems type issue. You articulated clearly that you isolated that impact on your gross margin. So what I'm wondering is what was that in Q2? And how should we think about that specific impact as it mitigates through the back half of '19? And the second of that, it seems just looking at your results today. It seems though you're correcting those problems that have emerged in Q1 quicker than you initially expected. So, A, is that fair and then B, why is that happening?

David M. Denton -- Executive Vice President and Chief Financial Officer

Yeah. So listen, I think we have a fairly comprehensive plan to improve our margin performance in, I would say that if I just kind of tick down some of the things that we've done, you can get a sense for the progress we're making. But first and foremost, we kind of really did an evaluation our price complement across the categories, we've adjusted price. At the same time we've gone through and enhanced our point-of-sale system such that we're eliminating unnecessarily -- unnecessary discounting that is kind of, I'll say meeking at point of sale. As the team spoke many times throughout this morning, we really leaned in to kind of more targeted, efficient promotions and as you can imagine even coming out of Q1, we couldn't touch all the promotions earlier in the quarter, they were kind of already locked and loaded. So the changes that we made to adjust the promotional calendar largely happened in the back half of the quarter given the lean time.

And then finally, we're working with our vendors and making sure that we're managing cost and making sure that we're getting the right support for all the efforts that we're doing within our stores. That's probably the long pole in the tent to get done for the balance of the year. All of those factors are things that we're managing through the balance of the year, clearly when you change price is the quickest to respond from a P&L perspective.

So I think what you've seen is that the effect of that happen more rapidly in Q2, we're going to probably lean more aggressively on some of the other actions to improve our performance in the back half of this year. So that's what you're going to see that progression in both in Q3 and Q4 as we cycle into back half.

Marvin R. Ellison -- President, Chief Executive Officer and Director

And Brian, this is Marvin, the only additional comments. I mean we, there was a lot of work and I just have a ton of admiration for the merchant team financing, store operations team that really worked very hard to accelerate the recovery, but as I outlined in my prepared comments, I mean we have two initiatives coming for over the next 12 months that are going to be critically important. The rollout of our price management system in Q4, it's going to be just critically important for us to just get to competitive parity and then as we integrate this Retail Analytics platform from Boomerang it's going to really take us from trailing almost every major retailer to be at a best in class level on pricing analytics and I think you are aware that one of the most significant levers that any retail our size has is disposal around margin improvement is strategic pricing actions.

And we learn a lot of our strategic pricing in Q2 and we did it kind of the hard way and as our systems continue to get better, it's going to make this a lot more agile and so we have a lot of confidence in the future that we can continue to drive more sequential margin improvement from Q1. And you just continue to get this whole platform stabilize.

Brian Nagel -- Oppenheimer -- Analyst

Great. Well congrats on that.

David M. Denton -- Executive Vice President and Chief Financial Officer

Thank you. We're going to take one more question, please.

Operator

Our final question will come from the line of Eric Bosshard with Cleveland Research.

Eric Bosshard -- Cleveland Research -- Analyst

Thank you. Two things, first of all, the follow-on within gross margin. Dave, I'm curious what we should be expecting in the back half for gross margin, obviously 2Q was notably better than you had thought. Is that progress sustainable? Excluding the impact of the markdowns in 3Q, can we get all the way back to flat gross margin on a comparable basis in 3Q? How should we be thinking about that?

David M. Denton -- Executive Vice President and Chief Financial Officer

Yeah, I think you should expect a sequential improvement in the second half, jumping off of where we are in Q2. I don't think you're going to have a full recovery by the balance -- by the end of the year. Just I think mathematically that's tough to deliver at this point.

Eric Bosshard -- Cleveland Research -- Analyst

Okay. And then secondly, the step down in online. I assume it's more precipitous than you had expected, but if you could characterize that and then also characterize the pace and timing of the road back in growing the online piece of the business?

Marvin R. Ellison -- President, Chief Executive Officer and Director

Yeah, Eric. So I think when we look at online, it was definitely a below our plan, but as I mentioned, we made a strategic decision that we were going to slow it down primarily by not adding additional SKUs, but there is a broader pointed out, I'd like for everyone to consider. So, we delivered a 3.2% comparative sales in the US with 4% online growth. And so, to me that just screams upside opportunity because we know how to fix an online business. We've hired a outstanding President of Online, Mike Amend and Seemantini, our CIO has a depth of online experience from her time at Target.

So we have the right people in position to get this fixed and we have a very detailed transformation plan. So although we are disappointed with the results. It was part of a strategic decision to slow down short-term to make sure that we could get some issues corrected. We had just some fundamental process issue, if you added a new SKU online every store has to go through a manual process as though that SKU is being added to the shelf. And that was a priority project for every store, because of, they didn't flag it in the store, print a label and go through the same manual processes, though they were little added into the shelf you couldn't add it online.

As rudimentary as that sounds that was the process and we were able to get that fixed in the early part of Q3. And there were other just really prehistoric processes like that that really hindered our ability to add additional SKUs, and so the way we look at online is that we think for the balance of this year, we're going to have modest growth, but we're going to be working very aggressively on replatforming to Google Cloud and a lot of other foundational functionality to -- search checkout navigation, etc. And then we believe as we get into 2020 you're going to start to see this business began to grow at the rate that we expected to and we see nothing, but upside potential. Just as a reminder, online is, give or take 5% of our total sales and it grew at 4% and we still delivered 3.2% comp. So what we know that we have upside potential for the business by getting our arms around this business and we have the people that can do it.

William P. Boltz -- Executive Vice President, Merchandising

And Eric the only thing, this is Bill, the only thing I would add to Marvin's comments is that we're just in the early stages of getting the online merchants integrated with the core merchants. And so as that starts to gain traction and we get some of these legacy systems issues fixed, then the acceleration in the SKU, in the SKU expansion certainly starts to happen and we start to be able to really gain some traction on the online space. So there's a lot of good things in front of us for dot-com.

Eric Bosshard -- Cleveland Research -- Analyst

Okay, thank you.

Marvin R. Ellison -- President, Chief Executive Officer and Director

Thank you.

Operator

I will now turn the conference back over for any closing remarks.

Marvin R. Ellison -- President, Chief Executive Officer and Director

No. Well, thank you for your interest in Lowe's. We look forward to updating you on our next quarterly earnings call.

Operator

[Operator Closing Remarks]

Duration: 66 minutes

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