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Lowe's Companies, Inc. (LOW)

December 05, 2012 10:00 am ET

Executives

Tiffany Mason

Robert A. Niblock - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Gregory M. Bridgeford - Chief Customer Officer

Rick D. Damron - Chief Operating Officer

Robert F. Hull - Chief Financial Officer and Executive Vice President

Analysts

Michael Baker - Deutsche Bank AG, Research Division

Michael Lasser - UBS Investment Bank, Research Division

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Gregory S. Melich - ISI Group Inc., Research Division

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Eric Bosshard - Cleveland Research Company

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

David S. Strasser - Janney Montgomery Scott LLC, Research Division

Wayne L. Hood - BMO Capital Markets U.S.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Zahid Siddique - Gabelli & Company, Inc.

Operator

Please welcome, Vice President of Investor Relations, Tiffany Mason.

Tiffany Mason

Welcome to the Lowe's 2012 Analyst and Investor Conference, and welcome, to those of you listening on the web. Before we begin, please note that throughout this presentation, you will hear comments about our expectations and beliefs which constitute forward-looking statements. Although we believe we have a reasonable basis for making each of them, we can give no assurance that those forward-looking statements will prove to be correct. They are subject to a variety of risks and uncertainties that are highlighted on this slide, shown both here and on the web, and are further described in the company's annual report on Form 10-K and in its other periodic filings with the SEC. Also in today's presentation, we will be using several non-GAAP financial measures when discussing our performance and financial condition. You can find the presentation of the most directly comparable GAAP financial measures and a reconciliation of the difference between the 2 posted on our Investor Relations website, and for those of you attending in person, in the appendix of the booklets you received. You will also find in both places an explanation of why Lowe's management believes these non-GAAP financial measures are useful.

Today's program includes 2 presentations, followed by a short break, then Bob Hull's financial update and an extended Q&A session with all presenters. Thank you again for your attendance, and with that, I'd like to introduce Robert Niblock. Robert?

Robert A. Niblock

Thanks, Tiffany. Good morning, everyone. I appreciate you making the effort to join us here today. As we look at the home improvement industry, we know that consumers' affinity for their homes remains strong even as we emerge from the worst housing downturn since the Great Depression. As a result, we focused on transforming Lowe's to be the first choice in home improvement by providing better experiences through associates who serve customers face-to-face, on the phone, with our mobile apps and through Lowes.com; through localized products and services at competitive prices; and through the technologies and skills we're building to make it easier for customers to realize their home improvement goals.

We also expect to generate compelling returns for shareholders as we continue to align our people, processes and financial resources behind this vision. Our strong financial position and cash flow afford us the opportunity to: first, make strategic investments in our core business and in other opportunities to serve developing home improvement market; second, to pay dividends; and third, to repurchase shares. Today, we will provide more specifics about how we will prudently invest in our business and return capital to shareholders.

I'd like to begin by addressing how we're transforming our U.S. business to drive long-term sales growth, increased profitability and enhance shareholder returns. Our research shows that almost 2/3 of home improvement consumers cross-shop, and lack of differentiation is the culprit. There's a real opportunity to create a more differentiated brand experience and drive greater customer loyalty. In order to do that, we've chosen to focus on delivering better experiences by pulling together the best combination of possibilities, support and value. These experiences must be relevant and personal to create loyal Lowe's customers for life. In the complex world of home improvement, these experiences must also be simple and they must be seamless across selling channels because that's what customers demand. Better experiences will improve close rate and drive greater customer loyalty.

Our focus on delivering better experiences starts with the consumer mindset we call the creator. Customers with this mindset represent approximately 70% of U.S. home improvement spend. Creators are curious, thoughtful and aspirational. They seek new ideas and view home improvement as a lifelong journey, one that provides emotional return. They also want quality, tailored experiences and are highly influential within their peer group. At first, these customers mainly know that they want to change something about their home, perhaps a room, their home's exterior or their yard. They're looking for assistance, recommendations and solutions which provides us with an opportunity to engage them across all 7 stages of home improvement.

With the breadth of the products and services we offer and the support of our distribution and technology platforms, we have a unique opportunity to make home improvement simpler, and to seamlessly meet customers across channels. When done well, we should also unlock consumer demand that has been contained by either real or perceived barriers to starting projects. Even as we redefine our business to become more seamless and simple, we must also protect retail relevance, keeping what customers love about us and constantly improving our retail operations. We believe we can improve our performance by offering more intuitive-line design to simplify the customer's decision by having the right items available in sufficient quantities, priced competitively and displayed in an inspiring manner, and by equipping our associates with the tools and skills necessary to instill confidence and close sale.

Change is never easy, and our transformation has many facets. Today, we will discuss what we've accomplished to protect retail relevance. Likewise, we will share how we've taken steps to simplify home improvement and build the foundation to make further improvement, such as creating seamless customer interactions across channels and allowing customers to take greater control of their home improvement experiences. I will provide a broad overview, then Greg Bridgeford and Rick Damron will go into greater depth on these initiatives. Bob Hull will provide further financial perspective, addressing our strong capital structure, long-term financial objectives and how our focus areas support them.

As you know, our transformation is a multiyear journey. In 2011, we focused on upgrading the information technology within our stores. Store-based investments included expanding the data pipeline into our stores to facilitate transmitting data-rich content like pictures of a customer's room, installing WiFi to enhance customers' and associates' ability to access data and providing iPhone technology to our associates to enhance their ability to serve customers. We also began installing the foundational elements to allow customers to shop with us anytime and anywhere. That can mean shopping at a store or with a mobile device, then having the product shipped directly to the customer's home or to a store for pickup. Or it could mean visiting a customer at home or at a jobsite equipped with the tools to generate a quote and close the sale all in one visit. We are currently focused on 2 areas to protect retail relevance: Value Improvement and Product Differentiation. In 2013, we expect to finish the line reviews and product resets that make value improvement a reality for customers and to incorporate Product Differentiation resets into our base business. The process and systems we've put in place will help us better maintain and improve our product line, in-stock levels and store presentation.

In 2013 and beyond, we expect to improve our associates' ability to sell seamlessly across channels, introduce improved project management tools that expand fulfillment capabilities to cultivate personal and simple connections with customers. Naturally, as we transform the business model to better serve customers, our organization has to adapt accordingly. Through the years, we built a corporate infrastructure to support a single channel business that was opening over 100 stores per year. Today, we're growing differently and our seamless omni-channel strategies require a different infrastructure. We are transforming the way we plan and execute by redesigning processes to improve efficiency, clarify decision right and ensure that we have the right people in the right roles. We recognize that to deliver seamless and simple customer experiences, we must operate seamlessly by optimizing across channel. The first step in this effort was the creation of Greg and Rick's positions, Chief Customer Officer and Chief Operating Officer, and the alignment of functional heads within their respective organizations. The customer experience organization will create experiences that will best serve customers across selling channels, differentiating Lowe's from its competitors with a particular focus on incorporating customer insight into the design of a profitable business model. The operations organization will deliver the customer experience with a particular focus on efficiency and productivity.

Now, while the 2 organizations have distinct responsibilities, neither can act on its own. There's one plan and one method of operating with intense collaboration. Yet the clear delineation of roles and decision-making authority ensures clear accountability for designing and executing profitable customer experiences, and we are holding every leader accountable for achieving their commitment. Greg and Rick will elaborate further on this structure and how it is designed to create better customer experiences and make our operations more efficient. While customers increasingly expect us to offer products and services through alternative channels, we know the physical store continues to play the primary role in serving customer. There will always be an opportunity to fulfill everyday maintenance and emergency product needs or to inspire an impulse project. The store will also continue to play a critical role in connecting customers with knowledgeable sales associates across all stages of home improvement. In fact, our store size gives us flexibility to be more creative in displaying merchandise and to develop new ways to interact with customers. More importantly, we believe that our ability to sell products from a store, on Lowes.com, at the customer's home or place of business, or through our contact center is a distinct advantage over single channel players because it allows customers to engage with us on their terms whenever and wherever they choose.

We expect to increase sales and improve profitability as a result of the initiatives we've undertaken. And although we spent most of our time today discussing the things we can control, we are encouraged by recent trends and new and existing home sales and appreciation in home prices. However, stagnant employment, low income growth and the looming fiscal cliff remain as headwinds. And therefore, our outlook assumes modest growth in the home improvement market. Even so, we can quickly scale our processes to meet a more robust turn in demand if one should occur. Bob will discuss the macroeconomic factors affecting our outlook in more detail.

Looking beyond the U.S. home improvement business, we continue to evaluate opportunities in new and existing international markets. While we believe we can tailor our stores and offerings, we know we must take a prudent approach to entering new markets, carefully studying the regulatory risks, their cultures, and historical and forecasted home improvement opportunity. That said, I'd like to address a few specific markets.

First, Canada. Although Canada remains a very competitive 3-way market, we see opportunity, particularly with consolidation taking place across a broader marketplace. Canada is a large and stable home improvement market, estimated at approximately $40 billion, and we believe there is significant opportunity for growth. We like the market homeownership rate of approximately 70% and its well-developed distribution infrastructure, and our goal is to grow to a #1 or #2 position in total revenue in order to better leverage fixed cost of management, information systems and distribution. While we withdrew our proposal to acquire RONA, we believe there are other ways to obtain scale in Canada, including opening additional big box stores, the introduction of alternative formats and the acquisition of other companies, and we are evaluating all of these options. We expect to have 34 stores in Canada by the end of the fiscal year and believe there's an opportunity for at least 100 stores of varying sizes and formats.

In addition, in October, we launched a fully transactional website, Lowes.ca, with unrivaled functionality in the Canadian home improvement market. Customers across Canada now have access to over 30,000 products online and can choose between home delivery and in-store pickup.

Moving on to Mexico. We remain positive about our growth opportunities in this market that is estimated to be $25 billion, particularly in light of projected increases in both disposable income and new housing and a homeownership rate that exceeds 70%. We've gained significant market knowledge from our existing stores. We've adjusted our assortment, and we like the results we're seeing. Going forward, we will continue to adjust our assortment and develop new prototypes as we gain more experience with the Mexican home improvement market. We have 5 stores open in Mexico and believe there are a significant opportunities for expansion through various store sizes and formats.

Finally, we have a 1/3 stake in our Australian home-improvement joint venture with Woolworths. Our partnership allowed us to quickly learn this $40 billion market and to help the JV develop a well-tuned offering for stores branded as Masters. Since the first store opened just 14 months ago, Masters has grown to a chain of 23 stores in 5 states in the Australian capital territory, and we are pleased with their performance. Another 12 are under construction and there are over 100 approved sites in the pipeline. We believe there is an opportunity for as many as 150 Masters stores in Australia where homeownership rates have historically been around 70%. In all these markets and any other international market we might pursue, we take a long-term view to obtaining adequate returns. And with Doug Robinson's team in place to focus solely on international, we believe we have the right structure to efficiently manage our international operations, while Greg and Rick's teams focus on the U.S. market.

Before I turn it over to Greg and Rick, I'd like to share why I'm enthusiastic about Lowe's long-term prospect. Our business is sound and our brand is strong. We're the second largest player in the home improvement market, which provides tremendous buying power in economies of scale. Additionally, we are generating solid cash flows even as the economy emerges from the worst housing downturn in generations. We will use that cash flow to first make strategic investments in our core business and in other opportunities that draw on our ability to serve developing home-improvement markets; second, to pay dividends; and third, to repurchase shares.

Thank you for your time and attention. And now, please welcome, Greg Bridgeford.

Gregory M. Bridgeford

Thanks, Robert, and good morning. As Robert mentioned, we're coming to the end of the second year of a multiyear plan, a plan that will allow us to deliver on our vision; to provide the best combination of possibility, support and value; to make Lowe's the first choice in home improvement. We're excited about this journey, and we're pleased with our progress to date. Rick and I are going to share the stage today as we discuss the plan for U.S. home improvement business. I'll start by providing further insights into our near-term focus areas, and Rick will address a few opportunities that we have in 2013, as well as discuss opportunities that will bring delight beyond 2013.

Lowe's past success was the result of great face-to-face customer service, compelling products and value, and attractive and welcoming store environment, all done cost efficiently and effectively. These remain at the core of our culture. They continue to define Lowe's brand, which is why we must protect these qualities while we seek a new point of differentiation in the home improvement space. In 2012, we focused -- we are focused our attention on protecting retail relevance, building on our core strength. And those of you following our transformation are no doubt familiar with our Value Improvement and Product Differentiation focus areas. Let's talk about each of these specifically.

In a world of price transparency, we must more than ever ensure that we are priced competitively. But we must also recognize and are focused on the fact that consumers define value as "competitive price plus something more." Research in late 2010 and early 2011 suggested that the negative trend was emerging between Lowe's and our primary competitor with regard to price attributes, attributes such as: offers competitive prices, consistently offers lowest prices and provides good value for the money. As a result, we undertook a body of work to identify if retail prices needed adjusting or if the negative trend was more a function of perception. The only working hypothesis was that in the value equation of "competitive price plus something more," price was the most critical factor. As a result, we took some retail price action in late 2011 and cleaned up our price image in the stores. A year later, that same research suggests that we made good progress relative to big-box competitors on the price attributes that drove the initial body of work. We will continually, through the normal course of business, evaluate retail prices and make adjustments as necessary.

Further research in early 2012 suggests that customer advocacy and loyalty are primarily created not by price alone, but also by delivering on key promise drivers. In other words, key promise drivers that are the "something more" in the value equation. We've identified the key promise drivers as: A merchandising presentation that is simple to navigate; quality products, meaning having an availability, meaning having the right product at the right quantity at the right place at the right time. And we spent some time at last year's Analyst and Investor Conference discussing our target customer, the creator. This same research suggests that 80% of creator customers are searching for a retailer that delivers on those promised drivers. In other words, price may be the ante for consideration, but advocacy and loyalty are built by the promise drivers. We've taken this research very seriously as we strive to build on our core strengths, to hone our value proposition, which brings us to the first focus area, Value Improvement.

Value Improvement enhances our ability to offer compelling products and value. Let's talk about the process we're using to address this opportunity. Using consumer insight, as well as product and market analytics, each merchandise category team identifies the product attributes that are most important to customers in each location. Then the team uses a suite of tools we developed over the past several years, integrated planning and execution, to logically create clusters of stores. For each of our nearly 400 product lines, stores are grouped into an average of 4 customers based on differences in customer buying preferences. This information enhances the assortment strategy that guides the work of each line review process. For each cluster the lines are designed to improve the shopping experience by reducing duplication of features and functions within price point, which often means more specifically aligning brands with price points. The teams ensure that the project completers and important maintenance items are not eliminated in this process. Now as SKUs are rationalized, the teams are reinvesting inventory dollars into greater depth of high-volume SKUs. The result is a plan that includes more facings for SKU, localized assortment and simpler price point progressions. Remember, we're drilling in on those promise drivers that the creator customers are searching for. We then share the assortment strategy and corresponding customer insights with vendors who have been chosen to participate in the line review process. Vendors are expected to provide their ideas, as well as identify any new or innovative products that can enhance the product line. They are also asked to come to the table with their best, overall cost the first time that they quote us. This requires that we isolate and remove the added costs of doing business with Lowe's. For example, markdown coverage, promotional reimbursement, funds associated with reset and product support material. We are simplifying our deal structures to allow us to centrally allocate funds to optimize total company result. Promotions are a great example. We must allocate promotional dollars to categories with the greatest opportunity to drive incremental unit or better attachments versus allocating those funds product by product without regard to their role in the overall portfolio.

Simplifying deal structures also eliminates some of our program administration costs. And once we secure the best product cost, we know we can be priced right and ensure a fair margin. This vendor negotiation phase takes about 8 weeks on average. Once vendors have been selected and the line designs are final, plans are made to reset the stores. The teams exit discontinued inventory in the most margin-efficient manner possible by employing markdown optimization, working carefully to ensure we're not out of stock on the discontinued items before the new inventory arrives. Smooth transaction is critical to maximize profitability and to minimize disruption. This part of the process takes on average approximately 120 days. Now, keep in mind that the financial benefit of Value Improvement is greatest once we are past clearance and begun selling only new assortment products. Overall, the process has firm targets for inventory dollar reduction and lower first cost, as well as an expectation that with more space and greater depth of high velocity items, employee down-stocking and restocking time will be reduced. These actions are expected to translate into improved comps and gross margin performance, as well as better inventory productivity. But the true measure of success is customer advocacy and loyalty.

Well, progress to date has been solid. We expect to complete approximately 90 reviews -- complete reviews representing approximately 90% of our business by the end of this fiscal year, and we're exceeding our inventory reduction, we're making further progress to our cost reduction goal. We also expect to reset 40% to 50% of our business by the end of the fiscal year and substantially all by mid-2013. The resets are peaking now, and we've been pleased with our ability to mitigate disruption by increasingly efficient execution of these resets. Our team of in-house product service associates has reset products during nonpeak hours and the cross functional Value Improvement team has used our markdown optimization tool to minimize the margin dollar impact from clearing discontinued inventory. In fact, despite an increase of 80% in clearance sales in the third quarter, the clearance impact, in terms of overall gross margin rate is roughly the same as last year.

For product lines that are past the reset and clearance process, we've estimated we've obtained an average mid-single-digit comp sales lift and nearly a full percentage point improvement in gross margin rate, while also reducing inventory. and our customer surveys indicate that perception of our product availability is improved over last year. For those of you participating in the store tour this afternoon, we're going to showcase 2 particular resets. First, paint will bring this effort to light in a traffic driving category, then ceramic tile, a project category.

Value Improvement is the most significant body of work that we have in place today, significant in terms of organizational capacity and significant in terms of expected benefit. The organization is fully committed to this effort, and we are pleased with the progress to date. We've created a repeatable process and believe that we'll get better and better at this and in our further opportunities as this is operationalized. There's also an opportunity to begin communicating these changes to consumers to aid their awareness of the full value story, and we'll start testing consumer messaging in the first half of 2013. That way, we'll have a solid plan in place once the majority of the stores have been reset by midyear. We've shown restraint in this regard because we understand that the timing and staging of this message is crucial.

Now, our research shows that today, almost 2/3 of home improvement customers cross-shop, and lack of differentiation is the culprit. There's a real opportunity to create a more differentiated brand experience and earn greater customer loyalty. We've chosen to focus on delivering better customer experiences rather than differentiating on price or product alone. We've created a multiyear plan with that goal in mind. However, this is a journey, and one important step in the right direction is to drive more excitement back into the shopping experience. We've always taken pride in our attractive and welcoming store environment. However, we've been underutilizing our end caps, the most valuable real estate in the store. In fact, we've been using our end caps as wrap set, wrapping in line products from the aisle around and onto the end caps. These are mostly static displays, displays and presentations, and those that were changed from time to time for seasonal products were executed according to the same calendar across the chain rather than by temperate zones. We've lost -- but we had lost the balance between merchandising flare and operational efficiency.

So again, building on our core strengths, we introduced a focus area that we call Product Differentiation. We revised many of our end cap locations. The average store has about 60 that highlight innovative new products, significant values or showcase particular private or national brands. We've also revamped the promotional spaces or drop zones, as we call them, to better promote seasonally relevant, high-value items to drive sales and to provide more open sightlines to navigate and shop a Lowe's store. To date, we've reset over 1,250 of our stores. We're tracking the lift of the items on the end caps and in the promotional spaces, as well as the lift of the total store. The results of these changes in end cap and promotional spaces continue to improve as we've adjusted the mix of end cap themes, and we've improve the rotation of these products. Now, for those of you participating in the store tour this afternoon, we're going to show you the evolution of this concept over the past year.

We believe there are further opportunities to improve performance through better end cap item selection, increased depth of inventory and better adjacency of end cap items to the associated inline inventory. We're committed to this program. In fact, we'll be operationalizing and rolling into our base business in 2013. In other words, we're actively managing the end caps and drop zones, and that will become a continual part of our business process.

Now, keep in mind that the Value Improvement body of work supports this effort as new or innovative product is identified through the line review process and SKUs are rationalized, free up inventory dollars to increase the depth of inventory. You might think of Value Improvement as the inner circle enhancing the core, and Product Differentiation as the outer circle, providing excitement and flexibility.

Now, please help me welcome my partner in delivering better customer experiences, Rick Damron.

Rick D. Damron

Thanks, Greg, and good morning. Value Improvement and Product Differentiation have been a priority for the organization over the past year, and the initial work continues through mid-2013. Together, they will enable us to compete more effectively in the current macro environment. These focused areas build on Lowe's core strength and are expected to deliver positive comp transaction growth, better gross margins and greater inventory productivity by localizing assortment, driving excitement in our stores through better display techniques and managing an appropriate balance of product costs and retail pricing. They also allow us to protect retail relevance and are very much centered around the getting-supplies stage of home improvement.

Now, let's turn our attention to the pro customer, an important segment of our business. First, it's critical to understand that Value Improvement and Product Differentiation are as important to the pro customer as they are to the DIY customer. Value Improvement allows us to improve job lot quantities in categories such as building materials, rough plumbing, rough electrical, hardware, paint supplies, as well as hand tools and power tools. All categories that are critical to success with pro customer. Product Differentiation allows us to better showcase product. In particular, our Contractor Packs on value end caps and high-quality products that pro customers trust and seek out on our private or national branded end caps. We've also rebranded our commercial business to Pro Services with the goal of reenergizing our focus on the pro customer. New Pro Service employee vests illustrate to the customer that we have a dedicated team that supports their business. This comes 1 year after we introduced the 5% off everyday loyalty program for our pro customers when they use Lowe's proprietary credit products. This program has been very successful with the pro customer. Currently, Pro Services represents roughly 25% of our business and is a segment made up of 2 broad categories: construction trade and maintenance and repair organizations or MRO. Within these 2 broad categories, there are 8 segments. Lowe's has traditionally gone over -- gone after Pro Services segment in each category to some degree, and that strategy has worked to secure solid market-to-market share to date. The segments most loyal to Lowe's are retail maintenance, business maintenance and repair and remodeling companies, which according to our research, also happens to be the segments with a highest sales opportunities for home centers. However, property management companies are an obvious extension with solid opportunity as well, particularly in the current macro environment for homeownership rates are declining and housing starts are being driven more by multifamily construction. As a result of our research, we have chosen a specific focus on the MRO category, further solidifying our relationship with retail and business maintenance companies and targeting property management companies that operate at the local level. They need a neighborhood partner they can rely on, and we can fill that need. We still need to be relevant with the repair remodeler because of the work we're doing with Value Improvement to reinvest in deeper inventory levels. But our strategy and programs will be tailored for our target segments. The MRO is a great focus for Lowe's because these customers visit more frequently and shop more categories across the store, providing a good gross margin mix.

Our research also suggests that we have a substantial opportunity to close more sales with the 15 million customer, both DIY and pro, we interact with each week in our stores. We know that some customers visit our stores for inspiration and are not yet ready to make a purchase decision. However, research indicates that there is a 15 point gap between the percentage of customers that know exactly what they want to purchase when they come to our stores and our current close rate. We analyze our customer data to identify where near-term opportunities lie. What we found is that our traffic and average ticket are dearly consistent throughout the week, but our close rate appears to be significantly strong during the weekend. Over the course of a week, selling hours are 65% of total hours on average. However, Monday through Thursday, these hours are disproportionately skewed toward tasking as we recover from the weekend.

Going forward, we will be adding approximately 150 hours per week to the staffing model for nearly 2/3 of our stores, which will increase their proportion of average selling hours by roughly 200 basis points. We also reevaluated our current in-stock service level targets for inventory. After all, if the majority of customers know exactly what they want to purchase when they come into our stores and we assure that we have adequate staffing, inventory is the next logical opportunity in the near term.

Our Value Improvement focus area is delivering simplified, more localized assortment. And as SKUs are rationalized, the teams are already reinvesting the inventory dollars in greater depth of high-volume SKUs. But that reinvestment decision up to this point has been based on our historic in-stock service level targets. However, there is an opportunity, especially in high-volume SKUs, to raise those targets. Going forward, in certain categories, we are raising our target by approximately 300 basis points. We believe these changes, increased labor hours and higher in-stock service levels will help us further capitalize on the traffic we have in our stores today, resulting in close rate improvement.

One of the main reasons we have confidence in our vision is that we're making the necessary organizational changes to deliver on it. As Robert mentioned, we are transforming the way we go to market by redesigning processes to improve efficiency, clarifying decision right and ensuring that throughout the organization, we have the right people and the right role. Our reporting structure is in place and we're working through the process to merge functions where necessary and eliminate redundant processes. For example, we no longer need separate marketing organizations, one for the stores and one for Lowes.com. While they are different selling channels, the consumer messaging should be consistent and seamless and we are delivering on a first execution theme, protecting retail relevance with the Value Improvement and Product Differentiation focus areas and with our Pro Services effort. In fact, our new organizational design enhance these efforts in the second half of the year because Greg and I set the tone upfront, allowing for better cross-functional collaboration to fine tune the process. We identified the parameters for decision making and the metrics we would be tracking to gauge success. And therefore, we are able to better hold our teams accountable for delivering results, than was the case with a more solid organization. After all, the work we have in flight today is customer-centric. Let me repeat, customer-centric; not merchandising, not operation-centric. So we must work in concert across the organization to achieve results. As we embark on the next phase of our transformation, Greg's organization is responsible for designing customer's experience, and my organization is responsible for reviewing the plans and adjusting operating models or processes as appropriate to ensure the customer experiences can be executed within the cost parameters necessary to achieve the desired business results. Together, Greg and I are ultimately responsible for the performance of the overall U.S. business.

So we have spent a fair amount of time discussing our desire to protect retail relevance. But to deliver seamless, supportive and aspiring experiences wherever and whenever customers choose to engage, we also had to build on the infrastructure to allow access to customer, project and product information at relevant touch points for customers and employees. In 2011, we began launching capabilities, the first building blocks of our longer-term strategy. So let's look at the progress. We deployed 42,000 iPhones across the U.S. which averaged about 25 per location. Associates use the iPhones to perform tasking and selling activity, and new features have been added to provide associates with greater access to assist customers. Additionally, we are piloting mobile point-of-sale with e-receipts. Providing mobile technology and apps to customers and to our associates is an important first step towards simple and seamless experiences and allows us to participate in the evolution of mobile technology. While we're in the early stages of the mobile life cycle, the results are remarkable. In less than 24 months, the consumer-facing mobile properties have grown to represent 20% of overall Lowes.com traffic. We will continue to add capabilities that improve the customer's any time, anywhere experiences and make our associates more productive. We implemented flexible fulfillment last fall which allows us to deliver Lowes.com partial orders from the most efficient location directly to our customers. This means that more items are available for partial shipment than ever before, and we can provide faster delivery. In fact, we now ship from over 50 fulfillment locations around the country, and for most stock items, can satisfy over 90% of the U.S. markets within 24 hours at standard shipping rates.

A year into this new capability, we have more than doubled the number of partial shipments which have contributed Lowes.com sales growth of approximately 60% year-over-year as of the third quarter. The MyLowe's customer base also continues to grow. Since we launched this customer-enabling personalized website in 2011, over 14.5 million cards have been activated and over 4 million cardholders have registered their cards on MyLowe's. We know registered users spend more with Lowe's overall. In fact, they transact more often and the spend per transaction is greater than those not registered. We continue to enhance the capabilities we've already delivered while developing new capability, all with an odd to further increase engagement with customers. Beyond 2013, we will evolve our sales culture across all channels to better understand and serve customers' needs and further leverage our investment in technology. The next phase of our transformation is focused on our associates and their relationship with customers. It is a shift from an order-and-transaction-oriented culture to a project-oriented culture, with a particular focus on lead conversion and average ticket growth. We will build trust by partnering with customers to recommend solutions that fit their needs and help them make the right decisions based on their individual home improvement goals. In fact, we have already kicked off a sales training program for store and contact center employees to further develop our sales culture and pave the way for this next phase of our transformation.

We have isolated 3 distinct customer interactions: customers looking for inspiration, customers with a pre-determined shopping list and customers working on a multistage project. We developed role-playing exercises to build skills and confidence in our associates. It is important that we make each customer interaction unique and create defining moments for each of our customers. Additionally, associates across selling channels will have a singular view of customer interactions and projects. One record per customer from lead capture to project completion as we replace our legacy selling tools. And customers will receive ongoing communications that provide status and visibility throughout their project.

We will also further develop our flexible fulfillment capability by deploying central dispatch and central production offices. The central dispatch office will allow for centralized scheduling of delivery and better route planning, resulting in lower fuel cost, greater fleet utilization and more productive overall delivery. The benefits to the customer emerge through the ability to schedule a delivery appointment online with shorter and more accurate delivery windows and up-to-date status visibility. We are currently testing this concept in 3 markets today, utilizing both Lowe's, as well as third-party fleet. The central production office will provide operational efficiencies through the consolidation of labor. The centralized production management includes products, installers and multistage sequencing. Today, each of -- each store has its own installed sales office. Future state will consolidate that labor into our contact centers, resulting in a reduction of over 3.5 million hours annually.

The customer's experience is enhanced through better coordination and consistency. This concept is tested -- being tested in nearly 200 stores today and is achieving customer satisfaction scores above the company average. Just imagine what we can do with the full solution.

We discussed earlier in our presentation that improving close rate is a near-term opportunity. So the new capabilities that we just introduced and are being developed over the 24 months will drive deeper, more meaningful relationships with customers and should also benefit close rates over the longer term. Including 2012, we expect to improve our close rate by at least 300 basis points by 2015.

Now, please welcome Greg back to the stage.

Gregory M. Bridgeford

Thanks, Rick. Close rate and financial metrics are clearly lagging indicators of progress, so let's discuss some leading indicators that we're tracking to gauge success as we move through our transformation.

There are 2 metrics that we'll highlight today that measure whether we're capturing the hearts, the minds and the trust of customers over our competitors. First, brand strength and stature measures the Lowe's brand on the foundation of retail relevance and the ability to create meaningful brand differentiation. Through consumer surveys, we track these attributes and roll up the brand strength and stature metric, equally weighting retail relevance and brand differentiation. A baseline was developed and we set interim goals to measure our progress. For 2012, the progress we're making is skewed towards retail relevance which is understandable and encouraging, given our near-term focused areas, particularly Value Improvement. Our expectation is that over time, the brand differentiation attribute will become increasingly more significant.

Rick D. Damron

The second metric is social brand advocacy, which measures our ability to create customer experiences that lead to positive word of mouth. More simply said, that lead to customers recommending Lowe's over the competition. The previous metric, brand strength and stature, gives us insight into our customers' opinions of our strength in retail relevance and brand differentiation. This metric, social brand advocacy, goes a step further to help us understand what percentage of our customers actually recommend us to others. For 2012, we're tracking in line with our interim goal. As we continue on this journey to create better experiences, our expectation is that these metrics will provide a more complete understanding of whether we're meeting customer expectations, which will help us make better decisions and will ultimately chip away at the percentage of customers who cross-shop.

Gregory M. Bridgeford

So you've heard us describe how we're improving our business model in the near term as we achieve the benefits from Value Improvement, Product Differentiation, the additional store labor and inventory investments, as well as our Pro Services focus. You've heard about our organizational commitment to deliver better customer experiences today and designing and driving profitable differentiating experiences tomorrow. And you've heard us describe the capabilities in place now that are coming -- and that are coming over the next 24 months that we will use to drive deeper, more meaningful relationships with customers.

Rick D. Damron

In the aggregate, these initiatives are expected to contribute an average of 350 basis points per year to the overall comp sales increase that Bob will discuss shortly. We also expect to drive operating profitability through gross margin improvement and labor productivity. We expect roughly 90 basis points of gross margin expansion through 2015, primarily the result of our Value Improvement focus area as we manage an appropriate balance of product cost and retail process. As discussed, we are making changes to our store staffing model, adding hours in certain locations dedicated to selling Monday through Thursday, somewhat offset by the consolidation of labor by centralizing production management. Those changes, together with the tools and skills necessary to instill confidence in our associates, will allow us to reach sales per hour of $148.

And finally, we expect to improve asset productivity as we're forecasting a 16% improvement in inventory turnover, the result of more localized assortment and better overall in-stock level.

Gregory M. Bridgeford

We are committed to the challenge of executing against the opportunities available in today's market and delivering results that you expect. Delivering these results positions us to design and deliver an array of future experiences that no one else can offer in home improvement. We recognize clearly the trust and responsibility you place in us today and your willingness to believe in a future that will set us apart as we deliver on this vision.

Thank you for your time and attention today, and thank you for your interest in Lowe's.

Operator

We will now take a 15-minute break. Refreshments are available in the lobby.

[Break]

Robert F. Hull

Good morning, everyone. I'm excited about the progress we've made on our journey and the financial results that will benefit from the improved customer experiences at Lowe's, turning brand advocacy and loyalty into shareholder value. We have been transforming our company, but the economy has been transitioning. In my time with you today, I'll share our 2012 outlook. I'll discuss the economic transition and its implications for the home improvement industry and our business, and I'll wrap my comments with our latest thinking on 2015.

Let's get started with our 2012 outlook, which is unchanged from our Q3 earnings release. As a reminder, fiscal 2011 was a 53-week year. For 2012, we estimate total sales will be $50.3 billion or flat to 2011. On a 52 versus 52-week basis, the total sales increase would be 2%, with comp sales expected to increase approximately 1%. For the year, we plan to open 10 stores, which includes 1 relocation. We expect to end 2012 with a total of 1,754 stores in the U.S., Canada and Mexico. EBIT or operating margin should increase approximately 40 basis points over 2011 to 6.9% of sales. Net earnings are expected to be roughly $1.9 billion or 3.8% of sales. This represents an increase of approximately 3% over 2011 and a 7% increase on a 52 versus 52-week basis. This leaves the earnings per share of $1.64, up 14% from 2011. We estimate the 2011's 53rd week helped earnings per share by approximately $0.05. As previously discussed, our guidance is based on GAAP and includes nonoperating charges.

Before moving to my next topic, I want to note that we will provide you with our 2013 outlook on our fourth quarter earnings call in February. Now to our expectations of the economy and the forecasted impacts to our business. As we've said in the past, our business is driven by both income and housing. I'll start with a look at housing. Following the robust growth in housing from 2001 to 2005, we experienced 6 years of declines and instability. In fact, 2012 represents the first year of growth across all of the core housing metrics: housing turnover, single-family starts and median home prices. These recent positive trends are helping consumers regain confidence in both their local housing markets and their home values. Keep in mind that even with expected growth in these core housing metrics, all are still significantly low prerecession levels. For instance, housing turnover, noted in the blue bar -- blue portion of the bar on the chart, is expected to reach 5.5 millions by 2015, but will be some 2 million units below the 2005 peak. By 2015, single-family housing starts, shown in red on the bar, are forecasted to be more than 1 million below the 2005 peak of 1.7 million units. And median home prices, which is shown in the green line, will be about 195,000 in 2015 or $27,000 below the 2006 peak. Even with the housing recovery, consumers are still coping with the remnants of the recession, as mortgage delinquency rates will remain at historic highs. So while we're optimistic about housing recovery, employment and income growth will continue to be sluggish. In the near term, personal consumption expenditures are expected to grow faster than personal income. Consumers will need to prioritize how and where they are spending. Broadening a bit, the lead up to the fiscal cliff and its outcome have the potential to negatively impact both consumer and business spending, which is why we've seen several downward revisions to GDP for 2013.

Many companies are hesitant to commit to big-ticket investments or to add jobs given this uncertainty. So for consumers to have confidence to meaningfully invest in their homes, we need both housing and income working together. To estimate the impact of the housing recovery on our business, we use a combination of consensus estimates and internal data to project that housing should aid comp sales by 50 to 100 basis points per year for 2013 to 2015.

Now let's move on to my next topic, our long-term financial expectations. Before getting into the figures, I want to take a moment to talk about what's changed since last year relative to our 2015 expectations. First, our 2012 performance is coming at the low end of our expected comp range. Last year, we were forecasting 2012 to be in the middle of our 1% to 3% comp range versus our current expectations of closer to 1%. Second, we've tempered our international growth assumptions, as we will test our way into new formats. So while this negatively impacts sales growth, it also reduces our capital expenditures. Next, while our CapEx over the next few years is expected to be lower, there is a higher mix of information technology or IT spending. Given the short depreciable life of IT assets, depreciation expense will be higher than prior expectations. Also, as you heard from Rick, we are making inventory investments to better enable us to capitalize on existing customer traffic. While this should lead to improved close rates, it does revise our 2015 inventory productivity target downward.

Now as you heard from Robert, our capital allocation parties are, first, to invest in the business where we believe we can generate an adequate return; second, to target a dividend payout ratio of approximately 35%; and third, use the remaining funds to repurchase shares. This is the same order that we've shared in the past several years. The $18 million in share repurchases that you saw last year wasn't a hard commitment. It was the output of a model that included planned investments in the business. You'll see that this year we've modeled lease adjusted debt to earnings before interest, taxes, depreciation, amortization and rent to be around 2.15x. This provides us with approximately $250 million of flexibility per year to invest in the business or to return to shareholders. Now to the extent we have additional investments in the business or returns to shareholders, they will be funded by incremental borrowings, so our lease adjusted debt to EBITDAR could ultimately be closer to 2.25x.

Also, I want to take a moment to comment on what's not contemplated in our outlook. As mentioned previously, our forecast model assumes improved housing and modest income growth, but we recognize that there are additional risks associated with the fiscal cliff. Additionally, as many of the rules associated with the Affordable Care Act are yet to be written, we have not included anything related to higher future health care costs. Now one last comment before getting into the figures. Please don't let the precision of the amount shown on the slides give you a false sense of accuracy. This is a modeling exercise to affirm long-term trajectory only.

Okay, let's get into our long-term financial expectations and our efforts to drive return on invested capital through operating more profitably. These efforts are expected to yield a 4.3% average annual comp sales increase for the next 3 years. The initiatives that Greg and Rick described should drive 3.5% of the comp. The remaining comp comes from improvements in housing, which should drive home improvement spending. I said that earlier, we expect the estimate impact of housing to be in the 50 to 100 basis point range. We've modeled 80 basis points here. In addition, we expect to open 10 to 15 stores annually in North America, which adds 0.6% of a percent. It means that total sales grow by about 4.9% per year. As I mentioned earlier, we're planning to test alternate formats internationally because these new formats are not in the market today, and we need time to evaluate the results. The rollout of these concepts is not included in our forecast. The 4.9% sales growth takes our 2012 sales from $50.3 billion to $58.1 billion in 2015.

The next slide on the slide is earnings before interest and taxes. As we realize the benefits of our initiatives, we expect to strengthen our relationship with customers to build loyalty, holistically solving the value equation. This should lead us to be more profitable. As a result, we expect EBIT growth of roughly 280 basis points over the 3-year period, with about 1/3 coming from improved gross margins and the remaining 2/3 from expense leverage. As Greg and Rick discussed earlier, Value Improvement drives most of the 90 basis point expected increase in gross margin, as we more than recover the roughly 70 basis points of decline that we experienced from 2011 and 2012. We expect SG&A leverage of approximately 180 basis points over the next 3 years. There are a few main areas driving this leverage. First, we realized store payroll leverage from the comp sales increase. We're also working to streamline decision making and simplify our corporate office structure. In the aggregate, we expect people-related costs to contribute 60 basis points of expense leverage. Second, more direct communications with our customers should improve the productivity of our advertising spend, which contributes about 45 basis points. In addition, rent, utilities, property taxes and other facility related expenses drives 40 basis points of leverage. Lastly, we'll see expense leverage and other lines from those sales growth and cost reduction efforts.

Depreciation leverage is approximately 10 basis points, as it grows just under 4% per year relative to the 4.9% sales increase. In total, our efforts are expected to yield an EBIT increase of roughly 90 basis points per year or about 20 basis points for each 1% of comp sales, reaching approximately 9.7% in 2015. We expect a profitable sales growth will increase earnings by an average of 18% per year, reaching $3.1 billion. Earnings per share should grow faster than net income as a result of share repurchases. Our outlook shows average annual growth of approximately 28%, which results in projected earnings per share of $3.44. For the balance sheet, I want to highlight our efforts to improve asset productivity. the first item I will touch on is inventory. Primarily as a result of Value Improvement, we anticipate driving sales growth with 4% fewer inventory dollars. This will improve inventory turnover from an expected 3.8x in 2012 to 4.4 turns by 2015. Fixed assets are lower in 2015 as CapEx averages $1.2 billion per year, which is less than the expected $1.7 billion in depreciation per year. Also without annual asset retirements, we expect a $1.9 billion decrease in fixed assets. As a result, we expect total assets to decrease by roughly $1.3 billion in 2012 to 2015, which combined with higher sales, results in a 20% improvement in asset turnover from 1.5x to 1.8x in 2015.

Moving on to liabilities. Over the past number of years, we've leveraged supply chain financing and other tools to work with our vendors to improve terms. As a result, we are modeling day sales outstanding at 59; and with increase in purchases, this results in accounts payable of $5.1 billion. As I mentioned earlier, we are modeling lease adjusted debt to EBITDAR of 2.15x. Given this, we assume incremental borrowings of approximately $5 billion over the next 3 years. For this time, debt maturities are expected to be $600 million for a net increase in debt of $4.4 billion. With slowing square footage growth, CapEx is remixed primarily to focus on existing stores and IT. The existing store CapEx includes reset activity and end cap rotations, as well as maintenance CapEx. In total, IT CapEx, which is included in all 4 categories on this slide, is estimated to be about $550 million per year. The IT spending is for new tools to better enable customer experiences such as additional Lowes.com functionality, mobility and improved selling tools. We are planning for cash CapEx to average about $1.2 billion annually.

The next aspect of our outlook is cash flow. We expect cash flow from operations to grow from almost $3.4 billion to approximately $5.4 billion in 2015, an annual increase of about 18%. The growth is driven by higher earnings and working capital productivity, offset by deferred taxes. After taking into account cash capital expenditures, we're able to arrive at free cash flow. We'll expect that we'll have $2.1 billion of free cash flow this year, which grows with earnings and expected to double to $4.2 billion in 2015. With this free cash flow, we were able to return a significant amount of capital to shareholders. We're targeting a 35% dividend payout ratio, which means that annual dividend payments reach $1 billion by 2015. On a per-share basis, we expect dividends to grow from $0.62 this year to an estimated $1.08 in 2015, which represents a 20.7% annual increase. The $4.2 billion shown for this year represents share repurchases through the third quarter plus an additional $550 million for Q4. Provided that there are no other uses for cash, the expected share repurchases for 2013 to 2015 is $12.8 billion or about $4.3 billion per year. At the end of the third quarter, we had $900 million remaining under share repurchase authorization. All future authorizations are subject to board approval.

Internally, we talk about improving ROIC by growing profits faster than sales and sales faster than assets. Today, we shared with you our plan to become more relevant with existing customers, to drive an annual increase in sales of 4.9%. We provided examples of how we're going to operate more profitably, resulting in EBIT dollars growing on average 17.5% per year and reaching 9.7% of sales. Also, during this time, total assets are expected to decrease by 4%, resulting in a 20% improvement in asset productivity. In addition, we expect to return over $15 billion to shareholders in the form of share repurchases and dividends for 2013 to 2015. This results in ROIC of approximately 16.8%.

With our commitment to finish the journey, you can see that we are focused on building the experiences customers want, leading to brand advocacy and loyalty, which in turn drives return on invested capital and shareholder returns.

Thank you for your interest in Lowe's and your time today; and now here's Robert to wrap up our presentation.

Robert A. Niblock

Thanks, Bob. I'd like to thank you once again for joining us today. Before we go to the question-and-answer portion of the program, I want to summarize what you've heard this morning. We have confidence in our vision, and we're making the necessary changes to our business and our organizational structure. We've laid the foundation to improve our core business over the past 2 years, and we plan to make additional progress in 2013 and beyond. We continue to evaluate opportunities in new and existing international markets. We are transforming our business to develop deeper, more meaningful relationships with customers. And finally, our company is solid and our brand is strong. We are well positioned to grow profitably, generating strong cash flows and returning significant cash to shareholders.

Now I'd like to ask the team to come out and join me on stage to address your questions.

Question-and-Answer Session

Unknown Executive

For our live audience, there will be microphones on either side of the aisle to take your questions. Please limit your questions to one plus one follow-up.

Tiffany Mason

Michael. Michael Lasser.

Michael Baker - Deutsche Bank AG, Research Division

It's Mike Baker from Deutsche Bank. I want to ask you about the line reviews. Greg, you had said that you're seeing a 5% lift. Can you discuss -- first of all, how many or what percent of your categories are through that clearance process? And put that 5% lift and that 100 basis point lift in gross margin in context to what your plan is, do you expect that to continue? Are these your best categories? Is there something about these categories that would give them a better or worse lift?

Gregory M. Bridgeford

Thanks, Mike. Yes, actually, I said mid-single-digits comp lift. I know, I know. Bob said worry about the preciseness of the numbers. But actually, it's -- as I mentioned in the third quarter conference call, we have less than 20% of the categories through the clearance process, where we call the inventories normalized, so we don't have a legit clearance sale that's causing noise in the -- as we try to look at the margin impact and try to look at the true sales rate. So it's less than 20%. But thus far, it's meeting our expectations. We feel strong about the balanced delivery of sales, of margin accretion, of inventory performance and even when you look at things like average selling price. So we're looking at all the aspects, all the metrics surrounding the categories that have normalized and feel strong that, that's a good indicator because we've had a variety of categories within there. I mean, we're talking about from pure commodities to hardware categories that are much more steady state in their selling profile. So you've got a mix of seasonal commodities, steady-state maintenance categories. So I think it is representative of the kind of performance that we see in the future.

Tiffany Mason

Michael Lasser.

Michael Lasser - UBS Investment Bank, Research Division

Michael Lasser from UBS. I have a 2-part question. One, throughout the presentation, there was some emphasis given to exploring other international opportunities. Can you walk us through your thought process given that you have a lot going on, on the domestic front? And it seems like you want to leave the door open to furthering the footprint. And along those lines, for Bob Hull, last year you talked about a 2.25 leverage ratio. Now you're going to a 2.15 with the option to take it to 2.25. So what changed that may have put you on a more conservative balance sheet approach?

Robert A. Niblock

I'll start, Michael, and then let Bob address the leverage issue. No, I mean, our primary focus obviously is continuing to improve our U.S. home improvement business, and that's why we've got the organizational structure set up the way we do, with Greg and Rick running the U.S. home improvement business. As we went through, we've got an investment in Canada, a small investment down in Mexico and also ramping very quickly down in Australia. Australia, doesn't take a lot of time, because it's -- we got a couple of people down there that are ex-pats. But because we're 1/3, it's really just from a board function standpoint. For Mexico and Canada, our goal now is to -- our primary focus is to how do we get to scale. We like what we're seeing in the markets, but how do we get to scale to get an adequate return on the investment. Doing Greenfield was probably harder than we anticipated in both markets for different reasons, but in both markets, so how do we get to scale? That's what our primary focus is, and we're looking at options to be able to do that. We will continue, as we've done that for several years, look at other international markets. That doesn't mean that we move into one, but we look at them. Now we talked about in the past, we go back a few years ago particularly before the downturn, there was a lot of talk about China and India. We looked extensively at both of them and ultimately walked and said, we don't see a profitable model in this market, okay? So it's just saying we will continue to look at opportunity. If there's an opportunity out there that we think is viable, we'll take a look at it. But that's the reason for setting Doug Robinson up to to run international is really these guys aren't spending any time. We'll get involved in something, obviously, for example, like the RONA deal. Bob, the financial team, legal team, those are involved in looking and analyzing that. But Greg and Rick aren't spending any time with that. They're solely focused on the domestic market. So Bob, if you want to address the leverage issue?

Robert F. Hull

Yes. So Michael, the second part of your question, which is why we've modeled 2.15x versus 2.25x. If we took a look at conversations over the past year, people were fixated on specific aspects of a plan that we outlined last year as if they were finite, which kind of led to the objects are not as precise as they appear footnote. So really, it's just to give us more flexibility to operate the business, to make investments if we choose to. As Robert indicated, if we find a viable alternative investment that makes compelling sense, we'll take a look at it. If not, we'll give the money back to shareholders and move on and just provide more flexibility.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Dan Binder, Jefferies. My first question was around your comp assumption for the next 3 years. Just curious did you think about the cadence of that? You've taken the average comp up from where it was last year. I'm assuming that's mostly macro. Just curious, is that more sort of a progression where you had accelerating comps? Or do you actually think, realizing 4.3 is -- to be precise is per year may not be the case. But generally, how do you think that's weighted?

Robert F. Hull

So as we think about the next 3 years, as I said, we're working in a lot of initiatives that you heard from those guys that's going to drive some underlying improvement in our business. From a macro perspective, housing is starting to turn. So we feel better about housing, not so much regarding disposable personal income, which is going to grow -- expected to grow modestly in 2013. So having said that, as we look at 2013, it's probably below the average of 4.3, growing higher than obviously in '14 and '15.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

And my follow-up question was regarding your sales per square foot and margin targets, looks like the sales per square foot is the same as you'd targeted for 2015 when you laid this out last year. The EBIT is about 30 basis points less. Is that primarily the increased labor? And maybe if you could tie into that answer, I think the last time you were at $292, you were at even higher operating margin, probably approaching 11 or so. Can you kind of reconcile, is that price, labor? What were the major differences?

Robert F. Hull

So the $292 target is the same as last year with fewer store openings. It's on a lower square footage base. As we think about the operating profit targets, the margin is not too different than what we showed last year, a little bit more SG&A leverage, a little bit less depreciation leverage. So I talk in my prepared comments about the drivers of higher depreciation expense, which is why it only leverages 10 versus, call it, 40 to 50 last year. As we think about labor productivity, interestingly, Rick talked about investing hours in selling, but the sales for our target for 2015 is $148, which is the same as last year. So we're getting there also a different way. Some of the SG&A leverage is coming from more targeted spending at our corporate office. We've talked about rightsizing our corporate office, streamlining decision making and whatnot. Last piece I would say is from better fixed cost leverage, so the -- in sum, the 30 basis point decrease is a function of depreciation expense being a bit higher.

Gregory S. Melich - ISI Group Inc., Research Division

It's Greg Melich with ISI. I want to get more into that comp, that benchmark you gave. I think last year, you broke it down 1/3 traffic, 1/3 ticket and 1/3 online. Maybe could you put that in a construct? If the close rate seems to be a key part now of getting to that sort of 3.5 that's internally driven, could you put that in the context of traffic and ticket and online comparison?

Robert F. Hull

Sure. So kind of 2 slices of it, Greg. First, the balance of ticket and traffic, we think is about 50-50. So you heard description from Greg on things we're doing to improve retail relevance, which should help on the traffic side of the equation. And Rick talked about selling hours and selling skills, the focus on project selling, which would drive the ticket. As it relates to kind of in-store and other channels, it's still probably 2/3 in-store and 1/3 other selling channels that drive the comp going forward.

Gregory S. Melich - ISI Group Inc., Research Division

So just to -- it sounds like a similar split to last year, just proposed differently that getting the close rate is the key part to getting the ticket component of it.

Robert F. Hull

I think last year, we actually said the transactions was 2/3 relative to 1/3 ticket. Now we think it's more balanced.

Gregory S. Melich - ISI Group Inc., Research Division

Got it. And maybe just a follow-up, if we don't get to the comp, if it ends up being -- we stick around the 1 or 2 that we're sort of running now or if we do better and do a 6, what's the variable margin you'd expect either direction from that?

Robert F. Hull

I think for each 1 point of comp, 20 basis points of EBIT is a good benchmark to use, up or down.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

It's Aram Rubinson at Nomura. A question, if you can clarify because I know you're putting more emphasis in kind of your depth of products and your Contractor Packs, et cetera. But then I think there was a remark this morning that you're kind of a little less on the R&R remodeler and now on the MRO. You've been doing this business a long time. My experience is -- so that the MRO has been more of a direct channel over time, less of an in-store. Why -- what do we make of that nuance change there? It surprised me.

Rick D. Damron

Yes. No, I think when you look at our business historically, the actual contract or commercial business, construction business is the much smaller percentage of overall volume. The MRO business, the business management, the retail maintenance customer is historically been a much higher percentage of our overall volume. So what we're doing with that initial focus is really making sure that the stores understand where we need them focused. We're putting the proper resources around continuing to develop that MRO customer base as we know that they are in the stores much more frequently. They do shop across the categories, so they mix out a much better margin overall. And so we do see good traffic in the stores related to the MRO business holistically. The important thing to remember as it relates to the repair and remodeler, the things that we're doing from a Value Improvement perspective are the things that really add value to them from depth of inventory, from processing and making sure we have the right products in the right place at the right quantity, both continue to add relevance to that customer.

Gregory M. Bridgeford

I'll just add in to Rick's comments there. When you think about industrial MRO, absolutely, you're right. In an ever-increasing basis, but there is a massive subcategory called retail MRO for example. And the smaller the business, the more important we are because they shop across categories on a one supply trip basis. So that's been a sweet spot for our business for decades.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And as a follow-up to what will be a wholly unrelated topic, but $500 million a year in IT spending, more CapEx a year on IT than Home Depot is spending in technology. What do you spend $500 million on? It sounds like just a huge amount.

Robert F. Hull

So I'll start and let others chime in on specifics. So as we take a look at our architecture and IT infrastructure, we've cobbled together many disparate systems over the years, so there's an opportunity to better streamline those. We've spent some time talking to you about selling systems, so we've aggregated at least 5 different selling systems. We're working this year to consolidate those down to 2. That's a big part of the IT spend in 2013, ongoing IT development for Lowes.com for mobility. If you think about how quickly technology is advancing, you can buy better processing, less expensively so just continually refresh. So that's kind of the focus there for that place holder. We've got ERP systems that we're working through upgrades. It's just taking a look at the entire office IT architecture and being smarter going forward. Now as we do that, that should result in lower operating cost to maintain fewer systems.

Tiffany Mason

Chris?

Christopher Horvers - JP Morgan Chase & Co, Research Division

Chris Horvers, JPMorgan. I want to focus on your international comments. You talked about looking into other prototypes internationally in different boxes and so forth. What drives that? Is that the reality of real estate availability? Is it something different about how the customer shops, the ability to build a different supply chain? So can you talk about that? And then, if it works internationally, why won't you look at it necessarily on the domestic side?

Robert A. Niblock

Right. Yes, in many cases, if you look at somewhere either -- whether it's Canada or Mexico, 2 markets that we're in, a lot of the opportunity in Canada is in dense metro markets, but there's also some that's in some of the less populated markets. And so you can't, in Canada, get a return on a big-box store in those less populated markets. You may also need to be, from a real estate either availability or call standpoint and being able to get into some of those dense metro markets, you may have to look at some alternate formats as well. Same thing down in Mexico, Mexico is a very expensive real estate market. And when you look at the different -- the fact that you really don't have a lot of lawn and garden business down there, the stores we have, we've tried a drive-through. We haven't gotten the productivity of that drive-through that we thought. So we think we can take some -- take that prototype down smaller. Take some of the cost out of it, still get the key categories and look at opportunities to continue to expand and get the scale that we need down in Mexico. So those are some of the things we're looking at. It's really just customizing to the market and the opportunities. And part of it is being driven by -- if you think about how the advances in technology have taken place, particularly in Canada. We just talked about, we've just now launched our website in Canada. Well, think about how much technology has changed here in the U.S. We've slowed down our store format. Yes, we may look at some other formats in the future in the U.S. to get into some of those markets because now you can come in and supplement it with a lot of other omni channel things that you're doing here in the U.S. Just by the time the technology got here in the U.S., we were pretty rolled out from a store standpoint here. So that's why we would look at those international markets potentially different than we have in the U.S. But yes, it doesn't mean we can't potentially come back and look at opportunities in the U.S. in some of the markets that we're underserved in to look at potentially different formats in those markets as well.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then on a different topic, you talked about the focus on close rate and the sales per labor hour. Can you talk about the benchmarking that you've done? So your peers -- I mean, 2/3, that looks like 2/3 close rate on existing traffic in the stores. It seems like a pretty high number for a retail. Can you talk about other retailers, other benchmarking that you've done to compare and frame out your ability to get that extra, what looks like, 10 points on top of what is already a high close rate?

Robert F. Hull

So we're using a new methodology to capture close rate. We've relied on a third-party measure previously that was less than robust, but that prior third-party gave us an indication of where we stood relative to some others in our competitive space. And we actually broke it down category by category, and we saw some pretty significant gaps in some categories where there was an opportunity for us to improve our close rates. So with the new methodology, we're decomposing it and trying to understand what proportion of that's driven by, I can't find somebody to help me, I can't find the product I need, from the opportunity to have improved selling skills, and the targeted investments that you heard Rick talk about are to address gaps in our arsenal, where we're not at the close rate that we feel we should be.

Rick D. Damron

And I would just add to that as well is when you think through that, if you remember a couple of years ago, we reallocated some structural organizational dollars in the store staffing structure to the weekends. And we have been extremely pleased with what we've been able to see from a close rate performance with those additional hours on the weekend. So we think that is a great benchmark for us to look back at our close rate through the week and determine where we have those opportunities to improve. So as much as what Bob talked about from an external perspective, we were able to look at our own internal numbers and make those kind of decisions based on what we've seen over the last 2 years related to our close rate performance, particularly with what's happening on the weekend.

Gregory M. Bridgeford

So Chris, it's not just labor allocation and focus that's going to do it. The work that the logistics team is doing in inventory, targeting specific categories where we think we've not been as strong as we need to be in job lot quantity, will improve close rates. So that's a -- I think it's a big impact over the next 3 years.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So if you had say to it was in stock versus sales, it's 50-50?

Rick D. Damron

I would think it's probably close to that number. When you really break it down and look at it. The good thing is what we've been able to do since we introduced our new hour scheduling systems, maintenance systems last year is really to be able to look at the sales per hour throughout the day, looks at the curves throughout the day, look at the hours allocated by department and really be able to make some very logical decisions about where these hours need to be, where we see the biggest gaps and where those gaps are by department versus just looking holistically across the store. So it allows us to be much more precise on how we allocate these hours and determine where we see the biggest gap between our existing hours and coverage and customer transactions within the store.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

It's Brian Nagel from Oppenheimer. So I guess my question is for Bob Hull. I just wanted -- maybe 2 questions on the -- your EBIT longer-term targets. The first, you broke off -- you broke between the gross margin and SG&A so I understand that it's not precise, but how should we think about sort of the cadence between those 2 factors 2013, 2014 and '15? I mean, is it going to be more weighted toward one than the other early in the process? And then the second, you gave some detail on the -- kind of the breakdown, the 180 basis points for SG&A. Is there any similar type breakdown you can get for the 90 basis points in gross margin?

Robert F. Hull

So I would say that if we take a look at the mix, the gross -- probably more gross margin early. If you think about the work Greg described with the line review process and results to date, we're going to get most -- the rest of the lines in 2013, so that'll drive some gross margin expansion in '13. And then back when I was answering Dan's question regarding the comp trajectory, as we think about higher comps in '14 and '15, that's going to drive higher SG&A leverage in those years.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Could you just talk about the 90 basis points? Is there any breakdown how we think about that 90 basis points in gross margin?

Robert F. Hull

Yes. I said a little more in '13. We'll see more of that in '13 because of the line review process. Then you will -- more modest in '14 and '15.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

But you said -- I'm talking more about how -- where is that 90 basis points coming from? I mean, I know we talked a lot about -- could you speak to the specific buckets within that number?

Robert F. Hull

The biggest driver is the Value Improvement and the line reviews. Next will be from ongoing private label branding. That should grow about 1% per year, which will be additive. And then as we get more market assorted, there ought to be fewer markdowns going forward. So really, those 3 key pieces. But the first push in line reviews and the results from that will be the biggest driver.

Gregory M. Bridgeford

One other factor in there, Bob, that I'll add, Brian, is that when you look at our promotional activity, a well-publicized miss in the second quarter, I think that our work together as a team to drive integrated, promotional and advertising planning to drive both traffic drivers and what we call "basket driving" items has been crucial and good, good work and good progress towards that. So that will help as you see another component come into that play in the 90s.

Simeon Gutman - Crédit Suisse AG, Research Division

Simeon Gutman from Credit Suisse. A quick follow-up to that question on gross margin. The 90 basis -- 80, 90 basis point basically brings you back to the prior peak. Why, if this business is becoming more efficient from a turnover standpoint, doing the resets in the category management by category, why wouldn't we see something above and beyond that over a 3- or 4-year time frame?

Robert F. Hull

I think it could be higher. I think, as we've talked about, coming on the omni channel and being price competitive with many different players, we need to make sure we're priced right every day. So it could be higher absolutely, but that's not what we modeled in this scenario.

Gregory M. Bridgeford

Yes. Is there margin opportunities? Absolutely. But we're holding ourselves to a tough standard of being competitive in the marketplace and in certain categories it's -- that's caused some adjustments over the last 16 months. So that's -- we're trying to be very realistic about the marketplace going forward.

Robert A. Niblock

Yes. I think, as Greg actually said in his comments, if you dial back all the way to 2011, some of the survey work we did found that we'd gotten our prices somewhat out of line. So we're not wanting to head down that path again. We're not in a real -- we're not wanting to rely on margin to be able to deliver the numbers. We want to make sure we're priced competitively and do it through driving more volume, improving our close rates, managing our costs, those type of things. So...

Simeon Gutman - Crédit Suisse AG, Research Division

And a follow-up on pricing. As you work with the vendors through the review process, how do you know or how do you ensure that you are getting the lowest cost? And how do you think you compare in terms of buying ability to your largest competitor?

Gregory M. Bridgeford

I really can't speak to -- they're buying. They can speak for themselves. But I would say that we don't come out of every line review doing what I think is 100% job on driving first cost. This is not a one-time process. If we don't get it the first time, believe me, as we go through the second pass, we're seeing some nice progress. This is an ongoing process. This is not -- and people have a pretty big misunderstanding about that. This is the way we're going to run our business in the future. So those who don't bring first cost to the table the first time, the best cost to the table the first time, they may get another opportunity at it, but it's not a process that the vendor community wants to go through. So we're seeing, as we go -- begin this cycle actually, some line reviews today, we're seeing that prices are coming to the table first time, best cost.

Eric Bosshard - Cleveland Research Company

Eric Bosshard, Cleveland Research. Two questions. First of all, you talked about more consumer messaging, I think, in the first half of '13, to highlight the changes that you're making. If you could score that with talking about leveraging ad spending 40 basis points over the next 3 years? And then secondly, for Robert, it sounds like you've got your team and structure where you want it. I'm curious how a new head merchant, which I think is still an open position, fits into that structure.

Gregory M. Bridgeford

I'll start, Eric. And the way I would describe it is that we said we would test some consumer messaging in the first half of 2013 and see what's relevant for the consumer. To be honest with you, that's not an area I want to focus on. I want to get the job done right, and I want the experience to be right for the consumer. And if they have that good experience when they come in the store, that's the best spend we can possibly have, and that gives the ability for us to leverage against those marketing and advertising funds. Now another thing that's really part and parcel of that is that we are driving a much more balanced portfolio moving forward in marketing. It is a mix of traffic-driving items and traffic-driving messages, along with a market basket-driving approach so we can get -- which has an impact on our outgoing margin, has an impact on the ability to drive attachment items and sell the whole project. So if we execute that and we've seen good progress, especially in the last 5 months, then that enables us again to get leverage on the marketing and advertising spend as we move out through the next 3 years.

Robert A. Niblock

And Eric, on the organizational stuff, as you know, I guess it was back in May, we announced the new organization alignment, a lot of changes within the organization. I think it's starting to come together for us now internally with the changes, with the alignment that Greg and Rick are going through, some of the micro design within their organization. As you know, a big part of what we did then was the new customer experience design that Bob Gfeller moved over to run, reporting to Greg. He's also continuing to help run merchandising as Greg is out looking for a chief merchant. So we've got -- as we go -- as we talk about that organizational change that we did, we still have 2 positions left open. One is the chief merchant, which reports to Greg, and we're actively in search for that position; and then also a head of supply chain that reports to Rick. So 2 open position still. But yes, a chief merchant is still a very key and critical part of the organizational design -- organizational structure we've set up going forward. So yes, that's stuff we still plan on fulfilling. So...

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

It's Matt Fassler from Goldman Sachs. One strategic question then a couple of follow-ups for Bob. I want to talk briefly about online. Last year, it seemed to be a more prominent part of the discussion of the day, but in terms of the threat and also on opportunity, you addressed omni channels as part of your vision. You spoke about Lowes.com putting up some pretty strong numbers. But if you could give us some more detail on where e-commerce fits for you in terms of categories, pricing, anything else about tangibly moving start to see it contribute back to the business.

Gregory M. Bridgeford

I'll start then I'll ask these guys to add in, Matt. I think the reason that you're not hearing so much about online, it's becoming a part of our base business. I mean, it truly is. If we're speaking about it as a separate part of our business, as a focus on developing another channel 2 years from now, then we probably have failed. I mean, it really is part of an integrated multichannel experience that we want for the customers where there are no channel barriers so it is seamless in the experience. We made really good progress to this .com this year. I think Bob shared some -- and Rick shared to give you some growth figures that we're achieving. And part of it is we're at 450,000 items right now. We've doubled our offering in the past year, and part of it was the acquisition of APG and the processes that they were able to expose us to for adding items at a much higher capacity than we could before so we can offer a stronger array of assortment, stronger breadth and depth of product experience for our customers. So good progress with .com, which -- again, it's got to be the -- it's got to be part of a seamless experience. And so we don't tend to focus with a separate -- treating any of these businesses as a separate channel. We're viewing it as one experience for the customer.

Rick D. Damron

I would add, when you come back and you think through the organizational design, and we talked about this in the opening comments, around being customer-centric. If we're really focused on that customer and working seamlessly across channels, we're not optimizing one channel at the expense of the other. What we're trying to do is bring that customer's experience to life across each of those channels in the most effective way possible. So when we talk about that -- you heard us talk a lot, not just about .com but about outside selling, mobility, POS anywhere. All of those things enable us to really deliver on that mission of anytime, anywhere. And .com plays a role in that. But our ultimate challenge is, from an organizational standpoint, how do you incorporate that into everything you do every day? So you've seen with flexible fulfillments, keep us -- keeping the expanding flexible fulfillment nodes, up to approximately 50 now. That gives us that ability to continue to add SKUs, to continue to have assortment and to be able to meet the needs of the customer with next-day shipping at standard rates. So it's really about how do you take all of those verticals and really start thinking about them not from a stand-alone silo perspective but horizontally across the structure and taking that experience across each one of those to deliver what we ultimately believe is a differentiated experience for the customer. So in order to do that, you have to understand what experience you want to create first, and then you have to define how each one of those different verticals plays in that new role. And that's the reason when we talk about those things, you're not hearing us isolate on one because it's the integration and the aggregation of all that really builds out what we're trying to accomplish.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Great. And then a follow-up for Bob, if you could give us some numbers on the increase in depreciation and amortization from the prior plan, which I guess was the biggest change from last year's guidance. And also, the stock price implied in your buyback numbers over the next 3 years?

Robert F. Hull

So Matt, roughly speaking, depreciation is up about $200 million per year. As far as the implied stock price, I don't have the specific price, but it's -- a modeling exercise was basically off of 15.4 P/E. [ph] So higher than today.

Joseph I. Feldman - Telsey Advisory Group LLC

Joe Feldman, Telsey Advisory Group. Wanted to go back to the -- your adding 150 labor -- customer-facing hours in the stores mid-week. How do you get to the 60 basis point payroll leverage over the next few years? Is it -- it's just going to drive that much incremental sales, I guess? Or -- because it would seem that, that's a pretty decent step up in comp.

Robert F. Hull

Yes. So Joe, I'll take the 60 basis point comment. I'll let Rick talk about what's taking place in store. The 60 basis point total people related cost was store, corporate office, salaries, contract labor, consulting, benefits. It was all people and people-related costs across the enterprise that were focused on. You want to talk about...

Rick D. Damron

Yes, absolutely. When you think about the rest of it, and we talk about the hours that we're adding, I think we need to step back and really look at the last several years, the last 6 years as we've seen the economic conditions play out and our sales continued to decline. Everyone in this room knows that we have base staffing hours. And when we have more and more stores hitting those based hours, when you try to leverage, you go to those stores that are outperforming and find those dollars. So over time, we've really taken hours out of a cluster of stores that we just look back and feel we need to put back in out of those markets that are really performing well, out of those stores that have really performed well over the past. So that's what gives us confidence that adding those back or putting those back in the markets that have the greatest opportunity to deliver against those in the future. That's the reason we're saying 2/3. The other thing I think that's important when you think about payroll leverage is really coming back to all the things we've been doing over the past. We've talked about migrating tasking hours to selling hours. You've seen us do that over the past 18 months at a much quicker rate than we have in the past. We talked about the production offices and the 3.5 million hours that's going to free up that comes back in by centralizing those areas and be much more productive in those hours but, at the same time, offering the customer a much more consistent, better experience through that consolidation. So as you think through that, we'll continue to get there through better working -- be much more productive in how we work, continuing to look for ways to eliminate tasking to migrate to that selling hours and those consolidation opportunities that we have in the future. So I think that's what gets us there, is really a multi-stage process, not one that doesn't build on the other.

Robert F. Hull

And just a follow up on that. So as Rick described, we have done a really good job on the non-customer-facing, the tasking, which affords us the opportunity to invest in more selling hours, which is why the sales-per-hour target remains unchanged at $148.

Joseph I. Feldman - Telsey Advisory Group LLC

And one follow-up. I know you had mentioned that the new guidance doesn't contemplate ObamaCare or the Affordable Care Act. I mean, I'm sure you've run some numbers. Anything rough that you can kind of give us? What it might mean to you guys or how you might approach it?

Robert F. Hull

Well, we've done some modeling based on what we know about. The challenging piece of this modeling is what you don't know about, which is why we're hesitant to share with you the impact because we haven't seen all the rules yet and all the implications.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

David Strasser from Janney Montgomery Scott. Going back to the close rates, I guess a couple of questions around that. Number one, do you know where, when you're losing that customer, not closing, where they're going? Do you know -- can you track how much of that is going back on to .com in your own website and maybe just off the track? And then just along that line, when you kind of look at weekday versus weekend, do you think it's a different -- could it be that part of it is behavioral, the Monday to Thursday customer versus the weekend customer, why that differential is occurring on the close rate? And have you thought -- where -- could that come into it to some degree? Or how much?

Robert F. Hull

So the first part of it is -- so we kind of know customers that are coming to see us. We know our transactions, therefore we calculate the close rate. Where they're going, we don't necessarily know. But apart from that, as you see performance of others, you can have a hypothesis about what's taking place relative to your business and what categories or what aspects you're losing share on. Also, we can do, as I said, diagnostics on specific aspects of whether it's the right products, whether it's the depth of products, whether it's the right level of selling to help us understand where the gaps are.

Rick D. Damron

And then, I think, when you come back through that, I mean, you're looking at -- from a customer standpoint, what they're really there for, when they're coming in the stores, whether it's weekday or weekend. And we talked a lot about the close -- the selling training we're putting the organization through, really moving them into understanding the customer and what they're there for. And it's breaking it down into those 3 different types of customers that are coming in. You're right. Through the weekday, you may have a customer coming in that's really looking from -- for an inspiration standpoint, may come back at the weekends, you don't know. But really, they're fact finding, gathering that information. You have those customers with a mission trip, which are predetermined. They know what they want, they know what they're in store to get and what they're doing. And then you have the project customer that may be in to pick up something related to the project or where it's at. So when we look at that, and what we really use to define where we see the opportunity, is really beginning to look at -- according to where we see transactions throughout the day by department, and how we're allocating those hours across the store by department. That can tell us where there are possible gaps in the coverage that we have within the stores. A great example of that may be flooring. It's a project-related sell. It takes a longer amount of time to assist a customer in that category. If throughout midday you have one associate in that department, they're going to be tied up with a customer for an extended period of time, and then you may lose that sell opportunity with a customer that there's also, whether they're trying to get inspiration or whether they're trying to complete the project. So we've done a lot of analytics around where we see that opportunity, how do we see it spent and what we think we're there to do. As it relates to where do they go, what do they do, I think it comes back to the type of product the customer is in there to buy. So an example would be this Spring, a very wet Spring. So you saw OPE sales really take off. If -- 2 things happened. One, I didn't have enough hours in that department or B, I did not have the inventory to support that need. I don't think the customer waited. They had to get the grass cut, so they had to go someplace else. So we're looking across all of those factors, understanding what the customer is there to do, understanding the mindset of that customer, the categories that are performing to really begin to allocate those hours differently.

Gregory M. Bridgeford

David, let me layer on Rick's answer because this is a critical part of this experience. So Rick's investment in -- focus and investment in labor hours is going to be leveraged or deleveraged by the job we do in Value Improvement. Because if you look at this -- and it sounds like, "Yes, it's just basic merchandising. 400 line reviews and they're going to use customer research." Well, it's a lot deeper than that. It's actually dedicating a team of research analysts years ago, a couple of years ago when I was in that category, to work with the merchants for -- actually, over 1 year before we did our first line review to feed out the customer insights that really going to drive shop and purchase behavior and then create a series of relevant hypothesis about this particular category. Now those hypothesis have to be confirmed. So they have to be owned by the merchandising team. That isn't -- that hasn't always been the case in the past. And they had to be very visible, and we actually monitor that on a centralized basis. Did the team use the consumer insights that brought a shop and purchase? If they did, and they do -- and they do, then when the product category shows up reset in the stores, as a CSA, as a customer service associate, I have a lot less of hassle factor in my job every day, because the category itself is answering the challenges that the customer would have about this category. So I come in and the first I'm looking for is style. I'm looking for finish. I'm looking for scale. I'm looking for durability. We're answering that with these Value Improvement product line reviews. As a CSA, I'm loving this because all of a sudden, my job is a lot easier. We're creating the depth and the inventory -- the inventory breadth that's appropriate for that line. Now I'm not up and down the ladder so often because I know what's going to move, I know why it's going to move and I'm way ahead of it in terms of -- right in the sweet spot of the strike zone of the product customer interaction. I've got a lot of inventory there available for sale. So this all has to work together, and that's why it's so critical, what Rick's creating in terms of the labor hours and focus and what we're trying to do from the product and the equation, the value equation for consumers.

Rick D. Damron

And I'll just go back to add one other thing as it relates to the research that we've done to really understand where those customers are. To go back to the comment, we know that there's a 15 basis point difference between those customers who are on a mission trip throughout the week. Those customers are coming in, they know what they want. They've predetermined what they want and our ability to close. And our hypothesis is that there's 1 or 2 things that are impacting that. A, they could not find the level of service they wanted in the store to be able to get and locate the product; or B, we did not have the product they needed. So it's utilizing that kind of data to really understand where we see that opportunity.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

I just wanted to follow-up -- actually more for Robert, and it's actually a little bit -- I'll follow-up on Chris's question about acquisitions, RONA and some of the stuff you talked about, is it looking for that convenient opportunity? Is that a precursor at all to some thoughts about the U.S.? How important is it to find somebody with that convenience element to learn? And is that -- is it thinking -- and it's also a little bit along these lines, too, is it thinking a little bit about maybe there is a convenience format in the U.S. that could be coming in the not-too-distant future?

Robert A. Niblock

Right. Well, as we talked about, this -- as I talked about in my comments, we still think the store is relevant. There are certain purchases, sort of immediate-need purchases, the impulse project, those type of things where the store is still very relevant. And to the extent that the store is where you want to transact, convenience of location is paramount. Okay? So if you're doing a major project, yes, maybe I'll invest 30 minutes to drive to whoever I want to do business with. But if I'm going to be spending $100 or whatever, I don't know that I want to invest with so much time and distance to be able to go and source that product. So yes, absolutely. There are obviously key markets in the U.S. where we're still disadvantaged from a convenience of location standpoint. In some cases, yes, there may be opportunities for additional big boxes that we'll put in those markets, but we'll also probably look at other, other opportunities to be able to overcome that convenience issue that we have and being able to address being more relevant to those consumers. So we're looking at all of those. Yes.

Wayne L. Hood - BMO Capital Markets U.S.

Wayne Hood, BMO capital. One question for you, Bob, was on the payables number that you gave in 2015. If you look at that relative to the inventory, it's about 65%. So that's the highest rate you've been at in the past and sort of higher than where Depot is today. So could you describe a little bit about the dynamics of what's driving that at such a high rate? And then I had a question for Robert back to international capital spending in small-store format.

Robert F. Hull

Is your question regarding where we are in '12 or where we're going to be in '15?

Wayne L. Hood - BMO Capital Markets U.S.

In '15.

Robert F. Hull

Really, it's more of a function of improvement in inventory turnover. So days payable outstanding is 59 or so today. It's expected to be 59 in 2015. We did all the heavy lifting 4 or so years ago to migrate to the 59 days, really just a function of sales growth that we described and only a modest increase in inventory going forward. Actually, a modest decrease in inventory going forward.

Wayne L. Hood - BMO Capital Markets U.S.

But that's 65% ratio. I mean, that's really high relative to where -- again, I understand the changes, but even where Depot is. I mean, is all this structural too that the term agreements with the vendors are such that you can push it that high?

Robert F. Hull

Again, we're not changing agreements. It's 59 days today and 59 days in 2015. It's a function of inventory productivity. Now each company has their own opportunity to determine how they want to do business for their vendors.

Wayne L. Hood - BMO Capital Markets U.S.

Okay. And then, Robert, just a question on the international. I just want to get your thoughts around this a little bit, right, because when you go into Canada, for example, and you look at something like RONA that's a franchise business or distribution business, small, large formats, all the things you're very well aware of, you look back over time, even in RONA's best years, there are margins in both of those businesses where -- below where you are today and where you want to be. So you sit back and reflect and go, why would you even want to be in that business when you could say, "Well, I bring some synergies to it because I'm going to globally source," but you're limited around global sourcing because they want you to buy product locally? I just -- so I'm trying to get my hands around your thinking around why go there other than you need scale? Why not just go ahead and take the impairment and get out? And then as Greg knows, you started here with small stores in small towns and now you're going back to that. It was always the thought around the bigger box has created higher returns. So I'm trying to rassle with this, going back to smaller formats and the capital spending abroad, if you could help me with that a little bit?

Robert A. Niblock

Yes. I think, looking in the U.S., there's where a majority of our stores are always going to be the larger-format stores. Okay? As I've described earlier, one thing that's changed over the past few years is technology and what it's doing from -- with consumers' access and availability to be able to shop the store's product and this whole omni channel world which we live in, which is tomorrow maybe buying online. We want to use our stores, one, to be able to sell the product in them. It has great delivery vehicles to be able to meet customer's needs, whether it's delivering into their home, whatever the case may be. So if there are -- what we're seeing in U.S., if there are opportunities where you can't get in there for the big boxes, where you don't think you can get an adequate return, we may look at other options. As we get to Canada, Mexico, any -- the market -- every market is different. Okay? We need to look at the market and say, "Okay, what is the best way to go to market? What's the best format," those kind of things. Our stores in Canada are doing equal volumes of what they are here in the U.S. So the stores are doing great volumes, we just need more scale up there to cover the overhead. That's what we're focused on. As you look at RONA and their individual business and go all the way back, the offer we had was that we could get in and do due diligence. So we can take a closer look and understand, are there areas of their business that made sense, some that didn't? So we could kind of decide how -- would it make sense to go forward with the transaction? Unfortunately, the board was not willing to engage in a friendly negotiation, so we pulled out. So we're going to look at other means just trying to get scale in Canada. But we're only going to do it if we think we can -- if it makes sense and we think it's going to be the right format for the market and if we get an adequate return on either, what we have to spend to buy a business, or incremental capital we have to open up incremental formats. But we think it's a great market. It is consolidating. There's going to be market share for the grab, and we think it makes sense to try and participate in that.

Gregory M. Bridgeford

And if I could add in Robert -- Wayne, to the comment about the role of the store in the future, we've watched for decades how the role of the store has evolved, and outside research says that in excess of 92%, 93%-plus of transactions today involve the store in some way. There's actually a fairly -- it's mid-single digits, the percentage of transactions that are entirely virtual. So the store has a role today. And what we're doing is 99.9% of our people are focused on making the store of today a vibrant platform, of living up to our potential. So that's the way we look at it. Less than 1% of our team is focused on what could -- what is the role of the store in the future, and how could that play out? And how could that lever our framework and what do we need to do to be prepared for that? So that's the context we've put it on, a non-distracted parallel path done by a very tight team to make sure that we recognize the relevancy of all the channels from the future and how it plays out for customers today.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

It's Colin McGranahan of Bernstein. Three questions, first one for Greg. I think, as an organization, you've always done a pretty good job with customer research and consumer research. And if I recall, looking at your scores on some of the things that you track relative to your primary competitor, you'd historically done as well or better on everything except convenience. But it sounds like in 2010 and 2011, you started to get some concerns about price perception, and that drove the strategy around Value Improvement. So first question is, what are you seeing on convenience and those other metrics today? And is there anything you're seeing in your consumer customer research that an emerging opportunity that would drive the next leg of strategy?

Gregory M. Bridgeford

Great question, Colin. Let me go back, though, because I do think that there's a little bit of a misconception in your question about the...

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

So you're saying I'm wrong, Greg?

Gregory M. Bridgeford

What's that?

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

You're saying I'm wrong.

Gregory M. Bridgeford

Colin, I wouldn't say that. I'm just saying that when you said that our pricing intelligence led to the Value Improvement -- let me go back because this is really interesting history, and it actually puts some context around Value Improvement. Actually, Value Improvement -- the genesis for Value Improvement was in integrated planning and execution, which was basically going to be, for the first time ever in our history, our ability to market and sort, and to maintain and have a learning market and sorting process where we got better and better at it every year and to put in the infrastructure to do that software, et cetera. So as we got into that, we began to realize, "Well, are we missing a key element here? Market sorting is great, but do we understand what drives value for the consumer of x category?" And then we began to look at the components of that and said, "Well, are we looking at this as a business? And are we looking at this as an ongoing process, as part of our business model?" So that's what -- that's really the genesis of Value Improvement. And what it really does for us is it goes back to the core of why we're a retail. What do we do? And are we connecting consumers with the solutions that they're looking for? And so from a price standpoint, yes, we recognize that there were some early trends -- early signs of gap that we're showing up that we couldn't live with and took some action 1 year ago to fix that and then, more importantly, put in place a competitive intelligence network, which, I'm telling you, takes a much wider view of the marketplace than we ever had before. I think when David was asking about where are you losing share if you're not closing on customers, we have a pretty darn good picture of that. We know who our competitors are. It is very wide. It's specialists, it's virtual retailers. Certainly, some big box competition obviously out there today. But we track it now, and we know where we are pricing-wise compared to that array of competition as opposed to the past -- basically, we would comp against 3 competitors. And so that's extremely important, that that's part of our business model in the future. From a convenience standpoint, the way I look at it is that our geographic position is what it is. Our opportunity is something else again, and we think we've not been not living up to our potential of driving our business model. I think it shows in our average sales per store. I think it shows in our penetration rates per market. I think it shows everywhere. We look at ourselves and say, "What should we be doing in these markets? What could we be doing in these markets by category?" And we're not satisfied with our performance over the last 4 years -- or last 5 years, and that's where our opportunity is. I believe in the future to wring out the opportunity that we've got within the marketplaces where we exist, plan a multichannel inclusive basis with -- looking at customer experience holistically.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Second question for Rick. Clearly, close rate and improving close rate is really an important part of the strategy here. Can you just give a sense of where you are in terms of the percentage of hours currently you're selling? I think last year you said maybe a 200 to 300 basis point of [indiscernible]. Last year a 300 basis point per [indiscernible]. I'm assuming that's consistent and not additive.

Rick D. Damron

Right, that is consistent. And we continue to see roughly, as I said earlier, about 65% of ours hours being dedicated to selling. The challenge comes in is as we continue to look across the store, and Bob mentioned this, as we continue to migrate non-selling to selling, that non-selling work still has to get done. And what we found as we continued to move those hours out, that more of our selling hours, even though they're dedicated selling, was participating in those non-selling activities of processing or stocking or things of that nature. So what we had to do was step back and say, "How can we begin to really address this holistically?" And what we did was took a look at volume thresholds and understood by incremental volume, what was happening to the business and what was happening to transaction count, as well as service components as we took it each stage of incremental volume up. So we began to map that out and understand where those lever points were and where will we really stressing the organization too far from an hour standpoint. And what volumes do you see the biggest breaks? Where do you begin to see the sharpest drop off as it relates to those key figures of comp sales performance, the invoice count growth, of customer service scores and overall experience scores. Where does that begin to happen? And so by doing that work and doing that data, it allowed us to begin to understand where those opportunities that exist, that were larger than what we originally thought in the past.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And just obviously, as you've gone to kind of cleaner deals with vendors through the line of review process, I'd assume that means you have to do some things that have some tasking hours in the stores that previously the vendors were doing. So is that ratio still flexing the way you want? Or you're just kind of having to put some of those hours and obviously, you're getting the gross margins benefit for that?

Rick D. Damron

Yes -- no. I think when you look back, I think -- a lot of the vendor's processes that were done in the past, we addressed those several years ago. We have our own product service teams, both in the store and in the markets that have managed our resets for the last several years, and managed the POP, the point of sale, all that kind of material in the store. So that has not had a dramatic impact on our ability to serve customers when we're in the stores. When you go through Value Improvement, one of the things that we did was -- after the initial sets, came back and said, "We're beginning to see some things we don't like," related to the amount of labor at the store that was being required to set these, based on cadence, based on labor availability and based on readiness for the set. So we established a team who tracks every one of those resets now, and they have the go/no go decision on that reset based on is the inventory ready? Is the sell-through ready? Is the POP ready so that when the stores set these resets, they're complete. We're not having to go back and revisit multiple times to get those things done, and that allows us to be much more efficient with the labor. That allows us to really continue to use the network that we have, our product service associates both in the store and at the market level to be able to assist us without putting undue burden on the store employees. And many of these sets are done at non-peak hours or even off hours, depending upon the complexity, utilizing our own in-house service.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then just a final quick question for Bob. Just going back to the comp progression through the 2015 period, is it fair to assume that as you get to the second half of '13, you're basically complete with the line reviews and the resets that, that should be the peak of the comp growth, because that -- thinking of the 350 basis points from your initiatives relative to the 50 to 100 from the market, is it going to be a second half of '13, first half of '14 that's going to be your strongest comp in this forecast period?

Robert F. Hull

I think, from an internal driver standpoint, that will be the largest component. But you've got the macro piece, so think about what's transpired with expectations for GDP for 2013. They were 2.6% in January. They're now 2%, and they're weakest in the first half of the year with the uncertainty of the fiscal cliff. So that is the biggest driver of our internal factors contributing to the comp. But that may not coincide with the biggest driver for the macro piece, both housing and income.

Tiffany Mason

Okay. We have time for one last question from the audience, please.

Zahid Siddique - Gabelli & Company, Inc.

Zahid Siddique, Gabelli Asset Management. Two somewhat related questions, one on the dividend. One trend we have seen lately is companies paying out some kind of dividend this year because of the tax issues. Your thoughts on that? And then some companies, especially in the gaming and lodging, have been spinning out their real estate assets into some kind of REITs, for example. Any thoughts on that as well?

Robert A. Niblock

I'll start with the dividend, and I'll let Bob go to the second part. On the dividend, no, we had our board meeting November, and we've already announced our fourth quarter dividend, which is paid, I think, like first week in February, February 6 or something like that. We did no change in trying to accelerate the dividend into this year. So within a 5-week acceleration, not knowing where things were going to land with the fiscal cliff, the board just chose not to make any changes given that we were meeting in November. Certainly, as we're getting closer, I can see how other companies would be doing that. But we chose not to change anything. Bob, did you want to address the other question?

Robert F. Hull

We've been presented many options and opportunities regarding our real estate portfolio, and they are quite interesting and somewhat diverse. However, we felt that, at this point in time, our opportunity to have kind of unfettered control of our primary operating asset was important to us. So we've not made a determination to spin off real estate into a REIT or anything like that.

Tiffany Mason

Thank you for your time and attention today and for your interest in Lowe's.

Unknown Executive

Thank you for your time and attention today and for your interest in Lowe's.

This concludes our 2012 Analyst and Investor Conference. We invite attending analysts to join us for lunch, which is being served down the hall. Thank you.

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