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Lowe’s Companies, Inc. (NYSE:LOW)

Q4 2013 Earnings Conference Call

February 26, 2014 09:00 ET

Executives

Robert Niblock - Chairman, President and Chief Executive Officer

Greg Bridgeford - Chief Customer Officer

Bob Hull - Chief Financial Officer

Rick Damron - Chief Operating Officer

Analysts

Greg Melich - ISI Group

Laura Champine - Canaccord

Michael Lasser - UBS

Brian Nagel - Oppenheimer

Aram Rubinson - Wolfe

Seth Basham - Wedbush

Keith Hughes - SunTrust

Kate McShane - Citi Research

Mike Baker - Deutsche Bank

Scot Ciccarelli - RBC Capital Markets

Peter Benedict - Robert Baird

Operator

Good morning, everyone and welcome to Lowe’s Companies’ Fourth Quarter 2013 Earnings Conference Call. This call is being recorded. (Operator Instructions) Also, supplemental reference slides are available on Lowe’s Investor Relations website within the investor packet. While management will not be speaking directly through the slide, these slides are meant to facilitate your review of the company’s results and to be used as a reference document following the call.

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

Hosting today’s conference will be Mr. Robert Niblock, Chairman, President and Chief Executive Officer; Mr. Greg Bridgeford, Chief Customer Officer; and Mr. Bob Hull, Chief Financial Officer.

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

Robert Niblock - Chairman, President and Chief Executive Officer

Good morning and thank you for your interest in Lowe’s. We delivered comparable sales growth of 3.9% for the quarter with positive comps in 10 of our 12 product categories and a continued balance of ticket and transaction growth. And our ProServices business continued to perform well. We achieved this growth despite a holiday season, where the retail sector experienced softer sales than anticipated. Through continued use of our enhanced sales and operations planning process, we balanced softer sales of seasonal gift and holiday decorations with solid performance in core categories for interior refresh projects.

We continued to see strength in recovery markets with particular strength in California, Arizona and Florida, where the housing recovery is well underway. In fact, even with pressure exerted by extreme weather late in the quarter in the northern and central areas of the country, we recorded positive comps in all regions except for the region most directly impacted by Superstorm Sandy recovery activity last year. I am also pleased with our performance in Canada, where the team has delivered double-digit comps in local currency for the third consecutive quarter.

Gross margin expanded 40 basis points in the quarter driven by a number of factors that Bob will discuss. And we delivered earnings per share of $0.29 for the quarter, which included approximately $0.02 of charges related to long-lived asset impairments. For the year, we delivered comparable sales growth of 4.8%, our strongest annual comp since 2005. Earnings per share were $2.14, a 26.6% increase over fiscal 2012. Delivering on our commitment to return excess cash to shareholders in the quarter, we repurchased $958 million of stock and paid $189 million in dividends. For the year, we repurchased $3.7 billion of stock and repaid $733 million in dividends.

Looking at the landscape for 2014, economic forecast suggest moderately accelerating growth. Stronger job and income growth should create a more favorable environment for consumer spending which coupled with the lagged benefit of the housing recovery should generate continued growth in the home improvement industry. While credit conditions remain tight relative to the housing boom years, conditions are improving and household finances continue to strengthen, which should also contribute to stronger growth in 2014. Also supporting increased home improvement market growth is positive progression in consumers’ views around personal finances and home values that we saw in our fourth quarter consumer sentiment survey.

Homeowners continue to believe the value of their home is increasing and report that they are less likely to decrease spending. With consumers more willing to invest in their homes, the job and the income growth forecasted for 2014 should provide the wherewithal for continued home improvement spending. In 2014, we will continue to capitalize on opportunities within an improving economy. We will build on the momentum established in 2013 as we further optimize our business model. We have substantially completed our initiatives to enhance retail relevance, including value improvement, product differentiation and our store labor investment and we will operationalize and refine these initiatives in 2014.

Our top line performance improved this year as a result of our focus on cross-functional collaboration and consistent execution along with our strategic initiatives which allowed us to more fully capitalize on market demand. Now, we are focused on improving our profitability even while investing in key capabilities to drive sales growth.

Over the longer term, we remain committed to satisfying customers’ needs whenever and wherever they choose to engage with us into differentiating with better customer experiences than any other home improvement provider. Determined to be a customer-centered omni-channel retailer, we have been investing in infrastructure, both systems and processes. Our focus on transforming our current multi-channel offering in-store, online including mobile technology, in-home and by phone to an omni-channel experience with our brand. Through enhanced customer service tools, we expect to improve our associates’ ability to sell seamlessly across channels, introduce new project management tools and to expand fulfillment capabilities beyond our bottom line, pickup in store are partial fulfillment of online orders both of which we do today. And we will cultivate personal and simple connections with customers over and above what was accomplished to-date with MyLowe’s. These new capabilities are projected to be in market in 2015.

We will differentiate Lowe’s by delivering better customer experiences. In order to help customers visualize our home improvement projects, we will offer a cohesive group of products that provide relevant occasion-based solutions and will present them in an inspiring manner. Greg will discuss further how we will begin building customer experience design capabilities in 2014.

The commitments we have made to improve for customers and shareholders require unrelenting determination. Completing the transformation we have undertaken is not like flipping a switch, it’s more gradual and deliberate like turning up the dial as we add new capabilities. I want to thank our employees for their dedication and hard work toward this long-term commitment. The momentum created by retail relevance initiatives are strengthening execution and our keen focus on productivity and flow-through give us confidence in our business outlook for 2014. Bob will share those details in a few minutes. Thanks again for your interest.

And with that, let me turn the call over to Greg.

Greg Bridgeford - Chief Customer Officer

Thanks, Robert and good morning everyone. We continue to drive balanced performance in the quarter with strong execution and further momentum from our initiatives. We offset a soft holiday gift giving environment by assisting customers in preparing their home for guests and cleaning and organizing after the holidays. For instance, many customers were looking to replace their older appliances. Using our enhanced sales and operations planning process, we have tightly coordinated advertising, promotions and inventory. As a result, we drew customers to Lowe’s and we met their needs through a broad assortment of innovative appliances, which combined with our service advantages of next day delivery and haul away and in-house facilitation of service calls provides the best in customer service and simplicity.

We also drove strong sales of fashion fixtures both by making incandescent bulbs available to customers working to beat the government deadline and by providing compelling new fashion plumbing products and sets for customers who are refreshing their bathrooms. And we know that winter weather can be unpredictable. So we are ready to respond quickly to the demand for items needed to cope with the January storms across many markets in the northern and central areas of the country. Customers needed snow blowers, space heaters, heating fuels, snow shovels and ice melt as well as pipe fittings to replace those that burst from the extreme cold. Working with our vendor partners, we drove strong performance in these products using our distribution network to quickly and efficiently move them to where they were needed most.

Our performance in the quarter is also a testament to the improved line designs and inventory depth resulting from value improvement. I am pleased to share that at the end of the quarter, we had completely finished the first round of value improvement line reviews and substantially all of the associated resets. We will continue to conduct line reviews in the normal course of business, but the annual volume of resets will be lower going forward. Examples of resets completed in the fourth quarter include core products like pliers and wrenches, décor products such as bathroom vanities and pedestal sinks, and seasonal products such as house and patio plants.

Value improvement is now fully operationalized. This means that the improved line review and product reset processes are woven into our everyday business and are being used at an appropriate cadence for each of our nearly 400 product lines. Even so we expect the initial round of value improvement resets to further contribute to our profitability in 2014 as we obtain a full year of benefits from resets completed over the course of 2013. We are now better positioned to meet customers’ product needs and drive better inventory productivity.

We are also pleased that we modestly leveraged payroll expense in the quarter. We have made the store labor investment more productive by refining our allocation of these hours by store and by selling department. In the quarter we increased sales per hour by approximately 2%. As we lap the introduction of the store labor investment in the first quarter, we expect to obtain even greater leverage which will contribute to greater 2014 operating profit. The store labor investment and value improvement are two of our initiatives designed to enhance retail relevance. Our third is product differentiation, which is intended to drive excitement in our stores through better display techniques including our revised end cap strategy and revamped promotional spaces. Product differentiation has been reset in 1,400 stores to-date and will be rolled to the remaining U.S. home improvement stores in the first half of 2014.

In addition to operationalizing our most recent initiatives, in 2014 we will focus on driving more of our revenue growth to the bottom line through expense control and disciplined execution of our plans. We will also focus on three priorities to drive further top line growth. The first two aimed to capitalize on opportunities within an improving economy. First, we will use our enhanced selling and operations planning process to address micro-seasons by market. And second, we will improve our product and service offering for the pro customer. Our third priority will be to build customer experience design capabilities.

Through our sales and operations planning process, we have addressed an opportunity to improve seasonal planning including the cadence of product introductions, promotions and staffing. While we have always planned and executed these seasons in our stores, previous planning was completed function by function, and then reconciled to minimize conflicts, now the process starts earlier and is anchored on the customer mindset for the season. The process more thoroughly considers detailed input from all functions to determine resource allocation and it enables Lowe’s to provide a consistent messaging experience across all selling channels; stores, Lowes.com, contact centers and in-home selling.

We also have an opportunity to better capitalize on pro market, which is growing faster than the consumer market. We will do this by enhancing our product and service offering with this important customer. While pros shop across the store, the penetration of sales to pro customers is highest within the traditional building and maintenance categories, including lumber and building materials, millwork, rough plumbing, electrical and tools and hardware. So we grouped those categories into the leadership of a general merchandise manager who is focused on ensuring we have the types of products and brands that pros demand.

Of course, winning the pros business also requires great service to make doing business with us as quick and convenient as possible. So we continue to ensure we reach out to pros through multiple channels whether in-store where we have dedicated specialists to answer questions and dedicated loaders to help and get back to the job quickly or the pros’ place of business where our account executives help regional maintenance, repair and operations customers order and replenish products across multiple stores or through the national account representatives who assist the customers doing business with Lowe’s across the country. In the second quarter, we will re-launch LowesForPros.com, which will provide a dedicated platform for pro customers to purchase online from Lowe’s. LowesForPros will also allow pros to access contract pricing, develop requisition list and view purchase history, and LowesForPros will be enabled for convenient mobile access.

We also have an opportunity to more broadly enhance the customer experience. Customers already give us credit for a better customer experience and we are strengthening that advantage. We are developing a process to coordinate the elements of great occasion based customer experiences. To clarify, I would like to define occasion. Customers don’t simply shop for products, they shop to repair something, to replace something, to refresh a room or complete a major remodel. These are occasions and we have the opportunity to build experience around these occasions that will inspire customer diversion, differentiate Lowe’s in the marketplace and ultimately lead to superior business results.

To do so, our customer experience design team is getting under the hood with customers, understanding how they think about home improvement projects, from planning, shopping and buying, to using and enjoying and based on these insights, designing an ideal experience with all channels in mind. Now, that experience must meet three critical criteria. First, it must be desirable to a target customer. Second, it must be feasible, in other words, must fit within our organization’s competencies. And third, it must be viable, something that we can deliver in a profitable and sustainable way.

In 2014, we will begin building these customer experience design capabilities. We also – we will also introduce a number of changes to our stores and website that will become a stage for future experiences. We will invest in experiences that we expect to drive market share growth and solid return for investors. We expect 2014 reset expenses to be approximately flat to 2013 as declining expenses associated with line reviews are offset by increased customer experience design resets.

As Robert said, we continued to turn up the dial of our transformation. Even as we focus on optimizing our business model, driving profitability and capitalizing our market opportunities within an improving economy, we are investing in customer experience and omni channel capabilities to drive future sales growth.

Thank you for your interest in Lowe’s, and I will now turn the call over to Bob.

Bob Hull - Chief Financial Officer

Thanks Greg and good morning everyone. Sales for the fourth quarter were $11.7 billion, which represents a 5.6% increase over last year’s fourth quarter, but was approximately $100 million below our expectations as the result of extreme January weather Robert mentioned. Total transaction count increased by 4.4% and total average ticket increased 1.1% to $63.08.

As discussed last quarter, the Orchard Supply smaller format neighborhood hardware stores are located in densely populated markets and offer a product selection focused on paint, repair and backyard categories. As a result, Orchard stores have more transactions per square foot, but fewer per store and a lower average ticket than a traditional Lowe’s store. So while Orchard aided total company sales by approximately 100 basis points and added roughly 260 basis points to our transaction growth, it negatively impacted average ticket by almost 150 basis points. The Orchard stores are considered non-comp, but will be included in our comp sales calculation after the anniversary of the acquisition in the third quarter of 2014.

Comp sales were 3.9% for the quarter. As you heard from Greg, further momentum from our initiatives and improving execution drove balanced performance in the quarter. Comp average ticket increased 2.4% and comp transactions increased 1.4%. Looking at monthly trends, comps were 3.3% in November, 6.3% in December and 1.4% in January. For the year, total sales were $53.4 billion, an increase of 5.7%, driven by a comp sales increase of 4.8%, the Orchard acquisition and new stores. For 2013, comp average ticket increased 3.2% and comp transactions increased 1.6%.

Gross margin for the quarter was 34.67% of sales, an increase of 40 basis points over last year’s fourth quarter. Value improvement helped gross margin by approximately 40 basis points in the quarter. Also sales mix and lower inventory shrink aided gross margin, but these items were essentially offset by markdowns necessary to clear seasonal product and our proprietary credit value proposition. For the year gross margin of 34.59% represents an increase of 29 basis points over fiscal 2012.

SG&A for Q4 was 26.12% of sales, which de-leveraged 69 basis points. The SG&A de-leverage was driven by a variety of factors. In the quarter we incurred $32 million in expense for asset impairments. This compares to $8 million for asset impairments and discontinued projects last year, resulting in 20 basis points of expense de-leverage for the quarter. Risk insurance de-leveraged approximately 10 basis points due to favorable adjustments experienced last year that didn’t repeat this year.

Property tax expense de-leveraged approximately 10 basis points due to an increase in property valuations and cycling of favorable adjustment from last year. The strengthening U.S. dollar cause losses in market values of forward cash position and forward contracts causing almost 10 basis points of de-leverage. Also building and site repair reset and proprietary credit expenses each de-leveraged about 5 basis points in the quarter. For the year, SG&A was 24.08% of sales and leveraged 16 basis points versus 2012. Depreciation expense was $370 million for the quarter, which was 3.17% of sales and leveraged 56 basis points. The leverage was driven by the increase in sales as well as assets becoming fully depreciated.

Earnings before interest and taxes for the quarter were $627 million, which represents a 27 basis point increase to 5.38%. EBIT was about $15 million below our expectations driven by lower sales and the impairment expense. We are pleased with our efforts to manage expenses to mitigate these two items. For the year, EBIT of 7.77% represents an increase of 72 basis points over 2012. Interest expense at a $128 million for the quarter de-leveraged 11 basis points as a percentage of sales. The increase in interest was attributable to the $1.4 billion increase in total debt relative to last year.

Pre-tax earnings for the quarter were 4.28% of sales. The effective tax rate for Q4 was 38.7% which was consistent with our expectations. The higher rate this quarter relative to the 36.7% last year was driven by expiring tax provisions, which impacted year-over-year earnings growth by approximately $10 million. For the year, the effective tax rate was 37.8% compared to 37.6% for 2012. Q4 net earnings of $306 million increased 6.3% versus last year. Earnings per share of $0.29 for the quarter were up 11.5% to last year. The asset impairment expense resulted in an EPS drag of approximately $0.02 for the quarter. For fiscal 2013, earnings per share of $2.14 were up 26.6% versus 2012.

Now, to a few items on the balance sheet starting with assets. Cash and cash equivalents at the end of the quarter was $391 million. Inventory at $9.1 billion was up $527 million or 6% over last year. Approximately, 30% of the increase was driven by Orchard Supply and the remainder to support demand. Inventory turnover is calculated by taking a trailing four quarters’ cost of sales divided by average inventory for the last five quarters was 3.74 times, which was flat to last year. Asset turnover is determined using the trailing four quarter sales divided by average assets for the last five quarters increased 12 basis points to 1.59 times.

Moving on to the liabilities section of the balance sheet. We ended the quarter with $386 million in commercial paper outstanding. Accounts payable at $5 billion was up nearly 8% to last year. The increase in accounts payable relates to the timing of purchases. At the end of the quarter, lease adjusted debt to EBITDAR was 2.23 times. Return on invested capital measured using a trailing four quarters earnings plus tax-adjusted interest divided by average debt and equity for the last five quarters increased 217 basis points for the quarter to 11.5%.

Now, looking at the statement of cash flows. For the year, cash flows from operations were $4.1 billion. Cash used for capital expenditures was $940 million resulting in free cash flow of almost $3.2 billion, which was a 24% increase over 2012. During the quarter, we repurchased 19.9 million shares for $958 million through the open market. Also in the quarter, we received approximately 1.6 million shares as part of the final settlement associated with the accelerated share repurchase program executed in Q3. For the year, we repurchased almost 87 million shares for a total of $3.7 billion. I am pleased to announce that our board has approved an incremental $5 billion share repurchase authorization. With $1.3 billion remaining on the prior authorization, we had total share repurchase authorization of $6.3 billion at year end with no expiration date.

Looking ahead, I would like to address several of the items detailed in Lowe’s business outlook. As Robert noted, the economic forecast suggests modestly accelerating growth in home improvement industry in 2014. We are optimistic about our improving execution, but with a recent slowdown in both housing activity and jobs growth we have taken a cautious approach to our 2014 outlook.

For the year, we expect total sales increase of approximately 5% driven by a comp sales increase of 4% and the opening of approximately 15 big-box stores in 5 Orchard Supply locations. We expect to have our highest comp in Q1. This is an important quarter for home improvement and the easiest compared to last year. In addition, we expect the first half comp to be modestly higher than the second half of the year. We are anticipating an EBIT increase of approximately 65 basis points. As we have discussed in the past, 20 basis points of EBIT expansion per point of comp above 1% is a good rule of thumb for the year. However, there might be some choppiness quarter-to-quarter.

Let me offer two items that will put some pressure on the flow-through for the first quarter. In Q1 last year, we had a negative comp and reduced bonus accruals. This year we have planned to accrue the target levels resulting in de-leverage of 20 basis points in Q1 while leveraging roughly 20 basis points for the year. Also we will experience risk insurance de-leverage in the first quarter as we cycle favorable adjustments from Q1 last year. This item is expected to de-leverage 20 basis points in the first quarter, but only 10 basis points for the year. We expect EBIT improvement will come from both gross margin expansion and SG&A leverage. Our initial focus during our transformation was on market growth. While market growth is still a priority, we are also focused on flow-through. The effective tax rate is expected to be 38.1%. The higher rate is driven by the expiration of tax provisions at the end of calendar 2013. The higher rate impacts earnings per share by almost $0.01 per share. For the year, we expect earnings per share of approximately $2.60, which represents an increase of 21.5% over 2013.

Our 2014 outlook includes approximately $35 million of incremental expenses associated with the Affordable Care Act or about $0.02 per share. We are forecasting cash flows from operations to be approximately $4.1 billion. Our capital plans for 2014 is approximately $1.2 billion. This results in estimated free cash flow of $2.9 billion for 2014. We expect to issue incremental debt during the year as we manage through the 2.25 times lease adjusted debt to EBITDA target. Our guidance assumes approximately $3.4 billion in share repurchases for 2014 spread evenly across the four quarters.

Regina, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Greg Melich with ISI Group.

Greg Melich - ISI Group

Hi, thanks. I wanted to ask strategically on the store expansion the 15 big boxes, where are they going and also why add Orchard Supply stores, what do you see there and how you are thinking of using them?

Robert Niblock

Greg, this is Robert. On the Orchard Supply stores, I think we got about five of them we are planning for this year. There is a lot of focus on remodeling the existing 72 stores that we purchased. As you know, those stores have not had a lot of investment put in them number of years and we are seeing a nice lift in the remodeled stores. So that’s a big focus. And I think at about 10 remodels or so that they will be able to accomplish this year. So we are continuing to be – any new stores for Orchard are really focused on dense urban metro areas that would have some clear air from a big box, so that you can really focus on being a community store and go to market with the key categories that they focus on. Beyond that on the other 15 stores, we have got about 6 in the U.S., 4 in Canada, and about 5 down in Mexico.

Greg Melich - ISI Group

Okay, great. And then on SG&A, I think Bob you mentioned that proprietary credit only hurt SG&A by 5 bps, did your credit penetration decline or what was behind that in terms of the outlook? Any color you could give on that the test of additional labor you did last year whether you expect to do more of that or how the traction is on that?

Bob Hull

Sure, Greg. I will take the credit question and let Rick speak to you about plans for labor productivity in 2014. So, credit penetration in fourth quarter was 26.5%, which is 160 basis point increase relative to the comparable quarter last year. As we think about the credit de-leverage, there is really – we had some favorable developments in loan loss reserves in fourth quarter last year. We had a little bit less favorable performance this year creating some expense pressure, which drove the 5 or so basis points of de-leverage from a credit perspective.

Rick Damron

Okay Greg, this is Rick. Regarding the labor investment, we made a decision at the end of Q3 to move the test into a permanent part of our staffing model and completed that session this past year. We were very pleased with what we saw as our employees learned more about the store, we are able to get them into departments and get them trained. We saw greater productivity from that, which ultimately led to an improvement in close rate of 80 basis points in Q3 and Q4. So we were very pleased with the results and we do not foresee any incremental investment required or any additional test necessary. We are very comfortable with the investment we made and we will continue to drive greater leverage and productivity through 2014 with it.

Greg Melich - ISI Group

That’s great. Good luck guys.

Robert Niblock

Thanks Greg.

Operator

Your next question will come from the line of Laura Champine with Canaccord.

Laura Champine - Canaccord

Good morning. Thanks for taking my question. Your close rate performance was impressive, how do you measure that?

Bob Hull

Laura, so a couple of different ways, so of late, we have been using satellite imagery. So we take pictures of parking lots throughout the course of the year. We max that up with actual transaction counts in stores. Of late we have been actually using some technology that involves traffic counters in the stores, which gives us close rate by day, by hour, which is going to further allow Rick and the team to optimize labor going forward. We have tested both methodologies for the same stores and got similar results. We are pretty comfortable with the methodology. It allows us to forecast and see actual improvement in close rates.

Laura Champine - Canaccord

Great, thank you.

Robert Niblock

Thank you.

Operator

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

Michael Lasser - UBS

Good morning and thanks Rob for taking my question. I wanted to dig in a little bit on the – some of the investment spending you are going to do this year, so last year you underperformed the benchmark of 20 basis points of leverage for every 1% of comp above and beyond that 1%, and due in part to some of the investment spending. So I guess the expectation was there may be a little bit of a catch up this year. It sounds like you are going to perform in line with your rule of thumb. When - at what point do you start to see the leverage, some of those investments pull back and the flow through really start to hit the P&L or do you have to continually invest in order to maintain that market share?

Bob Hull

Michael, the first part, the rule of thumb, if you take the 4.8% comp and subtract 1, that gives you 3.8 times 20 which suggests 76 basis points of EBIT expansion. We had 72, so we modestly missed the target. Remember, we guide off of GAAP and our target is based off of GAAP. There are some non-operating fluctuations year-over-year, but it is what it is. So I would suggest we are fairly much on our rule of thumb for 2013. Greg, do you want to talk about investments and experiences relative to resets?

Greg Bridgeford

Sure, so as Bob was describing right now, Michael we are going forward and cycling down the massive amount of reset activity that we had through value improvement which is obviously going to allow for more flow through. But we are in the process of testing and piloting some customer experience work within the stores that we think is very important for now for the foreseeable future. There will be more of a balance of the total spend when you look at the resets , remerchandisings associated with customer experience and the decline in the large amount of resets that for the first round of value improvements that we have seen over the last two years. So it somewhat balances out when you look at all the reset remerchandising spend per store.

Michael Lasser - UBS

Okay and a follow-up question is on the $3.4 billion in share repurchases that you are expecting this year, that’s a little bit below what you have done for the last two years, so what’s influencing that part of the outlook? Thanks.

Robert Niblock

Yes, so we have talked about a little cautious outlook coming into 2014. So as a result our comp outlook of 4% is below what we would have intimated at the Analyst Conference in December 2012 for 2014. If you think about 2013, our initial comp outlook was 3.5%. We delivered 4.8%, that’s roughly $650 million higher versus the expected comp plan. In addition, our EBIT was about $175 million higher than plan, which is about a 26% flow through rate. So if the market opportunity is there, we are going to capitalize on the opportunity and we are going to deliver enhanced profitability.

Michael Lasser - UBS

Okay. Thank you very much.

Operator

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

Brian Nagel - Oppenheimer

Hi, good morning. Congratulations on a nice quarter.

Robert Niblock

Thanks Brian.

Brian Nagel - Oppenheimer

I wanted to ask a question, this will be a quick one, just on the weather. You mentioned the weather, a lot of (indiscernible) talked about the weather, but is there a simple way we should think about what impact the weather had upon that comp and what the comp would have been had it not – have you not seen the weather. And then as a follow-up to that what about gross margins, was weather a cause for negative gross margin in the quarter? Thanks.

Robert Niblock

The $100 million that I have referenced is approximately 100 basis points in the comp Brian. So it would have taken the 3.9 to approximately 4.9. And then as it relates to gross margin, I mentioned mix had a modest positive impact based on the mix of products sold, so slight favorable impact on gross margin rate.

Brian Nagel - Oppenheimer

Okay. And then and I don’t know if weather has actually turned in any part of the country yet, I am sitting in Nashville and it’s still pretty cold here. Are there parts where you have seen the weather start to turn and do you have any indication that you are seeing in sales in those markets so far?

Robert Niblock

Yes, Brian, this is Robert. Obviously, that was an extreme weather and as I mentioned in my comments, Bob gave you the impact that we thought it had on the fourth quarter. But in those parts of the country where we have seen the weather improve or where we haven’t been as impacted by the extreme weather, we have been pleased with the comp performance we are delivering, so.

Brian Nagel - Oppenheimer

Okay, thanks a lot.

Robert Niblock

Thanks Brian.

Operator

Your next question will come from the line of Aram Rubinson with Wolfe.

Aram Rubinson - Wolfe

Hi, thanks. Thanks for taking my question. Two quick things, if it’s okay. One, I am still trying to make sure I understand this customer experience. It sounds great, but can you guys walk us through kind of for instance or two to make sure that it kind of clicks in my mind? And then I had a follow-up.

Greg Bridgeford

Sure, Aram. It’s Greg, I will be happy to. So when you go back to the question that we talked to – Michael talked to about a minute ago with investment spend, some of the programs that we are testing right now have to do with going deep into customer research and see what’s important for customers and make sure that we can start to build an experience that hit the attributes that they are looking for both from all phases of a project, all the way from inspiration, to planning, to getting started, to getting supplies all the true enjoyment. I mentioned to you a couple of years ago that we devoted six research – some research analysts from our research team to the merchants to begin this process a couple of years ago. So for instance going on right now and we are probably about half way through this reset. We have looked at the fashion bath area, and it was a challenge for customers to try to pull together a bath refresh project. They don’t go behind the wall in a refresh, but they potentially change out faucets, vanity tops, mirrors, lighting, a lot of details on the – kind of on this side of the wall of the bathroom.

So what they told us that they wanted was, they wanted to visualize the results of this project. They wanted to bring, they struggled to bring style and finishes together and look across the entire array of fixtures and accessories. And they want to understand what this looks like in end use, but they also wanted to touch and feel of the projects, with the different products. And they wanted styles that met their taste. So what we did was we literally created pods, these are 8 foot to 16 foot pods to bring these different styles and finishes together in these categories, faucets, bath, hardware bath lighting, mirrors, wall surfaces and even countertops. And then, in these pods we brought the height down.

So literally all of these projects, these products would be within reach of the customer, which was an important aspect of the shop for them. And then, with the work we have been doing through the value improvement program and the cluster work that we have been using, we are able to localize those assortments. So when they go into the store that’s in their market, those styles and those finishes and even things like a four inch center spread or an eight inch center spread for a faucet will be more relevant to that market than before we entered into this process. So we are trying to bring all of those elements together that reflect the needs that they told us they really that provided them value and inspired them in a bath refresh project. So its baby steps in a process that we are engaging in, we are piloting, we are learning from some of these first few projects, but you will see more of it as we move into the latter part of 2014 and certainly in 2015.

Aram Rubinson - Wolfe

Great, that was such a helpful response. So I think I will spare you my second question and pass on the queue. Thank you.

Greg Bridgeford

Thanks, Aram.

Robert Niblock

Thanks, Aram.

Operator

Your next question will come from the line of Seth Basham with Wedbush.

Seth Basham - Wedbush

Good morning. I wanted to follow-up on that regarding the customer experience design and that was a really helpful response, I agree, but if you could help us understand a little bit in terms of the cadence of investment and then the expected benefit in 2015? That would be helpful. I have a follow-up.

Greg Bridgeford

These are a rotating series of programs. In ‘14, you will expect – you should expect that we will do a lot of piloting as we learn what’s working within these different tests. We will be at trial in probably five or six categories, but it will be stretched out through the year. So, we will begin to see the payoff until ‘15 in virtually all of these different projects. The bath refresh, we might see a payoff in this latter part of ‘14, but I would say for the other pilots that we are doing, we will see returns begin in ‘15. And when you think about the returns in some cases it’s going to be – it’s going to come back to us in different ways. For example, if we do an outdoor living reset and we accessorize product with the, what we call, the anchor product of a project, for example, accessorized complete patio set. One of the goals there would be to sell the set with the accessories at full price prior to the end of the season. That has significant financial implications in that category. That’s different from the timing and the type of project that you are engaged in if you are doing a bath refresh.

In that case, it might be able to create that entire look of product and to be able to offer installation services and whether we would be able to offer the complete project installed for customers. So, there is different financial components that will be part of the outcome and that because that we are trying to build these experiences around the attributes that customers are saying, these are gaps – these are gaps or pain points in my current experience. So as I said earlier, that as we approach these customer experience design, we have to make sure that we have the capabilities to offer these attributes to customers and meet them and we also need to make sure that these produce the financial results that are sustainable. So, we look – we start with the customer, we look at the potential to recreate that experience. We look at the attributes that we are going to offer, make sure they fit our capabilities and make sure we have clear understanding of the financial outcome. And it can be very different based on the occasions that we are trying to serve the customers through experience design.

Robert Niblock

Just to tie back to Greg’s comments and part of your question and remember because he talked about the amount of investment we are making on in-store resets as we are rolling off all of the line review, value improvement resets, but he said the amount of reset activity would be fairly similar year-to-year, last year to this year, because we are now – because some of the customer experience resets that Greg talked about that we will be investing in.

Seth Basham - Wedbush

That’s really helpful. And just a follow-up, I mean, these investments play right into the increase we are seeing in big ticket comps relative to small ticket comps, can you give us those metrics for the fourth quarter and else how you expect them to play out during ‘14 and ‘15?

Greg Bridgeford

So in the fourth quarter, the tickets above 500 were 8.9% comps, tickets below 50 were 1.2% and the middle was – the 50 to 500 was 2.2%. As we think about the four comps in 2014 about two-thirds of that will be driven by ticket, one-thirds by increasing transactions. So we do expect to see continued performance in the above 500 category.

Seth Basham - Wedbush

Great, thank you.

Operator

Your next question will come from the line of Keith Hughes with SunTrust.

Keith Hughes - SunTrust

Thank you. Just to dig in on your last answer on the 8.9% on the growth in 500 tickets, within the categories were there any ones that stood out there to help drive that number?

Bob Hull

The biggest one in the fourth quarter was outdoor power equipment. We also had strength, which is snow throwers and then appliances and fashion fixtures those were the three categories that propelled the big ticket growth in the fourth quarter.

Greg Bridgeford

And Keith also flooring was a strong category. This is Greg. And it always tells you a lot about the weather, when your top selling sub-category is snow throwers. We hit historical highs in sales of snow throwers.

Keith Hughes - SunTrust

I am sure you have in places, where you normally don’t have historical highs. One follow-up question, you had mentioned about more installed sales, can you elaborate that a little more? Are there certain categories you are going to be pushing more on that or any detail will be helpful?

Rick Damron

Yes, Keith, this is Rick. As we look – think about installed sales, we continue to see strength across all of the major drivers of our programs this past year. As Greg mentioned, flooring performed extremely well and we continue to see growth in that category as customers look to update flooring into new styles and new trends. The other components of that, Keith, that we have invested in over the past couple of years have been our in-home selling models as we talk about our strategy to be able to meet customers anytime, anywhere they like, we realized that in-home was a major component of that. So we now have our project sales exterior specialist in all stores, in all markets across the country. We also have our interior specialist programs which we had significant test for the past couple of years in two regions and some other geographical areas. We are continuing to roll that out in 2014 and we will grow that into five additional regions in this upcoming year.

Keith Hughes - SunTrust

Okay, thank you.

Operator

Your next question will come from the line of Kate McShane with Citi Research.

Kate McShane - Citi Research

Thank you. Good morning.

Robert Niblock

Good morning.

Kate McShane - Citi Research

My question is on gross margins, I am just wondering how you are thinking about managing this going forward, while you continue to push the gross margin higher and if so will that be reinvested or flowed through?

Robert Niblock

So Kate, if you think about our outlook back from the Analyst Conference in December of ‘12, we talked about a third of the EBIT improvement coming from gross margin, which is about 90 basis points. In 2011 and 2012 our gross margin fell roughly 84 basis points. So really, we are just talking about recovering back to 2010 levels. Once we do that, we don’t expect significant margin expansion on annual basis, after that, it’s more of a maintenance mode.

Greg Bridgeford

I think, Kate, this is Greg. I would also say that the work we do in sales and operations planning, I think tries to create the proper balance between driving transaction, driving ticket. And in doing so, we try to drive basket builds. So the outgoing gross margin is something that is accretive for us. So it’s a good mix that we have been getting better and better I think over the last 18 months since we have instituted this process of making sure that what we direct customers to through our advertising and through our in-store merchandising, it creates the gross margin outcome that we want as we drive the entire basket of attachments and anchor items.

Kate McShane - Citi Research

Okay, thank you.

Operator

Your next question will come from the line of Mike Baker with Deutsche Bank.

Mike Baker - Deutsche Bank

Thanks. Two questions. So, since you keep referencing that December 2012 outlook, I think of that outlook, you talked about 9.7% operating margin, even with the 65 basis points that you talked about in 2014 you will be away from that. Can we still expect 9.7% by 2015 which would imply a pretty big jump in 2015 versus ‘14?

Bob Hull

So Mike, as we think about the rule of thumb of 20 basis points of EBIT expansion for point of comp, hopefully we will see strength in 2014 and be able to over-deliver above the sales and EBIT plan in 2014, which would suggest a much lesser increase required in 2015. So simple math, if you take a look at the rule of thumb, that would suggest 20 basis points for point of comp above 1, a 5.5 comp in 2014 and 2015 gets you there. However, if there is a more modest comp and there is an opportunity to further focus on expense productivity, there might be another way to get there. So, we do have line of sight to drive market growth and enhance profitability was as through line design and building baskets, as Greg just described or as Rick talked about, further optimizing the labor investment we have already made in our stores, we are really focused on that.

Mike Baker - Deutsche Bank

Okay, thanks. So that was my longer term question, the short-term one, so first quarter is guided above 4%, is that what you are seeing in February or is it more of a function of March it was – I think last March was down 10%, so very easy comparison coming, but then again of course April was a tough comparison, so where are you I guess relative to that 4% – higher than 4% plan for the first quarter?

Bob Hull

So we did have a negative comp in the first quarter last year. The first two weeks of February were tough. Trends have improved significantly since then and we are very comfortable with our outlook for the first quarter and for the year.

Mike Baker - Deutsche Bank

Okay, thank you.

Bob Hull

Thanks Mike.

Operator

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

Scot Ciccarelli - RBC Capital Markets

Hey guys. Can you provide any more color in terms of what you are seeing on the pro or contractor front, and frankly I don’t know how granular you can get, but what kind of impact do you expect as you start to expand the services and products for the pros as you previously referenced?

Rick Damron

Okay, I will take the first part of that and I will let Greg jump in on the categories and products. Scot, we had been very pleased. As you know, we have been focused on the pro extensively for now for about the past 18 months and looking at how we went to market and the opportunities or guests that we saw that we needed to close to continue to gaining share and be more relevant with the pro. We have completely redesigned our operating model regarding the pro this past year, which really took place in January and how we went to market from a service perspective with the pro. And Greg referenced that this morning as we talked about our in-store specialists meeting the needs within the local market. Then we also redefined our account specialists in the market to really go after the larger MRO accounts and contractors within the market to give us the ability to meet them on their job sites or in their place of business. And then also we established our national accounts team which focuses on those pros who deal with us across many states and many stores and make it much more simple for them to shop with us.

The other components of that, that we have really took and really made sure that we continued to evaluate was the value proposition. As you know, the pro receives 5% value product discount on anything on proprietary credit. That continues to resonate well with the pro as well as our Close Program on very large orders. And then also the value that our Contractor Pack program provides which is really purchasing bulk quantities within the stores. So we think we really addressed that with looking at how we went to market from a service standpoint, also providing great value everyday to the pro. And then quite frankly, we are extremely excited about the relaunch of LowesForPros, which will happen late Q1, early Q2 this year, which provides them much greater access to product as well as to purchase history and purchase information. So Greg, I don’t know if you want to talk a little bit about price.

Greg Bridgeford

Thanks Rick. I think Rick really described very well our ability to deliver in a sense the delivery system against expectations for the pro. And so the key is that I want to talk about is, what do we have to deliver, what’s the content. So we spent, if you go back in the last two years, we spent a significant amount of value improvement, process improvements on looking at the categories that are extremely relevant, have a high penetration of pro sales, whether that’s hardware tools, rough plumbing, rough electrical, power tool accessories, handheld power, hand tools, building materials and we have tried to make sure that from an – and as you know, we have also tried to make sure so if we get our cross structure, right, try to make sure form an inventory standpoint that we have the proper inventory. We have worked hard. We have been very avert about what we have been doing with inventory, specifically focused on the categories.

Earlier in 2013, we said we need even a greater focus on this. So we have subdivided merchandising. When Mike Jones came in, one of the first things he did within three months was subdivided the merchandising divisions and put a heavy focus on what we call the building and maintenance categories with a new GMM. That’s provided the kind of longer term strategy and shorter term tactics that we think we need to meet the needs of the pro and to address all the attributes that’s important for them.

So we have got a very, very heavy focus on it right now, what’s the proper offering and for this discrete type of pro customer, for this segment, whether it’s an MRO customer, whether it’s an R&R customer, and are we meeting those needs. And we are using research for going back to the basic approach with the experience design. Even in building and maintenance, we are saying, okay, what are the experience attributes that are important for these sub-segments. So armed with that we are building longer term strategies to be important for that customer and shorter term tactics that we think can optimize this great category, this great business, one of the best businesses at Lowe’s and one that we have a long, long history. When Rick and I joined Lowe’s, sales to pros were 60% in terms of our sales mix, so we both are dedicated to seeing relevance in this category.

Scot Ciccarelli - RBC Capital Markets

Excellent, thanks a lot guys.

Robert Niblock

Regina, we got time for one more question.

Operator

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

Peter Benedict - Robert Baird

Hi guys. A couple of questions here, first a week or so ago you guys outlined your spring seasonal hiring plans, I think you said like 25,000 associates this year, that was down pretty materially from last year, just could you give us some color as to what drove the decrease?

Rick Damron

Sure, Peter, this is Rick. As it relates to the announcement from last year, keep in mind, some of the changes that we implemented last year. The weekday team that we hired was a component of that announcement last year, with the 40,000 hires that we announced last year versus the 25,000 hires this year. As I said earlier, those positions moved from temporary or seasonal into regular or part-time positions throughout the year. So when you look at that, we were able to maintain a much higher base of level of employees this year compared to the previous year, which frankly, helps us from a training perspective and on boarding perspective and we were able to carry those employees throughout the year, versus having to go so heavily into the spring hiring process. We were able to continue to manage our full-time, part-time mix to give us much greater flexibility and help us manage the payroll in a – during Q4 especially in the latter half when the weather really turned bad, gave us the ability to use that flexibility to continue leverage payroll but also maintain our existing employee base. So we were carrying many more employees through the winter and in the addition of the weekday teams also helped us to be able to pull that number down.

Peter Benedict - Robert Baird

Got it, that makes sense. And then just two quick ones for Bob, Bob you mentioned that the reset expansion in ’14 will be flat relative with 2013. Can you remind us – and I apologize if you mentioned this already, how much reset expense was incurred in 2013? And then on the depreciation line, obviously, D&A was down around 10% in the fourth quarter on a year-over-year basis, can you help us understand what your outlook for 2014 assumes in terms of D&A on the income statement? Thank you.

Bob Hull

Yes, so depreciation should be flattish from a dollar perspective, 2014 versus 2013, which drives some modest leverage as a percent of sales. As we think about the reset expenses, we haven’t broken out the specific aspect of resets. We have talked about maintaining our stores, giving them the updates that meet, whether that’s the physical property or the updates to the product space and customer experience that Greg described. So that’s kind of embedded in our operating model going forward is based on part of maintenance CapEx if you will.

Bob Hull

Okay, great, thanks guys.

Robert Niblock - Chairman, President and Chief Executive Officer

Thanks for your continued interest in Lowe’s. We look forward to speaking with you again when we report our first quarter 2014 results on Wednesday, May 21. Have a great day.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you all for joining. And you may now disconnect.

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