Lowe's Companies, Inc. (NYSE:LOW) 2018 Analyst & Investor Conference Call December 12, 2018 9:30 AM ET
Tiffany Mason - Treasurer and Senior Vice President, Corporate Finance
Marvin Ellison - President and Chief Executive Officer
Bill Boltz - Executive Vice President, Merchandising
Joe McFarland - Executive Vice President, Storage
Jocelyn Wong - Chief Marketing Officer
Jennifer Weber - Executive Vice President, Human Resources
Don Frieson - Executive Vice President, Supply Chain
David Denton - Chief Financial Officer
Seemantini Godbole - Executive Vice President and Chief Information Officer
Greg Melich - MoffettNathanson
Simeon Gutman - Morgan Stanley
Eric Bosshard - Cleveland Research
Mike Baker - Deutsche Bank
Laura Champine - Loop Capital
Michael Lasser - UBS
Brian Nagel - Oppenheimer
Jason Haas - Bank of America
Chris Horvers - JPMorgan
Scott Mushkin - Wolfe Research
Joe Feldman - Telsey Advisory Group
Peter Benedict - Baird
Unidentified Company Representative
Please welcome Treasurer and Senior Vice President of Corporate Finance, Tiffany Mason.
Good morning and welcome to Lowe’s 2018 Analyst and Investor Conference. It’s a pleasure to have you with us today as we introduce new members of our executive leadership team and share our strategic priorities. Today’s program includes a series of presentations, followed by a short break and then our financial update as well as an extended Q&A session with all presenters.
Before we get started, please note that throughout these presentations, you will hear comments about our expectations and beliefs, which constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. 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 and are further described in the company’s annual report on Form 10-K and in its other periodic filings with the Securities and Exchange Commission.
Also in today’s presentations, we will be using several non-GAAP financial measures when discussing our performance and financial condition. You can find information on these non-GAAP financial measures and a reconciliation to the most directly comparable GAAP financial measures posted on our Investor Relations website. You will also find an explanation as to why Lowe’s management believes these non-GAAP financial measures are useful. Thank you again for your attendance.
And now, it is my pleasure to introduce our President and Chief Executive Officer, Marvin Ellison.
Good morning. Hey, thank you Tiffany. I am honored to be here today as your President and CEO of Lowe’s. And as you can imagine, I have had a very busy and fulfilling 5 months here and I want to begin today to give you a few of my observations.
First, Lowe’s is a terrific company with an outstanding brand and a powerful balance sheet. In this really challenging retail landscape, Lowe’s is fortunate to operate in a sector with strong demand. We also have great people, over 310,000 associates in our stores, distribution centers, call centers and store support centers, who are resilient and committed to serving the customers and our communities. And without question, our associates are our greatest asset as a company. These early observations along with a very engaged and supportive Board of Directors give me confidence that we have a great foundation to build on. As many of you know, I competed against Lowe’s for 12 years. And during that time, I gained a lot of respect for the company and the culture. And I remember how fierce a competitor the company used to be. So, when I took over CEO in July, I began a comprehensive reassessment of the business to understand a couple of things.
First, I want to see why it seemed that we had lost our competitive edge. Second, I want to understand why we were underperforming in the market. But more importantly, I wanted to understand what it would take to once again make Lowe’s a best-in-class retailer, a retailer that provides outstanding experiences for customers, a great place for associates to work and one that delivers better, more consistent returns for shareholders. Therefore, the past 5 months, we have had a complete reassessment of the business, established a new leadership team and worked with that team to develop action plans to regain the competitive edge that will return us to best-in-class performance, plans that we will share with you today.
So, let me take a step back and let’s look at the opportunity here at Lowe’s. We continue to see a strong macroeconomic environment for home improvement. And although interest rates have ticked up and housing turnover has been pressured, consumers are still investing in their homes. And as you can imagine, we modeled hundreds of thousands of macroeconomic data points to understand the key drivers of our business. But through that work, we have found that real residential investment, home prices and income growth have the strongest correlation with our business. And while we love helping customers with big discretionary projects, two-thirds of our business is based on repair and maintenance work. And given that the average U.S. home is approximately 40 years old, we see a great deal of potential for our categories to serve customers’ ongoing repair and maintenance needs.
Our company is well-positioned in a large and growing nearly $900 billion home improvement sector, which is very fragmented outside of the top two players. And although I understand why the top two players garner so much attention, the truth is our success isn’t mutually exclusive. Given the large home improvement marketplace and the fragmented nature of the space, we don’t see this as a zero-sum game. In other words, this is not a win-lose proposition. And although we have a major competitor in this space, combined we have less than 20% market share, so we have room to grow in both pro and do-it-yourself. And although the DIY customer will remain a very important customer to us in order for Lowe’s to achieve the revenue and sales productivity that we desire, growing our pro business is going to be a major priority. Also despite the favorable macro environment, we have not performed to our potential as a company. Therefore, we believe that we have a significant opportunity to grow market share by addressing our poor execution. And by doing this, we will create our own financial tailwind. We look at the opportunity for growth in the DIY and pro areas and we feel great about the future here at Lowe’s.
So, now let me take a few moments and discuss what drove Lowe’s to under-perform the market and give you a quick update on the current state of the business. So, as some of you may remember when Lowe’s led the industry in terms of supply chain capabilities, pro and store experience. So what happened? Well, simply stated, the company shifted its focus and lost its way. We undertook initiatives that did not add value to our core retail business. We exited national brands in pursuit of better margins, which dramatically hurt our pro business. In addition, we lost expertise in store operations and in merchandising. And we failed to keep up with advancements in e-commerce, IT and supply chain. So as I mentioned earlier, we rolled up our sleeves.
And over the past several months, we have conducted really detailed business reviews with all of our functional leaders. I spent time with suppliers. And some of my most valuable time has been spent engaging with our customers and our associates across our 14 U.S. regions, Canada and our maintenance supply headquarters businesses. In the time I have spent with our associates, their talent, their resilience and dedication to serving the customer really stood out to me. But what also became evident was despite their best efforts to serve customers we have put our associates at a competitive disadvantage with outdated and cumbersome systems. And as many of you witnessed 2 weeks ago, our challenging IT infrastructure was evident on Black Friday when we experienced system outages. This system failure presented to the outside world what our associates deal with on a daily basis. It was an embarrassing moment for the company, but one that presented our current state to the world. However, these challenges reflect where we have been, but not where we are going and we will fix these issues.
In addition to the omni-channel systems, we have work to do to improve our associate and our customer-facing systems. And as an example, let me walk you through how we currently manage large, complex install projects. So, while I was visiting a store recently, I posed a question to a group of associates. I said, okay, I am a customer. I am buying flooring, cabinets, countertops, a suite of appliances, so that kind of equals a kitchen remodel, right. So I said to the team how do we manage this kitchen project for the customer? So, you want to know what the associates showed me as our project management system, a dry erase board in the back of the store. So after I got past the shock, I had a follow-up question. I said, well, the customer didn’t have a dry erase board. So how did they keep track of the project? Their answer, well, Marvin, we give them a binder. So dry erase boards and binders as a project management system, hard to believe that a retailer our size with our balance sheet is working with these systems in 2018. But this is the position we put our associates in. So, the question I asked myself is, how much would our sales and customer engagement improve with modern systems? The answer to that question creates a lot of energy and motivation for me and the new leadership team.
So now that we have identified the opportunities, what are we doing about it? So today, we are going to tell you more about how we are getting back to the basics and sharpening our focus on driving sales. We have plans in place to capture all of the opportunities the leadership team and I have identified over the past 5 months. We have two great advantages to solve these issues and quickly modernize the business. Number one, we have assembled a leadership team with subject matter expertise and deep experience. And this is the lineup of the leaders that you will hear from today. Number two, we have a great balance sheet and the financial wherewithal to reallocate capital to invest in our core retail business.
So, let me spend a moment discussing the importance of experience in three key leadership roles. So, at the beginning of this year, our senior leaders for merchandising and store operations had a limited amount of home improvement experience and expertise. Today, our Executive Vice President of Merchandising, Bill Boltz and our Executive Vice President of Storage, Joe McFarland, have a combined 55 years of home improvement experience. Also at the beginning of this year, our Chief Supply Chain Officer had no previous supply chain experience when he was placed in the role. Today, our Executive Vice President of Supply Chain, Donald Frieson has over 30 years of supply chain experience. I am a big believer that experience matters specifically in key roles in retail.
Now, let me quickly remind you of the progress we have made thus far. So let’s begin with the organizational structure. We have aligned our leadership team to improve our focus, our execution and our decision-making. As I just mentioned, we recruited seasoned executives with extensive retail and technical experience who will establish the necessary building blocks to create a world-class omni-channel environment. This new leadership team has what I call been there, done it skill set. In other words, they faced similar challenges before in their careers and have a track record of success. We have also aligned our portfolio to focus on our core home improvement business. And as you remember, part of the focus was we closed Orchard Supply Hardware operations, we decided to exit the Mexico market as well as Alacrity Renovation Services and the Iris Smart Home business. We also streamlined our real estate portfolio, which resulted in closing underperforming stores in the U.S. and in Canada.
In addition, I tasked the team to aggressively rationalize our store inventory to remove clutter and reduce lower performing inventory. We completed that effort in the third quarter and now we are investing in top-selling SKUs in job lot quantities for our pro customer. These decisions were not easy. But we believe they were the right decisions for Lowe’s and we are working hard to create a true expense reduction culture. No longer will we throw payroll to our problem, instead, we will rigorously scope it out, we will identify the root cause, we will implement technology to improve process and systems and to ensure we drive improved return on invested capital we have implemented a more rigorous process for capital improvement. It is important for you to know that we are running Lowe’s differently and doing so in a way that sharpens our focus on what I call retail fundamentals. And while you hear us discuss certain initiatives today that maybe reminiscent to things you have heard Lowe’s mentioned in the past, the expertise, the operational discipline, the focus of this leadership team will allow us to successfully execute on these strategies and capitalize on the opportunity that’s in front of us.
So, let me know transition into how we will take advantage of this opportunity we have in front of us. So to do this, we are going to stay true to our new mission statement, delivering the right home improvement products with the best service and value across every channel and community we serve. This mission is not fancy or overly ambitious, but it defines what we will stand for each and everyday as a company. We will achieve this mission by winning in four key areas: merchandising excellence, omni-channel, operational efficiency and customer engagement.
So, let’s start with merchandising excellence. This simply means having the right products in the right place at the right time, so that our customers can shop anyway they choose. To deliver merchandising excellence, we are working to improve productivity, drive localization and streamline our reset process to improve our execution. Bill Boltz will outline our merchandising excellence initiatives in more detail shortly.
Our next strategic focus area is omnichannel. Our aim is for Lowe’s to be a great omni-channel retailer, serving customers the way they want to be served. We will deliver a great omni-channel experience by enhancing the overall customer experience, advancing our fulfillment and delivery capabilities and delivering operational excellence. Today, approximately 60% of all online orders are picked up in a store. This underscores the importance of omni-channel experience for home improvement. Omni-channel is where we think our transformation is going to play out. You will hear more about our omni-channel initiatives from Don Frieson and our new CEO, Seemantini Godbole later today.
Now, moving on to our third strategic focus area, operational efficiency. To deliver operational efficiency, we will focus on simplifying store operations. Not only will simplification improve the customer experience, it will unlock operating profit for the entire enterprise. And as we mentioned many times before, everything in retail begins with being in stock. Therefore, we are working hard to improve in-stock execution to better capitalize on the traffic we are driving to our stores and our website. And as a company, we will become more operationally efficient.
Our fourth and final focus area will be intensifying customer engagement. At the core of this objective is winning the pro. We have a tremendous opportunity to grow this portion of our business. This is a customer that is very important, because the typical pro spends 5x as much as the average DIY customer. And although the pro is an important customer, it’s a customer with very basic expectations. And my experience has taught me that in order to win market share with the pro customer, you need to do five things well. First, you have to offer competitive prices, including strong value proposition for volume purchases. The pro customers are extremely brand loyal so you must also stock products with brands that resonate with them. Next is it important to deliver a consistent level of service, because for pros time is money. Then you must demonstrate to the pro that you value their business by providing a differentiated experience.
And finally, it’s important to build a relationship with the pro to make it easier for them to run their business and to demonstrate that you have a genuinely understanding of their need. So later today, Joe McFarland will provide specific details on how we will improve the pro business and drive operational efficiencies. In addition, Jennifer Weber will outline how we will drive improved associate engagement across the company. And you will hear from our Chief Marketing Officer, Jocelyn Wong, who will share with you how we are establishing a stronger connection with our customer while focusing on marketing productivity.
So, what you are viewing on this slide is not content for a series of fancy wall posters or a list of slogans. What you see here is our operational plan. Every initiative has a designated captain supported by cross-functional team. And my direct reports from now meet weekly to review progress reports and scorecards for these cross-functional teams. As the old golf saying goes, we will inspect what we expect on these key initiatives. And as I mentioned earlier, we are simply running Lowe’s differently. So, what do we believe these initiatives will be worth to the business? We believe over the next several years we can deliver an operating margin of 12% and return on invested capital of 35%. Dave Denton will provide specifics on both the short and long-term value we plan to generate from the initiatives we will outline today.
And as I think about the timeline of our transformation here at Lowe’s, I view it in phases. The first phase of our transformation will be all about focusing on retail fundamentals that will allow us to capitalize on the immediate opportunities and improved results. The next phase over the next 18 to 36 months will be about driving sustainable growth. And the last phase is focused on taking market share. The initiatives we will discuss today with the exception of supply chain will rollout over the next 12 to 18 months resetting the bar for 2019. But let me be clear, we are not waiting 18 months to deliver financial improvement. It is our expectation that we will experience continuous improvement as we work our way through each phase of this transformation plan. The leadership team and I are very excited today to outline these initiatives for you.
But before I conclude, I would like to discuss our business in Canada. The RONA integration continues, including the execution of our e-commerce strategy and the rollout of appliances and the optimization of shared supplier partnerships and procurement efforts continue. And similar to the U.S., we are implementing plans in Canada to improve execution, expense discipline and operational profitability. And although comps have experienced some pressure recently stemming from a weaker Canadian housing market, we continue to take share and believe the business is poised for long-term growth.
So in closing, some of you maybe disappointed that we are not going to spend time today updating you on our strategies to leverage virtual reality in home by outlining the importance that artificial intelligence will play in our decision-making. Don’t be concerned, these are very important elements of our current and our future strategy. However, I felt today you should be more focused on providing you with a transparent view on the current state of Lowe’s while giving you a clear line of sight on our immediate plans to improve our retail fundamentals as part of our three-phased blueprint. As we say, we are from Tennessee we decided to bake the cake before we started to serve you frosting. This is a new day and this is a new Lowe’s. I expect that we will renew our focus on retail fundamentals that we will outline today. We’ll capture market share opportunity and generate significant cash flow over the next several years. And as we focus on our core retail business and optimize capital allocation, I believe we will make Lowe’s an investment that will yield meaningful long-term returns for all of our stakeholders.
I want to thank you again for being here today. And now I am pleased to turn it over to our Executive Vice President of Merchandising, Bill Boltz.
Thanks, Marvin. Good morning, everyone. It’s a pleasure to be here as part of the Lowe’s team. A year ago, I was on the other side of the business working with the team as a vendor. And I thought that Lowe’s had done a pretty good job of recognizing and understanding the expectations of an omni-channel retailer. The challenge was that Lowe’s did not have the right systems, processes or focus to execute on that vision. And since joining Lowe’s 4 months ago, I have been able to get an inside look at the state of merchandising and have made several key observations.
Let me begin with category management. Today, we do not have a category management strategy to govern our resource allocation. And as a result, we are not aligned to a customer need or our product placement decisions have been more national rather than market-specific leading to lower sales productivity. For example, we have used valuable endcap space as showrooms rather than placing product that drives customer interest in traffic. You can see here that we have used 3 endcaps in our stores, sometimes as many as 4 for smart home devices in the same aisle and we weren’t tracking any productivity targets in this space in terms of sell-through or profitability. We were focusing on an emerging trend. However, it was done without the understanding of how it connected with the customer and their expectations.
We had also fallen out of step with the pro. There have been a lack of focus on the depth of inventory, the right pricing and the products that they expect. In fact, we lost some critical brands years ago, because there was a focus on margin rate rather than the understanding and responding to the comprehensive needs of that important customer. We also found that our online assortment was lacking with a significant SKU deficit versus the competition again, creating lost sales and a lack of localized assortments has also led to lost sales and a lower productivity in many of our markets. For example, this endcap in Bullhead City, Arizona is a national endcap of Dyson fans. Now if you are familiar with this market, the average household income in this market is roughly $31,000 a year. So while Dyson is a great product and a great brand, an average price point north of $300 for a fan might not have been our best choice for an endcap in this store.
And then finally, our reset execution has been poor. It’s lacked process, structure and discipline, leading to slow ineffective reset activity: out of stocks, lost sales and a huge distraction for our store associates. So having seen all this, we recognize that we have a significant opportunity to improve performance by just executing at a higher level. And to do that, we are focused on the retail fundamentals and that means being focused on the right things, the basics, blocking and tackling and really a need to keep it simple and so within merchandising, it all starts with sales. Now that sounds obvious, but we have to create a sales-driving culture.
And to do that, we have to improve our productivity by establishing and implementing the category management process. We know that we haven’t maximized our sales per square foot, because we haven’t consistently tracked it. And as we visited stores and we have talked to our merchants and our store associates about the sales productivity of those specific endcaps or other critical areas of the store, we were surprised at the limited sales information that they had at the store level. This lack of information has prevented us from having a significant focus on driving sales productivity. So, we need a cohesive strategy to determine what we focus on, where we invest and how we are going to assort our products in the store and online. And we know that up until now, we haven’t allocated our resources to the areas of greatest opportunity. We also know that we have to do a better job at meeting the needs of the customer at the market level. And to do that, our merchants have been meeting with suppliers to make sure that we are focused on the right brands and the right products to deliver these localized and relevant product assortments that are driven by the needs of the customer. And we must improve our speed to market.
We know that we have a lot of room for improvement to do things better, to do it more efficiently and with a greater sense of urgency. And we know that retail is a race. And so as a merchant team, we know that we have to move faster. And we have to execute with a greater precision to capture on these market opportunities. As a former vendor to Lowe’s, I understood firsthand how difficult it was to get decisions made and to launch a new product. So, improving our reset and our in-store execution process is a huge part of improving our speed to market. And going forward, we are committed to having and delivering on merchandising excellence. And that’s really, just as Marvin said, having the right products in the right place at the right time, so that our customers can shop with us anyway that they choose. And we are establishing a rigorous category management process to drive better sales productivity both in our stores and online. Using a customer-centric analytics based approach, we will define the role of each category at Lowe’s and identify the inherent category opportunities in the headroom in order to make intentional and resource allocation and focus on those areas of greatest opportunity for the business. The category definitions that we have landed on are choice, traffic driving, destination, core and convenience.
Now choice categories are those in which you offer multiple options, you can include both national brands as well as private label product. Traffic driving categories capture the customer interest with great offers and value and they are designed to be highly competitive and disruptive. Our destination categories are the ones that cause customers to drive past other retailers to come see you. And for these categories, we will focus on brands, assortment, breadth, depth and quality. We will work to leverage these categories so that we can attract and retain new customers. Our core categories are the must-have, those home improvement items that are typically project-focused. In these categories, there will be minimal promotions and less transition. And then lastly, the convenience categories are the impulse or mission trip items what we call basket completers. And these categories have less price sensitivity so that we will focus on attachment to drive sales and margin. So this strategic approach will allow us to meet customers’ needs, invest for maximum return in each category and improve our sales per square foot while also improving margin.
We expect to see initial benefits from this initiative beginning in the second half of 2019. We will leverage this category management process to make informed decisions about where and how to expand our online assortments as well to offer customers more options for their home improvement needs and to shore up an identified competitive weakness. We have also created a more functional operating model by aligning our online merchants with our core merchandising teams allowing us to make cohesive assortment decisions across all of our channels. Merchandising excellence also requires us to build the right assortments in the right quantities for the right stores that will meet the needs of our customer.
So we are focusing on localization at the market and at the store level and leveraging improved, relevant and localized product assortments to drive customer engagement. For example, we have had situations where we have had deck stain in markets where houses don’t have decks. And going forward, we will change this situation with targeted assortments that reflect the needs of the customers in each of these markets to drive sales productivity. This is critical for the pro customer as local building codes require these customized assortments at both the market and the store level. So to assist with this effort, we are investing right now in a field merchandising team, placing local merchant expertise in each of our regions to give us this enhanced competitive view of the local markets. And these teams will focus on maximizing the use of our endcaps, our flex space all at the local level to drive this increased relevance and improve their sales per square foot and thus driving inventory productivity. We are currently building out our field merchandising teams right now to rollout in the first half of 2019. So, as we build our assortments at both the national and local levels for both in-store and online, we are going to develop and provide our merchants with assortment tools that help them make fact-based decision-making and these tools will leverage Lowe’s transaction data as well as customer and competitive data to help design the right product mix by location and channel. We’ve seen the power of assortment optimization in driving sales as well as delivering inventory turns. And as an example, in our past lives, Joe and I partnered to expand the assortment of cleaning products in urban markets in place of outdoor power equipment. This allowed us to have better use of space and kept lawnmowers and tractors out of city stores and thus drove an increase in sales per square foot.
So in 2019, we will leverage also our exciting brand opportunities with Craftsman and Sherwin-Williams. We are very excited about the continued rollout of Craftsman given the strong response that we have seen in the category thus far. We have rolled out Craftsman in roughly 220 stores so far in 2018 and we will continue that rollout throughout the first half of 2019. We will be capitalizing on the growing trend in battery powered outdoor power equipment and we will be introducing new Craftsman cordless outdoor power products in both a 20 and 60-volt battery platform. We will also introduce new gas powered products that will help round out the assortment. These new 20-volt cordless items in garden are compatible with all of our tools in our tool department, while the introduction of the new 60-volt platform brings the power and performance of gas in a battery powered product and creates a new Craftsman loyalist.
We are very excited to be the exclusive destination in the home center channel for this iconic brand offering some of the best tools, tool storage and outdoor power equipment in the industry. We are also going to leverage our expanded strategic partnership with Sherwin-Williams, which is one of the most recognized brands in the paint industry. It’s highly respected for quality products by both homeowner and pro. With this partnership, Lowe’s is the only national home center to offer top selling stain brands, Minwax, Cabot, Thompson’s WaterSeal. The teams delivered a simplified lined structure that makes it easier for customers to select the right product for their painting needs and we have an exclusive line of HGTV Home by Sherwin-Williams as well as Valspar interior and exterior paints. And we can’t forget about the accessories, because we now have the top paintbrush brand in the industry with Purdy. So we are excited to bring DIY and pro customers more the top brands that they trust for their next paint or stain project. We will continue to leverage this partnership with increased marketing support as well as an improved inventory position so that we can meet the needs of the business.
In order for us to drive merchandising excellence, we must also improve our speed to market to more readily capitalize on market opportunities by improving on our reset process. As we have mentioned before, our rest execution process has been rough. In fact, our recent window blind reset had an 8-week plan and this reset actually took us 27 weeks to complete. And throughout that long process, the customer was seeing empty shelves, they were growing frustrated and we missed opportunities to make the sale.
So we dug in to understand the drivers of this poor reset execution and I want to share with you five critical observations that we have identified. First, the reset approval process lacked financial rigor. It prevented us from properly prioritizing the most important resets. Second, we used a one-size-fits-all approach without recognizing that lower volume stores that had much less payroll flexibility would struggle to find the resources necessary to execute a timely reset. And third, our supply chain played no active role in consolidating that reset product to create a seamless and efficient delivery process to our stores. Fourth, there was no consistent exit strategy to clearance or removed product being reset by a specific date. And then last, we weren’t organizationally aligned to facilitate smooth reset execution, meaning our planning team and our execution teams were housed in separate organizations, which led to misalignment.
So now by having a clear understanding of the issues and the challenges, we are now focused on implementing our new reset execution process. Specifically, we are doing the following. We are investing in the execution teams in our stores. We have already begun building out and piloting our merchandising service team or what we call MST. This is funded by the vendors. It’s an industry standard. We have got an average of 8 full-time associates per store. These team members will be responsible for our day-to-day maintenance of the bay presentations in our stores. Along with our endcap execution, they will also be responsible for executing off-shelf, improving our in-stock maintenance and helping our store associates with daily pack up. These teams are critical to improving on our execution at store level and we need to take these time-consuming tasks off the shoulders of our red vest associates so that we can free them up to take care of our customer.
We have also centralized the accountability for reset execution within our merchandising team, which is now able to manage the end-to-end process. Going forward, our supply chain team will work to ensure that we have resets packaged upstream in a way that is easy for the teams to execute and this will reduce reset disruption at the store and allow for us to complete these resets faster. We will also coordinate training and heighten the communication prior to executing the reset to ensure that our store teams understand the strategic rationale behind each reset. We will also establish clearly defined guardrails for product transition activity that’s going to allow us to have a path to efficiently liquidate all the non-go forward products prior to the reset starting.
And as we work to improve reset return on investment through the category management process, we are instituting more financial rigor around the need in the overall reset activity. Each reset will be evaluated by a business case with our hurdle rate criteria. And we will also be enhancing our reporting tools so that we can better measure the reset performance. We believe that this new reset process under one organization, along with the introduction of our MST team and our field merchant teams will help us improve our speed to market allowing us to rollout new products quicker and to drive market share gains while also allowing less disruption at the store and delivering an improved return on investment. So this is a new day and a new Lowe’s. And hopefully, you can see that we have an exceptional opportunity ahead of us to make profitable share gains by having the right products in the right place at the right time, so that our customers can shop with us anyway that they choose. And by focusing on the retail basics, by putting the needs of the customer first, driving sales and margin productivity through our rigorous category management process, driving localization by matching our merchandising assortments to the right markets and improving our speed to market and our reset capabilities, we believe that we are building the foundation for us to provide home improvement solutions that will drive sales and grow market share.
I want to thank you for your time this morning. And now, it’s my pleasure to please welcome my partner, Executive Vice President of Stores, Mr. Joe McFarland.
Well, thank you Bill and good morning everyone. Today, I am excited to share with you our path to delivering an excellent customer experience and making Lowe’s a more operationally efficient company. To begin that journey, we took a hard look at the current state of our stores. We saw that customers were very excited to come to Lowe’s and therefore, our traffic growth was quite strong. However, frequent out of stocks led to poor conversion, lower transaction growth and a frustrated disappointed customer. We have terrific associates who know this business well and give their all each and everyday to find solutions for our customers. But we also saw that we made it difficult for those associates to do their job. Lack of process, procedures and clear direction made their work inefficient. Complex, outdated point-of-sale systems require too much time and training to navigate, leaving our dedicated associates scrambling and long lines of customers waiting.
In effect, the staffing models placed too many hours in associate and tasking activities and not enough in selling activities and the lack of focus on the pro customer left us without key pro brands without a proper pro service model and without a competitive value proposition. And though we expected our stores to function as part of an omni-channel ecosystem, we didn’t provide the tools to do it. Order management systems were archaic, split between multiple platforms that didn’t speak to each other and didn’t properly connect back through our supply chain, so they didn’t have an accurate view of available inventory. This made for inefficient use of associate time and a propensity for order cancellations. We also didn’t have a single view of the customer. Instead, we had multiple views across multiple systems leaving us unable to really know the customer in a way that we could effectively anticipate their needs and offer solutions.
Meanwhile, as we face challenges in the business such as poor conversion, we threw payroll at the problem rather than undergoing a full root cause analysis and developing effective solutions leading to further inefficiency in the P&L. However, after our extensive review, one thing was readily apparent, the sheer size of the opportunity ahead of us. As you will hear consistently today, we believe every challenge is addressable and fixable and the good news is I have significant experience solving problems just like these. We have built a team of strong operational leaders to help us in driving operational excellence and efficiency. In doing so, we have a tremendous opportunity to capitalize on strong customer affinity for this brand and better serve the strong traffic that we drive to our stores.
Today, I will take you through how we will become more operationally efficient by simplifying store operations and improving our in-stock execution. Next, I will share how we will work to deliver share gains by improving our product, service and value offering to win the pro customer. Last, I will discuss how we can improve our services business to drive profitability and better serve the do-it-for-me customer. The first steps to delivering retail fundamentals in our stores, is simplifying store operations. We will provide clarity for associates while putting the right processes and systems in place to provide the best experience for our customers. One of our main challenges at store level is the sheer number of things we are asking the stores to execute. So, we started by streamline the communications and messaging to the stores. We have moved to a simplified weekly playbook that focuses the teams on top priorities, key metrics and critical deliverables. And we have implemented a filtering embedding process to ensure that we are sending only the most important communication to the stores and keeping them focused on just the right things.
To combat the problem of information overload and inconsistency, we shut off 95% of the reports going to the stores. This is to get our people out of the office, putting stacks of reports and on to the sales floor spending more time with customers. We then replaced those reams of hardcopy reports with a streamlined dashboard to provide better visibility to store performance versus the expectations. What you are seeing on this slide are the actual reports and e-mails sent to a store manager in one of our stores in a 1-month period. This is not a prop. We actually collected these documents to better understand the flow of information to an average store manager. I think you would agree that this is virtually impossible to effectively manage and prioritize. However, this was a view of our actual state approximately 6 weeks ago.
Another key focus is we simplify store operations is aligning and allocating payroll correctly. Having associates in the right place at the right time is one of the most important things that we can do to serve our customers. And other than cost of goods sold, payroll is the largest expense for the company. Our current labor scheduling system needs to improve. The current system is antiquated, ineffective and does not properly predict labor trends. It generates schedules 13 weeks in advance and does not schedule labor hours to align with customer demand patterns by department. This has resulted in significant ineffectiveness as well as wasted time for managers overriding and editing the schedules. In fact, our stores spend over 1 million hours each year writing schedules when a labor scheduling system should be carrying that load. We are now implementing automated selling in form by customer data to better predict customer demand by time of day, day of week and by department. We are also aligning our labor hours with peak traffic to ensure that we are using our labor hours efficiently and reducing payroll expense while delivering great customer service.
In addition to allocating our payroll more effectively, we will be reducing tasking hours to enable our associates to spend more time with customers. Only 40% of our payroll hours in the store today are spent with the customer and that absolutely must change. We have a goal of increasing our customer-facing hours to 60% of payroll by the end of 2020. As a first step, we have already eliminated sales for tasking activities during the busiest hours of the day, so that our associates can focus solely on providing excellent customer service. This process eliminates competing demands and provides a clearer, concise and consistent approach to deliver a repeatable and reliable experience across all of our stores.
And in 2019, we will leverage the MST teams that Bill discussed to reduce tasking responsibilities for our selling associates. We will also improve tasking efficiency in the front-end of our store on the sales floor and in the back-end of the store by establishing clearer processes and procedures and leveraging technology, such as the mobile devices. For example, in the front-end of the store, we are improving our point-of-sale systems. We are replacing a cumbersome, outdated green screen with a graphical, modernized, intuitive selling interface to make it easier for our associates to navigate and faster for us to train new hires and seasonal associates. We are also providing more checkout options for the customer. For example, we are adding self checkout in all stores over the next 2 years. And on our new handheld devices, we will enable mobile checkout capabilities to drive greater front-end efficiency.
On the sales floor, we are leveraging mobile devices to reduce tasking hours and increased productivity. For example, printing price labels on a store walk requires an associate to walk all the way from the aisle they are working in to 1 of 2 terminals in the store that actually print labels. Going forward, we will rollout handheld printers to allow associates to print priced labels right in the aisle and save valuable time. We will also leverage mobile devices to drive efficiency in other tasking activities. And Don will discuss how we will realize efficiencies from our supply chain transformation by moving big, bulky products, such as appliances to both distribution centers. As we use our payroll more effectively by reducing tasking hours and driving labor efficiency through standardized processes and procedures, we will drive payroll leverage. We will use a portion of these payroll savings to add three hourly department managers to each store beginning in January. These customer-facing roles will focus on improving the customer experience by providing better department coverage as well as coaching our associates in delivering excellent customer service.
As Marvin discussed, many of our associate-facing systems are in need of modernization. Therefore, we are upgrading our order management system replacing multiple legacy systems with one best-in-class system to manage orders and services and we are connecting this system through to our supply chain giving our associates a more accurate view of inventory and improved visibility throughout the system to provide customers with more reliable information. We will also make this improved inventory view available to our associate’s mobile devices to continue to shift from desktop to mobile, reducing the need for associates to run to desktop terminals to gather information and leaving customers standing in the aisles.
Now, let me take a moment to discuss the root cause of our out of stock problem. Historically, Lowe’s has managed to inventory dollar amount rather than an inventory turnover goal. So, we haven’t adequately invested in high velocity SKUs in job lot quantities necessary to maintain a proper in-stock position. As Bill described, ineffective resets have also led to out of stocks in key categories. And as Don will describe, flow challenges across the network have resulted in either excess inventory or insufficient inventory. Within the stores, I have seen a lack of engineered processes for tasks such as flowing product from receiving to the sales floor that has adversely impacted our in-stock position.
Finally, our store managers had no autonomy to reorder product leaving them unable to address out of stocks in key items. So, to improve our in-stock position, first, we developed a comprehensive in-stock process, including standardized procedures for effectively moving product from receiving to the sales floor and we rolled this out to all U.S. stores in the month of November. We also instituted a regular pack down process to ensure that we are consistently filling our shelves with the product that we already have. Next, we will improve the flow of inventory from the RBCs to the stores to ensure that we have consistent in-stock levels throughout the entire week then we will give our stores better visibility to the schedule of incoming shipments from the RBCs as well as the contents of what’s actually on that incoming truck. This will allow our store managers to better plan for receiving those trucks and allocating appropriate labor without having to pull associates off the sales floor just as we have done in the past.
Finally, we will give our store managers limited autonomy to reorder appropriate quantities of low risk, high velocity in SKUs to improve in-stocks on our key items. And as we monitor out of stocks, we will leverage associate’s mobile devices to evolve inventory replenishment from a slow, paper-based process to an efficient automated process. All of these work streams combined to improve our in-stock levels allowing us to improve our traffic conversion then increasing sales, while also improving on labor productivity. We expect that we will see measurable improvement in our in-stocks as we head into 2019.
Finally, let’s talk about how we win with the pro customer. First, we took a hard look at the gaps in our pro offering. We found that we had inadequate associate coverage at the pro desk and no dedicated loaders to help pros load their trucks. Time is money for all of our customers, but none more so than the pro. If a pro customer has to take one person off the job site and send them to Lowe’s to get more supplies, that results in lost productivity for their business. Now, if that pro has to take three people off the job site for the trip to Lowe’s, because the pro can’t rely on us to have loaders to help load the bulky product they need, that is even more lost productivity. We had no direct leadership of the pro teams in the store to focus the teams on critical pro activities. We weren’t properly assorted for the pro and we have had insufficient job lot quantities leaving us unable to meet their needs. This led to a poor pro customer experience and a lack of pro loyalty and a loss of pro market share. Well now, it’s time for all of that to change. The pro customer is too important within the home improvement and represents too large of an opportunity to just leave on the table. As Marvin noted, the pro makes up over 50% of the home improvement product available. And at Lowe’s, only 20% to 25% of our sales actually come from the pro customer. Therefore, pro is one of our largest opportunities to take market share and we are laser focused on capturing that opportunity.
As Marvin said, pro is a very important customer, but they have very basic expectations. Winning with pro comes down to five things. First, offering competitive prices, including a strong value proposition for volume purchases. At an individual SKU level, we are competitively priced. The pros find our volume pricing confusing and also unreliable. So we are rolling out a simplified, transparent pricing program for large volume orders, such that the pro customer can better understand our value proposition and count on it. We are also improving our contractor packs as another way to convey a value message to pros that are purchasing in large quantities.
Second, stocking pro relevant brands, given that the pro is incredibly brand loyal, we will also improve our offering with key brand introductions to bring the pro customer back to Lowe’s. We have already seen the power of destination pro brands in attracting customers with the introduction of SharkBite, A.O. Smith, Marshalltown, Hitachi and Bosch and we are not done. We have the opportunity to partner with other key national brands for the pro. And given that those vendors are not in exclusive arrangements, we are confident that they share in our excitement about the opportunity for the Lowe’s pro business.
Third, delivering consistent service levels, to ensure we have the proper store level focus on the pro, we are placing dedicated pro department supervisors in each one of our stores. We will also establish labor standards for the pro desk to make sure that we simply have appropriate staffing levels and we will have dedicated associates to help the pros load their trucks. We will also have knowledgeable and consistent staffing in key pro departments, such as rough plumbing and electrical, lumber and building materials, millwork and paint.
Fourth, providing a differentiated experience, we will differentiate with the robust product offering and great service, but also by leveraging our maintenance supply headquarters business to provide additional products and services for the pro. We have launched a streamlined product catalog for the MRO customer and are planning for additional branch expansions. Going forward, we will work to integrate our outside pro sales forces and better leverage the MSH catalog in offering product to our stores.
Finally, developing strong relationships with pro customers, strong relationships would be fostered with our dedicated pro teams that provide a familiar and friendly face for those repeat pro customers. Those relationships also come by demonstrating that you understand the needs of the pro customer. Given that sufficient inventory is one of those needs, we are investing in job lot quantities for the pro. This is to ensure that we have inventory depth at the store level to meet the pro customer demands and also to enable presentation impact on those top-selling items. This represents the current inventory levels in the lumber and building materials departments of a typical store. And now this represents how the department looks after we invest in job lot quantities. For a pro customer, visual presentation matters. If they are shopping on Monday and see limited inventory, they will not return later in the week for fears that you will be out of stock. So we are now investing in job lot quantities and will have our sufficient inventory in place for the pro in early 2019.
We also have an opportunity to improve our services business by simplifying our selling model, improving our project management systems, expanding our national installer network, narrowing the scope of the product checks that we undertake and improving the overall customer experience. As Marvin mentioned, our current project management process is archaic. So, we are working with Seemantini, who you will hear from shortly to modernize this part of the business. This will allow us to serve the growing do-it-for-me demand more effectively and efficiently. This is a new day and a new Lowe’s and the opportunity ahead of us is very clear. We can capitalize on our great home improvement sector and a tremendous brand by focusing on retail fundamentals to win in today’s retail environment. We expect that our focus on improving in-stocks, delivering better customer service and winning the pro customer will drive greater sales productivity over the next few years. While our focus on simplifying store operations, implementing technology and improving payroll productivity will improve our operating efficiency.
Thank you for your time today. And with that, I would like to hand it over to Executive Vice President of Human Resources, Jennifer Weber.
Thank you, Joe and good morning everyone. As both Marvin and Joe noted, we have some of the very best associates in the home improvement business. They are loyal stewards of our brand and are dedicated to serving customers. That being said, we must better leverage their talents and enthusiasm to maximize customer engagement. This is a critical piece of the puzzle as we look to drive sales across the business. So over the past few months, I have been working with our functional leaders to identify the areas where we can help our associates drive better customer engagement. I am very excited today to talk to you about two very specific but unique aspects of our action plan. It all starts with making sure our associates are focused each and everyday on providing excellent customer service. We are rolling out a new smart customer service model, which will guide the way we hire, train, evaluate and coach associates. This program models what a great experience actually looks like and drives behaviors that deliver the kind of experience that customers want. The smart model focuses on seeking out the customer in order to start a conversation, meeting the customer’s needs, adding relevant products, services and expert advice, reviewing how the needs of the customer were met, and thanking the customer.
Smart is more than just a training program. This is a fundamental shift in our culture, moving from one that focused our stores on tasking to one that is laser-focused on delivering great customer service. The smart program is a comprehensive tool kit, including a training program and mobile device, which are designed to provide our associates with everything they need to deliver outstanding customer service. Training in the smart model for all of our associates in the U.S. will take place in the first quarter of 2019. And the new smart mobile devices that we are rolling out to our stores will empower our associates with the data and tools they need to serve customers. These expectations laid out by the smart model will also be embedded in our hiring and associate development programs. We believe that great customer service is driven by having a strong and healthy selling culture, and the smart model is the underpinning of that culture. In addition to this companywide training effort that gets our people focused on delivering great customer service, we are also taking steps to help our associates develop critical trade skills that will better serve our customers and evolve into the kind of skilled trades’ people that could eventually be part of our contractor network or loyal pro customers.
Before I dive into the specifics of what we are doing, I want to take a moment to talk about the trends we have been seeing in the labor market for some time now. Over the last several decades, there has been a perception in our nation’s culture that a career in the skill trades is isolating, difficult, dirty and underpaid. The majority of kids in middle and high school view it as a failure if they end up in the trades as their profession, so plumbers, electricians, carpenters. 1 in 5 people globally say they don’t like their job and have no career path. Many believe that their craft or trade skills cannot provide prosperity in a modern technology-driven society. It’s simply does not have to be this way and it’s driving a chronic shortage of qualified trade professionals despite increasing demand for their services. With nearly 3 million skilled trade jobs expected to open by 2028, we are determined to change this. In February of this year, we announced the start of a new workforce development initiative called Track to the Trades. In partnership with Guild Education and Adult Education Company, Track to the Trades provides our associates with innovative career alternatives and financial support to pursue a skilled trade. As a part of this program, Lowe’s is offering paid tuition for trade skills certifications, academic coaching and support as well as placement opportunities for full-time pre-apprenticeships in our nationwide contractor network or continued growth with Lowe’s. By investing in our people, we are developing them into a team of trusted advisors that can provide support for our customers today while building a pipeline of skilled trade workers for the next generation that will better position us to meet the customer demands over the long-term.
Let’s take a look at a video highlighting the importance of changing the narrative around this critical profession. We first debut Track to the Trades in March with a pilot program for approximately 48 associates in four key markets, Denver, Charlotte, Pittsburgh and Richmond. The pilot program was a huge success with 200 candidates enrolled in the early months. We completed the rollout of this program to qualified part-time and full-time associates in every store, distribution center and call center across U.S. as of October and enrollment in the program continues to expand. These associates are completing coursework at their own pace so that they can become a master electrician, a plumber, a carpenter, an HVAC installer or appliance repair specialist. We are very excited to make this investment to develop our associates and advance engagement with both our DIY and pro customers.
As we focus on becoming a more customer-centric company, it’s absolutely critical that we continue to broaden our relationship with our customers. We are shifting the culture at the store level to focus on customer service over tasking, teaching our people the skills they need to deliver great customer service and offering training in the skilled trades to help our associates better serve our customers. By investing in the skills and capabilities of our people and leveraging their talent and enthusiasm to maximize customer engagement, we are turning them into that team of trusted advisers in our aisle today, while filling the pipeline of skilled workers for the next generation. I am excited with all of the work we have underway and believe that investing in our most valuable asset, our associates will help us win in today’s environment.
Thank you for your time this morning. And I will now turn it over to Senior Vice President and Chief Marketing Officer, Jocelyn Wong.
Thank you, Jennifer and good morning everyone. I am excited to share with you all the different ways we are working to evolve marketing and establish a stronger connection with our customers, while focusing on productivity. Over the last 18 months, we have shown good progress with our ability to drive traffic, something we have done by leveraging our strong brand, while building capabilities to quickly modernize our approach to digital marketing. Yet, there is still plenty of room for continued improvement. We have an opportunity to refine the messaging of our mass media to expand our reach and relevance and appeal to a wider audience. We are also working closer with store operations and merchandising to ensure that our in-stock and product availability aligns with the products and services that we are promoting. Now we also need to build the right data infrastructure so that we can better leverage our own customer data and reach customers along their journeys in meaningful ways. We are moving away from our past history of deploying incremental marketing spend that is largely reliant on mass media and into an era of leveraging better targeting and personalization to engage customers at the right place, with the right message, at exactly the right moment to drive incremental traffic with the plan to spend significantly less advertising dollars over the next few years.
So let’s begin with the customer. For more than a decade now, we have been the home improvement destination for what we call the light DIY customer. Now this is a more casual DIY customer who likes to do smaller home improvement projects themselves, but isn’t completely confident in their DIY skill set. We have become their go-to destination because we provide them with an experience that makes them feel comfortable, knowledgeable and ultimately confident enough to move forward with their project. We know them, and we serve them well. Let’s take a look at one of our spots from last spring which targeted this customer.
Now while our Moments campaign did well for us, we know we can’t achieve our growth ambitions without expanding beyond this customer segment. Our mass media creative must appeal to a wider audience in order to work harder for us in driving more traffic per dollar spent. Therefore, we’re working hard to refine our messaging, to focus on what it takes to win in the hearts and minds of the heavy DIY customer and prioritize segments of the Pro. Now, heavy DIYers are hands-on makers. They are DIYers through and through, and therefore, they have both the confidence and the desire to engage in more advanced home-improvement projects. The heavy DIYer is a frequent in-store purchaser that relies heavily on online channels for inspiration and research. But they want to see and touch the products they are buying and talk to our associates about the projects they are working on, especially when they need help troubleshooting a project that they have already started. Heavy DIYers spend more on products, nearly 2x the average and they shop in-store 1.5x more than the average customer. So we are responding by evolving our marketing campaign with the new tagline, Don’t Just Do It, Do It Right For Less, Start with Lowe’s. Now, we believe this new campaign will help us move up the home improvement customer skill set continuum, and our research also shows that the light DIYer also responds well to this campaign. This is important because it allows us to maintain our strength with the light DIY while we broaden our message. In other words, we believe that by 2021, we can reduce our marketing spend and concurrently speak to a larger base of customers. So let’s take a look at 2 of our upcoming spring 2019 ads that feature our partnerships with Sherwin-Williams and CRAFTSMAN.
Alright. So you will see that our new campaign is less whimsical than our past work and more authentic to what it feels like to do home improvement projects. It highlights real associates and provides a clear value message and call to action. This new creative should help us expand our core customer base to include the heavy DIY customer and create halo with the pro, a critical customer to us, as well. Now Joe spoke about our focus on better serving the needs of the Pro. And as his team works to improve our value proposition for the pro, in marketing, we’re working to make sure that the pro is considering Lowe’s in the first place. So as we think about what it takes to even be relevant with the pro, it forced us to not only reevaluate our message to this customer, but also how we deliver that message. We know that the pro doesn’t engage with media in the same way as the DIY customer, so we’re focused on delivering messages to the pro in the channels that fit them best. This comes to life in digital, social media and addressable TV, where we can use data to identify and target the pro and with radio, which reaches pro customers, both on the road and on the job site.
Now we have increased our marketing investment with the pro considerably, and the good news is, is we have seen exceptionally strong ROI here. Now while I just shared some of our traditional marketing elements, I do want to spend a moment talking about the advancements we have made in reaching customers throughout their shopping journey, because as you know, customers don’t consume media in a linear way. So, let me give you an example through the lens of a heavy DIY customer. This customer is streaming an episode of his favorite sitcom on his Smart TV when he learns that Lowe’s now carries Craftsman products through an online video ad. We targeted him with online video because we have data that tells us he has a propensity to buy tools. He knows he needs a new mechanics toolkit for his latest project, but he is not yet sure which brand to buy. So he does a quick search on Google and clicks on a Lowe’s search ad. Now we serve to net ad because we know he is close to a Lowe’s store and because we know that he is most likely to purchase at Lowe’s.
Let’s say he is not ready to make a purchase just yet, so he puts his search on hold for the time being. But being an avid sports fan, he later checks scores on ESPN, where we retarget him with the display ad reminding him of the Craftsman products that he was considering. After noticing the ad, he goes to Lowes.com where he spends some time researching the toolkit he is interested in, this prompts him to absolutely go to the store, interact with the product and make a purchase. Now all along his journey, we are able to measure the impact of the digital advertising on his eventual purchase, which leverages location data. And because we understand his journey was successful, we can scale and target others like him with relevant effective advertising. Now, this is an example of how we will use data to be relevant at the right time, which leads us to a path of personalization and ultimately a better customer experience.
Now, we are also continuing to invest in our military appreciation program. During the World Series and over Veterans Day weekend, we ran a television spot, which featured our veteran associates, thanking all veterans for their service, while building awareness of our 10% off discount for active duty and retired military. Not only did we launched a new media campaign in support of military customers, the stores also took steps, like designating veterans parking, military-themed patches and vest for our associates to represent how much we value our customers and associates who served our country. Now through our military discount, we will provide over $1 billion in savings for active duty and retired military this year. As we drive awareness of this program, we also expect to increase participation, which will drive greater loyalty among our current customers and drive new customers to Lowe’s. And with new customers registering for our military appreciation program, we will be able to build out our customer database with additional information and leverage this data to develop an even better understanding of this important customer segment and how best to serve them. This allows us to further personalize and communicate in a way that drives better engagement. So, let’s take a moment to look at this creative.
Now, you have heard others speak today about our efforts to enhance the customer experience. That experience often begins with the reach of our marketing effort and our work to deliver personalized, targeted messages that build the strong affinity for Lowe’s and drives activation. In addition, our objective to win with the pro is supported by our evolving a data-driven approach to reaching pro customers with messaging that is specifically relevant to them. Finally, you heard Bill speak earlier about localization and optimizing assortment to fit local markets. Localization plays an important role in marketing as well and it’s going to be a key strategic pillar for us next year. You will see us lean into local market to a greater degree, working with our operations partners to add meaningful local marketing layers to complement our national marketing. This is a new day and a new Lowe’s with a new approach to engaging customers at the right place, with the right message at exactly the right moment. We will work to drive traffic by focusing on our core customers, while we broaden our messaging to drive greater impact. We will provide relevance through personalized targeted marketing and tailored local marketing efforts, and we believe our targeted data-driven approach will allow us to achieve our objectives while reducing our overall marketing spend.
Thank you for your time this morning, and now please welcome our Executive Vice President, Supply Chain, Don Frieson.
Okay. Thank you, Jocelyn and good morning everyone. It is my great pleasure to be part of the Lowe’s team and to give you an update today on the efforts to transform our supply chain. Now, let me start by sharing that logistics is in my blood. In fact, I started my career in logistics over 30 years ago as a part-time car washer at United Parcel Service while I was a sophomore at the University of Tennessee. Since then, I progressed to a variety of supply chain roles, spending 19 years at Walmart, leading the world’s largest truck fleet and supporting more than 30 distribution centers that supplied merchandise to 1,600 stores, supercenters and neighborhood markets in the eastern U.S. I also had the opportunity to spend 2 years in Johannesburg, South Africa, building out a supply chain strategy for a 360 store chain called Massmart. And most recently, I served as the Chief Operating Officer for Sam’s Club, where I was responsible for club operations, including supply chain for more than 650 locations throughout the U.S. and Puerto Rico. I have worked throughout my career to build world class supply chains and now I have the absolute privilege of applying that experience to transform the supply chain here at Lowe’s.
So as Marvin discussed, our unified goal is to be a great omni-channel retailer, serving customers the way they would like to be served across all channels and at all stages of their shopping and fulfillment experience. For us to meet the omni-channel expectations, we must leverage our supply chain over the next few years to optimize fulfillment and delivery to improve customer service. Make no mistake, stores will continue to play a very significant role in allowing customers to shop and take things with them in the store, allowing them the convenience to shop online and pick up in-store. In fact, our research clearly points to an important role for the store in the omni-channel home improvement sector. Marvin also mentioned that over 60% of our online orders are currently picked up in-store. However, customers are increasingly seeking a set of more robust fulfillment and delivery capabilities to meet their unique needs. So as a result, we have seen growth in orders with fulfillment via delivery, pick up in-store, partial shipments and they have all outpaced the growth of what we call the in-store take with channel. So we had to take a very critical look at our supply chain and determine where we were properly positioned and how we will serve that demand. And quite frankly, and simply stated, we found that Lowe’s supply chain technology and infrastructure have not kept pace with the evolving customer expectations.
Now our supply chain was built utilizing a hub and spoke model, to service a network of stores rather than an omni-channel system. We found that this single channel, hub and spoke supply chain infrastructure, is also at the brink of capacity. Over the years, we expanded our network of regional distribution centers and flatbed distribution centers to support new store openings and sales growth. However, we have not opened a new RDC or FDC since 2013, which is 2 to 3 years beyond our average historical pace. Now along with constraints, our outdated supply chain has burdened our stores with complexity, impacting our ability to service our customers in a manner that they really deserve and compromising our ability to drive productivity.
So for example, today, big, bulky products, such as appliances, are stocked in every store. However, most customers don’t take that product with them after purchasing it. In fact, approximately 80% of appliances are delivered. This model creates inefficiencies and working capital as we are managing appliance inventory at the store level rather than managing it at market level. It also drives inefficiencies as it takes a lot of payroll to move big bulky product around the back room of the store, as well as staging it for delivery, not to mention the increasing damages that you see. And lastly, this model creates logistics efficiencies or inefficiencies rather as we manage deliveries at the individual store level versus the market level. We also found that we have limited visibility to inventory as it moves across our ecosystem and poor flow management. Specifically, we have limited visibility to product when it’s coming from our vendors therefore, stores don’t know what trucks are arriving at their docks or when they are arriving at their docks. Also there is a lack of visibility to special order product and the lead times associated with those that affects our competitiveness in the market. The flow challenges across the network result in either excess inventory or not enough inventory that lead to loss sales. And underpinning all of these challenges is the lack of data connectivity throughout the entire ecosystem.
We also found that we have limited visibility to inventory as it moves across our ecosystem and poor flow management. Specifically, we have limited visibility to product when it’s coming from our vendors. Therefore, stores don’t know what trucks are arriving at their docks or when they’re arriving at their docks. Also, there’s a lack of visibility to special order product and the lead times associated with those that affects our competitiveness in the market. The flow challenges across the network result in either excess inventory or not enough inventory that lead to lost sales. And underpinning all of these challenges is the lack of data connectivity throughout the entire ecosystem. We have slow, antiquated systems that are complex that utilize different platforms that don’t connect with each other. So in the omni-channel system, supply chain actually infiltrates every aspect of the business. The good news is that all of these challenges are addressable. And as we solve and evolve our supply chain, we have a tremendous opportunity to increase our competitiveness, improve our operating margin and more importantly, take share. We’ll do this by standing up capabilities to support the evolving customer expectations and better connecting customers’ needs with the products and the services that we offer as a company. We have a clear line of sight as to how we will transform our supply chain to enhance the omni-channel customer experience. We will support top line growth and we will drive better cost efficiencies. And we will do that through optimizing a network of assets in our distribution systems as well as the flow of product between those assets.
So the first pillar of our supply chain strategy is improving flow management and inventory visibility to improve our in-stock position. We’ll do this by supplying our stores with smaller, more frequent shipments to ensure that we have consistent in-stock levels throughout the entire week. We will be able to manage our inventory more efficiently at the store level, because there we see the amount of product that they need rather than receive an excess inventory than having to place it in top stock. We will also be able to provide our stores with more predictable deliveries that then allow our store managers to better plan their labor resources. And while more frequent shipments to stores can drive higher transportation cost, we believe we will see sufficient benefits from the improved in-stock as well as the efficiencies from reducing slow moving inventory to offset the increased cost.
Now to illustrate these challenges, consider this example of a customer buying a special order refrigerator. Without improved visibility to vendor inventory, we are unable to provide that customer with an accurate delivery date of the product. We don’t know when the product will arrive, and therefore, we don’t know how to schedule the home delivery with any type of accuracy. So to provide a delivery date to the customer, we provide a conservative estimate to account for that uncertainty. And if the estimated delivery date is 3 weeks out, we could possibly lose that sale. And even if the customer continues with the purchase, we will likely have to call them to change the committed delivery date, because the product ultimately arrives at a different time frame than our original estimate. We are now standing up systems and processes that such, by the end of 2019, we will have better visibility to product coming into the network as well as visibility to product location as it moves through the network.
Now in addition to improving flow management and inventory visibility, the second pillar of our supply chain strategy is evolving our infrastructure to optimize fulfillment and delivery. We have to ensure that we have the right inventory and the right place at the right time and most importantly, in the right quantities, with the required network and capacity to meet our customers’ needs. We are standing up a tailored network of bulk distribution centers, regional distribution centers, cross-dock delivery terminals, flatbed distribution and direct fulfillment centers. Each of these nodes has a very specific and critical role in providing a consistent end-to-end fulfillment experience across all channels to all customers.
Now to drive efficiencies and provide a consistent experience for customers buying big and bulky products, we are building out a market level delivery model. This will consist of a network of the bulk distribution centers with movement to cross-dock network. We will then pull the majority of our plans inventory out of our stores. We’ll pull them out of the regional distribution centers and place it in that network of bulk distribution centers. We expect to have 20 bulk distribution centers in place by 2021. These facilities will provide daily service of appliances and other big and bulky items. So think about things like riding lawnmowers, grills, patio furniture and storage sheds. They will then move to a network of cross-dock delivery terminals for last mile delivery to the customer. And replenishment of unlimited amount of appliances and other large products to stores so that we can service then take with appetite that some of our customers have. We expect to add approximately 90 cross-dock terminals over the next 3 years.
Now this network of bulk distribution centers and cross-dock facilities will then remove the burden of deliveries from stores, covering approximately 95% of our current and home deliveries. This delivery model will also produce labor efficiencies as it will use fewer payroll hours to move bulky product around. It will also provide working capital efficiencies as we are able to manage inventory a lot more efficiently than we do today because we will be doing it at market level and logistics efficiencies from planning deliveries at the market level as well. Finally, this helps to eliminate the multiple touch points in the supply chain and when you reduce those touches, you start to reduce damages. Now as we evolve our supply chain, we are also evaluating capabilities to better service the pro. We will do direct to job site delivery, leveraging our flatbed distribution centers and delivery from our stores.
Now let me take you through a very quick example of how that will illustrate how these changes will impact our customers and our associates. So today, if a customer in a Charlotte store buys a refrigerator for a home in Hilton Head Island, the selling store in Charlotte has a choice, they can either arrange for the refrigerator to be delivered from our Hilton Head store, which in the current environment is very complicated from a systems perspective or they can have a box truck travel over 500 miles round trip from Charlotte to Hilton Head to make the delivery. The store will choose the 500 mile round trip delivery almost every time, simply to get credit for the sale. Unfortunately, this isn’t a hypothetical example. It’s a true story. In the future, we will solve this problem by giving the Charlotte store visibility to where the refrigerator is available in the bulk network and arrange to have it delivered from the closest delivery location to Hilton Head. It allows for faster delivery, less costly fulfillment for us. It will also change our operating procedures to ensure that that Charlotte store gets credit for the sale. That will help the teams really focus on fulfilling sales in the most efficient way possible.
The third pillar of our supply chain strategy focuses on improving the speed, reliability and efficiency of our parcel shipping network. Given the demand for parcel shipment has really increased significantly, we expect that trend to continue to accelerate. We opened our first direct fulfillment center in Tennessee in the third quarter this year. That direct fulfillment center will fulfill approximately 75% of the U.S. in two day ground demand. It will relieve our DC capacity by handling break pack for the entire network. So in addition, we are evaluating our second direct fulfillment center to be located in the Western U.S., which will recover the remaining 25% of parcel demand with two day ground shipping. For the same day and next day shipping, we will have the – they will actually have the option of them leveraging our stores, which have the advantage of close proximity to the customer as well as sufficient capacity where they no longer have to stock appliances and other big and bulky items in the backroom.
So to illustrate the potential for our omnichannel evolution, consider that today, 90% of an average store’s backroom is filled with appliances. In the future, the majority of these appliances and other bulky items will be stored in the bulk distribution network and fulfilled through the cross-dock terminals, freeing up significant space in our backrooms. Now we currently have 84 parcel shipping stores and the additional backroom capacity in our stores would now give us the potential to have over 1,700 parcel delivery locations throughout the U.S., if needed. We can then leverage artificial intelligent to determine the optimal assortment for these parcel locations based on historical buying patterns on Lowes.com. We believe that this is a competitive advantage over other home improvement retailers who lack the requisite store capacity to stand up store level parcel shipping capabilities.
This is a new day and this is a new Lowe’s. We are excited about the opportunity ahead of us and we have plans in place to capture that opportunity. All said, we expect to make a capital investment of $1.7 billion in our supply chain over the next 5 years to improve the omnichannel customer experience. We will optimize fulfillment and delivery through a tailored distribution network. This will allow us to support top line growth while also driving operating efficiencies. And we believe we have the plans, the skills, the experience and the capital to capture that opportunity.
So thank you for your time this morning. And now please help me welcome Executive Vice President and Chief Information Officer, Seemantini Godbole.
Thanks Doug and good morning everyone. It’s a pleasure to be here with you all today. Prior to joining Lowe’s just four weeks ago, I have spent over 25 years working in global technology organizations, such as American Airlines/Sabre and Travelocity. Most recently, I served as Senior Vice President, Digital and Marketing Technology at Target, overseeing the company’s global e-commerce, enterprise marketing and loyalty technology strategy and operations. As Marvin indicated earlier, there is a common thread across the presentations today, a focus on the retail fundamentals. But there is another commonality in what you have heard today, the need for significant improvement in technology solutions across our business. In fact if you look at the ten areas of focus in our strategic framework, six of them have system improvements as a critical dependency.
Having joined Lowe’s only four weeks ago, you might say I have signed up for a lot. However, given my experience leading large scale transformation efforts, I strongly believe in our plan to deliver the technology improvements needed to address the challenges and capitalize on the opportunity outlined by the team today. Like my peers, my first starter of business upon arriving at Lowe’s was to conduct a deep dive assessment of the current state of my functional area. What I found is that Lowe’s technology is well behind leading retailers in terms of strategy, architecture, process maturity and capabilities. Our store and supply chain systems were developed in the ‘90s, while our merchandising, pricing and digital systems are rooted in early 2000s. Only our back office system really measures up to current standards and that’s obviously not ideal for a customer facing organization. Leading retailers have modernized their technology platforms and advanced their digital capabilities through investment in software engineers and targeted acquisitions. However, at Lowe’s we have historically underinvested in talent and technology, opting instead to use off the shelf software packages and then heavily customizing them resulting in poor integration, difficult upgrades and slow responses to business needs.
Taking a step back and looking at how we got here, our technology goals were focused on managing cost and headcount rather than building capabilities that serve customers in a modern omnichannel world. Misaligned goals and inconsistent execution further contributed to a growing gap in our capabilities. For example, in 2009, we launched the services platform initiative, which was designed to provide connectivity between our omnichannel assets and closed many of the capability gaps described by the team today. Services platform was scoped as a 4-year program, but was shutdown after 7 years. And in the end it delivered less than half the original business value intended. Inconsistent leadership, evidenced by the rotation of five CIOs in last 8 years, draw an inconsistent strategy and low accountability, which in turn delivered poor results. We have capability gaps in stores, supply chain, merchandising and digital systems and we must remedy them in order to win in today’s complex retail environment. We have set forth plans to begin the modernization process as we head into 2019 and then position ourselves to make investments beyond 2019 to stay current in a rapidly evolving space.
Going forward, we will focus on three main areas; first, creating a best in class architecture to support our omnichannel ambition, second, establishing an operating model that accelerates our development, third, building a best-in-class team of highly skilled and motivated technology professionals. First, we will create truly omni-channel architecture. When I say that, I don’t mean a single app or just a sleek website, but a ground of single view of customer orders irrespective of whether they were placed online, in the store, through the call center or on the job site. It is about creating a single view of our customers, product, prices and inventory, but there are inventory besides in our bulk distribution center, our stores or our direct fulfillment center. This information will be readily available to all our associates and customers through a flexible architecture deployed closest to the end user for optimal performance. This type of architecture will dramatically improve our speed, scale and flexibility. It will allow us to deploy a bit more frequently as we will be able to quickly change only the parts we need without affecting or changing the whole structure. We will be able to reuse components, which are literally like LEGO blocks to rapidly construct new capabilities for our associates and customers to embark on a journey of continuous innovation.
In addition, as part of our new technology strategy, we are moving to cloud-enabled technologies, which will improve application availability and scalability while lowering the total cost of ownership. Today, less than 5% of our enterprise application portfolio is running in the cloud. With this critical foundational architecture in place we will be able to offer new functionality for our associates and customers and deliver the best-in-class retail experience. In addition to improving our omni-channel architecture to drive better results, we have started our journey to fundamentally change our technology operating model. We are standing up product teams, pairing engineers with product managers and business experts to co-innovate and deliver functionality faster. Gone are the days of multiyear mega-projects. Instead throughout 2019, we will be bringing new functionality to our store associates and customers on a continuous basis.
To deliver on this omni-channel architecture and all the functionality it enables, we intend to hire over 2,000 software engineers over the next few years. And we will put these engineers at the center of everything we do in technology. We will ensure that the work environment, level of environment and compelling product work will create one of the best places to hire and retain top talent. We have historically relied on our special software packages when we then customize, which was inefficient and created isolated platforms with isolated data and it required us to staff separate teams, each with different skill set. We have now shifted our focus to a digital transformation strategy that relies on building customized solutions and leveraging open source technologies, which are far more nimble and cost effective.
By 2021, I plan to shift the build component of our application portfolio to over 80% leveraging our team of software engineers, which will improve our agility, reduce maintenance expense and enhance our performance and monitoring capabilities. As we stand up our new capabilities, we will put our associates and customers at the center of everything we do. We are improving our architecture, operating model and the team to create exceptional experiences for customers. When we talk about at these experiences, they will be ranging from an outstanding website experience to delivering the most useful apps for our store associates to creating tools to manage a complete installation project, to inspiring AR/VR experience. In a sense, we will empower our store associates and customers across our website, stores, call centers and job sites.
I would be remiss if I did not address the improvements we are making to deliver improved customer experience on Lowes.com. We recently reduced checkout steps on the site from 6 to 3 allowing for a faster checkout and better experience. We also optimized our site for natural search, which yielded better results of our customers. Going forward, we are working to improve our site stability and speed by improving our website architecture and building a technology platform that will allow us to scale and launch new features quickly. This new platform will enable all technology teams to build capabilities using open source software and improve speed to market and reliability.
Looking ahead, we still have great deal of opportunity to deliver an improved experience online with more relevant site search result, customized content and accurate view of inventory and expanded assortment to increase our online conversion. All the technology improvements I have described will clearly take significant investment to achieve. And we do plan to invest between $500 million and $550 million in capital per year through 2021. This investment will be coupled with clear priorities, focus and superior technical expertise and greater accountability. We believe that these investments, aligned to our strategic priorities, backed by exceptional execution, will significantly improve the return on technology initiatives. In fact, we are seeing some early events that our investments and our operating model is paying off.
In closing, as Marvin mentioned, we have sufficient capital to invest and functional leaders with clear vision of where we must take the company. In 2019, we will focus on stabilization and modernization. Then in 2020, we will deliver rapid functionality improvements and capability rollout. In 2021 and beyond, we will continue to make ongoing strategic investments in our business. Throughout my career, I have led creation of extremely complex, highly distributed systems as well as large scale transformation efforts. As I have watched the technology landscape evolve, the current advances in cloud deployment, open source technologies, artificial intelligence and machine learning have made this an opportune time to execute a large scale technology transformation. My experience, combined with current technology climate and the support and deep expertise of this leadership team gives me confidence in our ability to achieve these goals and leverage technology to take advantage of the opportunity ahead of us. I am truly excited for what lies ahead in our multiyear technology plan and excited to be part of this retail transformation. Thank you for your time today.
Unidentified Company Representative
We will now take a 15-minute break. Refreshments are available in the lobby.
Unidentified Company Representative
Please welcome Chief Financial Officer, Dave Denton.
Good morning, everyone. Welcome back from the break. I am very excited to be part of the Lowe’s team as we focus on improving the core fundamentals of our business, which we believe will allow us to drive significant shareholder value over time.
Now while my first official day was in late November, I spent a significant amount of time over the past several months immersing myself in this business. I have actively participated in the strategic planning process, the development of the ‘19 financial targets and plans and the creation of our long-term financial outlook and targets. As we set the stage for the future of the company, we are focused on three key areas to drive significant shareholder returns and this will be our road map for unlocking value as we go forward. First is our drive towards operational excellence throughout the enterprise. Second is our ability to generate significant levels of cash flow. And finally is instilling a more effective approach to capital allocation. Maximizing shareholder value will be a major focus of the company and I believe that all three areas will contribute to our success.
So with that, here is a look at my agenda for today. First, I will review 2018 and help you better understand our core performance, excluding all the noise associated with our strategic reassessment. My objective will be for you to have the right financial baseline by which to evaluate our performance over the next several years. Then, I will lay in our roadmap from a financial standpoint for the next planning horizon, including our guidance for 2019 as well as our long-term financial targets. And then finally, I will review our priorities for capital allocation.
As you well know, 2018 has been a rebalancing year for Lowe’s of sorts. We have narrowed our focus and have been eliminating underperforming and non-core assets all in an effort to create a platform for growth and enhanced long-term returns. The good news is that we are very well-positioned in both the large and growing home improvement sector. And as Marvin shared earlier, this nearly $900 billion market is very fragmented outside the top two players, which means there is a tremendous opportunity for share gains. We have a strong consumer brand, we have a broad customer base and we have a very diverse set of product offerings, not to mention a very healthy balance sheet that we are going to put to work to create value for shareholders over time.
Having said all that, you heard this morning about the challenges facing our business today, much of which are totally within our control. We have discussed the need to improve our execution and better serve the pro customer. Our technology infrastructure is in need of improvement, while our supply chain needs to evolve to meet the needs of an omni-channel environment. And this year’s strategic reassessment allows us to have greater investment focus on our core retail operations.
On our last earnings call, we shared our updated expectations for 2018 and we are reiterating that guidance here today. Total sales are expected to increase approximately 4% driven by comp sales increase of approximately 2.5%. We expect an operating margin decline of between 240 and 255 basis points, which includes about 135 to 150 basis points associated with our reassessment of the business. We expect diluted earnings per share of between $4.08 and $4.24 a share and adjusted diluted earnings per share of between $5.08 and $5.15 per share and we will generate a very healthy $5.5 billion of free cash flow. As we said, we have substantially completed our strategic reassessment of the business and have now honed our focus on making significant progress on our initiatives in 2019. So given all of the moving parts in 2018, I will spend just a minute re-baselining our financial performance, so that you can better manage our progress going forward.
Now this slide starts with the midpoint of our 2018 GAAP guidance and eliminates charges associated with the strategic reassessment, including between $460 million and $580 million of additional charges that we expect to occur in the fourth quarter. And the amounts, the nature and the timing of any additional charges associated with the intended exit of our Mexico retail operations will depend on the plan that we execute in that space and, therefore, not reflected in our guidance. Likewise, we are currently undergoing our annual goodwill impairment test. While it’s too early to determine the outcome of any potential non-cash impairments resulting from this effort, they are not contemplated in our guidance today.
From this adjusted view, we then re-baseline so that you have the right jumping off point from 2018. First, we have closed all Orchard Supply Hardware stores, which removes roughly $560 million in sales from our base and eliminates about $60 million in losses associated with that business. The exit of our Mexico retail operation as well as certain non-core activities in the U.S., which include both the Alacrity Renovation Services and the Iris Smart Home business will remove about $210 million in sales and eliminate approximately $40 million in losses and these actions are represented in the business unit optimization column on this slide. We also announced the closure of 20 underperforming stores in the U.S. and another 27 in Canada. So we have added back the liquidation impact of those closures. And then finally, we have completed an aggressive rationalization of inventory removing both low performing and slow moving items. So we have added back the impact of that event in both the U.S. and in Canada. The net effect of all of this re-baseline is a re-baseline of an operating margin of 9.3% and EPS of $5.51 per share for 2018.
So here is a quick roadmap outlining how to think about the next few years from a qualitative perspective. Again, 2018 is a rebalancing year where we are eliminating underperforming and non-core assets and again allowing the organization to focus on retail fundamentals. In ‘19, we will shift our attention to realizing many quick wins across our business but also aggressively implementing the initiatives that we outlined earlier today. And given the practical timing lag between the implementation of the business fixes and the realization of the financial benefits, we anticipate that 2019 will only deliver modest financial progress. However, looking forward, we expect that beyond 2019, the business will begin to more appropriately reap the financial benefits of these important operational changes. But clearly, transformation of the supply chain and establishing a robust omni-channel platform will require investments beyond 2019.
So with that as a backdrop, let’s review the company’s 2019 financial guidance. We expect total sales growth of approximately 2% driven by comp sales growth of approximately 3%. We expect our initiatives to enable us to begin to close the gap to market growth. Drivers of our 2019 sales plan include the steps that we’re taking to achieve merchandising excellence, including category management, enhanced local assortments, better reset execution and the continued launch of the Craftsman brand at Lowe’s. Additionally, our operational efficiency efforts will lead to more productive labor utilization and better in-stock levels, which we expect will allow us to better convert traffic into transactions. Our pro focus should also generate incremental sales for ‘19. We are making investments in both inventory brands and services to better meet the needs of this important customer segment.
And finally, we expect that improvements to Lowes.com will yield better top line results. So in addition to solid sales growth, we expect 235 to 250 basis points of improvement in operating margins. This represents approximately 30 basis points of improvement versus the re-baseline to roughly 9.6% in 2019. We expect the primary drivers of operating margin expansion beyond sales growth to come from SG&A leverage. Store labor productivity as well as reductions in advertising costs from more effective and targeted marketing programs, they will be the major contributors.
Strong sales and growing margins are expected to generate approximately $6.5 billion in cash from operations in 2019. We are planning for capital expenditures of roughly $1.6 billion in 2019, which is elevated compared to our historical run-rate of about $1.2 billion over the past several years. And now that we have substantially completed the strategic reassessment, we have identified the critical areas where focused capital investments are required to both drive near and long-term performance. And the good news is that the amount of incremental capital required to fund this effort is not significant. In 2019, approximately 60% of our CapEx will be dedicated to maintaining and reinvigorating our current asset base and improving our technology solutions, while 25% will be focused on strategic efforts that will drive improved performance both in the long-term as well as in the near-term. New store growth in international investments will be very modest, requiring only about 15% of planned capital spend and we expect that the next 12 next 18 months will be the peak capital investment period and the company’s level of investment would be modestly below the peak longer term.
Now before I highlight our longer-term targets, I want to point out the cadence of some of our key initiatives. And as this chart indicates, most of the initiatives have go-live date sometime in 2019. The supply chain and digital investments will be the exception, requiring a multiyear journey. While benefits from many of these efforts begin to accrue in 2019, we expect the impact from these initiatives to increase significantly over time. And this is a chart that we will use going forward to track our progress. With an increase and intense focus on retail fundamentals, we have a significant opportunity to drive performance and returns over the next several years. Based on the actions currently underway and our planned initiatives, here’s a quick snapshot of our longer-term financial targets. Over a reasonable planning horizon, we are targeting sales per square foot of $370. Now, this level of sales growth equates to early 15% increase on a per store basis. We are targeting an operating margin of 12%, 270 basis point improvement from our re-baseline levels in ‘18. This improvement will be largely achieved through a combination of both sales leverage and better SG&A performance. This level of performance would slightly outpace our peak level achieved some years ago. And finally, with accelerating sales growth, improved operating margin and better capital deployment, it is our goal to enhance ROIC by 1,600 basis points to 35%. And based on the plans we currently have in place and the corrective actions underway, we believe we have very clear line of sight to achieve this level of financial performance. Improving ROIC is critical as we look to enhance shareholder value over time.
So with that, I am going to switch gears for just a minute and I am going to focus my comments on our balance sheet as well as the capital structure of the company. Our objectives are geared towards funding our business operations, supporting future investments and optimizing our capital structure. We are very committed to maintaining a strong balance sheet and a solid investment grade rating because a healthy balance sheet is a key element to providing flexibility for the company to invest in high return efforts, which in turn will allow us to maximize shareholder value in the long-term, but we feel we can maintain that flexibility at a slightly higher leverage level.
We will now target an adjusted debt-to-EBITDA ratio of 2.75x versus our previous target of 2.25x. We believe that increasing our leverage ratio will allow us to optimize our capital structure and our cost of capital and drive incremental returns for our shareholders. Our debt maturities are well laddered with no 1 year requiring a significant outlay of funds, which provides us incredible flexibility as we issue additional bonds and increase our leverage.
Now looking forward over the next 3 years, we believe strongly that the company is positioned to generate significant levels of cash. Assuming a reasonable financial plan, the company could generate operating cash over this period of approximately $21 billion. Now if you were to assume that slightly more than 20% of this cash would be invested back into the business in high return efforts, over $16 billion in free cash will be generated. Now, additional cash of about $9 billion could be made available as we reach our new leverage level of 2.75x. This will result in approximately $25 billion available to enhance shareholder returns. Given the strong cash generation of the company and the improved outlook for the company today, our Board of Directors have authorized $10 billion in additional share repurchases to be completed over time. This brings our total share repurchases from an authorization standpoint to $14.5 billion. During 2019, we expect to complete between $6 billion and $7.5 billion of share repurchases significantly above the roughly $3.5 billion on average over the past several years. While we expect the incremental repurchase to have a modest effect on 2019 EPS accretion, we expect it to generate significant value to shareholders longer term. As a result, we expect to deliver adjusted earnings per share in ‘19 of $6 to $6.10 per share or approximately 10% over the 2018 re-baseline levels.
So here is a handy summary of our capital allocation priorities. Our first priority is always we would make the necessary operational investments to drive healthy growth and returns within our core retail business. Acquisitions will not be a priority in the near-term, but we will always evaluate opportunistic situations that add needed capabilities. We plan to maintain our current dividend payout ratio of 35%, while managing again our capital structure to 2.7x adjusted debt to EBITDAR. We are committed to making disciplined risk adjusted decisions when deploying our cash. We will invest in projects that help us grow and stabilize our business with healthy long-term returns. We will either fund these types of projects or we will return the capital to our shareholders if that creates the best value. This is a new day and this is a new Lowe’s. We believe we have set reasonable financial targets for the company. We have a renewed focus and energy on driving long-term shareholder value and we look forward to providing updates on our progress in the coming quarters.
So with that again thank you so much for your interest in Lowe’s. I am now going to ask my colleagues to join me on stage. I am going to take some questions from the audience.
Unidentified Company Representative
For our lot of audience, there will be microphones on either side of the aisles to take your questions. Please limit your questions to one plus one follow-up.
Q - Greg Melich
Hi, good afternoon. Greg Melich with MoffettNathanson. So, I guess I want to start with the, I think the real shift here where we can see the 2,000 engineers really impacting much of the company. And I just love to hear a little bit more about why do that 80% internal, will all those people be here in Mooresville or will they be spread across the different business units? How are you actually executing on that and why do it all internally in-house when there is probably a lot of other places you could get that expertise? And then I will follow up on leverage.
So, I will take the first part and I will let Seemantini get into the specifics. But as we did a search for our new Chief Information Officer, we really wanted someone that could help us think about the future. And if you think about large companies making large scale transformations, you don’t make those buying package software. So, I wanted someone and we wanted someone that had a skill set and a track record of specific design in this new age of cloud technology and open source arenas of technology. And so she has that. And so I will let her speak specifically to the vision around doing it in-house versus going outside.
That’s a good question. And I think my experience, what it tells me is if your underlying business process is non-differentiated and if it is well-known and well-documented and if it is not changing much, those are great places to buy packet software. So for example, if you want to run your company’s payroll, that’s a great place to buy a packet software, because every company out there is running payroll kind of similar to each other. However, if you want to run your own inventory or you want to take orders, these are the places where you are actually bringing differentiation. This is your secret sauce. Generally, packages develop software, which is lowest common denominator across all your clients and they are not able to accommodate for secret sauces. So, this is something we want to internally do. And 2,000 engineers is our estimate given our omni-channel ambition like you heard all across. This is our estimate of what we will need. Any great engineering organization today, I think has always to be in a talent mode of hiring, retaining top talent, I personally spend a lot of time making sure that I have a really good network, robust network and I am continuously looking for people. So I think it squarely falls in our ambition of omni-channel, developing our secret sauce internally with our own engineers and that is the estimate that we will accommodate that.
And so let me give you kind of where we are today, we have quite a bit of package software that we customize. And so we are paying license fee for a product that we can’t even get serviced on because it’s so customized. And so we have the worst of both situations and we have to work our way out of that. And relative to where these individuals will be located, that is still under discussion. We have – we are fortunate to have office locations not only here, but on the West Coast, different parts of Carolina and around the country. And so Seemantini is working with Jennifer and I and we are thinking through what would be the best location for us to recruit and to retain these individuals, so that’s to come.
And Dave, welcome, it’s great to have you here.
Thanks for the very clear path and plans and goals. I guess I would love to get a little bit more idea of the sensitivity, just to top line and macro and why really take leverage up to 2.75x now when it looks like the organization has a lot of change going on and there are some macro headwinds in terms of housing turnover and whatnot, so I guess what sort of world environment would you see that 2.75x target where it might make sense to go back to 2.25x, how flexible would you be around that?
Well listen, we are never going to put the company in harms way. We do think there is an opportunity to take advantage of the balance sheet between kind of where the company is today and levering up to 2.75x will unlock a lot of cash. You heard I think very strongly about the business and the opportunities we have in the business. Despite what happens from a macro perspective there is a lot of opportunities to drive performance in the business even if we had a softening of the macro. Having said that, we will be cautious, we will work and we will manage ourselves through certainly 2019 and beyond, but I do think it’s appropriate to get our leverage back up there. And we are going to use the capital to reward shareholders as we go along in this journey to improve Lowe’s over time from a financial returns perspective.
Thank you. Simeon Gutman from Morgan Stanley. Marvin, you somehow lost 5 or 10 points of pro share in five months, I don’t know where it went, but you can talk about the old days that we were using – why did that definition come down. And then if you can talk to us about what do you think your share of wallet is with the pro customer, we think your competitor is somewhere in the mid-teens, so you can you put both of you together, it’s still pretty small piece of the market.
Where is all that other business, it would tell us that it doesn’t have to come from them and is there any big buckets or lower hanging fruit there?
Yes. So Simeon, I will take the first part of that and I will let Joe McFarland provide some additional context. The pro penetration has always been an estimate. And as we dug into our version of that estimate, we felt that it was estimated too high based on the view that Joe, myself and Bill with our experience in this space have typically viewed pro penetration. And so from that, we felt that the number is closer to 20% to 25%, again based on a renewed view of the estimate and we feel more comfortable with that as a representation of our penetration. Now setting that aside, as we mentioned on a couple of different occasions today, this is a $900 billion home improvement marketplace and 50% of that is pro. And so we know there is a lot of share out there that us and our largest competitor does not have a significant amount of, so we do know that the fragmentation of the home improvement marketplace, including pro is a very available marketplace for us to go to try and drive the business. And so I will let Joe talk about MSH, which we think is a huge opportunity for us to unlock part of that, but also just the fundamental things we do in the store and what we will do over the next couple of months and into 2019 and we think will allow us to start to grow that business.
So I think it’s important to understand that from a pro capture standpoint, the way that we have in the past looked at that is really primarily through our private label pro credit card. And then we have matched up known transactions like transactions to the pro. And as you think about even being in our store, you think about the pro and the building, it is painfully obvious that we don’t have that pro customer in the store. And so through our own internal, really kind of deep dive and resetting the expectations of pro, we believe that 20% to 25% is pretty accurate. When you think about the footprint we have and we often get asked a lot of times do we have a disadvantage in our footprint from a pro standpoint, even in our most rural locations, there are mom and pop lumberyards, there are lighting showrooms, there are flooring showrooms. And so all of these opportunities out there and between the two of us, having such a small portion of that pro business, it’s not them or us, it’s the sheer size of the opportunity that’s out there. In addition, as Marvin mentioned and I mentioned in my presentation, we have a great opportunity with MSH to continue, to expand, to open up new branches. MSH really has a very focused catalog for the single-family MRO customer. We believe that there is a lot of synergies between our outside sales force and the MSH outside sales force in working together. We have launched our very first kind of joint partnership in understanding how we leverage MSH inside of a Lowe’s store and how we would leverage the Lowe’s store with the MSH customers as well. So very early days, but I think we are pleased with the reception we are receiving from the customers and we think there is a lot of synergies there. So the opportunity ahead of us as we had supervisors, as we increase the depth in job lot quantities, as we improve the service model with the loaders, MSH as we sharpen kind of our larger volume quotes out there from the pro standpoint, we believe there is tremendous opportunity to unlock that pro business inside of Lowe’s.
And my follow-up is for David, can you share any color on what each comp is worth the EPS and my premise is that it’s worth more that you are going from a two to a three than zero to a two?
Yes. Certainly, as you go up with the fixed cost nature or semi-variable cost nature of the business like this, clearly taking those next points up would be more impactful to us financially. But [ph] I am not able at this point in time to give you a clear delineation of that. I do think given ‘19 is a bit of an initiative implementation year, I think once we get that, the business, I will say more stable and we think about the out years, there would probably be a better metric at that point in time to come back to you with that.
Thanks. Eric Bosshard, Cleveland Research. The slides I had have Xs [ph] for the years for the 12% margin, so…
Perhaps you can clarify that, I guess two questions, one, if you could help us understand the thought process, I know it’s a new Lowe’s, but traditionally we are used to 3-year plans and so is that implied as 3 years. And then secondly, there is a lot of spending going on and it seems like the incremental margin in the next $25 a foot, sales per foot is quite high, so if you can just talk a little bit about – connect those two dots please?
I will take the second part. Relative to the 3-year plan and the Xs, this is a really new team. I think that’s worth noting. And this is also a company that candidly does not have a great track record of hitting financial forecast. So we wanted to be appropriately conservative in determining our long-term view of the business because 2019 is the rebalancing year. And so we are definitely focused on a 3-year plan and beyond that relative to supply chain and IT and digital. And so the Xs represent our near-term view. And you can define near-term in any way you want, but it’s our near-term view. And we will leave it at that and we think we will have a much better line of sight as we execute through 2019. As we think about the self productivity, I will let Bill discuss some of the things that he is putting in place relative to kind of how we today have such a lack of focus on driving self-productivity, whether it is end caps, off shelf space and pro. And the big unlock for us in driving self-productivity is the pro business. Any time you have a customer that’s worth 5x more the traditional DIY, that’s a customer you need to track because they unlock so much productivity value in the store. But Bill can talk about the value of MST in driving productivity, the field merchandising team and some of the things his team is working on right now just to be more productive with our space in the store.
Thanks Marvin. Yes. So as I said in my prepared remarks, we are making changes to the end caps and using a whole different philosophy in regards to changing them from what have been showrooms to now trying to sell product off of that. In addition, as we roll out MST, we will have the ability to now look at bay – in bay performance. And so we will look at bay productivity. So as part of the category management process and going through and identifying and applying a role and an intent to every category inside the store, we will be able to get a more clearer look at the productivity inside of each one of our base. That then allows us to make good decisions as it relates to how we then implement off shelf, what we put on our end caps and then how we grow our assortments online so that we can supplement what we are doing inside of our store and build out those our assortments online in a faster rate. And then we can invest, as we have – as Joe covered in his presentation, so that we can invest in job lot quantities and those high moving SKUs for the pro customer and that’s where we are headed.
Hi. Thanks. It’s Mike Baker from Deutsche Bank and these are maybe specific questions that you wouldn’t – that you have already answered, but I will give it a shot, within that $370 sales per foot, what kind of sense for sales is embedded in there, how much of that is macro driven, there is going to be some macro thought process in there, how much of it is company specific i.e. end caps, like making the end caps go from showrooms to some of the product that’s worth X amount of hundreds of millions of dollars or do you have any kind of specificity in there?
That’s the word.
Listen, at this point in time, we do have I would say, plans in place that take us out through that period of time. I think at this point in time, we are not willing to kind of go through that in detail. I will rest assure that there is – behind all of these initiatives, you can imagine the captains that we have that are managing these projects and the initiatives and the project plans beneath them to go drive to the performance. So we have pretty clear line of sight to that. But we are not really at this point in time prepared to disclose that.
So let me give you a couple of anecdotes that give me some confidence. We are in stores every weekend. I am in stores every weekend and most weekends and it’s not uncommon for me to be in a store like this weekend that’s a plus 2% comp with over 1,000 out of stocks. And out of stocks in home improvement is real easy to capture. You just count holes on the self, because if it’s not available for the customer to purchase it, it didn’t matter if there is any overhead of stock room, you are out of stock. And so when I look at that, I have two emotions; one, really, frustrated that we are providing such a poor level of service to the customer, but also really encouraged that I am at 2% comp in the store, I got 1,000 out of stocks. I will go across the street to the competitor and I can count a significantly lower number than that. And so macro has nothing to do with that noise, any of that structural that is 100% within our control. Conversely, I can go to a store in a pro market where I know the pro is strong based from my past experience and I can go to one of my stores and I am less than 20% penetrated pro. And I am thinking to myself, the opportunity here is enormous if we could figure out this business because this store, this market is a 40 plus percent pro penetrated market. And so we look at all of these things and not just from a perspective of anecdotes, then Joe and Don are working intently on the in stock piece and Bill is working on the assortment from a pro perspective and Joe is working on the service model. So we are working on all of these things. And to David’s point, I mean we can’t give you a basis point value to each, but because we have so much experience on this team that’s kind of been through this journey before, we intuitively know the value is there and we have to execute it. And so – and these things are not impacted by the macro in any shape, form or fashion.
Thank you for that answer. One more follow-up on microphone [ph] and this is for Jocelyn and Jennifer, I think as I look up there, you two are the only people who were there with the previous management team and Jocelyn, I asked you this at breakfast, but can you maybe describe what you see different in the way Lowe’s operates today than maybe 3 years ago?
So it’s really hard to say something negative when I am sitting next to her, but she is definitely free to do that and she knows she is…?
So I will start and then you can jump in. I think I will just elaborate on the conversation that we had earlier. I think what’s really exciting is the strong focus that you can see. Culturally, I think there is also a renewed sense of urgency. One of the examples that I was giving you this morning, which can really allude to this, is the military spot that you just saw that we played earlier that played in the World Series. From the time that Marvin, Bill, Joe and I talked about it to the time we wrote the script, we shot it in a store and we shipped it to air with 10 days. So that is probably a really great illustration of the urgency that we are operating and the alignment behind all necessary parties to just align on what we need to do and get it done. I think it was obviously an amazing thing to be able to launch that TV spot. It’s a program that we stand behind, but I think that’s probably a really good example from the seat that I am in on the change from a culture standpoint. We are getting to alignment. We are talking about the tough issues. Once we decide, we go. And so I think as you hear about the opportunities that we have with execution, the areas of focus, sense of urgency, alignment, focus. Those are key enablers for us getting the job done. So I will let Jennifer dive in from her point of view.
Sure, absolutely. Thank you, Jocelyn. I will just add to that. What I would say is one of the notable differences that I am very encouraged by is we are simplifying the business and we are doubling down on retail fundamentals. And as I travel in the field and I talk to our store associates, they have known what we need to get after in terms of enhancing their ability to more effectively serve our customers. And that’s what they are hearing from this leadership team, very clear articulation of the expectations going forward, what we are doing to get after it, accountability around execution and then a very routine cadence of communications. Marvin does a weekly podcast to our field associates and I get so many comments on that on how much they appreciate that we are refocusing on retail fundamentals, that they feel like there is an open and transparent and authentic communication with the senior leadership team. And then finally, one of the things that I think of about as an HR leader that until the team comes together, you are never quite sure is there is a great alignment and chemistry with this team. And so we – this team is working so well together. There is great chemistry. There is great confidence and support of each other. And that’s something that until you bring the team together, you don’t know. But I really credit everyone sitting up here with that because we really place an emphasis on making sure that we are aligned as a team. We are focused on sense of urgency and executing with accountability.
Good morning, it’s Laura Champine from Loop Capital. Dave, when you mentioned the potential to raise $9 billion in debt, would that be likely front loaded given the rising interest rate environment?
Well, we wouldn’t do that. That $9 billion is really over a 3-year period of time, so we certainly would not do that in 2019. We will obviously take our leverage ratio up to – in ‘19, so we will place incremental and additional debt. We haven’t really come up exactly what our financing plans would be because the markets are a little choppy right now. I think particularly at this leverage ratio, those type of companies in that – in those typical rating categories, there is kind of barbells and you see some that have been struggling, like the GEs of the world as an example and they have created a little bit of shock to the credit markets I think. So I almost think that after the first year, we will kind of get a better reassessment of how the credit markets work and how they look and how frothy they might be to determine how we go to market.
Got it. And this one is for Marvin related to the expectation that interest rates will rise and that may impact the demand for your categories overall, what’s embedded as a rate of industry growth inside that 3% comp for next year, because I don’t think that’s where your ambitions lie longer term?
Well, I don’t know that we have an embedded industry growth as much as we look at the macroeconomic data points that really correlate our business, income growth, home price appreciation and real residential investment. What I have said many times over the years is the home improvement market is in a good position when you purchase a granite countertop for your kitchen and you view it as an investment and not an expense. And the difference is correlated to the value of your home. If your neighbor sells his or her home and they lose money, then everything you buy, it feels like an expense. But if they sell their home and the value is up, then everything you buy for your home feels like an investment because you believe that you are going to get it back and that goes to consumer confidence. And so we are in – even interest rates are up and we acknowledge that and you have some affordability indexes kind of you are ticking in a place where they are hard than they have been, but still relative to kind of historical norms, still from an affordability perspective around the country, we are still in a really good position. Our business and those metrics really support us, and that’s part of why we view the ability to grow above kind of hopefully that we could grow above what we have presented, but we want to be appropriately conservative because we want to gain some credibility as a team that we can deliver on our financial expectations. But the macro is still supported. But more than anything, we believe we can create our own tailwind. I can go on and on and on about the entities, about the stocks, about how we are not servicing the pro business – that photo that Joe McFarland has showed on the lumber and building materials, those are real photos. That’s a real photo of a store that you go in and you see all of the steel, all of the back wall. If you are a pro customer, there is no chance that you are going to shop us, because you are so concerned that later in the week, you are going to be out of stock. And so you are going to make this trip to the store, you are going to walk in with 1 or 2 people and there is no product. And so you just created a serious productivity issue for yourself. But when we can present product in a job lot quantity in a presentation level that they can say, okay, you guys are in business, you understand what I am trying to accomplish, then you create some confidence. And then Jocelyn is going to help us invite those pros back in to let them know that there is something different here and we can start to win a greater share of their wallets. So, all those things factor into what we believe we can do in the future.
It’s Michael Lasser. Thanks a lot for taking my questions. Marvin, you laid out a comprehensive plan here, but in the past, across retail sub-sectors, we have seen retailers who maybe lagged behind and have had comprehensive plans, have difficulty catching up for whatever reason, why is this time different?
It’s a very fair question. I think what’s different about it is that we have recruited individuals who have done this before. So there is no one on this presentation stage here, that had some level of transformation in their experience. And every single thing that Joe McFarland presented, we have executed before. Everything that Bill Boltz presented, he is executed before. Everything that Seemantini talked about from a large scale transformation, she has done it before in different places. And Don’s experience in supply chain, he has done these things before. So that gives me confidence that we are not guessing or we are not depending on consultants to tell us what to do, but we really understand it from a practical knowledge standpoint and we have the balance sheet. If you think about Dave’s presentation of capital, the reason why we are not seeing an enormous ramp up in spend is because we are just reallocating our spend to our core retail business. We are not investing in Australia. We are not investing in Orchard. We are not investing in Alacrity. We are not investing in Iris. We are investing in the Lowe’s core retail business. And so we have the capital to do it. And having done this before as a leader in different roles, we made mistakes, we have learned and so because of that, we have the institutional knowledge to get it executed and we have the discipline not to allow distractions to come our way. Now as I have said in my comments, we believe we can drive continuous improvement throughout every phase of this transformation and that’s expected of all of us, but that gives me confidence that we can do this.
And you mentioned continuous improvement you have talked to leading your progress, but how much should we expect to see some disruption along the way either because of legacy issues or because you are instituting a lot of change in a relatively short period of time. I mean, as recently as 3 weeks, we saw your website go out, the busiest – one of the busiest shopping days of the year. So how much have you factored in and how much should we expect to see some disruption along the way?
Well, I think we are not naive enough to believe that we won’t have some disruption, but the disruption won’t affect every corner of every aspect of every part of the business. Because again, I go back to the out of stocks, I go back to the lack of product presentation and pro, I go back to our service issues, I go back to our lack of investment and leadership training. These things will not create disruptions. These things will make us better in the short term and the long run. So we believe there is a good balance between improving the business in the short run with fundamental retail initiatives that will offset disruption that may occur as we figure out other things. And also we test and learn. I mean, in the past, this company has been notorious for just rolling out a large scale change without testing or piloting anything. We are even piloting the job lot quantities. We did not just decide to just rushing in and shove inventory to the store. I mean, Bill, Joe and Don have been working on specific markets. We were in a store a couple of weeks ago looking at the presentation. I mean, all of us making sure that we feel good about it and making sure that it represented what we felt was the right presentation. And so we’re testing and learning so that we can minimize the disruption. But again, will there be some disruption? Sure. But will that impact our business as in a large scale in a negative way we don’t see that as a possibility.
But also just think about the journey we talked about earlier this morning that the operating margin improvement as we cycle into ‘19 is pretty modest, because you talked a lot about of quick win opportunities we have, but we are not counting that all that’s going to flow directly to the bottom line because there might be some disruption, there is some investments we are making.
Hi, Brian Nagel from Oppenheimer. Thanks for taking my questions. So I have a couple, I guess, largely financial questions for Marvin and Dave. But first off, on the 12% operating margin target, reckon that that’s a nice balance from where we are currently, but it’s still lower than your primary competitor. On your slide, you got a benchmark of the 14%, I don’t know where that pertain to. But the question I have is, is that a talk in the – or was that of an interim type goal? And as you look at the model, if you really dug into the model now, are there structural limitations within the business that could keep it going from significantly higher – from meaningfully higher?
Yes. So I will do the structural and I’ll let Dave talk about how we see that as an interim rather top of our expectation. From a structure standpoint, not so much, as we look at our chief competitor, the one obvious difference is that they have more stores in metro market. So I think the numbers reflected in the top 25 metro markets in the U.S., they have 80% more stores than we do. That is structural. There is not a lot you can do about that in the short run. However, that’s just as we estimate one-third of the gap. So there is two-thirds that are 100% within our control. It’s for execution of resets. It’s an inefficient in-stock process. It’s lack of a focus on pro, etcetera, etcetera. These are things we control and things that we believe that we have the expertise and the processes in place to start to chip away at it and we will make some investments in some metro markets so that we can have a better presence, but that is more of a long-term horizon. So structurally, yes, but modest. And I will let Dave talk about where we see the business going beyond what we presented.
Yes. Listen, 12% is not the ceiling on this business. We strongly believe that. What we have tried to do is lay out a reasonable financial plan over a defined period of time – pretty quick period of time to get to these levels. We do think there is additional opportunities to go above and beyond that, but what we have tried to do is be very planful, understanding all the efforts we have underway and are about to implement in ‘19 and what will that deliver over the next several periods and that’s what you are seeing on the slide. And now we have to really take a step back to Marvin’s presentation earlier today, once we get kind of through some of the underbrush here, there is an opportunity of now think about our business a little bit differently and how can we improve our performance above and beyond that level.
So let me give you an anecdote. So Don showed, he gave an analogy on appliance delivery. And as he said, unfortunately that’s a true story. And so let’s just think for a second, if you pull all the appliances out of the store where 90% or almost 80% are delivered, but yet we house them in the store, and even if we have an appliance distribution center in a market like Dallas, when the customer orders the appliance, it’s shipped from the appliance DC to the store. The store still takes the burden of that process. And so the second largest theme we have from cost of goods sold is payroll. And so the amount of payroll that we have tied up in appliance delivery, just appliances in our store is enormous. Not to mention store’s containers, damage, transportation costs, efficiencies and all that. So just taking that and creating a market-based delivery model, pulling that out of the store and going direct to the consumer is an incredible unlock for us, unlock from our customer service but also an unlock from a profitability perspective. And so as we think about the future in Don’s 5-year supply chain plan, that’s factored in, but we don’t even know how much productivity we’re going to gain by pulling that out, but we know it’s significant. So that’s just one of many examples that we are very encouraged with the possibility to generate operating profit. And our competitor doesn’t have to deal with that, and that’s a compare and contrast from a cost perspective.
Got it. My follow-up question also on guidance, so for ‘19, I find it quite impressive, I am sure this is – with all that’s going on, you are still assuming up here in terms of sales and operating margins?
That’s right. That’s right.
Within that guidance, just being more qualitative, from a macro standpoint, we are assuming much change from what we are seeing currently. And then second, how much of that guidance reflects the beginnings of the benefits of the changes you are making at the company?
Well, clearly, there were some benefits baked into this. I think that the macro – you should almost disconnect the performance a little bit of our company to the macro, because I think there are so many self-inflicted issues that we have that we can solve to, I will say weather the storm of a softening macro if it were to occur. I do think you are seeing those initiatives begin to deliver performance in ‘19. The cadence of those – that delivery is probably more back half weighted just by the practical nature of the reality that once you have put in a fix, the financial benefits take a little bit a while – little while to accrue. So you are seeing that effect on ‘19 as we think about our financial plan.
Thanks for taking the question. This is Jason Haas from Bank of America. So I wanted to ask Dave on the 30 basis points in margin improvement, if you could give us a walk-through on that in terms of – it just sounds like you are going to be adding some labor to the stores and that’s at the corporate level. So what really are the offsets to that to get you the leverage? Thanks.
Well, you want to talk about payroll real quick?
And so I’ll take the payroll. I will tell you the amount of productivity improvements that we have identified just from a straight payroll standpoint, I will give you couple of examples. If you think about what I showed the green screens on our front-end cash registers. And so we have a fix going in, in late Q1, early Q2. And when you think about the amount of time it takes as we hire new cashiers, a lot of them have never seen green screens before. They have no experience with them. And you think about the amount of time, and if we hire 30,000 cashiers this year, and we can take their training down by 8 hours, if by putting the new touch screen interface on the registers, if I can shave 10 seconds off of every transaction we have, and so these are real productivity improvements. These aren’t just straight take payroll out and have kind of a shell game happening. These are real productivity things that we have line of sight. Have done many of these things before in the previous slides. As we think about moving from paper-based to the new handheld devices, we are rolling out the new handheld Zebra smartphone that will be in all stores by the end of March of this year. And so a lot of productivity tools going on that, going from manual process to digitized process. And so I think from a payroll standpoint, we are able to offset all the investments that we are making and the supervisors we are adding within the stores through straight productivity gains.
So at the end of the day, there is kind of three things driving operating margin for ‘19. One is a little bit of sales leverage as we think about the comp sales improvement performance. Secondly, we are getting some productivity through the stores through the initiatives that we are implementing. And then finally, we are honing our advertising costs to be more productive and targeted. Those three things are driving our performance in ‘19.
We will also be a lot more focused on SG&A in ‘19 than historically. So beyond the store, but non store-based positions also.
Great. Thanks. And then as a follow-up, I wanted to ask about how you are thinking about the store base and just where your expectations are for store growth going forward. And just also related to that just in terms of the strategic planning process, if you feel like, that’s largely been completed now?
Store growth is going to be modest. We still have voice in certain markets that will always address. But as I mentioned, we have a much more rigorous capital allocation process that we put in place. So the hurdle rate for new store approvals have become a little bit more stringent, which is the way it should be, but that does not prevent us from having voice that we will address. And relative to the strategic reassessment of the business, with the exception of some smaller, less material things, we will do the bulk of the major decisions are behind us.
Thanks. Good afternoon. Chris Horvers, JPMorgan. So I am trying to get a sense of the level of people change that’s occurred at the level below the management team in front of us. So, can you talk about that level of a turnover in terms of the direct reports, that major functions could we say, x percent has turned over and why is still to come? And then is there any duration on top of that where your direct reports have to go out and do a level of people change in the organization below that?
Well, I will answer the question more broadly, because we don’t want to do an HR review here forum.
Yes, for the world to hear. Well, what I will say is this, I challenge every leader, every new leader to come in to not only assess the business or assess the team and assess if we have leaders in position that, a) does not have the skill set that we believe we can develop or b) we need to upgrade. And we made quite a few changes based on that philosophy. Bill has made significant changes in merchandising. Joe has made significant changes on the store side. Don has made significant changes. Just pause on the supply chain for a second. We are over $70 billion retailer, and our past leader of transportation and delivery had never been in the supply chain before, never. He was managing this massive fleet in this significant cost center for us and had no experience. And so that’s an example of Don coming in and making a decision that he has contacts in the market to go out and find deep skill based knowledge to come in to upgrade those types of positions. And Seemantini is new in her role and she is assessing her team. And so I have given every leader the appropriate autonomy to make the assessment but also to challenge ourself as a world class company, we need a world class talent. If we don’t have that talent, let’s go and get it. But if we have the talent, let’s promote. Bill has made promotions within merchandising of existing leaders Joe has made promotions and so as Don. So it’s the combination of both. It’s not just bringing in a wave of external talent because we have no internal talent. We have great talent internally. Let’s elevate them, but let’s also find talent on the outside. So it’s a combination of all those things.
So, is there a next level down?
Yes, it cascades. But we have to be smart. I mean, spring is our holiday season. So we’re not going to go into the spring season disrupting organizational structures. And so a lot of the changes that we made, we made in preparation for having the right leaders in position for the spring season. And that’s what we’ve been doing for the last couple of months.
Then my follow-up is for Dave, you mentioned after the first year looking at capital markets, so this is about $4 billion of debt, is that....
Yes, somewhere in that zip code. Yes.
And so is your concern it’s – you can’t get it all done at once and at the right rate or are they...
No, it’s a rate issue quite honestly at this point in time yes.
Thanks very much.
Scott had a question.
Hey, guys. Scott Mushkin over at Wolfe Research. Thanks for taking my question. So I think with Michael’s question you kind of answered, I think one of the fears I am hearing from everybody is the organization is just going to run too fast, but it seems like you got a handle on that. The second question that we get is how are you going to differentiate Lowe’s in the marketplace? If you go toe-to-toe with Home Depot, that seems like a losing strategy. And I know there is a big market share out there, but at the same time, it seems like Lowe’s has some unique qualities, a unique brand. And I was wondering how much progress you have made understanding why people use Lowe’s and how to get bigger with people that might prefer Lowe’s? Thanks.
Well, I think it’s a fair question, but I think you answered it, in the fact this is a big market. And rather than being fixated on one competitor, I mean we are a customer-centric company. We have to listen to what our customers are saying to us, the customers who are shopping us and the customers who are not shopping us. And so we are really focused on that, but we understand that if you take our largest competitor and combine them with us, it’s less than 20% market share. So as I said, I mean, this is not – I mean, this is not a win-lose, zero-sum assignment. It’s not as though we’re competing for a contract like Boeing and Airbus. You got a winner and a loser. That’s not how this market – it’s a fragmented market. And so we are looking at it from the standpoint that if we can serve our customers in a way that they want to be served, if we can sell the products and provide the level of service and convenience that they desire, then we can grow and we can grow irrespective to what’s happening with our largest competitor. And that’s the way we are looking at this. So differentiation for the sake of differentiation is something that we are not interested in, but differentiation to serve the needs of a customer, because that customer has communicated that they desire that need in order to shop with us is something that we are definitely interested in and we make those adjustments. And I think Jocelyn’s view of the marketing campaign is a great example of doing deep customer insights work in understanding that our current marketing strategy speaks to one segment of the customer demographic. And yet we can tweak that and we can speak to a broader demographic by spending less money. And so that’s kind of the approach that we are taking, that is how do we attract more customers in this fragmented marketplace and not be so concerned about one competitor.
Hi, there. Right here. Marvin, you have laid an ambitious plan for Lowe’s and you are transforming the company and you have brought in a lot of talent as well and we can see it here. In the past as you mentioned, there were many things which were promised, but not delivered. I am curious how are you promoting the culture of accountability?
Yes. Well, I talked about the operating plan on the spot with the mission statement, our four objectives and our 10 initiatives. The culture of accountability is that on a weekly basis, the captain and a cross functional team will come in and present to this group. They will present their scorecard, their progress, their challenges and their wins. And collectively, there is no problem that they can present that somebody sitting up here shouldn’t have the ability to solve. And so you drive accountability, first, by having clarity. Jennifer mentioned the fact that if you could go out in the stores a couple of months ago and asked the question, what’s the mission for the company, nobody could answer it. As a matter of fact, this team couldn’t answer because there wasn’t one that was clearly articulated. And so it starts with clarity of mission, then it starts with the key objectives to deliver the mission and how do you measure, because if you can’t measure it, then you can’t execute it. And so we have gone back to a very basic framework of mission objectives, initiatives, measurements that define success, one view of success. The other thing that this company is really good at is having multiple versions of success. I got a report that makes my number look better than you think they look. Well, not anymore, because we have one scorecard for the company that we are all looking at. So we are looking at the same data and we are defining success the same way. And so as simple as that sounds for a large company is needed. And also one of the reasons why this company failed to deliver in the past wasn’t because of a lack of intellect. This is because of a lot of priorities that were distracting from the core business. And as I said to the team, we could run the best Orchard hardware store or small market hardware store in the world and it wouldn’t impact the valuation of the company. But if we can invest capital in Lowe’s core retail business and make a difference in operating margin, make a difference in comp sales, make a difference in return of invested capital than we are providing to shareholders the value that they deserve. And so refocusing and narrowing our priorities will also help to drive accountability.
Let me give you just an anecdote to help you there too. And in my presentation, I talked about getting to the root cause of the problem and not just throwing payroll at a problem to try to solve it. And when you think about from an execution standpoint, we have really restricted access to the stores to who sets priorities and created a real gatekeeper and a task management system that everything flows through the store operations team. If it’s going to be a priority, it’s going to go to a store manager to execute. It goes through one funnel that’s managed by the store operations team. The store operations team, at one point, was disbanded. So when I arrived, we didn’t have a core store operations team in the company. So we had no Senior VP of Operations. The labor team reported to one SVP. The loss prevention team reported to another SVP. The omni team reported to someone else. There was no one pulling everything together for the company. And what that ended up doing is on a weekly basis, I showed you the stack of e-mails that one store manager would get, that’s a buffet. And we had teams kind of picking and choosing what they were going to do, because there were so much to do and so much placed on them, so we took the task management. And when I arrived, we were executing somewhere in the low 50s to high 40s percent of all the tasks that would go out. And restricting those, making the right priorities, we are at a 98% plus execution rate and I am challenging the people that are below the 98% on why we are not at 100%. And so if we are limiting those tasks, we have to be at 100% execution and we have a weekly format to review that and to call it out. In addition, we shut off over 35,000 e-mail lists. And so this is e-mail all store managers in this district. I shut down 35,000 e-mail lists that existed in the company. And so you think about getting to the root cause of why our execution was where it was, everybody had a hand and it was kind of a free for all in what stores were asked to do.
I think there is one other thing in, you asked a question around accountability. We are driving a weekly meeting now. And if you think about having merchandise operations, inventory teams, supported by marketing and information technology, we talk about the business every Monday in a very frank and transparent way. We are planning together, we are understanding who is accountable for what. And when we walk out of this room and it’s held in this room, we are all on the same sheet of music relative to what has to be executed and that is a big difference from where we were from an accountability perspective.
Joe Feldman, Telsey Advisory Group. Wanted to ask again about the pro, how easy is it to get the pro to switch? Because our understanding or at least mine is that the pro it’s very sticky, very routine, they like their few places to shop and that’s it. So how do you go out and grab them even though you are doing all these great initiatives?
Well, I had the pleasure of running the pro business for our competitor for 6 years. And I remember when Lowe’s had dominant market share in home improvement in the pro and they switched. And they switched because we stopped selling the brands, they switched because we stopped investing in service. They switched because we stopped investing in inventory. They switched because we started to focus on inventory versus plan versus inventory turns, the things that Bill talked about and Joe talked about. And so it is our expectation, because we have 1,700 locations in the U.S. And so we are very convenient, that if we can just take a step back and we can offer consistent service, better inventory presentation, we can call out all the programs that we have and do a better job of filling out the assortment on the ones we don’t have, that we can win this customer back. We don’t think it’s going to happen overnight, but this customer from what I have learned is pretty agnostic to where they shop as long as those things are delivered. And if we deliver those things consistently and that’s the key word consistently, we think with Jocelyn’s team’s help to invite them back in then we can win that customer back over time and that’s our goal.
The only thing I would add is we talked a lot about the strength of our brand, overall. This last year and I alluded to it in some of my prepared remarks, our team has been really focused on testing and learning the different levers to get the pro’s attention and really trying to figure out what are the ways, what are the messages to get the pro back to Lowe’s. And we have had really, really, good success. And so what that tells me is that as we align with Joe and his team and obviously with the merchants on the brands, the services, all the things that we talked about, the job lot quantities, we can really partner in a very meaningful way. So, from just sending out the invitation, that’s what my team has been doing for the last year is testing what should be on the invitation, what’s the best way to send the invitation? And the pro that would tell me the pro is ready. So it’s when we are ready and we bring all those pieces together, I think the opportunity is pretty significant.
Thank you. And then a quick follow-up, maybe for Bill, with merchandising and the category management that you are doing, do you expect to end up focusing on any different categories maybe or deemphasize any categories? I know the big competitors talking about home décor a little bit more, just anything you can help on that?
Yes, great question. I think that the role of the category helps us one go through and clearly define the roles of the categories inside of our stores and online today. It also helps you identify those opportunities for future growth, maybe categories that you are not in today that you could be in tomorrow. And if you think about our stores and different locations that they are in, there is that opportunity that, that process provides you. And so as I said earlier, we have the opportunity to look at how do we enhance our online assortments at a faster rate to support some of the customization and configuration that she might be looking for in décor categories for example. And then that could open up space to allow us to get into new categories that are more relevant right now in the home improvement space that would be relevant inside of our stores. So all of that is part of the category management process.
We have time for one more question.
Peter Benedict at Baird. Marvin, I will start with you. The accountability stuff is great. Employees and people in general tend to behave the way they are incented to behave. So just curious if you can touch on the incentive structure that you have in place both for the senior executives but also down to the store level?
It’s a very timely question. We have a quarterly, hourly bonus program for our store associates that no one knows how it’s calculated. It is so complicated that – and Jennifer knows this, because I torture her and Joe with this all the time. I go out and I test it in every town hall by saying, okay, who can tell me what our quarterly bonus is called, and how it’s calculated? And no one has got it right yet. And it’s not because anyone tried to do anything wrong, it’s that we made it complicated trying to incentivize the associates more and we did the opposite, because they don’t know how to drive it. And so we are taking a step back and we are simplifying it going into ‘19. So, it’s going to be crystal clear to the associates on what they have to do to deliver a really great program, a quarterly bonus program for an hourly associate. So, it’s a great program. We just don’t do a great job. We give our associates a 10% discount everyday. We don’t tell anybody that we do that. Our competitor does not do it and we don’t even recruit – we don’t use that as a recruiting tool. I didn’t know we got a 10% discount until I joined as CEO and someone gave me a discount card. I was like, what is this and they said, you didn’t know you get a 10% discount. I said, I did know and I don’t want it.
So we are still able to recruit him, though.
Yes. So that gives you an example that we have great programs and we don’t do a good job of communicating. So, we are going to fix the quarterly bonus to make it more simple. The other thing we are working on is aligning the financial metrics of the leadership team, which today are not aligned. We have different performance metrics for bonuses based on the function that you are in. And I am not a proponent of that. And so we are going back and Jennifer and I will be meeting with the comp committee and we are presenting three metrics that will be consistent across finance, supply chain, merchandising, stores, HR, etcetera, etcetera just for clarity and also for alignment. And it is my expectation that whatever I am reviewing on, so are the store managers. I want to go all the way from me to the store manager, so we are all in this together and that’s what we are working on. So it’s timely because Jennifer and I spent time working on this and we will be presenting to the comp committee, I think in January.
Thanks. And then I guess as my follow-up for Dave, back to the financial guidance, I appreciate the hesitation to put a timeframe on those targets. But are we to assume that the 12% operating margin goal coincides with 370 a foot, like that those are tied together, or one happened before the other? I am just trying to understand.
No, I would think of them as tied together. I think what you are hearing us a little bit is while we have confidence in many of the – on all the programs we have in place, when they are actually – when we know when they are going to be implemented, but when we actually turned the corner, when we start reaping some of the benefits of those initiatives, we don’t have quite as precision, quite as line of sight from a precision standpoint, from a timing perspective to pin those down at this point in time. So that’s why there is a little ambiguity in exactly when we are going to deliver that 12%, but I think it is reasonable and understand that we are going to do this in a timeframe that’s fairly expedient.
Alright. Well this concludes our 2018 Analyst and Investor Conference. Thank you for your time and attention today and for your interest in Lowe’s. We invite those attending in person to join us for lunch as well as product demonstrations down the hall and thank you very much.