Lowe’s Companies, Inc. (NYSE:LOW) UBS Global Consumer & Retail Conference March 5, 2020 12:00 PM ET
Company Participants
Marvin Ellison – Chief Executive Officer
Dave Denton – Chief Financial Officer
Conference Call Participants
Michael Lasser – UBS
Michael Lasser
Good afternoon, everybody. I’m Michael Lasser, the hardline, broadline and food retail analyst from UBS. We could not be more excited to have the team from Lowe’s with us today. We’re going to have a great conversation. I really don’t feel like I need to provide an introduction for these two gentlemen that have had storied careers. But I – because I certainly couldn’t do their backgrounds justice, but just for a quick intro, Marvin Ellison is the Chief Executive Officer of Lowe’s. He’s spent time at Target, Home Depot, JCPenney and really has an exceptional viewpoint of what’s happening in the world and what his plans are. Dave Denton is the Chief Financial Officer of Lowe’s. He’s been in that position since 2018. He spent 25 years at CVS as the CFO, most recently before that.
Format here will be Marvin’s going to provide a few opening remarks, and then we’ll get into a conversation with some questions. If during that time, you’d like us to – you’d like to weave in some questions that you have, you can go to www.ubs.involve.events.com. And with that, I’m going to turn it over to Marvin who’s got a few prepared opening remarks.
Marvin Ellison
Okay. Thank you, Michael. Good afternoon, everyone. So it’s a pleasure to be here, and Lowe’s is a terrific company with an outstanding brand and a very powerful balance sheet in a challenging retail landscape, but we’re fortunate to be in a sector with very strong demand. In order for us to capture the opportunity, we focus on what we call retail fundamentals. These are foundational elements that all retailers must be good at.
We’ve also, as Michael mentioned, assembled a really talented leadership team with retail experience and also deep home improvement experience. But to deliver these retail fundamentals, we’re focused on four strategic initiatives. And these initiatives are, first, merchandising excellence. And we’re going to achieve this primarily by adding an additional 7,000 vendor funded associates to our merchandise services team that will allow us to improve execution in our stores, from a reset and also a product presentation perspective.
We’re also going to continue to leverage our field merchandising team that will allow us to improve our localization, our space productivity. And we’re also committed to developing a best-in-class online experience. And we’re on track to complete a total cloud migration of our platform that will strengthen our foundation of our entire e-commerce ecosystem by the second half of 2020. A very detailed road map in place, combined with a very talented team with deep omnichannel experience. And as I mentioned, we hope to see these initiatives start to bear fruit as we get into the second half of the year.
Our next strategic initiative is operational efficiency. We’re going to achieve this by continuing to leverage the mobile technology we instituted last year. We rolled out over 85,000 mobile devices to our store associates, and it’s allowing them to access real-time data on the sales floor while they engage with customers. This is a huge innovation for us. We were very primitive before this rollout.
In each quarter, we’re continuing to add different applications to these mobile devices. And also, as we improve our operational efficiency, we modernized our entire payroll allocation and labor scheduling system. And this is allowing us to leverage our operational expense while providing better service to our customers, and this has also given us the ability to shift payroll from task to service.
Our third initiative is what we call supply chain transformation. If you think about Lowe’s supply chain today, it’s designed primarily to deliver products from the distribution center to the stores and from suppliers to the distribution centers. We know that the future of retailing is all about a seamless ability to deliver product to customers’ homes and to the job sites of our pros. And this initiative will allow us to do that.
And we have an initiative we call customer engagement. And this initiative is largely focused on improving our product offering and service levels to our pro customers. Today, we estimate roughly 20% to 25% of our sales are driven by pro customers. In 2019, we’re going to improve upon this with the implementation of a more modern CRM platform as well as a loyalty program that will create differentiation and a degree of stickiness between Lowe’s and our customers.
As you think about these four strategic initiatives of merchandising excellence, operational efficiency, supply chain transformation and customer engagement, it is part of our transformation, and we’re one year into this transformation. But in addition to these fundamentals, we’re committed to improving our IT infrastructure. And this is evident by our commitment to open our first global IT center in downtown Charlotte where we’re going to house and employ over 2,000 IT professionals, focused exclusively on modernizing every element of our company. And we believe this combination of retail fundamentals, combined with enhanced technology, will be a catalyst to drive our business going forward.
And so we’re really pleased about this year. We’re pleased and excited about going into 2020 with the strength and momentum that we built from the foundational work we put in place in 2020. And before I close, I’d just like to say that our thoughts and prayers go out to the families in the Nashville area impacted by the storms and also the many communities now being impacted by the coronavirus.
Michael, with that, I’d be more than happy to take any questions.
Question-and-Answer Session
Q - Michael Lasser
Thank you, Marvin. You came in a couple of years ago, put in a great plan. It’s been well proven to work with a really capable team. Are you where you thought you would be? Is Lowe’s where you thought it would be at this stage of the journey? What’s going right and what has not gone, according to your expectation?
Marvin Ellison
Well, I would say, as I mentioned, we’re one year into a multiyear transformation. So we are really pleased with where we are as a company. These transformations are rarely linear. So we know that there are always a few bumps along the way. But as I think about what we’re very pleased with and where we hope we would be, is relative to the work we put in the stores around service and the implementation of service training initiatives operationally to drive improved productivity, to allow us to leverage expenses while improving service both in DIY and pro.
We talked earlier about the field merchandising initiatives in merchandising and how it is allowing us to improve our localization, our space productivity. Pleased with some of the new brands we’re bringing on board and the efforts we’re making just to be a more relevant retailer to the marketplace, but also to our supply community because our suppliers also pay close attention to our commitment toward key consumer segments like the pro and as we continue to invest in pro, then that invites suppliers who want to come in to be a part of that journey.
But we’re also just pleased with the progress we’re making in this really big, complicated company, to change the culture, to improve our results, knowing very well that again, we have multiple years to be committed to this, but we feel great about where we are. As we think back to where we want to continue to lean in, I mean, obviously, when you look back to Q1, we had a challenge from a margin perspective that was driven not by execution and effort, but really about lack of visibility, by system issues, not understanding cost increases that had been implemented months and months before many of the leaders got on board.
But the good news is, if you look at subsequent quarters, the team did a really incredible job of improving and driving the business forward in subsequent quarters. So we believe that the efforts that we put in place and the improved systems have enabled us to just be a much better company. And we talked about e-commerce being under construction. Look, in this world of retailing, it’s not just one channel. It’s multichannel, it’s omnichannel. And as much as our productivity in our stores, brick and mortar stores have improved, we know that a big key to our success going forward is having the right digital presence.
I talked about how we’re migrating the entire platform to the cloud. I mean just at the beginning of last year, our entire e-commerce was sitting on a decade-old platform. It – we had no dynamic ability to do a lot of things. And now with the migration to the cloud, it’s going to give us the ability to have better search and navigation, more seamless checkout, the ability to add SKUs a lot more effectively, the ability to schedule orders online, shop by collection and just so many other things that most retailers take for granted. I mean we’re running a multibillion-dollar platform without those things.
So the question is about how good can we be? So in short, Michael, we feel really good about where we are after one year in. We know it’s a multiyear journey. But when I look around the men and women that we recruited and the initiatives we have in place and our level of confidence going into 2020, I mean, we feel like we’re at where we need to be.
Michael Lasser
Okay. The question comes up, and this may be a naive one. Why is it so hard to turn a retailer around? And you’ve seen the retailers across the gamut. Good ones, challenged ones. Is it a systems issue? Is it a culture issue? Is it an end market issue? Is it all of the above?
Marvin Ellison
Yes. I think it’s a really good question. And retailing is really all about your ability to attract the customer to transact with you. And oftentimes, when you think about a retailing turnaround, it really hinges on your ability to convince that customer to give you consideration in their purchasing. And over the course of the past five years, specifically with Lowe’s, when you look back at kind of where we are and how we got here, it came down to decisions on capital.
And so we’ve just basically shifted our capital allocation strategy away from acquisitions that create other channels of revenue and say, we’re going to modernize our retail environment so that our customers will have a seamless environment to shop, both in-store and online, and we’re going to be able to give them reasons to turn right into our parking lot or log on to Lowes.com, more so than a competitor. We oftentimes forget that when retailers make a mistake, customers are to first to know and customers have other options on places where they want to shop.
That’s why it’s so important for us to focus on retail fundamentals first because the – when you have a balance sheet like we do, the first thing you want to do is spend money to go buy things. But at the end of the day, there are certain things that will always matter in retail, whether it’s 2020 or 2050. And that is, you have to have engaged associates providing great service. You have to have product on the shelf available to buy. You have to have minimal friction points so customers can get in and out fast or can log on and check out fast. You have to have products that are exciting, innovative, that can make the customers’ homes and their lives better.
So all of these things matter, and we have to focus on. Those are fundamental things we want to do first. Now that we have that foundation in place, improving the supply chain, enhancing our digital platform, putting systems and technology in place to make the jobs easier and to make the customer experience a lot more inviting, those things are additive. And when we look at our technology road map for 2020 and beyond, there are a lot of those initiatives now that we think will take us forward. And that’s why we have so much confidence in 2020.
David Denton
And Michael, I think one thing’s different, too, here. You talked about kind of a turnaround. I don’t look at this situation as much of a turnaround as an improvement. We have a really strong brand. We have a really strong consumer. We have a lot of traffic. We have associates that are well engaged and supportive from a customer service perspective, but we haven’t really equipped them well to do better and really focus on the pro customer. So I think this is more of a – if we get ourselves aligned and focused, not so much a turnaround, but really just improving our business with a lot of opportunity and runway to do that.
Michael Lasser
That’s a really helpful point, Dave, because if I were to summarize those answers, it would be – there’s a lot of things that may seem simplistic, but in totality, are somewhat complex. And they all have to kind of work together in order to get the business to where it needs to be. So the question we constantly get is, when is Lowe’s just going to be a little bit more consistent? Is there a point at which everything comes together and it can produce consistency that the market knows is possible because it’s a good business in a good industry?
Marvin Ellison
Look, I think for us, consistency directly correlates to having the right system support that will enable decisions to actually deliver results. Go back to Q1 again. Talented team, limited system visibility to decisions that were made. As we now enhance the systems, it gives all of us the ability to forecast more effectively. This is the first year, candidly, that the company in many years has built a financial plan from the bottom up, meaning that we looked at the initiatives.
We looked at the trends of the business, and we’re able to basically put a classification and a financial value to the things that are on the project road map and when they’re going to be delivered, and that’s how we, in essence, built our financial plan. By doing it that way, you have a better opportunity to be consistent with the delivery of the financial numbers versus kind of where we’ve been in the past, and you’re looking at seasonal trends and hoping things work out.
Having said all of that, I mean none of us and no company is operating in perfection. And as much as we’re going to try, we know that there will always be opportunities. But when you have systems that are more robust, data that is more visible, it enhances your decision making and can allow you to be a lot more predictive on things that will happen and when things happen that are out of the ordinary, you have enough agility that you can make changes.
I mean one of the things we talked about on our earnings call, as you know we’re painfully transparent around Q4 sales and while we did meet the number that we felt that we should have, in November when we allocated marketing in this kind of shortened holiday, we negatively impact our appliance business. We knew early in the month that, that business was being impacted, but we felt, because of the shortened season, maybe we get more of it back than we actually did, but we also could not inject more marketing because that time of year, you’re not going to buy a TV spot, so you add a premium, and/or radio, and because our digital platform is kind of under construction, we couldn’t lean into the digital marketing channel like we would have liked to, because we would not receive the return on ads spend.
So that’s another example of where it looks like an execution issue, but was really as much of a systemic limitation, that we couldn’t invest in the channel we needed to because we’re still building that channel to make it more robust. The good news is, is that we have a very talented team, that understands this business, who will make the right investments, and that just gives us a lot of confidence going into this year and beyond.
David Denton
Yes. and I think consistency obviously is really important, and I think that the one thing to just know, in all the different tracks that we’re working on, there’s not a big bang philosophy around that. We are incrementally building and putting in place systemic and process fixes that are – that really improving our performance. So we’re not waiting for a big ERP application to come online to improve our performance. We’re actually just, even today, making changes to our e-commerce platform that is incrementally making it better. It’s not going to get a lot better the back half of the next year, or this year, but we’re not just waiting for that, a silver bullet to come along and do that.
Michael Lasser
And Marvin, I think this crowd would never associate the word painful and transparency together. So more transparency, the better. Now with that being said, you have been consistent in some – in identifying some of these issues like the marketing in the most recent quarter, like some of the gross margin issues in the year-ago period, first quarter period, as systems-related. So if you were to assign one as totally rudimentary, 100 as full visibility and exactly where you needed to be, how would you state where Lowe’s is right now, and how quickly can it get to that 100? Dave often offers the example that you were – a year ago, you had no visibility into the gross margin, then you had a manual process of, spreadsheets that you were gluing together. Where do you get to that point where you’re closer to 100, and where are you today?
Marvin Ellison
I think it depends on the system and the function, and that’s not, to be evasive, if we look at store operations, and what we’ve done with our scheduling, labor management system, what we’ve done with mobile technology; I would say that we’re much farther along. When I look at the steps we’ve put in place for our merchandising, and how we’re building now, consistent merchandising scorecards, versus merchants having a series of Access and excel spreadsheets they’re running the business on, I would say we’re making progress. I think when you look at supply chain and e-commerce, I mean, those are longer-term investment horizons. I would say, we’re farther out. But to Dave’s point, there’s no big unveil, no big bang, but we’ll get incrementally better every month of every quarter. And we have some time horizons, circle what we know.
As an example, in Q3, we noted those e-commerce initiatives will be – enough of them will be online. We will see that business have a trajectory change. We know as we get towards the second half of the year, initiatives in supply chain, regarding visibility and how we flow product will be better. So it’s a tough question to answer because this is a big, complicated business with a lot of moving parts. But the good news is we have great visibility. We have a really robust project management system we put in place. So we know where we are in every function, we know what needs to be done. And we’re just not trying to catch up. I mean, there are key initiatives that we want to be best-in-class. And when we look at what we’re doing in pro, with CRM and loyalty, I mean, we’re very confident that, that’s going to allow us to leapfrog some of our competition. Some of the things we’re doing with our price management system and the multiple phases of that rollout, when this is complete, we think we’re going to be ahead of the competition. So everything is not about just catching up, but it’s about leaping ahead and being a market leader, but those things take time to get there.
Michael Lasser
And speaking of leaping ahead, given the nature of this industry, it’s too easy to make comparisons. That might be frustrating for you because you probably want to be measured on the progress of your own performance. So how should outsiders be measuring you? What should we be holding you accountable to and accountable for?
Dave Denton
Well, I think a couple of things. One is, clearly, we’ve set a benchmark of getting to the 12% operating income margin in the next several years. And I think, obviously, watching us steadily progress against that, just from a financial perspective, will be really important. And think about us driving that really in two ways is improving our top-line performance fairly consistently, holding gross margin relatively flat, understanding that we’re going to take some headwinds as we invest in the supply chain, but we’re going to leverage SG&A significantly over that period of time so that, that flow through can happen from an operating income perspective. I do think, and you heard Marvin articulate it, is going back and holding us accountable to the operational fixes that we’re putting in place, whether it be in merchandising, whether that be in supply chain, in e-commerce, whether that be in operations, and importantly, winning that pro customer.
I do think one thing that we really as a business need to think about is we have two really impactful segments. One, the DIY customer, and we have the pro customer. That pro customer shops many more times on an annual basis. And at the moment, our market share or our share as a percent of our sales is about 20%. That opportunity to extend the reach into that existing customer base, and even attract additional customers, in the pro business is really important to us and a big opportunity.
So, I think having this come back and costly talking about the progress that we’re making there is something you should hold us accountable and will drive real meaningful return on invested capital over time.
Michael Lasser
I want to pivot the discussion to the backdrop, because the backdrop is pretty favorable. In fact, I’ve tried to get a hold of my mortgage broker for the last week. He won’t come back for some reason. How do you see the macro backdrop? And given these historically low interest rates, how long will it take that – the current condition to translate to its effect on home improvement?
Dave Denton
Yes. The backdrop is extremely constructive right now for us. I think if you think about the – just the health of the consumer, their perspective and confidence and also with the backdrop of a low interest rate environment, a housing sector that is aging, that is in need of repair, so really constructive for this segment of retail, and then complement that with all the fixes and all the improvements we’re making in our business, it really was the avenue for us to kind of lean in and capture additional market share. And as we look at kind of across all different categories and price points and geographies across the U.S., we see very strong demand across all those components. So, the macro is really constructive for our business model.
Marvin Ellison
And Michael, I’ve said a couple of different times, we had a lot of optimism coming into 2020, and it was really based on, that the macro environment was very supportive of our business model, but also a lot of the foundational work that we put in place in 2019. And we are very confident in our ability to deliver on our financial expectations. It’s early, but we’re off to a strong start this year. And we think it’s consistent with just the work that we put into the business, and it’s starting to pay dividends.
Michael Lasser
I think it’s the same as philosopher Mike Tyson, who said everyone has a good plan until they get punched in the face. So that – maybe that’s a good way to…
Marvin Ellison
I’ve used that a few times.
Michael Lasser
Maybe, that’s a good way to pivot to the current event. And there’s obviously two sides to this. One is the demand side. Perversely, I guess, home improvement could see a benefit. If we’re seeing hibernation across the country, there’s going to be nothing better to do than fix your house a little bit, and do some of that work. And so, a, are you seeing that? How do you be prepared for that? I’m sure there’s some stocking up that’s happening. And then I want to get to the supply side as well.
Marvin Ellison
Well, look, what I would say is, I mean, this is a unique market environment, with the coronavirus. I mean like all other businesses and retailers, I mean, we’re staying really close to our supply base around the world, our manufacturing base, because we are predominantly a business that really penetrates heavy in spring from a sales perspective. As we look at Q1, we see no short-term interruptions in the business. As a matter of fact, our business trends are strong. As we look farther into the year, into Q2 and beyond, it becomes more uncertain because you’re at the mercy of the new cycle. You’re at the mercy of what happens next.
Well, as recently as last night, I’m looking at factory production around the world and what their capacity is relative to where they’re accustomed to being. And so that’s the level of visibility we’re placing on this, tracking every PO, by manufacturer, by geographic location. And all I can say is we see no short-term negative benefits to our business. Our supply chain, relative to what we need for our spring business is either in the store, in the DC or on the water. And so we’re in a really good position there. We’re going into this season, with our best in-stock position in over five years.
So, we’re really ready for spring. But beyond that, it’s hard to have clarity because we just don’t know what’s going to happen, but we’re staying close to it, and we’re going to be as flexible and as agile as we can.
Michael Lasser
Does Lowe’s have more agility today than it did a year or two ago, to be able to respond to some of the events, position inventory where it needs to be and adjust for labor and staffing, if necessary?
Marvin Ellison
Without question. Our labor staffing flexibility this time last year was literally getting an eraser out and changing the schedule in the store. That’s just how primitive we were, that there was no dynamic nature based on transaction, sales trends, category performance by time of week. It was just a static schedule. If you want to be off Tuesday and Wednesday, you were off Tuesday and Wednesday, and we schedule the rest of the week, irrespective to the demands of the business. It was based on the demands of your availability. And so we changed it to a more customer-centric model. And that rollout has gone really well. And we put some other analytics around the dynamic nature of scheduling. So, we have much more scheduling flexibility than we probably ever had. Relative to product positioning, I mean, our allocation of product is much improved, and our supply chain function is much improved, even though we’re continuing to add technology on top of it.
So, we’re a much better company today than we were a year ago. We’re going to be a better company in six months than we were – than we are today. I mean – so the great thing about the transformation that we’re in, and Dave and I both have said it already, is that there is not one big bang or one big unveil. We’re just getting better every month, because there are new things coming on tap. But relative to our supply chain and disruption to the current state of the coronavirus, I mean, we’re kind of like everyone else. We’re paying close attention to it. We’re working closely with our manufacturers, and we feel – if nothing else occurs, we should be in good shape. But again, we can’t predict the future.
Dave Denton
I think Michael, the other thing, too, is we actually did pull and set spring a little earlier this year compared to prior years was kind of our plan. So we pushed more inventory earlier into our stores and into the DC. So as we think about the next several weeks, we’re very well equipped to handle spikes in demand, much more so than we probably have ever been. And even over the course of last year, as you know, we’ve invested pretty significantly in inventory. Inventory level’s up pretty high, year-over-year. So that just gives us additional flexibility as we think about demand from a consumer perspective.
Michael Lasser
And one of the most visible ways we’ve been able to see some of the progress thus far is in the operating expense side. Marvin, you helpfully provided some insight on how the laboring schedule system has worked a year ago versus today, and that’s contributed to some of the really tight expense control. There had been a perception that expenses were well controlled last year and now you’re running out of room. It seems like between that, centralized returns and others, there’s still going to be a lot of opportunity to keep a pretty tight lid on expenses. Is that fair? And are there other opportunities that you’re excited about that will help contribute to that?
Marvin Ellison
Look, everything that we do in the stores is designed around a couple of key goals. Goal number one is, provide better service to the customers. Goal number two, make the associate’s job more simplistic and more productive. And when you do those things, customers come back more frequently because they enjoy the service, they enjoy the engagement, and the associates are retained, and you have less cost and training expense. So, I gave you just a couple of examples. We’re one of the only large retailers left in America that still operate green screen cash registers. So if you happen to just peek around, the around one of our registers when you’re checking out, you’ll see a green screen with a lot of data on it, and you have to be a really technically trained associate to run a cash register. So think about the amount of training most of us have to run self-checkout. It’s usually zero. And so we’re redesigning our entire front end system, where our training for employees to run a register is going to be reduced dramatically. That may not sound like a big deal, but when it comes to the amount of expense you take out, because you can literally put a person on the register and they can learn how to run it in an hour, versus a significant longer period of time today, is a really big deal, and it also creates a much better customer experience. I mean, we’re doing things like mobile printing in the aisle. I mean anytime we change prices, you have to change the labels. In our environment today, we have two printers, one in receiving and one on the front end. And if you’re anywhere in the store, you have to literally leave where you are and go get those labels off that printer. It’s a very primitive process. And now we’re going to have mobile printing in aisle for the associate to do it real time. Centralized return to vendor is another huge expense and productivity savings. Most of our stores have at least one, in some cases, more, associates dedicated to doing nothing but managing returns back to the vendor based on predetermined vendor buying agreements. We’re centralizing all of this for the entire chain. So we ship everything, reverse logistics back to central facilities, and it’s all managed there. And we have productivity savings and expense savings. But we’re also, Michael, making some investments.
So we’d say, we’re not taking everything to the bottom line, because we’re not satisfied with our service levels in our stores. So, the operations team works with Dave’s team, and we make a determination on how much of those savings go to the bottom line from a productivity perspective, and how much goes back, reinvestments, into additional service on the sales floor. And that’s what we did last year. That’s why we were able to leverage expenses and also improve customer service in both pro and DIY, because we had a net addition of people on the sales floor, even though we had a total reduction in expense. And we’re going to do the same thing in 2020.
Dave Denton
And I think what’s interesting, Michael, is that the ops team, they literally have a waterfall chart for both this year, next year and the following year that says, okay, these are the initiatives that we have in place. And when we implement them, and they’re going to come on in Q1, Q2, Q3, Q4, they’re worth this amount of money. And they’re tied – sometimes they’re tied to technology. Sometimes they’re just tied to the process redesign, but we have a really clean roadmap. So yes, we’re going to take out expenses when that happens. But I think importantly, as we began to win the pro customer and we start accelerating our top line performance, we’ll be able to disproportionately leverage SG&A. And I think we have to count on both of those things to drive performance over time, because if you just think about it, those – that incremental pro customer, that incremental trip, largely from a gross margin perspective, flows directly down to the op incline because I – we’re fully staffed to be able to adequately support that transaction. So what we have to do is start getting that next trip and that next customer. And as we do that, that really unlocks a tremendous amount of value for us.
Michael Lasser
Pro customer's a big focus. There are several initiatives in place that are aimed at unlocking the potential that Lowe's has with pros, a CRM system, a loyalty program. Can you give us a sense for where each of these stands, what potential they offer and when we can see that potential unlock?
Marvin Ellison
Yes. Let me take you back first. I mean, we started in 2018 when our – with no real focus on pro, that was relevant to the customer. So we did customer surveys and focus groups and asked them a very simple question. Question number one, why did you stop shopping at Lowes? And number two, what can we do to get you to return? And we talked exclusively to customers that had left, or a customer that never shopped us. So we got a nice list of things. So those things were basically the foundational elements we put in place around job lot quantities for inventory, staffing the desk with someone who's dedicated to the area, designated parking, because pros have their most valuable assets in their trucks.
They want to have them safe, close to the store. Loading assistance. None of these things are very innovative. But pros basically say, these are table stakes. You can't do these things, I'm not going to shop here. So we spent the entire year increasing the service levels in those foundational things. Now we're asking the question, what can we do to create differentiation? And what can we do to create stickiness between us and our pro customers? And that's where CRM and loyalty comes into play. So we're working with Salesforce.com in development of our CRM program, and we'll have the CRM and the loyalty programs both launch in the first half of this year. We've been testing these initiatives for the last six months. All of the tests and pilots have exceeded expectations. So we're really pleased. Part of what I did in a past life was to roll out the pro loyalty platform at our competitor.
So we have a lot of institutional knowledge on loyalty, what works, what does not work. And again, the great advantage of being behind, if there is one, is that you have a second mover advantage. You can learn what is working. And we surveyed the entire marketplace in the U.S. and around the world, not just in home improvement, but in other companies that really have had sophisticated loyalty programs to determine what worked and what didn't work. And we've tried to modify and create our strategy that really hits those key things. So first half of this year, we should have it rolled out chain-wide.
Michael Lasser
And from the early tests, have you seen a benefit from your existing pro customers, presumably because it is focused on loyalty? And to what degree has it benefited you by – to helping attract new pro customers who might not have been done – doing business with in the past?
Marvin Ellison
They're a little bit of both, I mean, and Dave and I both have said consistently that the way the math works, if we didn't add another new customer and just got a larger percent of annual spend from our existing customers, it would be a tremendous return to the company. If you look at our traditional pro customer, and you look at their annual spend in our stores, it is obvious that they're using us for convenience and for a fill-in trip.
But they're not using us to really solve all of their product and service needs. And part of the issue is, is, a, they don't know that we offer certain products and services, or b, they have no relationship with us. So we don't understand what they're spending, what they're buying, and equally as important, what to not buy. And our marketing is really a big broad brush, so we're shouting the same message to all of our customers. And we're not talking specifically to the electrician. We're not talking specifically to the plumber. We're not talking specifically to the MRO. And that's why CRM and one-to-one marketing is going to be a big part of this new initiative.
So we're excited because the early results are extremely positive. And based on all the benchmarking we've done, we know that we're going to have something that's going to be best-in-class when we finally get it rolled out.
Dave Denton
And Michael, just think about the power of this. Listen, today, we don’t know systemically who this customer is, and we don't know what they're – what profession they're in – especially they're in. We don't know how much they spend. But if we can identify them, know what they're working on, and then actually actively engage with them, such that we understand what their pipeline looks like and begin to help them think about bidding on their pipeline, the amount of opportunities we have to capture a disproportion of their product needs on a day in and day out basis is tremendous.
And we have, today, no systemic way to do that. It – yes, we might have a really good store manager, and he or she knows the pro customer, so they've got their arms around him or her. But there's no way, as a company, to aggregate that up and really leverage it. And so this tool will unlock all that. Now it'll take us a little time to get the database right and really have it all honed the way we'd like it to be. But over time, this is a real opportunity for us to lean into this segment that's been largely ignored the most.
Michael Lasser
Can you help dispel some misperception? There's a common belief out there that the success in this sector is mutually exclusive with your biggest competitor. Why is that wrong?
Dave Denton
It's absolutely incorrect. I mean this market's a huge market. It's probably a $900 billion market. And this is not about us or our major competitors, not win or lose. It's as we – this – both of us are big enough and may have success capabilities to grow our business independent of one another and continue to perform quite well. So this is not us stealing share from someone or from our major competitor.
Obviously, we're going to work to improve our service model. So as the demand comes our way over time, and we're going to engage our customers in more robust ways, but this is not a zero-sum game.
Dave Denton
And I think that's the magic of this business. I mean if this is a $800 billion, $900 billion marketplace, if you take Lowe's and our two largest competitors, meaning that's less than $200 billion. So there's a lot out there. We just have to focus more on serving the customer and solving the customers' needs. If we can do that, and that's our most critical focus, being more of a customer-centric company. We think the market share takes care of itself.
Michael Lasser
And part of the answer is it not that it doesn't give credit to the idea that there's a lot of independent lighting stores. There's flooring retailers. There's…
Dave Denton
It is lots and lots.
Michael Lasser
Now with that being said, how does the company not lose focus on the core DIY customer that, it does – has done pretty well with over the years? And what initiatives are aimed at ensuring that it continues to excite and delight that customer?
Dave Denton
Well, that customer's always given Lowe's credit for the overall aesthetic of our stores. They've given us credit for the fact that we've done a nice job historically in areas like seasonal, garden, decor. But if you think about the investments we've made in the past 12 to 18 months, they've been very balanced. I mean we reset our entire flooring department. That department hadn't had a facelift in over 10 years.
We're putting in new signing, new way finding for the first time in 15 years in our stores, and that'll be completed by the end of this quarter. I mean we reset areas like millwork. We've reset areas like kitchen. We're in the process of doing that in a multiyear kind of reset. We're putting digital signs and appliances. And we're also just making the store more productive. When you think about all of those things, in addition to brands like Honda and YETI coming on board, it's a combination of serving both. So we're very conscious of the fact that the DIY customer is a critically important customer for us.
We know that customer well, and we're elevating our overall brand, our product assortment and how we serve those customers much better. So if you think back to what we looked like 1.5 years ago, we were terribly out of stock, we're poorly staffed. We didn't have consistent training, so we were actually not serving that customer well. So we feel like we're actually serving that customer better today than we were a year ago. And if we can balance both that customer and the Pro customer at the same time and not show any preference, but just being customer centric, we think that worth to model, because at the end of the day, if you don't have the right pro penetration and a foundation of pro business, you never get your productivity and your sales per square foot where you would like it to be because that customer is eight times more valuable than the DIY customer.
So you can't ignore them because they create almost a financial underpinning for your business, and that's what we're working on right now.
Michael Lasser
And part of the pro conversation related to the online business, the online business at Lowe's. It started to experience some challenge in the middle part of last middle part of last year. The expectation is by the second half of this year, it'll get into a better spot, such that you can start to see high single-digit growth, I believe. Why does it take so long to fix that? And is the – is the online business actually understating the actual drag on the total because 50% or more of the online business in this industry tends to be picked up in the store? So when you talk about your fourth quarter, it could actually – had a bigger impact, bigger drag because you didn't get that traffic from people who would have otherwise came and maybe added an item to the basket while they're there?
Marvin Ellison
Look, I think those are good questions. And as you think about our e-commerce business, even though that business was growing at a higher rate in 2018, it was very dilutive growth to the profitability of the company. It was sales that we didn't really want, and we didn't want to sustain that type of sales strategy. So quickly, because I know we're short on time…
Michael Lasser
We got all day, Marvin. We're just starting to have fun.
Marvin Ellison
I could talk about this all day long.
Michael Lasser
Yes. Me, too.
Marvin Ellison
Let me just give you a couple of reasons why our online business is not performing to the level it should and why we are excited that we'll have these areas corrected in the second half. Basic things like our current dot-com site was sitting on a decade-old platform. Because of that, your homepage was basically static. Whether you were in Miami or New York, it looked the same because we had no ability to make it dynamic. In addition to that, when you think about things like one click checkout, when you think about things like ability to search, navigate the site quickly, when you think about things as simple as buying a patio set and purchase everything in a collection versus choosing the chairs, then searching for the table, then searching for the umbrella.
That's how it is today. When you think about something as basic as, I'm going to buy an appliance, and I want to schedule my delivery day, and I want to schedule if it's AM or PM, today, you can't do that. If you go online today and you do a search and compare with us on a like item versus a competitor, more often than not, our prices are going to be higher on retail or at least it's going to be artificially higher because we have freight combined with retail, that's how the site was set up.
If you look at the number of SKUs we have online, we're probably 5x fewer SKUs than our closest competition, because it takes months to add a catalog of drop ship items when it should take hours and days. So I can go on. But all of the things I just rattle off, in addition to being able to ship product with special handling, believe it or not, until the fourth quarter of this year, we could not even ship a power tool with a lithium-ion battery, because it was classified as hazardous, and we couldn't ship hazardous material. I don't know about you, but if you're a home improvement retailer, you should be able to ship a power tool with a battery, and we couldn't. And there are still categories today in areas like cleaning and gardening that we can't ship because they require special handling because of the classifications.
Everything I rattle off will have material improvements as we get into the third quarter. And when that happens, we'll have the ability then and the confidence to lean in, to do more pay search. You'll see more integrated marketing that includes dot-com in the entire presentation of how we go to market. And to your earlier point, you just can't look at dot-com number and say number and say, well, that's your dot-com number. What about your brick-and-mortar sales, because it all ties together.
A lot of our categories we sell are highly researched online before the customer comes to the store. So if they have a bad experience online trying to research a riding lawnmower, trying to research a grill, trying research an appliance, they never make the trip to the store, but we lose the sale because of a poor online experience. So online is fully integrated, and – but we have a project road map, got a talented team. We're spending the necessary capital, and we should see this business trajectory change in the third quarter.
Michael Lasser
And given all that goodness, is high single digit a realistic expectation? Or is that just more conservative and you hope to do better than that?
Marvin Ellison
We hope to do better across every financial target that we've given, but we also want to be appropriately prudent in how we forecast, because we know that we have to execute and we have to deliver. And so we hope we can outperform that. But based on our current assessment, we feel like that's a fair forecast.
Michael Lasser
We also – one thing is fixing it and getting it right. The other thing is for the consumer to experience the new Lowes.com. And so there's some built-in latency that you have when you make a change like that.
Marvin Ellison
Because there's a lot of upside from there, which is also important.
Michael Lasser
As we conclude this conversation, I want to tie it all together, and it's been mentioned that you expect to get to a 12% operating margin, I think, over several years, you said, Dave. But if you, a, if you want to define several, that's great. But b, what are the key variables that are going to allow you to get there? Is it just you had laid out this case where it's flattish gross margins, operating leverage, so it's really just a function of sales? Or are there factors that could push you there that…
Dave Denton
No, I think you heard a lot today about the – all the operational activities and programs we have in place. All those collectively is going to drive our performance. But mathematically, if you step back and just look at the financial statements, it's pretty simplistic here, is that listen, as we start to lean into the pro, begin to take a little bit of market share, we're going to grow the top line. We're going to be able to do that in a way in which, I'll say on a like-for-like basis, we'll have more or less stable gross margins, with one caveat, as we are investing in the supply chain disproportionately.
So there'll be some headwinds from a supply chain cost to the gross margin line, that will be completely offset and accretive as we take SG&A out of the – out of our cost basis because we will take our delivery mechanism that's currently in the stores and move them up into a more efficient supply chain node. That will allow us to flow through in a more rapid fashion. So that is what will enable us to get to that 12% operating margin. And I just want to say that's kind of a – not the endpoint. That's a stop along our journey. We don't think that's a plateau. That's just in – over a reasonable period of time, a level in which we could get to.
Michael Lasser
Well, this was fun. And we look forward to seeing you along your journey. Thank you very much. Please join me in thanking the team from Lowe's for a great conversation.
Marvin Ellison
Thank you, Michael.
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