Earnings Call Transcript - LOW Q2 2024

Operator, Operator

Good morning, everyone, and welcome to Lowe's Companies Second Quarter 2024 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.

Kate Pearlman, Vice President of Investor Relations and Treasurer

Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer. I want to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be discussing forward-looking comments, including our expectations for fiscal 2024. Actual results may differ materially from those expressed or implied due to various risks, uncertainties, and important factors, including those discussed in our Risk Factors, MD&A, and other sections of our annual report on Form 10-K and other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to US GAAP can be found on the quarterly earnings section of our Investor Relations website. Now, I will turn the call over to Marvin.

Marvin Ellison, Chairman and Chief Executive Officer

Thank you, Kate, and good morning, everyone. Thank you for joining us. Second quarter sales were $23.6 billion, with comparable sales down 5.1% from the same period last year. While we're pleased that we delivered positive comps in Pro and online sales, we're continuing to manage through softness in DIY demand. Although this remains a challenging industry backdrop for the homeowner, I'm pleased with our team's ability to effectively manage the business. This is reflected in our disciplined expense management across the company, along with continual progress on our perpetual productivity improvement, or PPI, initiatives. These efforts helped us respond to the pullback in DIY discretionary projects and unpredictable weather across the country to deliver better-than-expected flow-through, while improving the customer experience. Later in the call, Joe will provide more detail on our improved customer service results in Q2. We're encouraged to see results from our ongoing investments in our Total Home strategy this quarter, allowing us to deliver mid-single-digit positive comps in Pro and 2.9% comparable sales growth online. This demonstrates the importance of these strategic investments and shows that our Total Home strategy is gaining traction even in this pressured macro environment. Our resilient small-to-medium Pro customers are responding to how we've transformed our product and service offerings to meet their needs. Bill and Joe will provide more detail on our successful Pro initiatives later in the call. Regarding online sales, we delivered growth across all three business areas, driven by continued improvement in conversion rates as customers responded to our compelling offers and to our new expanded same-day delivery options available on multiple platforms. In Q2, we added Uber Eats to our list of delivery partners, along with DoorDash, Shipt, Instacart, and OneRail. As we continue to evolve our omnichannel strategy, we've learned that having multiple delivery platforms extends our reach into both urban and suburban areas and helps us drive incremental sales with different types of customers, especially younger generations who are more digitally savvy. We're also reaching a broader customer base and making a deeper connection with our new and existing customers through our marketing campaigns, featuring sports icons like Lionel Messi. We've effectively leveraged our partnership with Messi to gain exposure to our new DIY loyalty program, MyLowe's Rewards. We're very pleased with our MyLowe's Rewards loyalty program, which just launched nationwide in March. Through this program, we've learned more about our customers' lifestyles and purchasing trends, allowing us to curate meaningful offers for them now and in the future. Now let me talk about how we're leading the way with innovation and home improvement. Lowe's is working with Apple to help customers visualize and design their dream kitchens using Apple Vision Pro. This past quarter, we piloted an in-store design experience for our customers in three test markets, where, with the help from a Lowe's associate, customers could wear the Apple Vision Pro and use the Lowe's Style Studio app to explore and customize hundreds of kitchen designs in 3D. This is just one example of how we're leaning into innovation, while we're also working with leading platforms like NVIDIA, OpenAI, and Palantir to develop AI solutions for both our customers and our associates to help us improve how we sell, shop, and how we work. Before I close, let me give you an update on the trends we're seeing in the macro environment. At the beginning of the year, our full-year outlook reflected our expectation that macro and consumer trends in 2024 would be similar to the second half of 2023. That assessment has proven to be accurate, yet there still remains a great deal of uncertainty, particularly around interest rates and inflation. In terms of housing specifically, we're seeing significant implications due to a lock-in effect. Simply put, people aren't moving nearly as often as they typically do because current mortgage rates are much higher than their existing rates. Consequently, housing turnover is hovering near its lowest levels since the mid-1990s. The preference for spending on services, especially among more affluent consumers, has persisted much longer than expected. That said, the three core drivers of our business remain strong: home prices continue to appreciate, sustaining historically high levels of home equity; disposable personal income is now growing faster than inflation; and the aging housing stock means people will need to make repairs and improvements to their homes. When you combine these factors with trends like a large number of millennials forming households, baby boomers aging in place, and the continuation of remote work, we remain optimistic about the medium- to long-term outlook for the home improvement industry. In the meantime, our operating philosophy in this challenging home improvement macro environment is straightforward: we will continue to invest in technology and innovation, offer our customers value and differentiation whenever and however they choose to shop, and be incredibly disciplined with our expense management. We will achieve this by improving our operational efficiency through our PPI initiatives and making the right investments in our Total Home strategy. Although we cannot predict the exact timing of recovery in home improvement, we're confident that we'll be in a strong position to take market share when it begins to turn. Finally, I want to thank our frontline associates for their dedication to our customers and communities. One of the best parts of my job is visiting stores every week. In the first half of this year, I personally visited all 15 geographic regions. These visits provide me with invaluable insights into how we can continuously enhance our customer experience. Thank you again for joining us this morning. Now I will turn the call over to Bill.

Bill Boltz, Executive Vice President, Merchandising

Thanks, Marvin, and good morning, everyone. Despite continuing softness in DIY discretionary demand, we're pleased that we delivered positive online comps and mid-single-digit positive Pro comps this quarter. We now have the right brands for Pros, the right inventory quantities, and the right product assortments to meet the needs of this demanding customer. Our strong Pro performance in this challenging macro environment indicates that our efforts to transform the Pro customer experience are working. Turning to our results in building products, we delivered above-average comps in rough plumbing, electrical, and millwork, and positive comps in building materials, driven by continued growth in Pro across all building materials subdivisions. Within rough plumbing, we drove strong results in some hot weather categories, like air circulation and HVAC, and we continue to deliver strong results in water heaters. Recently, we rolled out MRCOOL mini-split air conditioners in 1,200 stores. These ductless systems are known for their advanced technology, energy efficiency, and ease of installation, allowing our DIY customers to install their own mini HVAC system without hiring a professional installer. Now let's shift to home decor. We continue to see persistent pressure in bigger-ticket DIY discretionary projects in flooring and kitchen and bath, consistent with the trends that began in the third quarter of 2023. We lead the industry in appliances, and we are pleased with our overall performance, having delivered above-average comps and double-digit growth in Pro sales. In the appliance sector, we have the widest assortment of leading brands. We also provide a simple and seamless shopping experience, both in-store and online, with a best-in-class fulfillment solution offering next-day and two-day delivery options, thanks to our multiyear investment in our market delivery infrastructure. Additionally, we continue to introduce innovative products to the market, like the Lowe's exclusive Hisense convertible four-door refrigerator, featuring a fingerprint-resistant finish and an extra storage drawer with different temperature settings controlled via WiFi from your mobile phone. In paint, we are partnering with Sherwin-Williams to offer customers free same-day delivery nationwide. Since painting is the number one home improvement project, we are making it easy and convenient for customers to order paint and supplies online and receive quick delivery to their door. This delivery option adds convenience, especially if customers run short in the middle of a painting project. Now, let's discuss hardlines, where unfavorable weather pressured traditional spring seasonal categories like lawn and garden. Given our DIY customer mix, sales pressure in these DIY-dominant categories greatly impacted overall comp sales for the quarter. In outdoor power equipment, the addition of Toro gives us the strongest lineup in the industry, alongside John Deere, Aaron's, EGO, CRAFTSMAN, Husqvarna, Kobalt, and SKIL; no one can match it. In tools, we're expanding our collection of private-branded Cobalt tools, adding a 24-volt paint sprayer, multi-material cutter, and finish nailer. We've also introduced Klein Tools and their new KNECT system—an impact-rated system of sockets, drivers, and ratchets compatible with both hand tools and power tools—exclusive to Klein and the home center channel, giving us the largest assortment of Klein Tools in home improvement retail. During the quarter, we were pleased with the success of our CRAFTSMAN Days events, highlighting more than 100 CRAFTSMAN products across various merchandising divisions both in-store and online. As we look ahead to Q3 and the fall season, we have a strong product lineup ready for the fall, beginning with Halloween. It will be bigger than ever before with everything from new animatronics to inflatables, along with fall cleaning and decor that lasts the entire fall season, already available online and in-store. We continue to deliver on our perpetual productivity improvement or PPI initiatives. Our marketing team is rebranding our retail media network program to a simpler platform, helping our brand partners meet various marketing objectives, from performance on shelf and new product launches to seasonal promotions and multiproduct sales. We're pleased with the progress we've made working with our suppliers to reduce costs that we absorbed over the last few years. We continue collaborating with our suppliers to claw back these costs while reinvesting in our marketing and merchandising strategies to drive traffic and sales. As I wrap up, I want to once again thank our supplier partners and merchants for their partnership and hard work in bringing our customers the best brands, innovative products, and compelling offers that deliver value and new solutions for their home improvement needs. Thank you. Now I'll turn the call over to Joe.

Joe McFarland, Executive Vice President, Stores

Thanks, Bill, and good morning, everyone. I want to start by recognizing our frontline associates. Their dedication to serving our customers is reflected in continued improvement in our customer satisfaction scores over last year. While we continue to elevate the customer experience, we also managed staffing well in a dynamic environment, achieving greater payroll productivity. We achieved this improvement in customer service and productivity by continuing to shift associate time from non-customer-facing areas to focus on selling and assisting customers. This leads me to a question we often hear from investors about whether our perpetual productivity improvement, or PPI, initiatives negatively impact our customer experience. Let me address that head-on. We've found that the opposite is true. For several years now, we've been working smarter with tech-enabled solutions that make our associates more productive while enhancing customer service at the same time. The new In-Store Mode on our mobile app is a great example. When customers enter our store, they enable In-Store Mode using the Lowes.com app on their phone, receiving detailed product and location information to help them navigate the store easily. In addition to being a tremendous resource for customers, In-Store Mode also helps free up associates so they can spend more time selling and assisting customers who need help. We're already working on next innovations for In-Store Mode to further streamline the shopping experience. Our PPI initiatives are also enabling us to reduce returns, which are at historic lows for our company. A number of factors are driving these results, including modern omnichannel systems that allow associates to easily handle returns. We're also collecting more precise information on reasons a product was returned to work with vendors to resolve issues and prevent future returns. Additionally, we've identified key inflection points in our supply chain to reduce damages on fragile items like appliances, ensuring they arrive in pristine condition. Although we've made substantial progress on our productivity journey, our team is piloting round-next innovations on our PPI roadmap. I'm looking forward to sharing more about these initiatives at our Analyst and Investor Conference in December. Shifting gears to Pro, we're gaining momentum with our core small- to mid-sized Pro customer, delivering mid-single-digit positive Pro comps this quarter. Recent investments in job site delivery and high-velocity Pro SKUs are paying dividends, making it easier for us to fulfill larger orders and quickly replenish inventory. We're delivering outsized growth in Pro online sales as Pros appreciate the enhanced online shopping experience designed specifically for them. Looking ahead, we're pleased to hear from Pros in our recent survey that their backlogs remain healthy and consistent with last year. Furthermore, 75% of Pros are confident in landing new business. Quonta Vance, our EVP of Pro and Home Services, will discuss the next phase of our Pro growth strategy at the December Analyst and Investor Conference. Before I close, I want to thank our associates for their contributions to disaster relief efforts helping customers recover from storms, including Hurricanes Beryl and Debby. Lowe's command center, merchandising teams, and supply chain teams acted to pre-stage merchandise at key locations to quickly respond to customer needs before and after the storms. I'm grateful for all our associates' tireless efforts to serve our communities. Now, I'll turn it over to Brandon.

Brandon Sink, Executive Vice President and Chief Financial Officer

Thank you, Joe, and good morning, everyone. Beginning with our Q2 results, we generated GAAP diluted earnings per share of $4.17. In the quarter, we recognized a pre-tax gain of $43 million on deferred consideration associated with the 2022 sale of our Canadian retail business. Excluding this benefit, we delivered adjusted diluted earnings per share of $4.10. My comments from this point forward will include certain non-GAAP comparisons that exclude this benefit where applicable. Second quarter sales were $23.6 billion, with comparable sales down 5.1%. Comp sales were pressured by continued softness in DIY bigger-ticket projects, in line with our expectations. Unfavorable weather also pressured sales in seasonal categories. Comparable average ticket was up 0.8%, helped by strength in Pro-heavy categories and less average selling price pressure in appliances, beginning to cycle the normalization of promotions in the category. Comparable transactions declined 5.9% due to pressures from DIY project spending and fewer seasonal transactions, partially offset by growth in Pro transactions. Our monthly comps were down 6.4% in May, 4.1% in June, and 4.9% in July, driven by colder and wetter weather in May, followed by intense heat across much of the country in June and July, which pressured outdoor spring activity. Gross margin was 33.5% in the second quarter, down 19 basis points from last year due to ongoing supply chain investments, partially offset by lower transportation costs and ongoing PPI initiatives. Adjusted SG&A of 17.3% of sales delevered 87 basis points due to sales deleverage and cycling a favorable legal settlement. The impacts were partially offset by continued enterprise-wide PPI efforts and our quick pivot to manage expenses in line with sales that were adversely impacted by inconsistent weather trends. The adjusted operating margin rate of 14.4% declined 114 basis points. The adjusted effective tax rate of 24.2% was in line with the prior year. Inventory ended the quarter at $16.8 billion, down $581 million compared to Q2 of last year as we continue to align inventory levels with demand while also investing in high-velocity Pro items. Now, turning to capital allocation. During the quarter, we generated $2.7 billion in free cash flow. We repurchased 4.4 million shares for $1 billion and paid $629 million in dividends at $1.10 per share. We announced a 5% increase to $1.15 per share for the dividend paid on August 7. Capital expenditures totaled $426 million as we continue investing in modernizing our technology infrastructure and strategic growth priorities. Adjusted debt-to-EBITDAR finished the quarter at 3.03 times, and we delivered a return on invested capital above 30%. Now, turning to our financial outlook. Sales in the first half of the year performed largely in line with our expectations, but as Marvin mentioned, the home improvement backdrop remains challenging, and consumer sentiment remains weak. Based on these factors, we're updating our full-year 2024 outlook. We now expect sales in the range of $82.7 billion to $83.2 billion, with comparable sales down 3.5% to down 4%. We also expect a full-year adjusted operating margin in the range of 12.4% to 12.5% as we continue to tightly manage expenses while also investing in our strategic priorities. Additionally, we expect full-year net interest expenses of approximately $1.4 billion and to repay a $450 million bond maturity in September. We expect capital expenditures of approximately $2 billion and an adjusted effective income tax rate of approximately 24.5%. This results in an updated outlook for adjusted diluted earnings per share of approximately $11.70 to $11.90. To assist you with your modeling, here are a few points for the back half of the year. We're expecting third and fourth quarter comp sales to be roughly 200 basis points better than our second quarter results, given the easier prior-year comparisons. Operating margin rate for the second half is expected to be roughly in line with the prior year's rate, with Q3 approximately 70 basis points below prior-year rate and Q4 about 50 basis points above prior-year rate. The quarterly differences are driven by the timing of merchandising PPI initiatives as we turn through our inventory, as well as comparisons to last year's incentive compensation expense and year-end discretionary bonuses. Finally, reconfirming our capital allocation priorities, we will continue investing in the business to drive long-term growth while maintaining a 35% targeted dividend payout ratio and using the remaining cash flows for share repurchases. This disciplined approach to capital allocation, combined with improved operating performance, has almost tripled ROIC over the past five years. In closing, we're confident in our ability to execute at a high level as we navigate these near-term market uncertainties while making the right investments in our Total Home strategy, all while continuing to drive sustainable shareholder value. And with that, we will open it up for questions.

Operator, Operator

Thank you. We are now ready for questions. Our first question is from Simeon Gutman with Morgan Stanley. Please proceed with your question.

Simeon Gutman, Analyst

Good morning, everyone. I have one question about the top line and then a second about margin. On the spread between DIY and Pro, I don't think we have that for every quarter, but it looks to be about a 15-point spread, which looks like the highest number in a long time. If that's fair, it would imply you're taking share in Pro, but losing some in DIY. Is that accurate? Also, across geographies, how does the spread vary? Is it a function of the Pro spread or the DIY? What is causing that spread to vary?

Marvin Ellison, Chairman and Chief Executive Officer

Simeon, this is Marvin. I'll take the first part of that. It's difficult for us to determine in home improvement if we're truly losing or gaining share specifically in the DIY and Pro categories. I understand the foundation of your question, but we can confirm that our Pro business is growing, indicating that we are taking share based on our strategic initiatives mentioned by me, Joe, and Bill. Regarding DIY, our sales are primarily concentrated in larger DIY discretionary purchases. In the second quarter, DIY demand was weakest in those categories. As you mentioned, we're still roughly 75% DIY. Thus, any pullback in those big-ticket discretionary categories has a disproportionate impact on us. I don't think we're losing share in DIY as much as the dynamics of these discretionary projects affected our overall sales in the quarter. The good news is we feel confident about our assortment, pricing, execution, and marketing, and believe this is more of a macro issue relative to DIY big-ticket discretionary sales. Despite a challenging economic environment in Q2, our ability to grow mid-single-digit positive comp in Pro and nearly 3% growth online showcases our resilience. We believe that when the DIY market inflects, we're in a strong position to gain overall market share. I'll let Brandon take the second part of your question.

Brandon Sink, Executive Vice President and Chief Financial Officer

Yeah, Simeon, regarding geographic differences, we have seen relatively consistent performance. Marvin mentioned the growth in Pro, driven by both transactions and ticket volume. When we look across our geographic divisions, we steadily take share regionally. On the DIY side, we haven't observed notable geographic differences except for hurricane impacts around July with Hurricane Beryl affecting the Houston area, but otherwise, our performance has been consistent.

Simeon Gutman, Analyst

Okay. My follow-up regarding margin: In the second half, the relationship between comp and margin seems weaker than in the first half. Is this something Lowe's is doing differently in managing the business, or is it simply a function of those aspects that were discussed, like incentive comp?

Brandon Sink, Executive Vice President and Chief Financial Officer

It's really the latter, Simeon. The updated full-year operating margin outlook is consistent with our rule of thumb: about 14 basis points of contraction on the downside for every point of comp decline. As you've noted, the second half quarterly differences are primarily driven by timing of the merchandising PPI initiatives as we shift through inventory and comparisons to prior-year incentive compensation expenses. We highlighted last year a $140 million frontline bonuses paid in Q4. It's primarily a function of those two variables, with gross margins expected to be roughly flat for the full year, and that's embedded in our operating margin outlook.

Simeon Gutman, Analyst

Perfect. Thanks. Good luck.

Brandon Sink, Executive Vice President and Chief Financial Officer

Thank you.

Operator, Operator

Our next question is from the line of Steven Zaccone with Citi. Please proceed with your questions.

Steven Zaccone, Analyst

Hey, good morning. Thanks for taking my question. I wanted to follow up on understanding the guidance cut. It seems like the Pro business is outperforming expectations. If you dig deeper into the DIY side of the business, parsing categories around home decor and hardlines, what's really the biggest change to your outlook? Given that sales have been weaker than expected for longer, does that temper your view on potential recovery in DIY demand?

Marvin Ellison, Chairman and Chief Executive Officer

Thank you for the question, Steven. I'll take the first part. For our guidance change, it really comes down to being prudent based on the macro environment and overall customer sentiment around big-ticket DIY discretionary spending. Elevated interest rates and inflation have left the DIY customer on the sidelines, waiting for some inflection to take place. We can't predict when that will occur, but based on Q2 observations, we felt it was prudent to take a cautious approach to our guidance for the second half.

Brandon Sink, Executive Vice President and Chief Financial Officer

To add some context about the guide: the first half was largely in line with our expectations, excluding weather impacts. Looking towards the second half, we see a cautious consumer home improvement backdrop that remains challenged. We're managing through DIY challenges in big-ticket discretionary, but observing strong growth in the small- to medium-Pro area. This is why we decided to adjust the guidance, reflecting ongoing trends. Also, keep in mind, we are cycling a major DIY pullback that began in Q3 last year, which also influences our expectations.

Steven Zaccone, Analyst

That's helpful. Thank you. A brief follow-up on pricing: There's been a focus on pricing and the risk of promotions impacting the industry if demand stays weak. You saw ticket growth in the quarter, but do you see that as a risk, just pricing and promotions possibly trickling into the industry if demand stays weak?

Bill Boltz, Executive Vice President, Merchandising

Yes, Steven, this is Bill. We see our promotional activity remaining relatively stable. Around specific events like Memorial Day and July 4, we will have seasonal offers. We're focusing on ensuring we meet consumer needs during those times, with Labor Day offers coming soon. From a promotional activity standpoint, it remains relatively stable. The appliance side is returning to a more normal promotional activity.

Brandon Sink, Executive Vice President and Chief Financial Officer

I'd reinforce that the ticket increase isn't primarily about pricing; it's due to strength in the Pro business lifting the ticket while appliance pricing stabilizes. The pricing environment has remained largely consistent for the past few years. We foresee the ticket continuing to hold steady into the second half of the year.

Steven Zaccone, Analyst

Okay. Thanks for the detail. Best of luck in the second half.

Brandon Sink, Executive Vice President and Chief Financial Officer

Thanks, Steven.

Operator, Operator

The next question comes from Christopher Horvers with JPMorgan. Please proceed with your questions.

Christopher Horvers, Analyst

Thanks, and good morning. First, a clarification: You expect 3Q and 4Q comps to be roughly the same or sequentially improving over the year? Regarding the weather, how much do you think that impacted the comp in Q2? Can you comment on how you're trending quarter-to-date relative to the updated expectations?

Brandon Sink, Executive Vice President and Chief Financial Officer

Chris, regarding comps, they're expected to be relatively evenly split between Q3 and Q4 based on our guide. On the weather impact in Q2, unfavorable conditions pressured our DIY seasonal business. Cold and wet weather in May hurt sales and then intense heat in June and July also negatively impacted outdoor projects. Just as a reminder, we are cycling strong seasonal performance from last year in Q2, particularly with live goods and smaller outdoor projects. Other outdoor projects also felt the strain due to the weather, hindering bigger-ticket discretionary projects like patio sets and grills. Trends through August are aligning with our guidance for Q3.

Christopher Horvers, Analyst

Understood. Is it fair to say you're expecting gross margins to decline again, perhaps more significantly in Q3? How do you see the vendor clawbacks flowing?

Brandon Sink, Executive Vice President and Chief Financial Officer

No, we expect gross margins to increase in both Q3 and Q4 this year. Regarding vendor clawbacks, they are expected to accelerate starting in Q3 and continue into early 2025. Transportation costs continue to be favorable due to our scale, and we anticipate the favorable cost trends extending into 2025 as well. These factors will largely reflect our Q2 progress and expectations for the full year.

Christopher Horvers, Analyst

Thank you. Have a great Labor Day.

Brandon Sink, Executive Vice President and Chief Financial Officer

Thanks, Chris.

Operator, Operator

Our next question is from Scot Ciccarelli with Truist Securities. Please proceed with your question.

Scot Ciccarelli, Analyst

Good morning, guys. A high-level question on your earnings algorithm: This will effectively be the third year of negative comps. If comps remain negative in '25, is there a point where deleveraging accelerates due to the fixed cost nature of your model?

Brandon Sink, Executive Vice President and Chief Financial Officer

We expect our algorithm to remain intact. Our rule of thumb applies mainly to the fiscal year. We still see a 10 basis points increase for every incremental point of comp and a 15 basis points decrease on the downside. This framework has been reflected in our full-year guide, and we're working hard to maintain that as we drive productivity across our organization. It’s not a natural outcome, thanks to all of our PPI efforts. We'll discuss our 2025 outlook in December, but our framework remains consistent.

Scot Ciccarelli, Analyst

Great. Thanks a lot, guys.

Operator, Operator

Our next questions come from Kate McShane with Goldman Sachs. Please proceed with your questions.

Kate McShane, Analyst

Hi, good morning. Thanks for taking our question. Can you speak to how you're managing your inventory levels? I know inventory was down on a dollar basis in the quarter, but how are you thinking about inventory in a slightly more cautious demand environment in the second half, especially with higher ocean freight costs?

Brandon Sink, Executive Vice President and Chief Financial Officer

We're pleased with our team's capability in managing inventory. We continue aligning inventory levels with sales trends, achieving a 3.3% year-over-year inventory decline. We're focused on investing in Pro depth and brands to support and increase Pro growth. Overall, we're in a good position on in-stock levels and managing seasonal inventory well. Regarding transportation costs, we continue to see lower costs as we use our scale to negotiate favorable rates with carriers, mostly staying insulated due to contract pricing. We expect favorable rates to continue through early 2025, which is reflected in our gross margin guide.

Marvin Ellison, Chairman and Chief Executive Officer

Kate, also noteworthy is how we've converted our regional distribution centers (RDC) to focus more on product flow versus stocking. Six years ago, these RDCs operated as traditional hubs for holding inventory. This approach pressured turns and overall inventory positions. Over the years, the team has shifted towards a majority flow model. We're now primarily operating in a cross-dock setup, maintaining minimal stock rates. This transformation will evolve further. As Brandon noted, our ongoing investments in market delivery enhance our ability to lead in appliances without stockholding at all stores. We're addressing various aspects to enhance our inventory positions while improving turnover.

Kate McShane, Analyst

Thank you.

Operator, Operator

Our next question is from Robby Ohmes with Bank of America. Please proceed with your questions.

Robby Ohmes, Analyst

Thanks for taking my question. Two quick inquiries. On the PPI initiatives, how much room remains before diminishing returns set in? In the back half, should we expect that it's more about incentive compensation and bonus comparisons, which would allow SG&A to be lower than anticipated versus PPI initiatives?

Brandon Sink, Executive Vice President and Chief Financial Officer

We're very proud of our PPI progress, which offsets over $500 million in associate wages, inflationary pressures, and strategic investments. The roadmap covers all parts of the organization. We've aligned well to maintain discipline. Joe and Bill can elaborate on PPI within operations and merchandising, and further efforts continue to enhance customer experience and productivity.

Marvin Ellison, Chairman and Chief Executive Officer

I'm pleased with our PPI developments. Initially focused on store operations, we now foster a culture where all functional areas can drive their own PPI initiatives, leading to productivity and efficiency improvements. I'll let Joe elaborate on operations.

Joe McFarland, Executive Vice President, Stores

While we've made a lot of strides, we're still in the early stages of the productivity journey with much runway ahead. Our front-end transformation is less than 50% complete and encompasses both operations and sales. We've been refining advanced labor management tools while adding 30,000-plus associates to the sales force. The teams are collaborating to streamline back-end processes, providing more opportunities for improvement now and in the future.

Bill Boltz, Executive Vice President, Merchandising

On the merchandising side, we continually review costs with suppliers and work towards greater assortment productivity through weekly evaluations. We're also focusing on introducing more private brands into our offerings, which typically yield higher margins.

Robby Ohmes, Analyst

That sounds great. Thanks so much, guys.

Operator, Operator

Our next question is from David Bellinger with Mizuho Securities. Please proceed with your questions.

David Bellinger, Analyst

Hey, good morning. Thanks for taking my question. Regarding Pro growth, what's next for that customer segment? What additional levers might we see next - more brands, loyalty programs, potentially expanding upstream with larger Pros? Also, does Lowe's offer anything like trade credit for Pro customers?

Marvin Ellison, Chairman and Chief Executive Officer

David, thank you for your question. To begin, we've been focusing on a consistent and coherent approach to serving our Pro customers. Our early priorities involved enhancing service levels in stores, which were lacking. Joe and his team have made significant strides in raising those standards. Our next focus is on product assortment, necessary as we had previously lost brands that Pros were loyal to. Bill and his team have effectively restored those relationships, including the successful re-establishment of Klein Tools—critical for electrical and HVAC Pros. We also adjusted our inventory to instill confidence in the Pro space while ensuring stock levels do not leave us vulnerable. As foundational elements were established, we turned our attention to incentives and introducing our loyalty program over a year ago. As Pros provide significant growth potential, our EVP of Pro and Home Services, Quonta Vance, will outline our long-term strategy at the Analyst and Investor Conference, covering market segments we haven't penetrated significantly and strategies for fulfillment and digital interactions.

David Bellinger, Analyst

Thanks, Marvin. That's very insightful. Can you also provide an update on the performance of your rural stores? Additionally, with major e-commerce players expanding delivery times to rural areas, how should we address potential impacts on Lowe's rural stores?

Marvin Ellison, Chairman and Chief Executive Officer

We're pleased with performance in our rural markets, which align with our expectations. We're piloting various initiatives in these locations to assess what works. Our gig network allows us to serve all customer segments effectively, providing same-day or next-day delivery to those markets. We're excited about initiatives like our workwear offering with Carhartt and our pet food line. Overall, we're satisfied with performance in rural areas and our ability to utilize our digital platform and partnerships to provide service across urban, suburban, and rural locales. We view our rural strategy as integral to overall growth and will elaborate further during our December conference.

David Bellinger, Analyst

Got it. Thank you very much.

Operator, Operator

Our next question comes from Zach Fadem with Wells Fargo. Please proceed with your questions.

Zach Fadem, Analyst

Hey, good morning. If we assume the Fed starts easing soon, what interest rate level do you think will be impactful enough to stimulate demand in the category again? Do you see any insights from your past experiences suggesting a quicker recovery for either Pro or DIY?

Brandon Sink, Executive Vice President and Chief Financial Officer

Zach, it's challenging to know at what interest rate level our consumers will fully engage or how long demand will lag behind actual rate cuts. We recognize a backlog of demand in the business now, but consumer sentiment remains weak. We believe that lower rates will relieve consumer pressures and stimulate existing home sales activity. Yet, due to the lock-in effect, many homeowners are still operating at lower mortgage rates, so reluctance is possible even with a rate decrease. Our focus is on tracking broader metrics alongside rate activity.

Zach Fadem, Analyst

Thanks, Brandon. I don’t want to front-run Analyst Day too much, but you've mentioned a long-term margin target of about 14.5%. Given current circumstances and changes since that projection, is it still appropriate to view the business this way? What level of sales recovery do you think is necessary to reach that margin level?

Brandon Sink, Executive Vice President and Chief Financial Officer

We'll refrain from diving into that detail right now. The punchline is our original framework still stands. Since our December '22 outlook, the situation has worsened in '23 and '24, but we won't speculate on the timing of recovery. We believe there's strong demand pent-up, and we feel confident in medium- to long-term drivers. We anticipate recovery in the mid-single-digit comp range traditionally seen in the home improvement market, and our initiatives should enable us to clear that high bar.

Zach Fadem, Analyst

Got it. Thanks for the time.

Operator, Operator

Our final question comes from Brian Nagel with Oppenheimer. Please proceed with your questions.

Brian Nagel, Analyst

Hi, good morning. Thanks for taking my question. Following up on rates, we as operators and investors are waiting for a more accommodative rate environment to boost demand in home improvement. The question now is: with the ongoing malaise we see, where are the incremental risks? How could the business deteriorate further before we get that rate relief?

Brandon Sink, Executive Vice President and Chief Financial Officer

Though mortgage rates are expected to drop, our concerns persist about consumer sentiment and existing home sales. The challenges related to housing affordability continue. Demand from consumers remains subdued, especially in discretionary DIY projects. The upcoming macro trends will be essential to track and could dictate our results, especially in the larger DIY categories.

Marvin Ellison, Chairman and Chief Executive Officer

To provide a different perspective, we're leveraging our strong balance sheet to invest in technology and innovation, ensuring we execute our Total Home strategy effectively. This allows us to pick up Pro share and enhance our online capabilities while preparing for future DIY recovery. Rather than waiting idly, we're proactively investing to maximize our position for the eventual market turnaround. We're prepared to capitalize on these opportunities when they arise.

Brian Nagel, Analyst

That's very helpful. My quick follow-up is about Q3. You mentioned comps were down about 5% in Q2. With guidance for a 200 basis point improvement, does that mean the business is currently running around a negative 3%?

Marvin Ellison, Chairman and Chief Executive Officer

I appreciate your question, Brian. We prefer not to offer precise monthly comp percentages. Our business trends reflect our guidance without pinpointing an exact number. We're confident that our performance aligns with the outlook we provided.

Brian Nagel, Analyst

Thank you, Marvin.

Kate Pearlman, Vice President of Investor Relations and Treasurer

Thank you all for joining us today. We look forward to speaking with you on our third-quarter earnings call in November.

Operator, Operator

This concludes Lowe's second-quarter 2024 earnings call. You may now disconnect.