Good morning, everyone, and welcome to Lowe's Companies' third quarter 2015 earnings conference call. This call is being recorded. Please note, if you pressed star one to enter the question queue prior to the start of today's call, your signal did not register. You will need to press star one again to enter the queue. Also, supplemental reference slides are available on Lowes.com Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call. During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.
Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer, Mr. Rick D. Damron, Chief Operating Officer, and Mr. Bob Hull, Chief Financial Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Good morning, and thanks for your interest in Lowe's. I'm pleased that we delivered another solid quarter with comparable sales growth of 4.6%, or 9.7% on a two-year basis. Our comp growth was balanced, with a 2.5% increase in comp transactions and a 2% increase in average ticket. Our U.S. home improvement business achieved 5% comps for the quarter, with all 14 regions generating positive comps. While our businesses in Canada and Mexico delivered high single-digit comps in local currency, our consolidated comp was negatively impacted by foreign currency translation. We generated positive comps in 12 of 13 product categories, with outdoor power equipment delivering flat comps on top of double-digit comps last year. We had strength in seasonal living as customers took the opportunity to extend the outdoor season, driven by warmer and drier weather early in the quarter.
Tools and hardware also performed well as both pro and DIY customers responded to the improvements we continue to make in our assortment, further enhanced by exciting home center exclusives. And our strong brand and service advantages in appliances continued to drive double-digit comps in the category for the fourth quarter in a row. Lastly, our pro business also performed well as we continue to build deeper relationships with the pro by enhancing our product and service offering to meet their unique needs. For the quarter, gross margin expanded 26 basis points, and we effectively controlled expenses, delivering 130 basis points of operating margin expansion and earnings per share of $0.80, a 36% increase over last year's third quarter. Delivering our commitment to return excess cash to shareholders, in the quarter, we repurchased $750 million of stock under our share repurchase program and paid $260 million in dividends.
We've been working to improve our product and service offering for the pro customer and differentiating ourselves through better customer experiences that make us the project authority. We continue to enhance our omnichannel capabilities, transforming our brand from a multichannel offering in store, digital, in-home, and by phone to an omnichannel experience where all of our channels work in concert with one another. To clarify, this transformation is about much more than growing our e-commerce business. Our efforts are centered around supporting customers at every step of the home improvement journey and building greater affinity for the Lowe's brand. I'm particularly encouraged by the momentum we're gaining through increased engagement with our in-home selling efforts. During the third quarter, we expanded our Project Specialist Interiors program to an additional 475 stores and now offer the program in 1,365 stores across the country.
Coupled with our Project Specialist Exteriors program, which is available in all U.S. home improvement stores, and our highly motivated team of Account Executive Pro Services, who continue to strengthen relationships with regional pro customers, we have a strong outside selling force of more than 3,000 people who are able to meet customers on their terms, either in their home or at their place of business. The execution of our strategic priorities alongside a favorable macroeconomic backdrop make this an exciting time for Lowe's. In fact, the forecast for key drivers of the home improvement industry remain conducive for growth at least through 2017. Steady job and income gains, coupled with persistent home price appreciation and strengthening home buying, should keep home improvement growth buoyant. We continue to be pleased with the results of our quarterly consumer sentiment surveys.
Most encouraging this quarter is that the desire to invest in the home continues to grow as survey respondents are indicating that growth in their home improvement spending is outpacing increases in their overall spending. In fact, the number of homeowners indicating that their home improvement spending increased has almost doubled since 2012, boosted by the persisting recovery in home prices. This trend underscores the opportunity we have to address the needs of 75 million homeowners across the country who are increasingly willing to engage in home improvement projects, in addition to the 5 million who relocate or move into a new home each year. Before I close, I'd like to express my appreciation for our employees' purposeful commitment to serving customers. In particular, I'd like to thank those Lowe's team members who worked diligently to assist our neighbors that were impacted by the historic flooding in South Carolina.
In addition to working around the clock to ensure our stores in the affected communities were able to provide products needed for storm recovery efforts, many of our employees also pledged their time to help individuals in need. Thanks again for your interest. With that, let me turn the call over to Rick.
Thanks, Robert, good morning. As Robert shared with you, we delivered another solid quarter. The team executed well, driving traffic to our stores, growing both transactions and average ticket for the quarter. Our appliance category experienced the strongest growth in the quarter, producing double-digit comps. In addition to our leading brands and service advantages in this category, our investments in customer experience are also having an impact, both in store and online. We have further enhanced our appliance offering with the introduction of 17 appliance suites, showcasing coordinated appliances, allowing customers to visualize how their appliance purchase will fit into their space, not just as a single replacement purchase, but as a full set of new appliances.
Because we understand that more than 80% of customers begin their appliance purchase by researching and shopping online, we have enhanced our customer experience and presentation on lowes.com, including improved product search, enhanced videos, upgraded presentation, like 360-degree views, and simplified product groupings. In fact, J.D. Power and Associates ranked lowes.com the number one appliance retailer website for 2015. Our continued focus on improving the omni-channel customer experience, together with leading brands, breadth of assortment, competitive pricing, knowledgeable sales specialists, as well as delivery and haul away, combine to drive our share gains in appliances. Seasonal living also outperformed as we effectively anticipated customer needs and capitalized on favorable weather conditions.
Warmer weather in the north and west in the first half of the quarter drove strong demand for air conditioners, and we were able to meet that demand thanks to the flexibility and capabilities of our distribution teams as they worked efficiently to move product. Further, our customer experience design capabilities continue to pay dividends. These capabilities were first introduced with the outdoor living experience, showcasing patio and outdoor fashion, which recorded strong comps again this quarter. Along with the strong sales of patio furniture, we continue to see an increase in attachment of related products, such as cushions and other outdoor accessories. Our customer experience design capabilities take advantage of our larger store format to produce a showroom feel and create a more shoppable environment, which drives higher customer engagement and stronger attachment rates.
The layout and adjacencies also make it easier for store associates to offer a more coordinated project solution to meet customer needs. As we transition to fall, we leverage this capability to create a seasonal stage to anticipate customers' needs for the season, like planting, leaf removal, and exterior maintenance. As winter arrives, we will continue to leverage this capability and seasonal stage to help customers refresh their homes for holiday guests, decorate, then organize their home after the holidays. This quarter, we also saw above-average comps in tools and hardware driven by strong demand as well as our expanded offering, including continued innovation from brands such as Stanley Black & Decker, Hitachi, Bosch, DEWALT, LENOX, and IRWIN, and improved brand relevance in critical categories like pneumatics with our expanded line of Hitachi pneumatic nailers and fasteners, a home channel exclusive to Lowe's.
We recently completed the reset of our pneumatics destination, featuring the three strongest brands in the category, Hitachi, Bostitch, and Paslode. Our pneumatic brand partnerships make us a clear destination for pros and create opportunities to be more relevant to their business. Our paint performance was in line with the industry with a low single-digit comp. With our launch of HGTV Home by Sherwin-Williams at the beginning of the second quarter, we are now providing our customers with top brands they trust for their next paint project. Olympic provides quality at a lower price and easy application. Valspar specializes in color authority with their Love Your Color Guarantee. HGTV Home by Sherwin-Williams provides a strong brand recognition, designer-coordinated colors, and quality customers trust. Paint employees are now able to meet the needs of both DIY and pro customers who've been shopping us for paint sundries and requesting Sherwin-Williams.
We also continue to see strength in our portfolio of pro-focused brands. In addition to the brands we rolled out in the first half of the year, including Goldblatt Masonry Tools, GAF Roofing, Owens Corning Insulation, and Lennox HVAC, we are proud to introduce Masonite Entry and Interior Doors, offering a key brand that pros know and trust. These new brands continue to build on momentum with the pro customer and also represent the powerful partnership between our Pro Services and merchandising teams as we work together to incorporate pro feedback into a better offering and experience. This commitment is also evident in the assignment of field-based merchandising managers who are working closely with the pro customer to identify local market opportunities and introduce products optimized to local norms to be more relevant with the pro.
Along with strengthening our brand portfolio, we relaunched lowesforpros.com at the beginning of the second quarter, making it easy for pros to manage multiple properties and purchase items like appliances for their locations nationwide. This full omni-channel experience allows pros to easily order online and choose their preferred fulfillment option of parcel, store pickup, or store delivery, saving them time and money. We are also reconnecting with pros who have not recently purchased from Lowe's to show them what's changed in our stores and online. We're using targeted marketing as well as pro-focused events to drive awareness and generate new business. For example, September was Pro Appreciation Month. During the event, we offered vendor demonstrations, special values on core pro products throughout the store, and drove awareness of the support we provide, like job site delivery and credit offers.
Our focus on strengthening our portfolio of brands, serving pro customers through our Account Executive Pro Services team, as well as the recent relaunch of lowesforpros.com, are part of a broader commitment to build on our strong foundation with the pro. In addition to our efforts to drive top-line growth, we continue to focus on driving productivity and profitability. During the third quarter, our store teams once again effectively managed payroll, increasing sales power in line with comps. We continue to leverage our prior investments, optimizing store labor to meet customer demand, and continuing to focus on shifting more hours to customer-facing roles. Most importantly, we have achieved this greater payroll efficiency while improving customer satisfaction scores.
We also grow productivity and marketing by using a robust set of analytic tools to optimize our media allocation, leading to a reduction in print advertising and an increase in digital advertising, an expansion of social media, increasing the efficiency and effectiveness of our media buy and improving our advertising spend, all while maintaining our customer reach and improving exposure. While we've already seen positive results from this work, media optimization is a multi-year effort and opportunity. We also continue to identify and implement additional expense efficiencies by consolidating the procurement of similar types of goods and services across our corporate and store functions. For example, this year we have worked cross-functionally to streamline the procurement process for supplies used across our stores, distribution centers, and our corporate office. Early results are favorable, with savings across multiple lines.
We have also worked to increase profitability for the services we offer without impacting the customer experience. For example, as part of our appliance offering, we provide service advantages such as free delivery and haul away. This year, as part of our appliance recycling program, we work directly with end recyclers to increase recycling income despite a decline in the metals commodity market. As you can see, we are pleased with the third quarter results and the continued progress of our initiatives to drive top-line growth, productivity, and profitability. We look forward to sharing further progress with you over the coming quarters. Thank you for your interest in Lowe's. I will now turn the call over to Bob.
Thanks, Rick. Good morning, everyone. Sales for the third quarter were $14.4 billion, an increase of 5%, driven primarily by comp sales. Total customer transactions increased 2.8%, and total average ticket increased 2.1% to $67.34. For the quarter, comp sales were 4.6% as comp transactions grew 2.5% and comp average ticket increased 2%. The monthly comps were 5.1% in August, 4.8% in September, and 3.7% in October, while the monthly two-year stack accelerated through the quarter. Year-to-date sales of $45.8 billion were up 4.9% versus the first three quarters of 2014, driven by a 4.6% increase in comp sales and new stores. Gross margin for the third quarter was 34.75% of sales, which increased 26 basis points over Q3 last year. The increase was driven primarily by better sell-through of seasonal products and product cost deflation.
Year-to-date gross margin was 34.87% of sales, an increase of 5 basis points over last year. SG&A for Q3 was 22.89% to sales, which leveraged 91 basis points, driven primarily by 4 items. Advertising expense leveraged 17 basis points as we transition to a more efficient and effective media mix. The proprietary credit program leveraged 16 basis points due to continued growth in the program and lower operating costs. Costs associated with building maintenance and repairs leveraged 15 basis points, largely due to the timing of projects, as more of them occurred in the first half of the year versus last year. Store payroll leveraged 13 basis points as we continue to optimize hours against customer traffic. Numerous other expense lines also leveraged as a result of sales growth. Year-to-date, SG&A was 22.55% of sales, which leveraged 60 basis points versus last year.
Depreciation for the quarter was $375 million, which was 2.61% of sales and leveraged 13 basis points compared to last year's third quarter as a result of sales growth. In Q3, earnings before interest and taxes, or EBIT margin, increased 130 basis points to 9.25% of sales. For the first three quarters of 2015, EBIT margin was 9.89% of sales, which was 79 basis points higher than the same period last year. For the quarter, interest expense was $141 million, which was flat to last year as a % of sales. The effective tax rate for the quarter was 38%. Net earnings were $736 million for the quarter, an increase of 25.8% over Q3 2014. Earnings per share of $0.80 for the third quarter were up 35.6% to last year.
For the first nine months of 2015, earnings per share of $2.70 was in line with our expectations and represented a 20.5% increase over the same period last year. To a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was just over $1.2 billion. Our inventory balance of $10.4 billion increased $672 million or 6.9% versus Q3 last year. The increase was driven by timing associated with seasonal builds. Inventory turnover is 3.85, up 12 basis points over last year. Asset turnover increased 10 basis points to 1.75. Moving on to liabilities. Accounts payable of $7.3 billion represented a 13.6% increase over Q3 last year, caused by the timing of purchases year-over-year. In the third quarter, we issued $1.75 billion of unsecured bonds.
The bonds consisted of 3, 10, and 30 year issuances with a weighted average interest rate of 3.45%. A portion of the proceeds was used to repay a $500 million obligation in October. At the end of the third quarter, lease-adjusted debt-to-EBITDA was 2.17 times. Return on invested capital increased 276 basis points for the quarter to 15.78%. Looking at the statement of cash flows. Operating cash flow was $4.5 billion. Capital expenditures was $844 million, resulting in year-to-date free cash flow of $3.7 billion. In September, we entered into a $500 million accelerated share repurchase agreement. We expect to receive approximately 7.3 million shares, but the ultimate number of shares will be determined upon completion of the program in the fourth quarter. We also repurchased approximately 3.5 million shares for $250 million through the open market. In total, we repurchased $750 million in the quarter.
We have approximately $4.1 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert noted, the forecast for key drivers of home improvement industry remained conducive for growth. As our year-to-date performance is in line with our expectations, we are maintaining our outlook for the year. We expect a total sales increase of approximately 4.5%-5%, driven by comp sales increase of 4%-4.5% and the addition of 15-20 stores, which includes 5 Orchard and 2 City Center locations. We're anticipating an EBIT increase of 80-100 basis points and are targeting 25-30 basis points of EBIT expansion per point of comp above 1%. While this is our expectation for the year, as we've seen, there will be some choppiness quarter-to-quarter.
For the year, we expect that most of the EBIT improvement will come from SG&A. Expense leverage will come from store payroll, marketing, and leveraging our scale to achieve cost savings on indirect spend. In addition, we expect fixed cost leverage associated with sales growth. The effective tax rate is expected to be 38.1%. The higher rate relative to 2014 is a result of settlement of prior tax matters recognized in Q1 2014. The higher rate negatively impacts earnings growth by roughly $0.06 per share. For the year, we expect earnings per share of approximately $3.29, which represents an increase of 21.4% over 2014. We are forecasting cash flow from operations to be approximately $5 billion. Our capital forecast is approximately $1.3 billion, which results in estimated free cash flow of $3.7 billion. We will continue to manage to the 2.25 lease-adjusted debt-to-EBITDA target.
Our guidance assumes approximately $3.8 billion in share repurchases for 2015. Regina, we're now ready for questions.
To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead.
Thanks. Good morning. My first question, I think it could be a key question of the quarter is the flow-through, which was a welcome improvement. My question's on the sustainability of it. You've been discussing it, especially in the back half, some indirect expenses coming out of the business, and I think Q4 also screens pretty well for it. As we head into Q4 into next year, any reason why we shouldn't see this type of incremental margins continue?
Simeon, no. As we think about Q4, the drivers that came to fruition in Q3 should remain for Q4. Obviously, our outlook is 25 to 30 basis points of EBIT expansion per point of comparable one. Q4, we do have tougher comparisons going up against a 7.3% comp for Q4 last year. The EBIT expansion will be largely determined based on the comp growth in the quarter. The factors that drove the 130 basis points in Q3 should remain going forward.
Simeon, this is Robert. Just as we indicated throughout the year this year, as we've had our quarterly earnings releases, we give guidance for the year with the flow-through, there can always be choppiness quarter to quarter, just like you've seen this year. On an annual basis, it's basically what Bob has told you from a guidance standpoint.
Second, the follow-up, you mentioned the consumer sentiment survey, that the growth in home improvement is outpacing spending. Do you have additional context on that? Is the rate of what they're going to spend in home improvement, how is that changing?
If you look at, once again, this is. Simeon, a s we survey our customers and what they tell us for their intentions with respect to spending, we look at overall, their level of spending is not increasing, the amount that they're allocating to home improvement. They're indicating that they're spending more in home improvement than obviously how much of that winds up in our channels, which you have to look at. It was a significant increase over what we had seen last year on the third quarter. As you know, sentiment doesn't always turn into action, it's a leading indicator. We think that you look at what's happening in the overall macro environment, when you look at what's happening with home prices, it once again speaks to the fact that consumers are reengaging in discretionary spending around the home.
When we see them leaning that way, it gives us confidence in all the numbers that are built into our outlook for the remainder of this year and also as we lean into 2016. We did see a nice pickup in what their intentions were.
Right. This survey, does this push into your 2017, I guess, your outlook, or are there other factors that more of a macro look?
They're the same factors that we used to provide the 2017 outlook at the analyst conference last year. Obviously, the drivers of our business, income and housing, right? As we think about more people working and starting to see some wage appreciation, those are positive factors. On the housing front, housing turnover continues to pick up and we see ongoing home price appreciation. All the macro factors that drive our industry continue to line up for sustained growth through 2017.
Okay, thanks.
Thank you.
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Thanks a lot. Good morning. Congratulations on the quarter. My first question relates to inventory. If you could just give us a little more clarity about the increase, which was a bit of a departure for you, and also how we should think about the relationship between that inventory number and your gross margin increase, if any.
Okay. Matt, I'll start. This is Rick. The 6.9% increase in inventory reflects our preparation for our Q4 events coming up, as well as being in stock on some critical items our customers deem to be most relevant. The increase is really driven by timing associated with getting inventory in for our events for Q4. Looking forward, as we look into year-end inventory in Q4, we expect our inventories levels to be marginally higher. This is being primarily driven by the timing of Chinese New Year, which is roughly 11 days earlier this year than last, which pushes some order purchases earlier in the cycle for their seasonal build for 2016. When you look at the number in totality, it's really driven by our preparation for Q4.
Matt, the second part of your question related to gross margin. We don't see any gross margin pressure. As Rick said, this is inventory purchase for anticipated sales in the quarter. It's non-perishable product. The other item I would add is really no working capital impact because we've seen a corresponding increase in accounts payable.
Got it. Just a quick follow-up. You did everything you said you would do on the margin and expense front in the third quarter. In the fourth quarter, you sort of need to do it again. I know that the drivers of expense leverage were pretty diverse, came from a bunch of different places. As we think about the fourth quarter drivers, anything you would point to in particular?
No, Matt, really the same drivers. We should see some, again, modest gross margin expansion. We ought to see leverage in credit and bonus, in advertising, in store payroll. All the factors that drove Q3 should again drive operating margin expansion in Q4.
Thanks so much, guys.
Thank you, Matt.
The next question comes from the line of Peter Benedict with Robert Baird. Please go ahead.
Yeah. Hey, guys. I was wondering, can you talk a little bit about the pro marketing efforts in the second half? I know you mentioned September being the pro appreciation month. You've done a lot of work to kind of get the foundation in place to serve the pro better. Can you talk about or give us a sense of how you're going to be speaking to the pro more aggressively over the next several quarters?
Yeah. Peter, this is Rick. As we think about the pro, we continue to leverage our Account Executive Pro Services teams to meet with pros on their job sites to really understand what their needs are and where they're moving. We'll continue to leverage our in-store teams and our account management processes to make sure that we're communicating effectively around the relevant products for the particular time of the year, the particular jobs they're working on. From a mix perspective, most of our pro marketing is really targeted messaging from a direct communication standpoint, targeted messaging through email or radio. We'll continue to build upon what we've done over the last several quarters, leveraging both our field teams as well as our marketing programs to communicate effectively with the pro.
Just to build on that, you see us leverage some of our digital assets as well. We've talked quite extensively about lowesforpros.com. Gives us the ability to reach the pros. You'll see us use some of our more creative online techniques to get the right promotion in front of the pro at the right time. You'll see us, as we continue to migrate more towards digital, away from print. With pros, you'll see us take a slightly different balance where we use some print to talk to them as well. I think the key is that what we've done is we've made a considered effort to make sure we have the right brands that pros need, and now we're starting to reach out to those pros much more efficiently and effectively so we can get the right promotion along with those brands in front of the pros.
Thanks for that, guys. Then just maybe a follow-up for Bob. The 2.25 leverage target, I know you've been operating below that to a degree. It sounds like you got your view on the macro continues to kind of get better. What conditions do you think need to be in place for you to kind of get to that 2.25 level? If you can share that. Thank you.
Sure. It's a couple things, Pete. It's a matter of forecasting. Number 1, we were at 2.17 times into Q3, not too far off. As we think about the fourth quarter, we've got a perspective on sales and profitability, perspective on working capital. It's just a matter of how close do we want to balance the borrowing at year-end relative to our expectations. I would expect us to be somewhere in this 2.15-2.25 times range at year-end.
Okay, perfect. Thanks so much, guys.
Your next question comes from the line of Christopher Horvers with JPMorgan.
Thanks, good morning. Store payroll leverage showed some very nice improvement from 2Q. Can you talk about what's driving that overall? Is there something more systematic going around labor management systems? Is it process improvement? Is it focus? Any detail there would be great.
Yeah, Chris, this is Rick. As we continue to look at store labor, we've talked about the tools that we've deployed to help our store teams and our field teams manage our labor more to customer traffic. We're continuing to see those tools play dividends for us as we continue to match our hours more to traffic. We continually focus on making sure that we're doing everything possible to increase our customer-facing roles. Most of that is through process improvement, as well as the utilization of technology within the stores, making it simpler for our employees to engage with the customer, and improving our processes that make it easier for them to interact both with the customer as well as through the tasking process that we have within our stores.
Chris, one of the things, to give you an example of something that seems simple that can have a significant impact is we're now leveraging one of the tools that we used in our stores, which is the wayfinding app on our digital platforms. Now we incorporate that information on every product label for every item shipped from our distribution center. When that package arrives, it'll tell the employee the exact aisle and bay location that product's stocked. As you can imagine, tremendous efficiency for newer employees in trying to manage and navigate our stores. Makes the whole process much more effective, much more efficient. We transferred several of our processes that were manual paper-driven processes to more technology-driven, leveraging the iPhones and the iPads that we've deployed into our stores to make them more efficient.
What you're seeing is an accumulation of better tools to drive greater payroll efficiency, the continued focus on making sure that we're leveraging employee hours to customer traffic, and then the continued work to drive greater productivity through the tools that we provide our employees.
Do you think, because it was a lot better in 3Q versus 2Q, do you think that this is the inflection and that it's really gelled around the payroll management process as you look forward?
Yes. As we continue to look forward, I think we'll continue to see solid payroll efficiency.
Okay. One of the questions that we're getting is the performance in October and how to interpret the deceleration. Two-year stacks did accelerate, and they did look very strong. If we held stacks into 4Q would suggest comps decelerated about 200 basis points. Anything to point out there around October and your thoughts about the current quarter? Thanks.
Chris, in the quarter, weather had no net impact to the 3-month period. We did have favorable weather in the first part of the quarter, a little tougher weather towards the end of the quarter. As you suggest, we did see 2-year stack acceleration throughout the quarter. Feel really good about our ability to deliver Comp on comp. As we look to 4Q, we would expect further acceleration on a 2-year basis into Q4. As it relates to November to date, we are in line with our expectations, and we're really excited about Q4.
Thanks very much.
Thank you, Chris.
Your next question comes from the line of Laura Champine with Cantor Fitzgerald.
Good morning. You did a good job of expanding gross margin despite such strength in appliances, which is typically a lower margin category. What is your expectation in Q4 for mix's impact on your gross margins?
Mix should have a negligible impact. As Rick noted, we're now into four straight quarters of double-digit appliance comps. We've cycled some tougher compares. Although appliances continue to perform well. Mix should be a little bit less pressured in Q4, and going forward for that matter.
Thank you.
Thank you, Laura.
Your next question comes from the line of David Schick with Stifel.
Hi, good morning. Rick, a question for you or maybe Rick and Mike. You're talking about sitting down with a pro and the merchandising changes and all of that. Where do you think the balance of the opportunity is in the pro? Is it pros you already have spending more, or is it pros you're not reaching, and if so, where are they coming from?
This is Mike Jones. I'll start. We think the answer is yes. We think it's the pros that we already have spending more, we know that there are pros today that drive past us to go someplace else. We know we can do a better job at bringing them into our stores. We started by ensuring that we have the right inventory depth, the right brands, the right local market assortment. As that was corrected, we feel real comfortable about where we are. From there, we started to turn on our marketing, so that we can start to invite those pros back in. We're excited about both the pros we have. It's still a big part of our business, and we're excited about the pros that historically have purchased someplace else that can now come in and try and experience that Lowe's.
Yeah, David, this is Rick. I'll just add, when we look at the pro in general, we're very excited about what we're seeing from both a transaction point of view and a comp across all ticket ranges. When you look at comps by ticket size and the way that we evaluate those, we're seeing positive growth across all tickets, which is telling us that we're getting some new accounts in, but we're also selling our existing accounts more. The other thing, through our pro appreciation events and what we're doing to really target pros through the new brands, the increased inventory depth, and our five ways to save value propositions we're doing. We saw strong double-digit growth in new accounts during Q3 as well.
I think that also goes to support the fact that we're becoming more relevant, that the brands that we're introducing have an increased awareness with the pro, the aspects of services that we're providing is beginning to resonate as well.
Great. As a follow-up, Bob, you mentioned more efficient and effective media mix. Understand, I think, the efficient side. Could you give numbers on effective, in terms of how many you're reaching or some way for us to think about that?
I'll start and let Mike jump in. Dave, we're doing some media mix modeling. We're trying to understand the impact of different mediums on different markets, and we're adjusting according. Ultimately, we're taking a look at the most effective yield, which is the sales $1 yielded for $1 of marketing spent. As Rick mentioned in his prepared comments, we've shifted some dollars away from prints towards more digital assets. We're able to reach more folks in a very cost-effective way, which gets into the effectiveness and efficiency of marketing.
Just to build on it. If you look at the way we've remixed our advertising and marketing spend, we're moving more towards digital, more towards social media, and less out of some of the more traditional advertising vehicles. I'll give you some numbers and a way to think about this. Just looking at social media, Lowe's followers on Facebook are over 3 million. Pinterest, just about 3.5 million followers. Lowe's video views, well over 70 million. One of the easy ways for us to track is just watch our activity on social media. Our digital footprint is very large, and we continue to increase it. We're very proud of the work that's happened there.
Thanks.
Your next question comes from the line of Budd Bugatch with Raymond James.
Good morning. This is David Vargas on for Budd. Thank you for taking my question. On the pro business, can you tell me what the pro penetration was this year versus last year? Also, what categories within pro saw the strongest comp sales growth?
David, the pro isn't an exact science. We have some direct measurements of them, relative to managed accounts and credit vehicles. There's some imprecise measures. Currently, the pro mix is about 30%. In the past three quarters, it's grown in line with the company average. The fourth quarter last year was a little bit faster, so that would suggest it's migrated from a little bit higher in that 30% range.
Okay. Then what categories did you see the strongest growth in year-over-year?
A couple, actually. I'll pick on our tools, where we've really worked diligently to get the right brands. We've added brands like Irwin, Lenox, we've added Hitachi, we've added Goldblatt, as an example. You couple that with brands like DeWalt, Kobalt, Porter-Cable, Bosch. We saw double-digit growth in pneumatics. We saw very strong growth in cordless power tools accessories and rotary tools. We watch tools in particular because it's a good indicator of how well we're engaging the pros. This isn't just adding brands by happenstance. If you look at the way we've added brands around pneumatics, we've added Hitachi to complement our offering in Bostitch and Paslode. We have the three best brands in pneumatics. If you want to buy pneumatics as a pro, we feel that Lowe's is certainly the best place to come. We look at each category.
We strategically decide how to best serve the pros. We build brands that complement one another, and from there, we increase our relevant engagement with the pro. Certainly, we saw it in tools. We see it across the stores as we continue to grow our pro business.
Got it. Thanks. Then finally, one more question on just the consumer in general. What are you seeing this year versus last year in terms of customer spend on large ticket discretionary, like kitchen remodel, bathroom remodel? Are they moving towards more of that discretionary spend from, I guess, general maintenance and repair of large ticket items?
Okay, I'll start. This is Robert, and then I'll let the other guys finish. Certainly, when we look at consumers' discretionary versus non-discretionary spend, we're seeing that when you combine small and large discretionary spend, they're telling us that more than 50% of their spend is on a discretionary basis, which has tripped over from where it would have been prior years. We're seeing it move above that 50% level. When you look at, and we talked about appliances being double-digit comps for the quarter. We've talked about some of the project spending and initiatives that we're putting behind that, whether that's Project Specialist Interiors, which is major interior remodels, or Project Specialist Exteriors, which is the exterior programs we do, fencing, siding, new windows, those type of things. Both of those programs had double-digit comps in the quarter.
Appliances, PSI, PSE, all running double-digit comps in the quarter. We are seeing that consumer take on that willingness to spend around the home on discretionary projects driven by, as I said in my comments, the macro factors as well as continued comfort that comes from home price appreciation that they're seeing.
The other item I would add, in addition to Robert's comments, is if you take a look at tickets above $500, comped 7.2%. Continue to see strong growth in the big ticket categories.
Got it. Thank you very much.
Thank you.
Your next question comes from the line of Michael Baker with Deutsche Bank.
Thanks. I'll finish it up with, or it looks like we're getting towards the end, with one bigger picture question. This is for Mr. Niblock. You're still a 200 basis points away from your peak operating margin, but I think as you guys like to say, you have line of sight to it. When you start to get to that double-digit operating margin, how do you think about balancing further margin gains with some top-line initiatives? Ever so subtly, you're increasing your store count growth in other regions and other formats. Your competitor just made an acquisition. How do you think about maybe some new top-line growth initiatives to balance that margin gain? Thanks.
It's a great question, Mike. When you think about it from where we at peak operating margins previously to where we're at today and trying to hone back in on that, we really are a totally different company. If you think about back in those days, it was single channel. We were on a rapid expansion of the store footprint. We think the store is still the nucleus of our relationship with the customer, but the store in and of itself is not enough. You really have to be there on an omni-channel basis for the customer.
That's why everything we've been investing in for the past few years is really to be able to deliver that omni-channel offering so that we take those stores, we continue to build on those and leverage them, the PSI, PSE probes that we just talked about, whether it's the improvements that we've made on lowes.com, whether it's all the improvements that we've made with the pro customer to really get us back to the point where then we can look at other opportunities to try and grow that top line. Certainly, we expect to continue to have gross margin, operating margin improvement, continue to have nice flow through as we drive comp sales improvement like the guidance that we've given you. We will continue to look at how are there other opportunities as the consumer changes, the way the consumer wants to interact with us changes.
What are the other opportunities where we can do things that will continue to allow us to pursue opportunities for growth, particularly in a recovering market and the affinity that we're seeing with the consumer around investing in the home. Whether it's stuff like lowesforpros.com that we invested in because we know that that was a key gap that we had there, whether it's rolling out additional PSI programs like we added this quarter in the store, you'll see us looking at ways that we can continue to make sure that we're responding to where the customer wants to go. Whatever that ends up being, we'll end up evaluating that, but also using the base of stores we have to continue to drive nice flow through.
Okay. Thank you. One follow-up. On the previous question, you had said that now more than 50% of spend as you talk to your customers is discretionary. Can you tell us where that was at a peak, probably 2006 or 2007, and where it troughed out when housing crashed? Thanks.
No, I don't have the numbers back before the peak as to the exact numbers as to where it was at. That would be back in the-
2009 is when we started the survey.
2009 is when we started the survey, Bob's saying. We don't have numbers back before the decline.
What we are seeing, though, is a greater proportion of customers telling us they're leaning into the big-ticket discretionary from smaller ticket discretionary. As you think about greater consumer sentiment and confidence around their personal job situation, there is home appreciation. They're starting to think about those bigger ticket discretionary projects.
Okay, understood. Thanks a lot, guys.
Thanks, Mike.
Your next question comes from the line of Michael Lasser with UBS.
Good morning. Thanks a lot for taking my question. How do we think about the underperformance or the below-average comp in categories like kitchen, millwork, flooring, in light of your commentary about the success of the Project Specialist program? Go ahead.
This is Mike Jones. The categories were below average, but driven largely by the strength in appliances and seasonal living. We had a couple categories like millwork and OPE that were up against significant comps, well into the double-digit comps last year, same time. I think the consumer sentiment survey is probably a better indicator than looking at the distribution of our above average and below average. I just encourage to keep in mind that all of our categories are positive, with the exception of OPE, which was about flat. Again, we remain pretty encouraged by what we see both on the big ticket as well as on the transactional side of our business.
If we assume that those two categories added about 100 basis points to your overall comp, do you think that the market in the areas surrounding your store for categories like kitchen, flooring, appliance, millwork, is growing in the 3%-4% range?
I can say that the categories that you asked about did comp in the 3%-4% range. As Mike said, they were positive. They were below the company average based on the strength of the appliance and seasonal living businesses.
Okay. Is that the rate of growth you would expect at this point in the cycle for those categories?
The market-specific growth is based on the state of the economy and housing in those markets. The factors that drive the macro Lowe's business also drive each individual market, housing and incomes in those markets, some higher, some lower, depending on where they are in the housing cycle.
Got it. My last question is, I'm sorry to pick on all the other categories, Paint has been below the company average for five quarters in a row, despite the launch of some new products within the category. Can you talk about the reason for the underperformance, especially because paint is a category that's attached to a lot of other home improvement products, whether it's inside or outside of a house.
Sure, I can talk to that. The paint industry in total is below the average, and so our paint performance is about in line with the industry. I'd say we're not satisfied with that. We want our paint performance to be above the industry, as are most of our other business units. That said, we're seeing good momentum with HGTV by Sherwin-Williams. We've got a great relationship with Valspar and with PPG, with the Olympic brands. We've leaned pretty heavy into some promotions around paint, as I'm sure you've seen. Our promotional cadence year-over-year is about the same, but we did redirect a little more towards paint. We're pretty excited about our paint lineup. That said, the industry is below the average, and we're running at about average to the industry.
Thanks so much, and good luck with the holiday.
Thanks, Mike.
Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.
Good morning, guys. I actually have another SG&A follow-up. Obviously, you guys had very strong leverage in the quarter. You talked about that continuing going forward. Looking at the data a little bit differently, you've generally been posting SG&A per store growth of about 2%-3% unless comps were, call it, sub 1%. This quarter was only about 50 basis points on a very strong mid-single-digit comp. Can you help us better understand what changed in the expense growth rate? Is it you just don't have to spend any more on labor, and you've kind of topped out? Is it advertising flattening out? Is it reduced losses on international ops? I guess I just want to understand what's changed in that run rate and how we should think about that going forward.
Yeah. We talked about the choppiness quarter to quarter in the flow-through. That's a variety of factors. Performance relative to plan drives bonus accruals year-over-year. The nature of the credit program as we think about portfolio performance, loan loss reserves, that's driving some expense leverage second half of this year relative to first half. As I mentioned in my comments regarding building repairs and maintenance, our plan is more front-half loaded. Therefore, we're getting leverage based on the timing of projects year-over-year. There's just a variety of factors that contribute to movement year-over-year. I think that if I had to leave you with a punchline, you heard us talk about steps we're taking in payroll, in advertising, indirect spend that are sustainable, will drive benefit through 2015 into 2016.
A run rate, Bob, is it something between what we saw in terms of SG&A actual growth? Is it something between what we saw in the first half and third quarter because of the timing differences? When we think about the longer-term model, what's the right way to think about it?
For 2015, SG&A grows at roughly 46% of the rate of sales growth. I think something close to that 50% is probably the right way to think about it.
Got you. Just, hopefully, a clarification. There was a bunch of questions on pro sales and ticket size. When you guys look at your ticket size buckets, the strongest growth continues to be in those higher ticket transactions over $500. Is it fair to assume that it's primarily driven by pro customers, or is it more of a 50/50 deal between pro and DIY because of appliances and other high-ticket items, specifically within that over $500 bucket?
As you think about the mix of our business, it's 70% DIY, 30% pro. However, the pro ticket is larger than the DIY pro, so the driver of the big ticket is probably going to be closer to 60/40 DIY to pro.
Very helpful. All right. Thanks, guys.
Thank you, Scot.
Your next question comes from the line of Seth Basham with Wedbush Securities.
Regina, this will be our last question.
Thanks. I got in under the gun. My question's around close rates. You guys have talked in the past about how you've dealt with close rates, given the fact that you're optimizing labor. Any update there on how close rates and customer satisfaction is proceeding here?
Rick talked about customer satisfaction. We continue to see very strong customer sat results through our customer focus program. As you think about close rates, we've done a lot of things to address all the potential factors that might impact close rate, both the quality and quantity of labor, the depth of inventory, the local assorting. Rick mentioned wayfinding, which is the ability to navigate our store. A lot of good steps we've taken. As a result, we're seeing roughly a 100 basis point improvement in close rate this year relative to last year.
That's helpful color. As a follow-up, just to tie the knot on the near-term outlook. Comp store sale trends accelerated throughout the third quarter to a 6.6% comp in October, 11% on a two-year stack. How do you think about the fourth quarter? Can you hold that 11% two-year stack rate?
That's the expectation. We've seen good sequential progress through the quarters. We saw sequential progress through the months of Q3. As Robert talked about in his comments, good momentum as it relates to the consumer and drivers of our industry. Each day, our execution continues to improve, so we feel good about the ability to drive and achieve or exceed the outlook we put forth for the year.
Got it. Very helpful. Thank you and good luck.
Thank you.
Thanks. As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter results on Wednesday, February 24th. Have a great day.
Ladies and gentlemen, this concludes today's conference. Thank you all for joining. You may now disconnect.