Good morning, everyone, and welcome to the Lowe's Companies' second quarter 2012 earnings conference call. This call is being recorded. Please note if you press star one to enter the question queue prior to the start of today's call, your signal did not register. You'll need to press star one again to enter the queue. 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 it 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. Also during this call, management will use certain non-GAAP financial measures.
You can find a reconciliation to the most directly comparable GAAP financial measures and other information about them posted on Lowe's Investor Relations website under Investor Documents. Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and CEO, Mr. Greg Bridgeford, Chief Customer 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. Thanks for your interest in Lowe's. Following my remarks, Greg Bridgeford will review our operational performance, Bob Hull will review our financial results in detail. First, let me provide a summary of our second quarter performance. Comparable store sales for the second quarter were negative 0.4%, with an 0.8% decline in comp transactions and a 0.4% increase in comp average ticket.
The comp for our U.S. business was negative 0.2%. Ahead of the quarter, we expected comps to be within the 1%-3% range. While we fell short, our performance improved sequentially each month of the quarter, and nine of 14 product categories ended the quarter with a positive comp. In fact, seven of those product categories generated comps above 1%. The most significant comp pressure came from building materials, lawn and garden, and millwork.
Greg will discuss those categories in a few minutes. We also continue to see strength in our commercial business, which outperformed the company average in the second quarter. As a reminder, our commercial business is roughly 25% of our sales. While second quarter gross margin contracted 56 basis points, we continued to improve sequentially while working to strike the right balance relative to promotions.
We effectively controlled operating expenses in the quarter, delivering earnings per share of $0.64, which included approximately $0.01 of severance and other costs associated with our voluntary separation program. Delivering on our commitment to return excess cash to shareholders, in the second quarter, we repurchased $1 billion or 36.8 million shares of stock and paid $166 million in dividends. Before I turn the call over to Greg, I'd like to address two additional topics.
First, my level of satisfaction with the progress on our strategic initiatives, and second, our non-binding proposal to acquire RONA. In the U.S., we were focused on two large bodies of work this year, value improvement and product differentiation. Together, they will enable us to compete more effectively in the current macroeconomic environment. These focus areas build on Lowe's core strengths and are expected to deliver comp transaction growth and better gross margins by localizing market assortments, driving excitement in our stores through better display techniques, and managing an appropriate balance of product cost and retail pricing.
We are also in the process of transforming our business to deliver seamless and simple multi-channel customer experiences. We are seeing traction with mobile technology, our flexible fulfillment capabilities, and myLowe's. Individually and collectively, these efforts are significant but necessary to respond to the changing needs and expectations of consumers.
Given the magnitude of change, we understood there would be some level of disruption. We're willing to accept short-term disruption for long-term gain because we believe in our strategy. However, I expect the organization to rise to the occasion and execute consistently every day. We knew it would take time to see the full benefits of our actions.
The team is making progress on these initiatives, but frankly, the benefits are accruing at a slower rate than I had expected. It will likely be mid-2013 before we fully complete this phase of our transformation. We must be realistic about our timeline, and we must ensure that we fully realize the benefits of our actions before moving on to the next phase of our transformation. Greg will share his thoughts on improving execution and the interim milestones with you in a few minutes.
Finally, let me address our non-binding proposal to acquire RONA. First and foremost, an acquisition is not imminent. We are evaluating our options, and part of that evaluation, among other things, is whether or not we can complete confirmatory due diligence and ensure a fair price and an adequate return on our investment. Second, at our Analyst and Investor Conference last December, we discussed our capital allocation priorities. Those priorities were, first, strategically invest in the business. Second, grow the dividend based on our targeted 30%-35% dividend payout ratio. Third, return excess cash to shareholders through our share repurchase program. Regarding these priorities, let me emphasize two points. One, priorities have not changed.
We said in December that while we continue to focus on the U.S. home improvement market, we also look for opportunities in new and existing international markets to improve the overall portfolio of our business. Based on publicly available information, we believe that an acquisition of RONA would provide us with an opportunity to immediately and significantly expand our Canadian presence.
Two, the proposed acquisition cost for RONA is not entirely incremental because our average annual capital expenditure target through 2015 assumes some growth in Canada. If we move forward with the transaction, there will be some short-term impact on our share repurchase program, likely 2-3 quarters. Longer term, we expect to generate incrementally more cash flow as a result of the proposed transaction, providing a net benefit to our share repurchase program.
Additionally, the new organizational design that we announced in mid-April provides for a separation of management to either the U.S. or our international operations. We made this decision in recognition that our U.S. and international businesses are in different stages of maturity with market and cultural differences that require different approaches. Let me conclude with some thoughts on the second half of 2012.
While we are encouraged by improving housing metrics, we believe underlying demand will remain soft in the near term, and our guidance reflects that view. It has also been adjusted for our performance to date and revised timelines and benefit assumptions for our initiatives. I have confidence in our strategy and our employees, and while I recognize the significant magnitude of change that we've asked the organization to absorb as we transform our business, we fully understand that we must improve our level of execution.
Thanks again for your interest. Greg?
Thanks, Robert, good morning, everyone. During my time today, I want to dive a little deeper into our quarterly results, describe our challenges and progress, and provide clarity on our priorities. Our second quarter performance resulted from a number of factors, a challenging start, learnings applied, and a better finish.
For the first few minutes, I'd like to focus on product category performance. As Robert noted, building materials, lawn and garden, and millwork put significant pressure on our total comp growth. In fact, excluding these categories, the remaining 11 categories combined comped above 1% with particular strength in lumber, cabinets and countertops, paint, and tools and outdoor power equipment. We faced a headwind in building materials, which finished the quarter with double-digit negative comps. Substantial tornado and hurricane repairs drove double-digit positive comps in this category in the second, third, and fourth quarter of 2011.
In lawn and garden, the combined effect of a strong pull forward in the early spring season, followed by extreme heat and drought conditions, led to slow sales and distressed live goods inventory, which negatively affected margin in this category. Millwork sales were negatively impacted as we struggled to strike the right balance on promotions. Focusing on our monthly comp progression, our May comps were negatively impacted by a reduced promotional schedule that resulted in light Memorial Day weekend traffic, particularly in appliances, flooring, cabinets, and countertops.
As a result of early adjustments, we improved sales as the quarter progressed, but in hindsight, we overcorrected and added too heavily to big-ticket promotions, negatively impacting margin. Based on our experience in the second quarter, we've completely taken apart our promotional strategy.
Not to go back and add in more events for the third and fourth quarters, but to rebuild from the inside out, revising tab item selection to appropriately balance traffic driving and attachment items, building more effective traffic-driving messaging within our TV campaigns, our radio spots, looking at all of our media vehicles. We're on a journey to return to the operational leverage of EDLP, and we recognize it's not a day trip. Turning to our strategic focus areas, our most immediate priority is to improve our product sales business model through our Value Improvement Program. Let me take a minute to explain the purpose of this program. Using research support, each merchandise category team identifies the product attributes that are most important to customers. This information creates the assortment strategy that guides the work of the accelerated line review process.
The process has firm targets of lowering first costs through comprehensive line reviews and to realign and leverage inventory dollars to support sales. Another critical goal is to locally assort items by using new planning systems to identify the store's market needs. The approach is to define the category strategy based on research, create a differentiated product offering, and lower the cost structure. Here's a quick snapshot of where we stand at the end of the second quarter. We've now completed line reviews representing nearly half of our business and expect to reach approximately 90% by the end of the fiscal year. We continue to exceed our inventory reduction goals and are making progress to meet our cost reduction goals. A portion of these cost reductions involve redirecting vendor promotional and marketing support dollars to lower unit costs.
Based on our inventory terms, the benefit to our cost of goods sold will lag the completion of the resets by approximately one quarter. We will apply the savings achieved through the line reviews as appropriate to product categories to create better everyday pricing and support higher turn categories with deeper inventory. At the end of the second quarter, we've completed resets representing nearly 15% of the business, and we expect to reach approximately 50% by the end of the fiscal year. While we're on pace with the timing of line reviews and reset completion that we shared with you last quarter, we've set more realistic expectations in the back half of the year for the time that it will take for customers to respond to the improvements we've made and for gross margins to more fully reflect unit cost reductions.
With only a handful of resets fully in place for more than a few weeks, we're just starting to accumulate performance data from these completed sets. One category whose early results are favorable is paint. In the first quarter, we reset our entire paint category, including both paint and accessories. Paint is the number 1 DIY project among home improvement customers, yet we know that selecting the perfect color can be challenging. With our vendor partner, Valspar, who's exclusive to Lowe's, we developed the Lowe's Color Studio. The goal is to sell more paint by simplifying this process. We developed four new color collections, one for each season. Swatches of these colors are available in-store and online, and pre-mixed samples are available in the store in a clear sample jar that inspires the customer at the shelf and makes obtaining a sample quick and easy.
We also simplified our offering of paint applicators, making use of analytics generated using our market clustering and assortment tools. These analytics led us to eliminate items with identical function, leading to significant SKU and cost reductions while increasing our inventory of our highest volume items, resulting in net inventory reduction. In paint applicators and accessories, we're emphasizing our private brands at lower price points with the Project Source brand as the opening price point offering and the Blue Hawk brand as a step up to a better price point. We've also identified a cluster of roughly half our stores where the Purdy national brand is the most important to the commercial business customer.
The result is a bay of paint applicators that is much easier for the customer to choose from, and that provides national brands where they are most valued in a clear progression of features and brand relevance at increasing price points. To summarize, these paint category line reviews demonstrate how we're using the accelerated line review process to work with vendor partners to generate innovative product and display ideas, use brands in a rational manner to cater to specific customer needs, and use new analytical capabilities to identify opportunities to tailor our offering to each market and to simplify our assortment to make it easier for customers to choose the right product for their needs, purchase it, and get on with the project. An early read from this reset is that it is driving comp and margin growth above our initial expectations.
Another fundamental operating improvement we're making in our stores is the end-cap and promotional space resets that we are executing as part of the product differentiation focus area. We've revised many of our end-cap locations to highlight innovative new products and significant values leading into a category. We've also revamped the promotional spaces for drop zones to promote seasonally relevant high-value items to drive sales. To date, we've reset over 1,000 of our 1,700 domestic stores, over 350 in this quarter alone. While we've not yet obtained the full benefit expected from the first stores we reset, the results of these changes in end-cap and promotional spaces have continued to improve as we adjust the mix of end-cap themes and improve the rotation of products.
We believe there are further opportunities to improve the performance through better end-cap item selection, increased depth of supporting inventory, and better adjacency of end-cap items to the associated in-line inventory. We anticipate resetting another 400 stores in the third quarter. In growing our multi-channel capabilities, we continue to gain traction in enabling consumers to fulfill their needs seamlessly across channels. We implemented what we call Flexible Fulfillment last fall. This capability allows us to deliver lowes.com parcel orders from the most efficient location directly to consumers. We now ship from 53 fulfillment locations around the country and can satisfy over 90% of U.S. markets within 24 hours at standard shipping rates. In the second quarter, Flexible Fulfillment allowed us to more than double our parcel shipments versus last year and deliver over 98% of them on time.
These flexible fulfillment capabilities contributed to second quarter lowes.com sales growth of approximately 70%. The MyLowe's customer base also continues to grow. Since we launched this customer-enabling personalized website in October of 2011, over 10 million cards have been activated, and 3.3 million cardholders have registered their cards on MyLowe's. As a reminder, MyLowe's allows customers to access their purchase histories, home profiles, project lists, reminders, and folders. We continue to enhance the capability we've already delivered while developing new capabilities, all with an eye to further increase engagement with customers. In the same way, we're continuing to expand the use of iPhone technology in our stores. Last year, we deployed 42,000 devices across all stores, so approximately 25 per location. Each phone was used on average over 30 times a day in the second quarter, an approximate 40% increase over the first quarter.
Associates use the iPhones to perform tasks like looking up inventory and requesting new inventory. Additionally, new features have been recently added that provide associates with even greater ability to assist customers in the aisle. For instance, an associate has immediate visibility to rebates available on scanned items. We've now added voice capabilities that use our store Wi-Fi and that will allow us to eliminate a separate mobile voice system in the store. Additionally, we're piloting Tender in the aisle, and we'll continue to add capabilities that improve the customer's experience and make our associates more productive. Our strategic focus areas are centered around improving our product-based business model through the Value Improvement Program, communicating value and innovation through our Product Differentiation Rollout, and improving the customer experience through flexible fulfillment, the MyLowe's customer website, and mobile technology. Last, I'd like to make a personal comment.
Since Rick Damron and I took the new positions of Chief Operating Officer and Chief Customer Officer, respectively, at the start of the second quarter, we've been committed to a tight focus on running the business. We recognize that the most critical leadership we can deliver is a realistic assessment of our current and near-term performance and a focus on driving improved results over the short and mid-term. As Robert said earlier, we expect some disruption over the next few quarters, our teams will be working hard on the fundamentals of delivering a better and different shopping, purchase, and fulfillment experience that will lead to better sales, more predictable margins, and better asset leverage in the mid-term, even in this challenging consumer environment.
We look forward to better realizing the benefits and the investments that we've made in the Product Differentiation Rollout, with the Value Improvement Program, and new capabilities to deliver more seamless and simple multi-channel customer experiences. Thank you for your interest in Lowe's. I'll now turn it over to Bob Hull. Bob?
Thanks, Gregory. Good morning, everyone. As noted in our earnings release, there was a week shift in fiscal 2012 as a result of 2011's 53rd week. Sales for the second quarter were $14.2 billion, which represents a 2% decrease from last year's second quarter. The decrease was driven by the calendar week shift and negative comp store sales, offset slightly by new stores. We estimate that the week shift negatively impacted sales for the quarter by $259 million, or 1.8%. In Q2, total customer transactions decreased 2.4%, primarily a result of the week shift impact, while total average ticket increased four-tenths of a percent to $62.66. Comp sales were negative four-tenths of a percent for the quarter. Looking at monthly trends, comps were negative 2.1% in May, positive four-tenths of a percent in June, and positive seven-tenths of a percent in July.
Through the first three weeks of May, comps were running above 1%. As Gregory noted, we had a tough Memorial Day weekend, as a result, comps were negative for the month. With regard to product categories, the categories that had above-average comps in the second quarter included lumber, cabinets and countertops, paint, tools and outdoor power equipment, flooring, seasonal living, home fashion, storage and cleaning, hardware, and fashion electrical. Plumbing and appliances performed at approximately the overall corporate average. For the quarter, comp transactions declined eight-tenths of a percent, which is primarily attributable to lawn and garden, which was impacted by a seasonal pull forward as well as extreme heat and drought conditions in much of the country. Comp average ticket increased four-tenths of a percent.
The positive comp average ticket was driven by strength in our commercial business, above-average performance in cabinets and countertops, tools and outdoor power equipment, and flooring, as well as lumber inflation, offset slightly by the impact of the 5% off credit value proposition. Year-to-date, total sales of $27.4 billion were up 2.5% to the first half of 2011, driven by a 1% increase in comp store sales, a 1% net favorable week shift impact, and new stores. Gross margin for the second quarter was 33.93% of sales, which decreased 56 basis points from last year's second quarter. In the quarter, promotional activity, price reductions, and lawn and garden write-offs in drought markets negatively impacted gross margin by approximately 45 basis points. A proprietary credit value proposition, which offers customers the choice of 5% off every day or promotional financing, negatively impacted gross margin by 15 basis points.
This was more than offset by leverage in tender and other costs associated with our proprietary credit program. I'll provide the SG&A and EBIT impacts in a moment. These items were offset slightly by product mix, inflation, and lower fuel costs. Year-to-date gross margin was 34.3% of sales, a decrease of 63 basis points from the first half of 2011. SG&A for Q2 was 22.26% of sales, which deleveraged four basis points. During the quarter, store payroll deleveraged approximately 20 basis points. Expense dollars were essentially flat to last year, with the deleverage due to the sales decline associated with the week shift and negative comps. Bonus expense deleveraged 20 basis points, primarily related to higher expected attainment levels for store-based employees relative to last year. In Q2, we recorded an additional $15 million in expense associated with the voluntary separation program, or VSP, causing 11 basis points of deleverage.
Also in the quarter, we experienced deleverage in employee insurance, from merchandising costs associated with the product differentiation program, and systems and communications related to Wi-Fi, iPhones, and other in-store technology upgrades. These items were essentially offset by the following. We incurred a $17 million charge related to an evaluation of the carrying value of long-lived assets. This compares to approximately $83 million for similar charges in Q2 2011, which resulted in leverage of 45 basis points. We also experienced 36 basis points of leverage associated with our proprietary credit program. This leverage was driven by a combination of fewer losses, higher portfolio income, and lower money costs. In addition, interchange fees were lower as the penetration of proprietary credit increased roughly 300 basis points over last year's second quarter to 23.8% of sales. Year-to-date, SG&A of 23.4% to sales, which leveraged 36 basis points from last year's first half.
Depreciation for the quarter was $369 million, which was 2.59% of sales, and deleveraged eight basis points compared to last year's second quarter. In Q2, earnings before interest and taxes, or EBIT, declined 68 basis points to 9.08% of sales. We estimate that our proprietary credit value proposition positively impacted EBIT by five basis points for the quarter as leverage in proprietary credit, bank card, and other expenses, but this was more than offset by a negative gross margin impact. For the first half of 2012, EBIT was 8.2% of sales, which was 21 basis points lower than the same period last year. For the quarter, interest expense was $96 million and deleveraged six basis points to last year as a percentage of sales. Interest expense came in lower than anticipated due to tax settlements that resulted in lower interest accruals of $22 million in the quarter.
Total expenses for Q2 were 25.53% of sales and deleveraged 18 basis points. Year-to-date, total expenses were 26.83% of sales and leveraged 36 basis points versus last year. Pre-tax earnings for the quarter were 8.4% of sales. The effective tax rate for the quarter was 37.6%, essentially the same as Q2 last year. Net earnings were $747 million for the quarter, down 10% to Q2 2011. Earnings per share of $0.64 for the second quarter was flat to last year. We estimate that the week shift negatively impacted earnings per share by $0.03. In Q2, EPS was also negatively impacted by VSP and impairment, offset somewhat by lower interest expense associated with tax settlements. The net impact of these items hurt earnings per share by $0.01.
For the first six months of 2012, earnings per share of $1.07 represents a 9.2% increase over the first half of 2011. To a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.7 billion. Our second quarter inventory balance of $8.7 billion decreased $126 million, or 1.4% versus Q2 last year. The decrease was driven by building materials as we had higher inventory levels last year to support strong storm-related sales, as well as SKU and cost reduction efforts. Inventory turnover, calculated by taking the trailing four quarters cost of sales divided by average inventory for the last five quarters, was 3.75, an increase of 15 basis points from Q2 2011. Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, decreased 50 basis points to 5.24%.
We estimate that the impact of charges for last year's store closings, discontinued projects, and long-lived asset impairments negatively impacted return on assets by 70 basis points. Moving on to the liability section of the balance sheet. Accounts payable of $5.1 billion represents a 5.5% decrease from Q2 last year. The lower accounts payable balance relates to the timing of purchases this year relative to last year. At the end of the second quarter, lease-adjusted debt to EBITDAR was 2.4 times. Adjusting for the impact of charges for last year's store closings, discontinued projects, and long-lived asset impairments, lease-adjusted debt to EBITDAR was 2.22. Return on invested capital, measured using a trailing four quarters earnings plus tax-adjusted interest divided by average debt and equity for the last five quarters, decreased 43 basis points for the quarter to 8.61%.
We estimate the impact of the charges for last year's store closings, discontinued projects, and long-lived assets impairments negatively impacted ROIC by 100 basis points. Now looking at the statement of cash flows. Cash flow from operations was $2.8 billion, a decrease of $497 million or 15% from last year, largely due to the timing of purchases contributing to the decrease in accounts payable. Cash used in property acquired was $622 million, a 20% decrease from last year. As a result, year-to-date free cash flow of $2.2 billion is 13% lower than the first half of 2011. During the quarter, we repurchased almost 37 million shares at an average price of $27.20 for a total repurchase amount of $1 billion. We have $1.75 billion remaining on our share repurchase authorization. Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook.
In 2012, we expect total sales to be approximately flat to last year. On a 52-to-52-week basis, sales increase would be approximately 1%. We expect comp sales to increase by approximately half a percent, which implies a flat comp in the second half of 2012. In addition, we expect to open approximately 10 stores for the year, resulting in a slight increase in square footage. For the fiscal year, we're anticipating an EBIT increase of approximately 45 basis points. We do expect gross margin to increase in the second half, but to a lesser degree than our previous outlook. We expect depreciation expense of about $1.5 billion. The effective tax rate is expected to be approximately 37.8%. The sum of these inputs should yield earnings per share of approximately $1.64, which represents an increase of 15% over 2011. We've lowered our outlook for the second half of the year.
As Robert noted, the benefits of our initiatives are coming at a slower rate than we expected. We believe that we are working on the right things, but we also recognize that there is a lot going on. As a result, we've taken a more cautious approach to our outlook for the remainder of the year. For the year, we are forecasting cash flows from operations to be approximately $3.5 billion, which is lower than our prior forecast due to both lower earnings and lower accounts payable. Our capital forecast for 2012 is approximately $1.4 billion, with roughly $100 million funded by operating leases, resulting in cash capital expenditures of $1.3 billion. This results in an estimated free cash flow of $2.2 billion for 2012. Our guidance assumes $1.5 billion in additional share repurchases for a total of $4.25 billion for the year.
We have a $550 million debt maturity in September of 2012. For the year, we expect lease-adjusted debt to EBITDAR will be at or below 2.25 times. Alicia, we are now ready for questions.
We are ready for questions. To ask a question, press star 1 on your telephone keypad. To withdraw your question, press the pound key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Your first question comes from the line of Alan Rifkin from Barclays Capital. Your line is now open.
Thank you very much. To stick to the results that you're seeing from the line reviews so far, Greg, can you maybe just talk about, with the 50% of the products that you've already completed, what's the incremental gain there? Can we assume that the line reviews that you're conducting early in the program should yield greater results than what you're anticipating as opposed to the reviews later in the program?
Alan, I'll address that last part first. Not necessarily, because in a number of cases where we think that it's taken some time for the vendor community to digest the strategy that we're going after in some of these line constructions and the way we're trying to create value for the customer. To be honest with you, as we come around to a cycle of some line reviews, you're seeing the same vendors come to the table with actually much more alignment with where we're taking the strategy to create value within each of these categories. With respect to where we are with our expectations and the performance of the line reviews, as we described earlier, from a net inventory reduction standpoint, we're exceeding our initial expectations. From a cost standpoint, we're increasing our progress towards our target.
Again, we're looking forward for a stronger performance in that area as we go through continuing cycles of this accelerated line review process.
Okay, just a follow-up for Robert, if I may. Robert, do your results in the first half of the year and the fact that you've now lowered your expectations for the second half and the housing recovery seems to be as elusive as ever, does that give you pause that maybe you should be pursuing RONA at a different time, a time when the U.S. business is exhibiting a little bit more stabilization than what we're presently seeing?
Yeah. It's obviously a fair point, Alan. With regard to the U.S. business, we still feel really good about where we're going. We know that we had probably the peak of disruption in the second quarter with everything that we threw at the organization. I think we've gotten the organization settled back down. We are understanding that the benefits are still there, but it is taking a little bit longer to accrue. Certainly with regard to the transaction with RONA, to your question, first of all, as I said, the transaction's not imminent. Even if we could get to that point, you would be into 2013 before transaction would close, and we'd be through a lot of what Greg has talked about with the cadence of the line review process and the other changes, the heavy change that we're making in the store environment.
First and foremost, we're looking at several options as to how we get scale in our business in Canada. This is one of the options that we're looking at, and we really don't know until we can get to the point of confirmatory due diligence, whether it makes sense. From the outside, it makes sense. We need to get inside and get to confirmatory due diligence to be able to confirm those beliefs. We have a preference for a friendly transaction. We're not going to do something that doesn't make long-term sense for the company. It's something that we don't think we can absorb. That's why we've kind of bifurcated the operations of the company from international and U.S. to minimize any distraction there. We're not going to overpay something that we don't think we can get an adequate return on.
Unfortunately, you can't always pick the timing as to when something may be available and when it's the right time to pursue something, given what else we have in the business. We're going to try and manage through that and try and make the right long-term decisions for the organization. I understand your point. It's a point well taken.
Okay. Thank you, Robert. I appreciate it.
Yep.
Your next question comes from the line of Peter Benedict from Robert W. Baird. Your line is now open.
Hey, thanks, guys. First, just, Bob, thinking about the second half comp plan of flat. I know there's some comparison differences, third and fourth quarter. Is there anything we should think about in terms of the pace? I know that some of the merchandising efforts you've got should be accruing benefit increasingly as you go forward, but the comparison's a tough fourth quarter. Maybe talk about how you see the third quarter versus the fourth quarter. That's the first question, I have a follow-up.
Peter, thanks for the question. If you take a look at last year, we do have tougher comparisons in the fourth quarter. Q4 last year, we said favorable weather helped us roughly 150 basis points. We're certainly mindful of that comparison. Greg, in his comments, took you through the cadence of the line review process. Momentum is certainly building there. We are seeing good results from the few that have been set to date. Certainly more will get set as we move into the back half of the year. In addition, we've got greater number of stores set with the product differentiation, the end caps, and the drop zones. As the year progresses, we expect more benefits from those items to hopefully offset the tough comparison we've got in the fourth quarter.
We also recognize that we've got tough building material comparisons, as Greg alluded to, not only in Q2 of last year, but Q3 and Q4. Part of Q4 was in the 150 basis points of weather favorability. As a result, we land at a flat comp for the back half.
Okay, that's helpful. I guess, understanding that the early part of May wasn't a great indicator for the quarter, can you just maybe talk to the August trends to date? Can you just help clarify the promotional strategy changes that you're making? I'm not sure I completely understood that. Just how you're viewing the second half promotional strategy versus maybe where you thought it would be three months ago. Thanks.
I'll take the first part and let Greg address the promotional piece. 16 days does not make a quarter. Thus far in August, sales trends have continued to accelerate. August comps are higher than what we reported for the month of July, and again, through two or so weeks. Gross margin is essentially flat with last year.
Peter, on the promotional strategy, when I said we would take it apart and rebuild it from the inside out, what we're really doing actually has a number of components, and I'll try to address all of them. We're centrally coordinating our product selection to make sure that we are very strategic in what areas that we're promoting for the right time. We're specifically looking at the timing, the impact, and the duration of every offer. There's a heavy focus towards a balance in the item selection to balance traffic-driving items and attachment items. That has a very big impact on your out margin. We're also taking a look at the bigger-ticket promotions, again, making sure that the cadence is appropriate and the duration's appropriate.
From another factor in the quarter and a little bit of talking to where Bob is referring to sales momentum for the third and fourth quarter, we're taking a hard look at our lawn and garden plans and making sure that we've got a solid mix in the advertising plan of cross-merchandising opportunities so that we make sure that our attachment rates are strong in lawn and garden. Again, that has positive margin implications from executing on those plan revisions.
Great. Thanks so much, guys.
Thanks, Peter.
Your next question comes from the line of David Strasser from Janney Capital Markets. Your line is open.
Thank you very much. A couple questions. When you looked at the differences May, June, July, obviously May was hurt seasonally due to the traffic and the pull forward. Any other big changes within any categories as the business improved through the quarter sequentially?
David, this is Gregory Bridgeford. I would say that if you look at the cadence of the businesses, as we described, lawn and garden had a strong pull-forward effect. Then it really had an impact on our inventory sell-through. That had a margin impact. In addition, you had a really tough comp on the building materials side, which as they began cycling up against all the activity we had in the East or Central part of the country last year at this time. On the decor categories and on, in particular, we saw pretty solid performance that continued to do well sequentially. I would say that we're continuing to see strength there and we're starting to see, again, we're working through a balance on the big-ticket categories so that we can get a more balanced output, a more predictable output.
That's a heavy focus of all of our promotional tweaking.
Just as a follow-up, how about appliances, particularly ACs? How much did that help as the really warm weather, particularly in the Northeast, Mid-Atlantic, maybe I'm being too Northeast-centric here, but how much did that help a lot? Because when you look at the match-up numbers, it seems like that was a pretty big category, particularly as the quarter progressed.
David, it was a factor early in the quarter, and in the first two months as we cycled into some very hot weather, and we sold through. We had good performance in that category, strong comp performance, and a nice handling of the sell-through of the inventory.
All right. Thank you very much.
Thank you, David.
Your next question comes from the line of Michael Baker from Deutsche Bank. Your line is open.
Hi, thanks. I guess a couple of questions. One, in your estimation, how much of your comp weakness and gross margin weakness was sort of self-inflicted from this promotional activity?
Mike, this is Bob. I'll start. From the margin perspective, I said 45 basis points was from promotional activity, markdowns, and such. We estimate that roughly 20 basis points of the 45 results from promotional activity associated with big-ticket categories. As relates to sales impact, it's a mixed bag. We think it probably helped cabinet and countertop sales, appliance sales, flooring sales. We think promotional activity actually hurt millwork sales in the quarter. We think it's a mixed bag from a sales perspective.
Okay. Then a couple more quick follow-ups. You said you're pushing out when you're supposed to see the benefit from this phase of the transformation to mid-2013. That was, I presume, supposed to be by the end of 2012. Is that the right way to think about it? Where does that show up mostly, in sales or gross margin or SG&A?
Mike, I'll start. This is Robert, then I'll have Greg follow along. Yeah. As you know, nothing has changed on the line review schedule and the cadence that we talked about from the line review schedule. We still expect to have approximately 90% of those done by the end of the year. There was already some benefit that would be lapping over into 2013. It's probably pushing out probably a quarter or so when you get to mid-2013. Really what we're trying to say there is that we're excited about what we're seeing. We're seeing, as Greg said, the inventory reductions. We're moving in on the cost reductions. We just got to turn through the layers. These changes, until we get enough of the store out there, we're not really out promoting anything different to the consumer.
It's taking the consumer in the store shopping to be able to see the changes that we've made. Basically comes back to not wanting to overpromise, underdeliver. We also, as I said, with a lot of the disruption that we had in the organization, organizational changes in getting the new go-to-market structure lined up earlier in the year, that caused a little bit, probably more disruption than we'd anticipated. I think we've got the organization settled down and focused on getting back to business and running the business. It probably pushes out about a quarter. Quite frankly, we just decided to give ourselves a little bit more breathing room. We've got a lot of lines to go through. As we clear those lines and we'll be able to get through the sell-down process.
We want to make sure that we're doing that in an appropriate manner, managing the margin appropriately to give us enough breathing room to move through that as we need to, we can go ahead and get this phase of the transformation behind us and then start thinking about other phases. Greg?
Yeah. Mike, the best way I could describe it would be that as I look through the handful of categories that have been set for more than a few weeks, I know what some of the values and some of the line review improvements are, and it's interesting to see where you're seeing the comp and margin dollar progress. You go to a category that's very active and is a high-foot-traffic category like paint, and you start seeing the benefits flow through. That's when we describe that it will take the customer some time to encounter and discover the improvements we've made in some of the lower traffic categories. That's what Robert's referring to when he say we're going to see maybe a lengthened-out impact on some of the lower foot traffic volume categories.
Paint's the opposite end of the spectrum. We're seeing customers encounter the new accessories. They're encountering the new paint lineup. They're encountering the new displays. They like what they see, obviously.
Okay. That makes sense. One more quick thing. On the buybacks, you said $4.25 billion for the year. I think at your Analyst Day, you had been saying $4.5 billion a year to get to $18 billion by 2015. Is this a change, albeit a small change, but a change in that outlook, or are you still on pace for $18 billion through 2015, RONA not withstanding?
Yeah. When we laid out the four-year plan, the $4.5 billion per year was simple math. We just taken $18 billion divided by four. It wasn't exactly $4.5 billion per year. This would be more temporary in nature. It does not.
You haven't changed it from what you were thinking in December?
No, we're not.
Back in December, you were thinking 4.25 this year as well.
The only change, 4.25, is just a recognition that with top line coming down, with gross margin coming down, cash flow from operations is coming down. As we think about balancing that with a leverage target, we needed to moderate share repurchases at this point in time.
Okay. Fair enough. Thank you.
Your next question comes from the line of Brian Nagel from Oppenheimer. Your line is open.
Hi, good morning.
Brian.
I just wanted to follow up on the gross margin commentary further. Just so I'm clear, you call out the 45 basis points and the 20 basis points of promotional activity. Just want to understand, should we think about that as more a one-time in nature? What's really the nature of that promotional activity, and how does it play into the strategy going forward?
Brian, this is Greg. I'll take that. The majority of, as Bob described, the 45 basis points of adverse impact from promotions were the big ticket categories that when we looked at sales coming out of May and the impact of a much less promotional event calendar than we had in the comparable time period. I would say that we leaned into big ticket promotions heavily. Recognizing that our predictions about how customers would take up the various offerings that we had late in the quarter, we believe we overcorrected. That's a very heavy portion of that. There's other portions of it. Nursery, as I described, that had an impact in the sell-down of the distressed inventory towards the end of the quarter. We didn't get as strong an attachment item performance in nursery, which has an impact in margin.
When you talk about price actions that we took in EDLP that are stretching out year-over-year, that has a very minor portion of that 45, and we're cycling against those changes that we made as we got into this process in Q3. If you're looking at more of a longer-term impact versus a shorter-term impact, I was trying to parse that out. Does that make sense?
It does. I guess the question I have, I don't want to overthink this, we had the weaker gross margins this quarter, and with all that you're doing with the line reviews and the move to more of an EDLP strategy, should we put those two factors together or is it, was the gross margin decline as a result of promotional activity more of a one-time, more of a kind of seasonal effect this time?
Heavily impacted by decisions we made to increase big ticket promotions that played out basically in July.
Okay. If I could follow up and a bigger picture question, just on the overall environment. You made some comments in your prepared remarks about the housing recovery. As you look at the data you've seen recently, maybe since the last time we spoke a quarter ago, as a company, how is the view of the overall housing environment as that relates to home improvement demand evolving?
Brian, this is Robert. Overall, I think, the overall macro environment certainly has its challenges out there. While there have been some positive signs out there in housing, certainly there's a lot of that in sales and housing prices and stuff have been really driven by a change in the mix of houses available. Starter sales through some of the distressed inventory that's out there. That's led to an increase in home prices. Housing turnover is up, but certainly it is down from the peak it was prior to the downturn. We are encouraged by the positive signs out there in housing. Obviously, unemployment is still a challenge in the large macro. Overall macro environment are still a challenge and a headwind going forward. We don't know how demand will be impacted by that.
Certainly, we think housing is nearing the bottom of the cycle, as we get through the election, get into 2013, we hope that there'll be some tailwinds coming out of housing, we're not looking at any type of a dramatic tailwind coming from housing, so.
Okay. Thank you.
Alicia, we've got time for one more question.
Okay, your final question then comes from the line of Matthew Fassler from Goldman Sachs. Your line is open.
Thanks a lot. Good morning. Thanks for including me here. I have two questions, one of a general nature, then a follow-up on promotions. If you think about the progress that you're making on your internal initiatives and the notion that they're going a bit slower than perhaps you anticipated, where would you say the slowness is? Is it in the internal execution against the plan, or is it customer reception to the changes that you're making, if you could differentiate between the two?
Matt, I'll start. In VIP, our Value Improvement Program, it is customer recognition of the changes that we're making in the marketplace as that recognition turns into comparable sales and margin generation. As I described earlier, we're on target with our execution of the line reviews and our execution of the resets as we described last quarter, that progress is going well. I think we're just being a little more realistic about customers' perception of certain categories that we reset.
Matt, it's Robert. Still optimistic about what it'll deliver, it's just we were probably overly optimistic as to how quickly those benefits would begin to accrue. We still, longer term, think the benefits are there, and are optimistic about what it'll deliver and what it will mean for our future.
Got it. My second question relates to promotional activity. It seems like there is some zigging and some zagging over the course of the quarter. With that in mind, you gave us the comp trajectory during the quarter. What did the gross profit dollar trajectory look like? Is there a change in the value approach that you're seeking to pursue? I'm trying to see where the moves that you made intra-quarter sort of fit in within the philosophy that you had put forth initially.
Matthew, this is Bob. Roughly through the middle of the quarter, gross margin was close to flat with last year. As Greg indicated, there was a bit of an overcorrection regarding promotions, just as responding to a prior question, noted that the largest big-ticket impact was felt in July. It actually got a little bit worse in the big-ticket categories towards the end of the quarter, which is why when Peter asked me about the start to this quarter, I did note that gross margins are essentially flat to last year through two weeks. Again, two weeks doesn't make a quarter.
Matt-
Go ahead. Oh, Matthew, regarding the composition of the promotions, when we look to the second half, what we are planning for and executing is a more balanced approach to it. The way I would describe that would be whether it's our execution of the focal points of each weekend coming up or whether it's the promotional vehicles itself, it's an ad mix. We're looking for a more balanced approach to ticket-driving items, especially what you would call anchor items, which are items in which you build attachment rates around and more project starter type items. We will get a better mix out from that on a gross margin basis, which is key, because we're trying to make sure that just driving sales without it, we recognize the impact of that.
Thank you.
As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our third quarter 2012 results on November 19th. Have a great day.
This concludes today's conference call. You may now disconnect.