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Operator
Good morning, everyone, and welcome to the Lowe's Companies' second-quarter 2013 earnings conference call.
This call is being recorded.
(Operator Instructions).
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.
Also during this call management will be using certain non-GAAP financial measures.
You can find a reconciliation to the most directly comparable GAAP financial measures and other information about them, as well as reference slides pertaining to second-quarter results posted on Lowe's Investor Relations website under Investor Documents.
Hosting today's conference will be Mr. Robert Niblock, Chairman, President and Chief Executive Officer; Mr. Rick 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.
Robert Niblock - Chairman, CEO & President
Good morning and thanks for your interest in Lowes.
Once again this quarter we have provided slides on our Investor Relations website to supplement our call.
While we do not plan on speaking directly to the slides, we encourage you to download them to facilitate your review of our results and to use the reference document following the call.
After my remarks Rick Damron will review our operational performance and Bob Hull will review our financial results in detail.
But first I will provide some highlights of the quarter as well as our view on the economic landscape for the second half of the year.
Comparable sales for the quarter were positive 9.6% driven by a healthy balance of ticket and transaction growth.
As expected, we recovered most of the outdoor sales we missed in the first quarter from unfavorable weather conditions and we also capitalized, as planned, on consumers' natural mind set shift during the second quarter from lawn maintenance early on to outdoor enjoyment in the mid to latter part of the quarter.
Our Time to Shine campaign resonated with customers looking forward to spending time outdoors and celebrating summer with family and friends.
While outdoor categories were strong we also saw strength in indoor categories.
In fact, all 12 product categories had comps at or above 5%.
Likewise, all regions had positive comps in the quarter and our Pro Services business continued to perform well.
We're focused on improving our core business through cross functional collaboration and consistent execution in-store and across other selling channels.
I'd like to thank our employees for their hard work and continued dedication to serving customers.
Home-improvement demand was strong during the quarter and the team's improving execution allowed us to capitalize on it.
Gross margin expanded 42 basis points in the second quarter as we made further progress with our value improvement initiative.
We also continue to effectively control expenses and deliver earnings per share of $0.88 for the quarter, a 37.5% increase to last year's second quarter.
Delivering on our commitment to return excess cash to shareholders in the second quarter, we repurchased $1 billion of stock and paid $174 million in dividends.
I'm also pleased that we made further progress with our previously announced bid for Orchard Supply Hardware.
The government antitrust review has concluded and yesterday the Bankruptcy Court approved our bid for the 72 stores that we chose to include in the transaction.
We expect the deal to close at the end of August and to be funded with operating cash flow.
Strategically the transaction will provide Lowes with an attractive opportunity to increase our footprint in California where we are currently under-stored through a neighborhood format that is complementary to our strength in big-box retail.
Orchard's hardware and backyard stores have a loyal customer base and are situated in high-density prime locations.
We see significant potential for Orchard as a standalone business within Lowe's portfolio and we look forward to the opportunity to participate more fully in California's economic recovery.
Now looking at the landscape in the second half of the year.
The stronger-than-expected pace of home improvement industry growth so far this year was fed by modestly stronger gains in housing turnover and job growth than originally forecast, further offsetting the negative effects of higher taxes.
The industry outlook for the second half hinges on the impact of steep increases in mortgage rates experienced over the last few months.
The rate increases will likely take some steam out of the recent housing market rebounds, but shouldn't derail it as long as job gains persist, homes continue to appreciate and rates rise more gradually going forward.
The macro economic transition from recovery to sustainable expansion, together with our initiatives in improving operational collaboration, give us confidence in our business outlook for 2013.
Bob will show those details in a few minutes.
Before turn it over to Rick I would like to share why I am enthusiastic about Lowe's long-term prospects.
Our business is sound and our brand is strong.
We're the second-largest player in the home improvement market which provides tremendous buying power in economies of scale.
Additionally, we're generating solid cash flows even as the economy emerges from the worst housing downturn in generations.
We will use that cash flow -- first, to make strategic investments in our core business and in other opportunities that draw on our ability to serve developing home-improvement markets; second, to pay dividends; and third, to repurchase shares.
Thanks again for your interest in Lowe's.
Rick?
Rick Damron - COO
Thanks, Robert, and good morning, everyone.
As Robert shared with you, our performance for the quarter was balanced across categories where comps ranged from mid single-digit to double-digit, and across regions where our comps also ranged from mid single-digits to double-digits.
Additionally, ticket and transaction growth contributed evenly to our overall performance.
We also saw balance throughout the quarter with comps above 8% every month.
Finally, we were pleased that this top-line sales performance was accompanied by continued improvement in gross margin rate.
We achieved this balanced growth by executing well within the second-quarter's strengthening home-improvement market and ensuring we were ready to sell outdoor products as customers responded to the warmer spring and summer weather.
In fact, our outdoor product comps increased approximately 13% in the second quarter compared to a decrease of 7% for the first quarter resulting in an outdoor comp of 3.5% positive.
We achieved very strong second-quarter growth in products needed to improve and maintain the yard.
Tools & Outdoor Power Equipment and Lawn & Garden were among our best performing product categories in the quarter.
However, strong growth wasn't limited to outdoor categories; kitchens and appliances also outperformed in the quarter driven by a robust growth in appliance sales as the LG line gained further traction after its first-quarter rollout.
We are excited about the innovation that LG adds to an already strong lineup of national brands and the most extensive in-stock offering of appliances in the home center channel.
In fact, this month JD Power & Associates ranked Lowe's highest in appliance retail customer satisfaction for a fourth consecutive year.
We were also pleased by strength in the core of the store where categories such as Hardware, Paint and Fashion Electrical not only achieved mid single-digit comps but did so with solid growth in gross margin rates.
This balance of sales and gross margin rate improvement within these categories reflects the progress we're making in our value improvement initiatives.
At the end of the second quarter we had completed resets representing approximately 70% of our business and we expect to substantially completed the initial round of resets in 2013.
Examples of resets completed in the second quarter include core products like plumbing tools and wall plates and decor products such as blinds and shades, ceiling fan accessories and hardwood flooring.
A recent example of how value improvement was used to more effectively assort a product grouping was in power tool sandpaper, where the team created a clear price point progression and enhanced inventory productivity.
They eliminated price point and design duplications and established exclusives within the mass retail channel with the Gator Grip and ShopSmith brands.
Gator Grip offers opening price points and the ShopSmith line offers premium film backed ceramic grained sand papers which are more aggressive and durable and appeal primarily to the Pro customer.
As a result the financial benefit of value improvement is greatest once we have reached stabilization, that is when we are past the clearance and selling only new product assortments.
We estimate that roughly 50% of our business was at this stage in the second quarter.
We continue to expect average mid single-digit comps and roughly 100 basis points of improvement in gross margin rate for product lines that have reached stabilization.
As I mentioned earlier, our performance in the second quarter was not balanced across categories, but across regions as well with all regions achieving mid single-digit comps or above.
Those regions that struggled from cooler and wetter weather in the first quarter, including most of the East Coast and Midwest, recouped most of those sales in the second quarter.
In our North division we achieved our strongest performance in the upper Midwest which suffered from droughts last year and experienced a delayed spring this year.
Additionally, we estimate that the stores most affected by Superstorm Sandy contributed approximately 30 basis points to our total comps.
Housing recovery markets on the West Coast and Florida and healthy markets along the Texas Gulf Coast continue to show high single to double-digit comp improvement.
We expect to see continued strength in these markets and further improvement along the southeast coast and in the Midwest where the recovery is now taking root.
Looking at payroll, as expected strong second-quarter sales growth generated solid payroll leverage across all regions of the country as we leveraged the fixed component of store labor hours.
As a reminder, we added approximately 150 hours per week to the staffing model for nearly two-thirds of our stores.
These additional hours are dedicated to the interior sales floor.
We continue to monitor performance and make adjustments as necessary.
As Bob will share with you, our expectation for year-end inventory is approximately $200 million higher than we had forecasted last quarter.
Part of this increase is due to air conditioners and ceiling fans.
The cooler and wetter summer to date has greatly reduced our sales of these items.
We expect to sell them to the end of the summer, but we will carry over the remainder to sell next year.
The greater part of this inventory increase reflects our commitment to further lean into increasing demand as we bolster job lot quantities to benefit Pros, increase overall in-store service levels and present a compelling end cap displays.
We expect that these incremental inventory investments will be completed this year and that we will be positioned to achieve greater inventory productivity in 2014.
Before I hand it over to Bob I am pleased to share that for the first half of the year approximately 80% of our US stores have qualified for a service and sales employee incentive, or SSEI payment.
As a reminder, SSEI is our profit share program for hourly associates.
This quarter payment will be the highest we have made since the start of this program.
Thank you for your interest in Lowe's and I will now turn it over to Bob.
Bob Hull - CFO
Thanks, Rick, and good morning, everyone.
Sales for the second quarter were $15.7 billion, which was an increase of 10.3%, driven by positive comp sales and new stores.
In Q2 total customer transactions increased 5.3% and total average ticket increased 4.7% to $65.60.
Comp sales were 9.6% for the quarter.
Looking at monthly trends, comps were 9.5% in May, 8.5% in June and 11.3% in July.
For the quarter comp transactions increased 5% and comp average ticket increased 4.4%.
With regard to external factors, we estimate that the recovery of lost Q1 sales from a delayed spring aided second-quarter comps by approximately 120 basis points.
Also, lumber inflation and sales related to Superstorm Sandy recovery efforts added roughly 60 basis points and 30 basis points to comps respectively.
Our internal efforts, including the value improvement, product differentiation, Lowe's.com, proprietary credit value proposition, outside selling positions and the weekday labor hours investment, drove approximately 250 basis points of the Q2 comp.
The balance of the comp growth, 5% or so, we believe was driven by improving execution and strengthening industry demands.
Year to date sales of $28.8 billion were up 5.1% versus the first half of 2012 driven by a 4.6% increase in comp sales and new stores.
Gross margin for the second quarter was 34.35% of sales which increased 42 basis points over Q2 last year.
The biggest driver of the increase was value improvement which helped gross margin by approximately 55 basis points -- our estimate of the improvement net the clearance impact of the reset against the benefit of the stabilized line.
For the quarter the percentage of resets completed increased from 50% to 70% while the percentage of resets stabilized increased from 30% to 50%, which was consistent with our plan.
Also more effective promotional activity relative to Q2 last year aided gross margin by an estimated 20 basis points.
This improvement was offset somewhat by the following items -- first, our proprietary credit value proposition negatively impacted gross margin by approximately 15 basis points.
This was driven by higher penetration of our proprietary credit program which reached 24.7% of sales, a 90 basis point increase over Q2 2012.
Also the mix of products sold negatively impacted gross margin by 14 basis points.
Lastly, lumber inflation negatively impacted gross margin by roughly 10 basis points.
Year-to-date gross margin of 34.56% to sales is an increase of 26 basis points over the first half of 2012.
SG&A for Q2 was 21.73% of sales which leveraged 53 basis points.
During the quarter store payroll leveraged 30 basis points.
Payroll dollars were up approximately 7% versus Q2 last year, which includes the additional weekday hour's investment that Rick noted.
While payroll grew in the quarter it was at a lower rate than sales resulting in expense leverage.
Similarly, insurance, both casualty an employee, advertising, utilities, rent, profit taxes and other costs leveraged as a result of the 10.3% of sales increase.
Also, expenses incurred last year for the voluntary separation program resulted in roughly 10 basis points of leverage this year.
These items were offset somewhat by incentive compensation expense which deleveraged 31 basis points as a result of higher expected attainment levels relative to last year.
Year-to-date SG&A was 23.04% of sales which leveraged 36 basis points to the first half of 2012.
Depreciation for the quarter was $367 million, which was 2.33% of sales and leveraged 26 basis points compared with last year's second quarter as a result of the sales growth.
In Q2 earnings before interest and taxes, or EBIT, increased 121 basis points to 10.29% of sales.
For the first half of 2013 EBIT was 9.02% of sales which was 82 basis points higher than the same period last year.
For the quarter interest expense was $110 million and deleveraged 2 basis points to last year as a percentage of sales.
In Q2 2012 we settled various tax matters that resulted in lowering interest accruals by $22 million causing the interest expense deleverage in this year's second quarter.
Total expenses for Q2 were 24.76% of sales and leveraged 77 basis points.
Year-to-date total expenses were 26.31% of sales and leveraged 52 basis points to last year.
Pre-tax earnings for the quarter were 9.6% of sales.
The effective tax rate for the quarter was 37.5% which is down slightly from Q2 last year.
Net earnings were $941 million for the quarter, an increase of 26% over Q2 2012.
Earnings per share of $0.88 for the second quarter were up 37.5% to last year.
The $0.88 per share compares with our plan of $0.83 with a nickel beat driven primarily from higher than planned sales.
For the first six months of 2013 earnings per share of $1.36 represented a 27% increase over the first half of 2012.
Now to a few items on the balance sheet starting with assets.
Cash and cash equivalents balance at the end of the quarter was $1.1 billion.
Our second-quarter inventory balance of $9.1 billion increased $407 million or 4.7% versus Q2 last year.
The increase was driven by higher inventory levels to support demand, inflation and lumber and building materials as well as the air conditioner and ceiling fan carryover that Rick noted.
Inventory turnover, calculated by taking a trailing four quarters cost of sales divided by average inventory for the last five quarters, was 3.73 times or essentially flat with last year.
Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, increased 114 basis points to 6.38%.
Moving on to the liability section of the balance sheet, accounts payable of $5.7 billion represented an 11% increase over Q2 last year cause by the timing of purchases this year relative to last year.
At the end of the second quarter we suggested that the EBITDAR was 2.05 times.
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, increased 201 basis points for the quarter to 10.62%.
Now looking at the statement of cash flows, cash flow from operations was $3.4 billion, an increase of $560 million over last year largely due to the timing of purchases that contributed to the higher accounts payable balance as well as growth in net earnings.
Capital expenditures were $376 million, a 40% decrease from last year.
As a result year-to-date free cash flow of $3 billion was 37% higher than the first half of 2012.
For the quarter we repurchased 24.4 million shares or a little bit more than $1 billion.
Also in the quarter we received approximately 2.7 million shares as part of the final settlement associated with the Accelerated Share Repurchase program executed in Q1.
We have approximately $3 billion remaining on our share repurchase authorization.
Before getting into the details of the Lowe's business outlook, I would like to note that the income statement impact from the Orchard Supply acquisition is not expected to be material and, except for dealer-related expenses, it is not included in these figures.
Also, I wanted to note that our outlook for the second half of the year is unchanged from our prior outlook.
Our 2013 outlook combines the above planned sales and earnings performance in Q2 with our previous assumptions for the second half of 2013.
Now to our outlook for 2013.
We expect total sales to increase by approximately 5% driven by comp sales of approximately 4.5%.
We expect continued momentum for our internal efforts tempered by moderating home-improvement industry demand.
We expect to open approximately 10 stores for the year.
For the fiscal year we're anticipating an EBIT increase of approximately 65 basis points.
The effective tax rate is expected to be approximately 37.9%.
As a result of these inputs we're expecting earnings per share of approximately $2.10 which represented an increase of 24% over 2012.
For the year we are forecasting cash flows from operations to be approximately $3.9 billion which is lower than our prior forecast due to the higher inventory levels that Rick described offset somewhat by higher earnings.
Our 2013 forecast for fixed assets acquired is approximately $1 billion.
This climbed from our prior expectations related to spend rationalization, lower expected costs and project timing primarily related to information technology.
This results in an estimated free cash flow of $2.9 billion for 2013.
We expect to close the Orchard transaction in the quarter.
Our guidance assumes approximately $3.6 billion in share repurchases for 2013, which is lower than our prior expectation as a result of the $205 million Orchard purchase price.
For the year we expect that lease adjusted debt to EBITDAR will be at or below 2.25 times.
We continue to execute against the long-term strategy that we outlined during our analyst and investor conference last December.
Our initiatives are gaining traction and we are pleased with our results for the first half of 2013.
In addition, housing is turning, so for the first time in a while both internal and external forces are moving in the right direction.
We will not be holding an investor conference in 2013 but look forward to updating you on our strategy in mid-2014.
Regina, we are now ready for questions.
Operator
(Operator Instructions).
David Strasser, Janney Capital Markets.
David Strasser - Analyst
Congratulations on a great quarter.
It seems like a lot has gone your way here.
Bob, I just wanted to follow-up a comment you made as you were talking about the guidance about the moderating home-improvement demand.
I mean, July seemed the strongest category; it seemed like it was -- it seemed accelerating throughout the quarter.
Bob Hull - CFO
So, as we think about Q2, I talked about some improving execution.
So we had implemented some procedures, specifically sales and operations planning, that allows us to work on behalf of the customer in a more collaborative and coordinated fashion.
So that is aiding this year's performance.
But if you think back to Q2 last year, we had a lot of moving pieces as it relates to the value -- a voluntary separation program, the change in commission for some of the sales folks on the store floor, we had some reset challenges, the execution of resets related to value improvement.
We had inconsistent promotion activity in Q2 last year.
So some of the benefit in Q2 was specific to recovery of some disruption in Q2 last year.
Also as you think about the external factors I described -- the recovery of the lost sales from Q1, lumber inflation and Hurricane Sandy, 200 or so basis points largely doesn't continue into the second half of the year.
And then lastly, Dave, I'll talk about interest rates.
We are seeing positive momentum in housing but about wildcard is interest rates and the impact that has on housing affordability.
So we are kind of watchful over that potential impact.
David Strasser - Analyst
I guess as long as I have one follow-up question here, yesterday Best Buy and Home Depot talked about really strong appliances, you are talking about really strong appliances out there.
Is there something in the industry that is happening that is driving sort of just such dramatic demand in that space?
Each person had incremental brands and so on, but it just seems like the category has expanded fairly dramatically recently.
And I'm just trying to understand a little bit more about what may have driven that.
Robert Niblock - Chairman, CEO & President
Dave, I'll start and then I'll have Greg jump in, this is Robert.
I think part of it is underlying economic fundamentals we talked about, which we attributed part of the increase in the quarter to, that as home prices started to move up I think it does have home owners feeling gradually better about willingness to spend, particularly as you get to the big-ticket durables.
And I think some of the appliances; some of those things are probably some of the purchases that consumers have otherwise delayed during the downturn because they could get better clarity with regard to where the value of their home was moving.
So I think part of that is coming into -- you're seeing part of that come into play.
It is no different than what you're seeing in the auto industry and other places where you are seeing consumers have a willingness to move toward some of those big-ticket durables as they are feeling gradually better about things.
But specific to appliances and what we are seeing, Greg, if you want to add something.
Greg Bridgeford - Chief Customer Officer
Sure.
Dave, I agree with Robert that from a kind of a household economics trend standpoint, I think we are seeing the impact of what has been some delayed spending now coming into our favor.
And what has worked for us and what drove our share increases in Q2 was innovation.
The launch of LG continues to provide a lot of momentum for the category.
Also new innovative products from Samsung, innovative products from Bosch, some new rollouts from GE and Whirlpool, that's been driving our sales in appliances.
And I think we have gotten into the cadence.
Bob mentioned it earlier, I think with gotten into the cadence of the proper balance of traffic driving promotions and ticket building promotions too.
So that has been a big hit in terms of driving sales and driving margin simultaneously.
David Strasser - Analyst
Great, congratulations on a nice quarter.
Operator
Budd Bugatch, Raymond James.
Budd Bugatch - Analyst
I'll also add my congratulations on the quarter and thank you for taking my questions.
I guess my first question comes on the penetration of the Pro business.
Typically I think it has been around 20% for you.
Can you give us some flavor and comment on what you are seeing in the Pro and maybe how that penetration is moving?
Rick Damron - COO
Yes, Budd, this is Rick.
We continue to see good growth in the Pro.
For the quarter, our Pro business outperformed our sales totals, or comp totals.
If you look at it, overall it is roughly -- we say approximately 25% of our total volume at this point in time.
If you think back to several of our initiatives that we launched at midyear last year, we are gaining tractions with those.
When you look at the focus that we got on the MRO, the maintenance and repair customers, when they come into the stores, as well as the reorganization that we went through and talked about our account executive of Pro Services in the field, getting them focused on building stronger relationships with their core customers and really pulling that together as a cross functional program across the organization to make sure that we are really doing the things that benefit the Pro.
I talked a little bit about it in our opening comments, the job lot inventories, making sure we had the right depth of inventory, being able to present those effectively to the Pro customer has really benefited.
You look at [Northlake] in our product differentiation aspects and the freeing up of end cap space have allowed us to present our contractor pack of value offerings to the Pro customer, which is a way to give them discounts on multi-unit purchases.
And then the everyday val prop on our proprietary credit has also really benefited that category.
So we have been extremely pleased with the programs the teams have built, the progress that we are making and the traction we are making as the Pro continues to rebound in the marketplace.
Budd Bugatch - Analyst
Okay.
And my follow-up really has to do with the air conditioner issue.
Did I hear you correctly that you're going to pack away about $200 million worth of air conditioners?
And just my question is do you risk -- what risk of obsolescence do you have?
And have you done this before?
And what risk is there in this particular strategy?
Bob Hull - CFO
So, Budd, this is Bob.
The $200 million relates to many factors, not just ACs, so it doesn't relate to, as Rick described -- as we think about going through the lines we are adding greater depth of inventory to the products that are the eight items, the highest velocity items.
So greater in-stock levels there.
Also we do have some seasonal -- so that is the bulk of it.
We do have some carryover for both air-conditioners and ceiling fans.
As we think about seasonal product we evaluate the quality of that product, whether it makes sense to mark it down at that point in time or carry over.
AC is a category where there is not much change year over year.
So as we think about carrying over air-conditioners there is really no impact to the 2014 line, there is no risk to the line.
There is no risk of damaging the product as we carry it over through the season.
So, yes, we have done that before and feel comfortable with that decision.
Budd Bugatch - Analyst
All right, thank you, Bob.
Thank you very much, good luck on the balance of the year.
Operator
Laura Champine, Canaccord.
Laura Champine - Analyst
Good morning.
I understand the air conditioner and ceiling fan issue.
But given those strong sales trends in Q2 how are your in-stock positions as we move into Q3?
Robert Niblock - Chairman, CEO & President
See our overall -- Laura, this is Robert.
I think we feel really good about are in stock positions, a lot of the cross functional work that we have talked about, certainly our strength with our extensive logistics and distribution network that we have out there has allowed us to stay very comfortable with in-stock positions that we have.
And as I said, the seasonal categories, the air-conditioners, from a follow-up on the last question -- there's still time to sell through part of that and it is an easy product to carry over to next year.
So we feel really good about in-stock, but, Rick, I will let you --.
Rick Damron - COO
Yes.
Laura, this is Rick.
As you think about inventory in general, I think it's important to go back and realize some of the changes that we've made to our strategy this year that it is helping us impact our in-stock levels in the stores today and what we are continuing to do.
We talked about previously as we have looked at opportunities for inventory moving into 2013 that we saw some opportunities to improve our in-stock positions.
Actions that we took were greater than the job lot inventory, meaning that we have greater depth of inventory available for our Pros and our DIY customers when they come in the stores to complete those projects.
We also increased our in-store targeted service level across many items, particularly those that have gone through the value improvement line initiatives, to drive greater in-stock levels of that inventory when those categories come out of that line review.
So that has helped us meet those demands as well.
And then as it relates to Q2 related to seasonal categories, remember we talked about in Q1 the way that we built our inventories more aggressively to hit those high seasonal peaks and demands for the consumer allowed us to capture that upside from -- and that initial spike from the consumer was ready and it allowed us to real actively flow that inventory for the remainder of the season.
So I think collectively all of those initiatives have played out very well and have us in a good position going into the second half of the year.
Greg Bridgeford - Chief Customer Officer
And, Laura, this is Greg Bridgeford.
The only thing I would add to Rick's comments would be that when you look at the top four categories at above average performance for the quarter, three of the four are what we call flow-through and sell out categories.
And one of the keys to the quarter was really a tremendous performance on the part of our vendors, our logistics teams and our store operations teams for being able to flow through that much inventory and putting it in the hands of the customers, whether it is Outdoor Power Equipment, Live Goods, Lawn & Garden hard lines or appliances.
That was one of the keys to the quarter.
Laura Champine - Analyst
Thank you.
Operator
Brian Nagel, Oppenheimer.
Brian Nagel - Analyst
Congratulations on a really nice quarter.
I'm going to ask the same question -- I asked this to Home Depot yesterday too, but you called out as part of your outlook some concern, or maybe in the Q&A, some concern with respect to potential for rates to climb higher.
The question I have is, interest rates have already ticked higher by a bit here.
I mean, have you seen any indication yet in your business that this is having an effect?
And given the histories you have with Lowe's, how would you think -- if interest rates continue to climb higher how could that impact Lowe's business in the coming quarters or year or so?
Robert Niblock - Chairman, CEO & President
Brian, I will start.
This is Robert.
Certainly if you look at any of the numbers out there with regard to refinancing or new home sales, housing turnover, those types of things, certainly you're seeing the impact of interest rates starting to show up in some of those numbers.
As I said earlier, I think however the biggest impact that we have seen -- so far positive impact we think on the business to date has been the fact that overall from a macro environment home prices starting to move up and the strong housing turnover job gains that we had seen to date we think that that is contributed to what we've seen in the business.
Yes, interest rates I think over the past since May or something are up about 110 basis points or so.
So it is starting to have an impact on refinancings.
Those type of things.
As long as it kind of stays in this area, moves up a little more gradually we think it has some impact but we are not overly concerned about it.
If you would start seeing interest rates that were to move north of a 6% interest rate for a 30-year mortgage, we think that that would probably start to have some impacts that we would start feeling in the business.
Brian Nagel - Analyst
Got it.
And then maybe just a quick follow-up -- and I apologize if you addressed this in your prepared comments.
But any update on the remerchandising and resets and what lift you see in your comps in the areas of the store you touched?
Robert Niblock - Chairman, CEO & President
Greg, you want to address that?
Greg Bridgeford - Chief Customer Officer
Sure.
Brian, as we discussed we are -- as Rick discussed, we are making a lot of progress with value improvement.
We did perform a normal amount of resets for the second quarter and have provided the bulk of the -- when you look at the list that Bob detailed, 55 basis points contributed to value improvement --.
We continue to see progress being made in what I call the interior categories, which is the center of the store as we execute resets and refresh the lines that is provided a strong basis for the business because you saw a very balanced performance across the categories for Lowe's.
And then going into the season, obviously we performed line reviews preseason for categories such as Lawn & Garden.
And we actually do line reviews about twice a year on the appliance categories as new models and innovations roll out.
So continue to be a major foundational factor in our performance.
And it is at the point now, as Rick mentioned, with 50% of lines reaching [a form of] stabilization where it is becoming part of our business.
And it is a solid foundation to our business.
Brian Nagel - Analyst
Thank you.
And congrats again.
Operator
Michael Lasser, UBS.
Michael Lasser - Analyst
On the 150 labor hours that you added to the store, how much do you think that you have opportunity to maybe push a little further on that, increase service levels even more?
And what sort of benefit might you be able to see from that?
Rick Damron - COO
Yes, Michael, this is Rick, I will take that.
Right now we are comfortable with the program that we have in place and executing against that 150 hours.
I think it is -- when you go back and you look at the announcements that we did when we put those numbers -- those sales hours back in we felt confident that that would get us back to where we were from a service-level and in ours level to meet the sales needed for the quarter.
So we feel confident in that program, we are still making adjustments to that program as we move into Q3 and looking at how we allocate the hours, what departments we allocate the hours into and how we mix them across the floor.
But we are still comfortable that we are -- the 150 hours is the appropriate number and we don't see at this point in time a need to increase those hours.
Michael Lasser - Analyst
Okay.
And my follow-up question is on your outlook.
I am curious about the level of conservatism that you've baked into your outlook.
Can you kind of frame how you see the upside, downside, and potentially what type of momentum have you carried into the current quarter from a very strong July?
Thanks a lot.
Robert Niblock - Chairman, CEO & President
Michael, it's Robert.
I will start and then Bob maybe will jump in on the details of the outlook.
But if you think about it, if you remember back, Michael, at the end of the first quarter when we fell short of what our internal plan was we didn't really change our guidance because we anticipated that with the impact we saw from a delayed spring we would make up the majority of that in the second quarter.
In the second quarter we actually recovered most of those sales and then had actually performance above what our internal plan was.
So our thought process has been we take the amount that we exceed our internal plan for the second quarter, roll that into the annual guidance, combined with what our plan was basically for the second half of the year.
So we have got good momentum going into the third quarter so that gives us additional confidence.
There are some headwinds out there that, as Bob outlined in his comments, including some unknowns out there with things like interest rates that we just went through and the impact that that could potentially have on the industry.
So we feel good about the outlook for the second half of the year, but that is kind of how we got to building the revision to our guidance for the year.
So, Bob?
Bob Hull - CFO
So two comments, one related to your guidance question, Michael.
So you asked about where we were so far, so if you think about our 4.5% comp for -- outlook for the year relative to the 4.6%; that implies a comp of 4% to 4.5% in the second half of the year.
I would tell you that August to date we are running somewhere between that 4% to 4.5% and the 11.3% we ran in July.
So a nice big range for you.
The other point I will make, Michael, really ties together kind of your question on payroll and prior questions on inventory.
So as we think about the second quarter we saw a ramp in industry demand that we haven't seen for quite some time.
In fact, reported our highest quarterly comp in almost 10 years.
So we were focused on capitalizing on the opportunity.
As you heard from Rick, we will focus on the inventory productivity that we outlined and 2015.
We will get there but we didn't want to lose sight of the opportunity that was in front of us in this quarter.
Michael Lasser - Analyst
Okay, thank you very much.
That is a pretty wide range.
I think you could drive a sledgehammer through that.
Maybe no chance you could narrow that a little bit for us?
Bob Hull - CFO
You can build your model as you see fit, Michael.
Michael Lasser - Analyst
Okay, I thought I would try.
Thank you very much.
Good luck with the rest of the year.
Operator
Greg Melich, ISI Group.
Greg Melich - Analyst
I wanted to talk a little bit about guidance, but rather top line on the flow-through.
Specifically on the margin guide, you basically only increased the guide by 5 basis points even though second quarter was up 100 bps.
So I am just wondering why that was.
Is there something going on with the flow-through from the resets that maybe a little different than you thought?
Or on the SG&A side, as comps decelerate, help us understand the difference based on whether that deceleration is traffic or ticket in terms of the leverage.
Bob Hull - CFO
So following up on Robert's response to Michael's question, our outlook for 2013 is a function of taking our year-to-date performance, plus our prior expectations for the second half of the year.
So, yes, it looks like, on a 1% sales increase, the EBITDA only goes up 5 basis points.
We didn't change our second-half outlook.
We do expect a 4% to 4.5% comp in the second half to be balanced across the ticket in traffic.
We do have some expense pressures that we talked about previously, the 10 basis points from additional labor hours.
Reset expense is actually 20 basis points.
We talked about 10 basis points previously.
It is now 20 basis points for the year in incentive comp.
We modeled the year at -- performance at target.
Given where we are today the sales and earnings are forecasted above our plan, which means that we are accruing a bonus above target, which is another 10 or so basis points.
So we have got some expense pressures that are probably resulting in a flow-through rate looking less than what we have guided in the past which is the 20 basis points for each point of comp.
That is what is taking place in the second half of the year.
Greg Melich - Analyst
Okay.
And then if I could, Bob, on the D&A; that has been pretty choppy and bouncing around.
Should we use this quarter as the right run rate or how should we think about that?
Bob Hull - CFO
I think you can use a number of about $1.5 billion for the year.
Greg Melich - Analyst
As an average and then just accept that it's bouncing around a little bit more?
Bob Hull - CFO
It should be more steady going forward.
As we think about the nature of timing of asset ads, the last big store ramp was Q4 of 2005, a lot of seven year assets become fully depreciated or ramping up a couple years ago, some IT which is three-year lives, that caused some of the lumpiness that we saw in 2012.
I think we will see more consistent depreciation going forward.
Greg Melich - Analyst
Okay, got it.
Thanks a lot.
Operator
Matthew Fassler, Goldman Sachs.
Matthew Fassler - Analyst
I have one follow-up question on guidance and then one question on demand.
My question on guidance, sort of phrasing it another way, it looks like the implied operating margin guidance for the second half of the year would be up about 10 basis points.
And that is actually a little less than you did in the first quarter with a 1% comp decline.
Obviously you levered much more in the second quarter on a much bigger comp decline despite throwing a lot of money into expenses, probably a little more than you had initially intended.
Are the expense pressures -- those discrete pressures you discussed sufficient to limit operating leverage to 10 bps if you do comp 4 or so?
Or could that be a conservative number in the event that the top-line gets to that level?
Bob Hull - CFO
Yes, I guess I'm not sure where the 10 basis points come from.
We were at 82 for the first half of the year; expect 65 for the second half.
So the 10 basis points (multiple speakers).
Matthew Fassler - Analyst
I guess I was looking at it on a non-GAAP basis and that might be the difference.
Bob Hull - CFO
We report on GAAP and guide to GAAP, so (multiple speakers).
Matthew Fassler - Analyst
Fair enough, understood.
All right, we can move on from there.
I guess the second question relates to the kind of visibility of big ticket sales.
If you could talk about some of the projects that have sort of longer life cycles from the consumer's initial visit to completing the project, what is traffic in some of those categories looking like today and what can you glean about the sustainability of demand from your interactions with consumers in your stores?
Greg Bridgeford - Chief Customer Officer
Matt, I'll start and then if anyone wants to add in.
But what we have seen is again probably one of the most balanced performances that I've ever seen from a category performance.
So we saw strong demand for the digger ticket project categories in a way that we haven't seen in recent time periods.
Whether it is kitchen cabinets, whether it was appliance sales or whether it was fashion plumbing sales, we are seeing strength in those categories and interest and traffic in those categories that we haven't seen in previous quarters.
So as we look at the focus of a lot of our VIP work over the last nine months we are coming into somewhat of a sweet spot as we get into the second half of the year because 60% of fall project sales come from flooring, paint, bath and appliances.
And we put a lot of effort in those categories to make sure that we are able to capture that customer demand.
As I mentioned before, we are really working hard to execute and maintain a good cadence of promotional activity that is margin accretive, it is foot traffic driving, it builds basket and is margin accretive in the process.
And that's part of this plan as we head into the second half of the year.
Matthew Fassler - Analyst
Thank you so much.
Operator
Christopher Horvers, JPMorgan.
Christopher Horvers - Analyst
In looking at the benefits from the value improvement program, the gross margin was a bit higher than the math would suggest based on the percentage of resets completed and through clearance and so forth, so that was a little bit better there.
Was that a catch up from the first quarter?
And then thinking about the math both on the comp and the gross margin into the back half, I mean, should that normalized back to what that basic math of the percentage completed to reset and times a percentage the mid single-digit and 100 bps comp lift?
Bob Hull - CFO
So, Chris, your first, question was on the 55 basis point improvement relative to the 50% of line stabilized?
Christopher Horvers - Analyst
Right.
Bob Hull - CFO
It really is somewhat a function of the lines that are reviewed and then timing the reviews within the quarter.
As Rick outlined in his comments, we still believe and still are seeing the average mid single-digit comp increase 100 basis points [across large stabilize], so nothing would indicate that we would see anything different in the second half.
Christopher Horvers - Analyst
Okay.
And then thinking about the acceleration during the quarter and looking at two year stocks accelerating during the quarter and clearly the seasonal business peaks in the Memorial Day to July 4 timeframe.
So can you talk about the texture of demand within July?
How much was the moisture levels, maybe carryover impact to July versus what you would consider more core and sustained demand as you look to the back half?
Greg Bridgeford - Chief Customer Officer
I will start, Chris, this is Greg Bridgeford.
We did see probably more moisture on a nationwide basis in July -- more moisture in the ground than we have seen in years, maybe a decade.
And it did drive the opportunity for sustained live good sales, bagged good sales and in particular outdoor power equipment sales as the normal dryness that hits in July and August didn't retard the growth of grass.
So we had a very strong performance in the outdoor power equipment categories in particular.
And we were able to execute against that because we were ready.
Bob Hull - CFO
Chris, this is Bob.
You mentioned two year comps in Q2, given that we had some shift in demand between Q1 and Q2 I would encourage you to take a look at the two year stack for the first half, which is 5.6%.
And then if you take a look at the outlook for the second half, it basically assumes that a two year comp would be the 5.5% to 6% range.
So we do have tougher comparisons in the second half of the year, but on a two year comparable basis we are expecting relatively the same performance second half versus first half.
Christopher Horvers - Analyst
Understood.
And one final one, as you think about sort of the disruption last year around the promotional variation throughout the quarter and things that were successful and not successful, did that impact -- was that more of a June issue last year impacting comps or was that more of a July issue?
Bob Hull - CFO
A little bit of both.
I think specifically as we talk about last year, we had probably two lighter promotions for Memorial Day, didn't get the attachment rate.
We responded by larger big-ticket promotions.
We didn't get the unit movement.
So I think it is a little bit of impact all across the quarter.
Greg Bridgeford - Chief Customer Officer
I would agree with Bob, Chris.
It was a May issue -- May to mid June issue and then a separate issue in the latter half of the second quarter.
The cadence and the integration and the collaboration that we're executing through our sales and ops planning process today is helping to drive the balanced performance that you saw in Q2.
We intend to improve on this process and it's really driving -- it is really enabling us to meet expectations in terms of our performance.
Christopher Horvers - Analyst
Thanks very much.
Bob Hull - CFO
Thanks, Chris.
Regina, we have got time for one more question.
Operator
Eric Bosshard, Cleveland Research.
Eric Bosshard - Analyst
Wondering if you could give a little color -- I heard you -- I understand you talking about adding some inventory to the business, but curious of how the progress -- the focus that you have had on margin and now it seems like you are having obviously very good success with sales -- but how you're thinking about sales and market share performance relative to margin and how that is playing out in the strategy and how you are executing the strategy.
What has changed or what is evolving within that, if you could speak to that?
Robert Niblock - Chairman, CEO & President
Eric, I will start and get others to jump in.
Certainly as we have talked about with our sales and ops planning, I think we are doing a much better job approaching the business on a cross functional basis, which you know is helping getting the promotional cadence right, helping with the lines, helping -- making sure that we responded to demand that we saw in the second quarter.
And certainly with the resets, the value improvement, those type of things, we just think we're starting to hit our stride so that we are moving through those, got a good cadence to them, continuing with the markdown and clearing of the older inventory as the offsets get more normalized.
After we have done that sell through we are starting to -- continue to see the margin performance that we anticipated.
So we are optimistic about the path we are on and, as we have indicated, expect most of those -- a majority of those resets to be done by the end of the year.
So we feel good about that and being able to deliver margin goals for the second half.
Rick Damron - COO
Yes, Eric, this is Rick; I would just add a couple things to that.
First being, and this references back to the sales and ops planning that Greg spoke about.
Dennis Knowles and the store teams have done an outstanding job this year in driving attachment items to the project item, much better than we have done in the past, increasing the basket size so that we are able to add those higher-margin components onto the total transaction from a store standpoint.
That goes back to a lot of the training that he and the leaders and store operations rolled out in the past year of selling at Lowe's, getting the stores to really understand attachment and assisting the customer throughout the entire project, has really been beneficial to helping us drive that margin.
And again, that goes back to a lot of the sales ops planning that Greg spoke about earlier.
The other thing that I think we have done a great job on is understanding the reset activity itself.
We talked about a lot of the missteps when we first started rolling this out last year -- going back in to understand the flow of the reset; making go, no go decisions based upon preset guardrails and criteria before we allow it to hit the store; driving a better overall reset for the store to execute against on the consumer when they come in; helping us manage the amount of nonproductive inventory to a greater degree so we are not seeing that have as big a drag on us as we did last year at the same time.
Greg, I don't know if you have anything else you would like to say?
Greg Bridgeford - Chief Customer Officer
Yes.
And probably the last element, Eric, would be our big-ticket categories; we performed very well at the balance of driving sales and driving margin.
So as you can tell from the categories that performed above average, you wouldn't see that kind of margin performance unless we managed those very well.
And it was great execution I think on the part of the teams on the sales floor were able to -- to be able to deliver these big-ticket projects and items to customers with a good margin outcome.
Eric Bosshard - Analyst
Great, thank you.
Robert Niblock - Chairman, CEO & President
All right, thanks, Eric.
And as always, thanks for your continued interest in Lowe's.
We look forward to speaking with you again when we report our third-quarter 2013 results Wednesday, November 20.
Have a great day.
Operator
Ladies and gentlemen, this does conclude today's conference.
Thank you all for joining and you may now disconnect.