Q3 2019 Earnings Call

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Good morning, everyone and welcome to Los Company's third quarter 2019 earnings Conference call. This call is being recorded.

Please note if you press star one to answer the question Q prior to the start of today's call. Your signal did not registered.

The press Star one again to enter the Q.

Also supplemental reference materials are available on those investor relations website within the Investor packet.

I will now be speaking directly to the slides. The slides are meant to celebrate your view of the company's results and to be used as a reference document following the call.

During this call management will be using certain non-GAAP financial measures. The supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.

Statements made during this call will include forward looking statements as defined in the private Securities Litigation Reform Act of 95.

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 its filings with the Securities and Exchange Commission.

Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer, Mr., Bill bolts Executive Vice President merchandising Mr., Joe Mcfarland Executive Vice President stores, and Mr., Dave Denton, Chief Financial Officer, I'll now turn the program over to Mr. Allison for opening remarks. Please go ahead Sir.

Good morning, everyone for the quarter total company comp sales grew 2.2%.

US on recruitment costs was 3% despite low single digit online growth and harder than expected lumbered deflation.

We saw consistent growth across the business would all three U.S. divisions, and all 15, U.S. geographic regions generating positive comps for the second consecutive quarter.

These results reflect our continued progress on our transformation plan.

For my top are performing geographic regions, where in the West and division driven by strength in pro appliances outdoor project category improve in stocks and customer service. In addition to the west geographic regions that outperformed the total company comp in the quarter were Nashville, Boston, Tampa and Houston.

Commodity deflation exerted approximately 95 basis points of pressure on comp sales in a quarter. However unit growth in impacted categories remain strong.

Let me now take a moment and discuss what drove our success in Q3.

Let's start with pro.

Our focus on a pro continues to be catalyst for us sales growth and during the quarter. We continue to receive very positive customer feedback from pros experiencing firsthand what is new and different at Lowe's and we're pleased with the pros willingness to grow their business with us.

Our procom significantly outpaced the our why in the third quarter and a pro customers responding very positively to our investments in job lot quantities Department supervisors and on proof in store experience.

The result of these investments in pro not only delivered positive sales growth. There also reflected in a 700 basis point improvement in our pro customer service scores in the third quarter.

Despite this early success, we're focused on work ahead to better served us very important customer.

Later in the call Joe will detail some of these strategic investments we have planned for the pro customer in Q4 and 2020 .

In addition to the pro our success focusing on retail fundamentals is also evident as we again drove strong sales performance in merchandising departments that are historically underperform.

In total eight merchandising departments delivered positive comp performance above the company average and Bill will add additional color on our merchandising performance shortly.

Turning to Canada in the third quarter, we posted negative comps sales below our expectations, which exhibited significant pressure on our total company comp.

Third quarter were initiated a more detailed strategic review of our Canadian business inclusive of leadership changes when they focus on improving execution and profitability.

As such we plan to take the following steps beginning in Q4 to improve our long term results in Canada.

We're closing 34 underperforming stores and expect to substantially complete that process in Q4.

Given that the Canadian businesses operating five banners with multiple legacy systems, we're undertaking a banner simplification process to reduce operational complexity and drive back office synergies.

As part of simplifying operations, we plan to rationalize skews across the simplified banners to present, a more coordinated assortment to our customers.

Implementing a simplified banner strategy will allow us to gain efficiencies in marketing supply chain and merchandising.

We're also reorganizing our corporate support structure across Canada to more efficiently serve our stores.

And we plan to migrate Canada to the U.S.R.T. platform to eliminate inefficiencies and unnecessary technology duplications.

We're committed to the Canadian market and we're taking decisive actions to improve Canadian operations and provide a better customer experience, while improving profitability through margin improvements in SGN a reduction.

They will take you through the anticipated financial impacts of these actions in a moment.

Despite pressure from lower than expected comparable sales growth in Canada, we delivered adjusted diluted earnings per share of $1.41 cents for the quarter, which exceeded our expectations supported by improved merchandise category management enhanced process execution and expense leverage later in the call day will outline steps, we took in the third quarter to continue to improve.

Move our profitability.

During the third quarter lows dot com delivered comp growth of approximately 3%.

And as we noted last quarter, our ecommerce businesses under repair and we're addressing legacy issues with the platform.

Our first step in improving our online business is creating stability to that and we're working diligently to improve the foundation of lows dot com replatforming the entire site the Google cloud from a decade old platform.

This work is critical to improve the stability of our ecosystem and increase our agility.

We expect to have the entire lows our comp side on the cloud in the first half of 2020.

What a modernized stable architecture in place we have the ability to provide our customers with basic online functionality and address legacy ecommerce capability gaps.

Forgive me for example of things, we're fixing while were temporary slowing our dotcom growth.

First we're taking steps to separate freight from product costs to improve our price perception versus our competition second we're improving our systems and processes to allow us to quickly add skews and dropship vendors to more rapidly expand our online assortment. These enhanced with will reduce onboarding time for months today's.

Third we are building capabilities to ship certain skews, requiring special handling which will allow us to sell basic home improvement items like lithium ion batteries cleaning supplies in fysixteen, which is online.

Fourth we will improve the customer experience on our website, including a dynamic home page simplified search and navigation the ability to scheduling product delivery and one click checkout.

We know how to repair all of these capability gaps and we have a detailed roadmap combined wouldn't exceptionally talented team with deep omnichannel experience. It will simply take time and proper sequencing.

We expect to see our lowest icon growth rate starts to accelerate in the back half of 2020.

In the meantime, I'm very pleased that we can deliver 3% U.S. comp in the third quarter with virtually no benefit from lows Dot com is only speaks to the upside sales benefit we have in upcoming quarters. When ecommerce business is repair transforming our supply chain will also support acceleration of our growth as we look to build a true omnichannel ecosystem.

We're investing 1.7 billion to transform our supply chain over the next five years Parvus transformation can be reflected in our opening of two new bulk distribution centers and three cross dock terminals. This year. This infrastructure improvement will be key to lowes is transitioning from a store base home delivery model to a market based model.

We believe our future is right at Lowe's and as we entered the fourth quarter, we expect to deliver strong topline performance.

We plan to capitalize on robust consumer product demand and excitement for the holiday season with strong holiday you've been execution, while driving margin improvement and operational efficiency.

Before I close I'd like to take a moment to take our associates for their continued hard work and commitment to the company. The best days are we going about visiting stores. During these visits I continue to be proud of the men and women that represent our company on a daily basis and with that I'll turn the call over to Bill.

Thanks, Marvin and good morning, everyone, we posted us comparable sales growth of 3% in the third quarter as we continued to capitalize on robust customer demand, which drove strong traffic to our stores along with improved in store execution, which helped to convert that traffic into sales.

We also had terrific execution over labor day, which drove record sales within our best in class appliance offering during the event turning to our merchandising Department performance, we delivered above average comps in appliances decor hardware lawn and garden, millwork paint rough plumbing and electrical and tools.

Lumber and building materials comps were positive, but below the company average.

Paint, which had been a serial underperformer for us outperformed the company average again this quarter.

As we continue to refine our paint business will continue to work closely with our suppliers to introduce an improved propane offering to better serve the repair remodel leaders, who need paint to complete a larger project such as a kitchen or bathroom remodel.

Previously our decor Department had performed below the company average for 12 of the last 13 quarters. However in Q3 for the second consecutive quarter decor performed above the company average with mid single digit comp growth led by strong double digit comps in blinds and shades.

Millwork is another merchandising department, which historically underperformed in Q3 for the second consecutive quarter Millwork performed above the company average or improve comp performance. In these departments is a clear indication that the implementation of our retail fundamentals is gaining traction.

For the quarter. We also continue to drive strong comps in areas of historical strength for lows.

Tools led the merchandising department growth with a continued strong customer response to our craftsman reset.

We are proud to be the exclusive destination in the home Center channel for this iconic brand, which continues to drive market share gains within key tool categories.

We also continue to drive sales with our key programs such as the Walt the number one power tool brand in the industry.

And during the quarter, we launch an exclusive line of to Walt 12, volt compact tools, which focus on delivering more power in a smaller and lighter weight tool.

In addition, we introduced new and innovative products from Bosch Spider and metabolite HBT as we continue to introduce new and innovative products in our exclusive cobalt line of tools.

In appliances, we delivered solid mid single digit comps and further increased our market share with record sales during labor day and drove high single digit comps in refrigerators and freezers with great values in special buys.

We also posted above average comps in hardware with double digit growth coming from our fastener categories supported by investments in job lot quantities in the full rollout of G.R.K., Powerpro, one and fasten masseur, which drove pro demand.

Lastly, we again delivered comps above the company average in lawn and garden with double digit comps in live goods in landscape products benefiting from an improved in stock position and the extended growing season.

Within our seasonal and outdoor living business. We are excited about the announcement of our National home Center launch with Yeti, a leader in coolers equipment and Drinkware.

The brand along with the expanded product offering highlights our commitment to providing our customers with relevant innovative best in class products.

As part of our ongoing effort to further drive merchandising productivity, we're continuing to implement a category management process and are taking aggressive steps to improve our cross merchandising efforts and adjacent season our stores.

We are optimizing our store layout to ensure that products typically used together to complete a project are located in the same aisle to make it easier for the customer to efficiently shop their whole project.

Looking ahead to Q4, we're very excited about our plans for the upcoming holiday season, driven by strong Black Friday, and cyber Monday events, along with a compelling tool gift center.

We will continue to highlight our best in class appliance offerings and showcase strong values and special buys in the most sought after brands in home improvement products. This holiday season with exciting value such as select buy one get one deals across the wall cobalt Bosch and craftsman and the opportunity to receive a lows gift card when buying.

Two or more select major appliances.

We will showcase great gift ideas across the store, including great values for both the DIY and pro customer.

We're also excited to be one of the first retailers to introduce the new Weber smoke fire pellet grill on lows dotcom as part of the preorder product launch on cyber Monday.

Levers pellet drill is their initial entry into this fast growing category and is built to let grill users discover what's possible with pellet grilling, we're proud to partner with Webber to introduce this exciting new product.

This black Friday, we plan to leverage our NFL partnership turning holiday shopping into a chance to win the experience of a lifetime at Super Bowl 54.

As the official home improvement sponsor of the NFL. This year on Black Friday, each us Lowe's stores offering its first 300 in store customers the chance to enter to win two tickets to Super Bowl 54 in Miami.

As we look to close out the year strong we remain focused on retail fundamentals and driving sales and margin productivity by continuing our focus on the pro leveraging the strong customer response to craftsman enhancing our space productivity improvements and expanding our brand message with our exclusive NFL partnership.

Overall, we see significant upside from the initiatives that are underway and we're confident that we're building the foundation to provide home improvement solutions that will continue to drive sales and grow our market share. Thank you now turn the call over to Joe.

Thanks, Bill and good morning, everyone, our initiatives to improve in stock levels and provide a better customer service experience along with our advances in serving the pro customer contributed to our strong us execution in the quarter. We continue to build upon the actions we've taken throughout the year to further improve associate engagement and simplify our store operations.

We saw compounding benefits from our work to date.

Earlier this year, we deployed new mobile devices for our store associates called smartphones smartphone empowers our associates by giving them access to real time data without having to step up the sales floor to access a terminal throughout the year. We've added functionality to the devices such as standard performance scorecards and Star walk application to drive a more efficient stay.

TJX store review process. These applications allow our store managers to optimize our store performance by evaluating productivity by department and by Associates.

In the third quarter, we continue to add new applications to our smart devices. During the quarter. We added new pricing application that allows associates to update prices in the aisles, and standardizes and simplifies the price update process such that any associate in our store can do it.

The pricing application is already driven efficiencies of over 36000 associate hours per week for the company will complement this pricing application with new mobile printers, which will allow associates to print new private labels in the I'll, creating a complete mobile pricing solution.

In this test the mobile printing process is driven an additional two hours and efficiency per store per day, which will equate to efficiency of over 24000 associate hours per week for the company, we plan to wrought mobile printing to the company in the first quarter of 2020.

Our smart devices are significant step towards driving operational productivity in our stores and allowing our associates to spend more time with the customer and less time on tasking near the ended the quarter. We completed the national rollout of our new customer centric scheduling system, which better predicts customer demand by time of day, Dan weak and department.

Allowing us to align our labor hours with peak traffic, our new labor scheduling system allows us to provide better department coverage and customer service, while ensuring that we're using our labor hours efficiently and reducing payroll expense.

We also expanded our new one task team to over 1000 stores in the quarter. This initiative shifts task work from our selling associates to one centralized team that is responsible for completing non selling tasks during evenings and overnight hours.

Decentralized team will drive more consistent tasking execution, streamline noncustomer facing payroll and allow for improved cross training programs.

Our investments in store process and technology paid off in the third quarter. This is evidenced by our ability to leverage store payroll expense again this quarter, while driving an increase of 500 basis points on our overall customer service scores, we will continue to deliver on our commitment to improve both store efficiency and customer experience and we're very pleased with the risk.

Yes, we are seeing so far in fact, a recent news we surveyed measuring customer service in home improvement recognized lows as number one among big box home improvement retailers. This is one more example of the way our customers are recognizing our improved commitment to customer service in our stores.

Now moving onto our pro business as Marvin indicated we're very pleased with our pro performance in Q3, and the customers willingness to grow their business with us. Despite a noticeable increase in competitive promotions as I've discussed on previous calls this year. Our pro strategy has been focused primarily on improving retail fundamentals for this very important cost.

Furthermore, we have demonstrated a consistent focus on winning the pro by executing on basic fundamentals like job quantities improve service levels dedicated loaders Pro Department Supervisors, and consistent volume pricing our commitment to retail fundamentals and continued focus drove significant improvement in the pro customer service scores.

Yes, and pro comps, which significantly outperformed DIY comps once again this quarter, we invited customers into see our improved experience with another successful pro appreciation event. Although we are pleased with pro performance. In Q3, we are now transitioning from retail fundamentals to more strategic initiatives. Our goal is simple.

We want to deepen our relationship and continue to grow our sales with this very important customer.

In keeping with this more strategic approach this quarter, we launched a pilot for our pro loyalty program. Our early results have exceeded our expectations and our test markets. We plan to launch our pro loyalty program nationally in the first half of 2020 integrated with the CRM program, which will allow us to deploy more surgical strategic marketing to the pro.

And grow our share of wallet that are improved account management and suggestive selling I look forward to updating you on our pro loyalty launch on future calls.

In the fourth quarter, we plan to improve the in store per experience with the rollout of dedicated point of sale terminals. The pro desk to allow for more convenient faster service believe it or not today most of our stores have no wafer pro to purchase product at our pro desk. We will solve this problem in Q4. We're also very excited for our first dedicated black Knight.

Remember event for the pro with compelling offers to drive pro traffic all of these pro related initiatives reinforce the renewed importance of the pro customer at Lowe's. Thank you and I will now turn the call over to Dave.

Thank you Jill and good morning, everyone before I review the underlying operating performance of the business. Let me briefly discuss the pre tax charges taken during the quarter and importantly, our go forward expectations related to the Canadian business.

As Marvin outlined we are taking decisive actions to set our Canadian business up for both long term growth and improved profitability.

As part of our strategic review, we evaluated certain assets for impairment, which resulted in $53 million of noncash pretax charges in the third quarter in the fourth quarter, we plan to substantially complete the closing of 34 stores liquidating the inventory in those locations and rationalizing the.

Inventory and our remaining Canadian locations to support our banner simplification strategy.

As a result of these actions, we expect to incur additional pre tax operating cost and charges between $175 million to $225 million in Q4 related to the Canadian restructuring. These charges will consist of inventory liquidation accelerated depreciation and amortization.

Severance and other costs. These anticipated Q4 financial impacts are reflected in our 2019 gap business outlook and are excluded from our 2019 adjusted business outlook.

Ill now turn to review of our ongoing capital allocation program and the first nine months at 2019, we generated approximately $3.2 billion in free cash flow and through a combination of both dividends and share repurchases. We've returned over 4.8 billion to our shareholders.

In the third quarter alone, we paid $428 million in dividends and our dividend payout ratio currently stands at 36% over the trailing four quarters.

In Q3, we entered into a $397 million accelerated share repurchase agreement retiring approximately 3.6 million shares. We also repurchased an additional 4.1 million shares in the open market for $438 million.

This brings our year to date share repurchases to $3.6 billion, what the plan to repurchase $4 billion for the year.

We have approximately $10.3 billion remaining on our current share repurchase authorization.

And we continue to invest in our core business with a focus on developing capabilities designed to drive long term shareholder value in Q3, we had capital expenditures of just over $400 million.

Now turning to the income statement.

During Q3, we generated GAAP diluted earnings per share of $1.36 cents.

Now my comments from this 0.4 will be on a comparable non-GAAP basis, where applicable in Q3, we delivered adjusted diluted earnings per share of $1.41 cents, an increase of 36% compared to adjusted diluted earnings per share of last year.

This solid performance exceeded expectations in large part due to improving gross margin trends strong expense management and a favorable tax rate.

Sales for the third quarter decrease 0.2% to $17.4 billion as comparable sales growth was offset by the impact of previous store closures and the exit of Orchard supply hardware.

Total average ticket grew 3.6% to $78.71. This was partially offset by 3.7% decline in total transactions.

Consolidated comp sales were 2.2% driven by an average ticket increase of 2.4%.

Partially offset by slight comp transaction decrease of 0.1%.

In the us us comp sales growth was 3% driven by an average ticket increase of 2.7% and a comp transaction increase of 0.2%.

Now looking at monthly trends total comps were 2.8% in August 2% in September and 2% in October .

Additionally, monthly comps for our US business were 3.6% in August 2.7% in September and 2.7% in October .

Adjusted gross margin for the third quarter was 32.4% of sales an increase of 153 basis points from Q3 of last year, and 94 basis points better than Q1, the improvements since the first quarter reflect the benefits from the actions, we've taken including retail price adjust.

What's that had minimal impact to units a pivot to more strategic and targeted promotions greater vendor partnership for key promotional activities.

And a continued aggressive product cost management.

We're very pleased with the progress we made to improve our gross margin performance. The actions. We've implemented are gaining traction, but there is additional work to be done in this important area for the balance of this year.

This quarter, we experienced approximately 90 basis points of rate improvement.

The positive impact of cycling our inventory rationalization of that from last year was partially offset by 40 basis points of tariff pressure.

As expected, we also experienced approximately 20 basis points a pressure from supply chain cost.

We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery costs.

Inventory shrink exerted approximately 20 basis points of negative pressure on gross margin for the quarter.

And finally product mix shifts had a 35 basis points positive impact on gross margin in Q3.

Adjusted to ask DNA for Q3 was 21.4 person cells, which levered 53 basis points.

We drove approximately 40 basis points of leverage and payroll in the quarter and approximately 10 basis points of leverage through improved advertising efficiencies.

Adjusted operating income increased 215 basis points to 9.3% of sales.

The effective tax rate was 24% compared to 21.8% last year.

At $13.7 billion inventory increased $1.4 billion or 10.9% versus the third quarter of last year, but is down $1.3 billion versus Q1.

This increase was driven by strategic investments in the first half the year to drive sales such as an earlier seasonal load in the Craftsman resets increased presentation minimums and investments in job lot quantities for the pro.

Throughout 2020, we will refine our in stock expectations and begin to strategically reduced inventories in certain areas, while protecting our in stock position sales and gross margin now before I close let me address our 2019 business outlook as we've stated previously and as our analysis support.

The underlying macroeconomic fundamentals in the us remain supportive as the solid pace of job growth accelerating wage increases and home price appreciation continue to be tailwinds for our industry.

We are maintaining our sales guidance for 2019 and expect a total sales increase of approximately 2% the year.

Comp sales are expected to increase approximately 3%.

Given our strong financial performance in Q3, and our solid outlook for the remainder of this year, we are raising our 2019 adjusted operating margin and adjusted EPS guidance.

We now expect adjusted diluted earnings per share a $5.63 to $5 in 70 cents per share and we expect adjusted operating margin to increase 40 to 60 basis points versus last year.

This revised outlook includes approximately $20 million to $30 million up incremental investments into our existing store environment.

This two to three cents EPS investment will allow us to accelerate key reset projects during the fourth quarter to improve sales and space productivity over the long term.

Without disrupting the stores during the critical spring season.

Our business outlook also includes the impact of both wave three and way for tariffs.

The effective tax rate at adjusted effective tax rates are still expected to be approximately 24%.

And we are forecasting operating cash flows were approximately $4.5 billion and capital expenditures of approximately $1.6 billion.

This is expected result in free cash flow of approximately $3 billion for 2019.

Our target leverage ratio remains at 2.75 times and our guidance assumes that we will complete approximately $4 billion and share repurchases for this year.

In closing we remain excited about the future the company and its ability to deliver significant shareholder value over the long term.

Operator, we're now ready for questions.

Thank you we're now ready for questions if you'd like to ask a question. Please press star one on your telephone keypad to withdraw your question. Please press star to in order to allow questions from as many individuals as possible. Please limit yourself to one question and one follow up our first question comes from the line of Christopher Horvers with JP Morgan.

Please proceed with your question.

Thanks. Good morning, guys can you talk about the gross margin I would say seven some nice rate upside hit there how much did that pricing pressures.

Earlier in the year impact a third quarter gross margin it doesn't seem like it did besides a tab at the terrorists and then how you're thinking about for Q4 gross margin I think previously said flat and I think that big question that we get from investors is.

Longer term, how do you think about and getting back to that high 32, maybe 33% or rate, especially as you lap tour that pricing pressures in.

20.

Hey, Chris This is more of an uptake of first part and I'll, let David Bill.

Added additional color to your additional questions look we feel really good about margin improvement, we talked a lot about the issues that impacted Q1, and we went to a lot of detail. After Q1, providing the steps we were taking account of recover margin and just to create better visit.

Ability and better processes.

Thats been a cross functional effort and we actually are pleased with the results with there's a lot more work to do.

Wanted to key things that we're going to be launching reporting this year is a new price management system.

This will be for the very first time at Lowe's to have a consolidated depository one view of all things cost retail pricing and the impact of those changes and thats going to be something we're going to put in place. Later this year. So we feel good about the trajectory, but I'll just remind you that we think about out years and we take what operating income.

Our real focus is going to be on around trying to keep margin relatively flat and creating SGN a.

Benefited in the future and Thats going to beat a driver of our operating income growth in out years I'll, let Dave provide more color to that and build any additional insight as well I think as Marvin indicated obviously to spend as a team sport here working between cross functionally between financial merchandising, making sure that one we understand the cost complemented thought.

Yes that we're buying two that we're analyzing those effectively and kind of put any allstate working with our vendors to maximize.

The performance from either a value engineering perspective from the cost complement perspective to drive our costs lower overtime.

Collectively we've also been partnering with our vendors very aggressively to make sure that developed one when scenarios at both drive to topline, but also improve our margin performance in the near term and then finally I think one thing that's really come to life is really within the store to meet some very significant enhancements from a technology perspective at point of sale.

Now lets it allowed us.

To be more effective than that promotion that we offer at point of sale, thus improving our margin rate on those items.

David One thing I would and add to that is that in addition to that I have mentioned in my opening remarks.

Tonnage agencies in putting products.

Together across merchandising program that Joe and I will now at the latter part of Q3 is now up and running all of our stores and that certainly helps in addition to the promotional planning process.

Please starting with Q2 that really fits more focused offers out there the customer and less at least.

Yeah.

And so then as a follow up Q.

Do you still expect I think gross margin rate flattish to 31 and a half.

Last year and then can you also talk about.

The ecommerce front is that at transaction growth headwind because transactions did or up in the last but it was sort of an easier compare so any thoughts there as well. Thanks very much yes on that on the dotcom question Christy. The short answer is yes. It did have a negative impact overall transactions we will.

Very transparent last quarter.

We have this business on the repair the good news is we have a very talented very experienced team that solve these problems before it just takes time and sequencing, but in the short run it did put some pressure on our transactions, we feel really good about our perform.

In our USA stores and as I've noted.

Prepared comments I mean, we grow at 3% us com no benefit from Dr.

You just take a 15% to 20% dotcom growth clause that towards that comp number north of four per se in the U.S. So we noted that benefit is coming in the future of blood in the short wrong, we're going to kind of muscled through it but we have a really good roadmap and a good plan in place and we think that we'll be able to get this business growing.

Again.

In the second half of next year elevated level about the margin rate increase you know obviously, our objective is to recover from our gross margin down draft. In Q1, I think we're making really nice progress against that is not our expectation that we fully recover that here in 2019 that is our expectation over the longer term is to recovery that.

That down draft that we experienced in Q1 and get back to a more stable environment long term.

First and have a great holiday.

Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley . Please proceed with your question.

Thanks, Good morning, everyone.

So you're modeling sequential improvement in the comps and the fourth quarter can you discuss the puts and takes into that forecast and then related EPS, it's a little bit below the implied is a little below the street can you clarify is at the incremental store investment and how does that compare to somebody on the underlying results of the bid.

Business for the fourth quarter.

Let's say me notice as Marvin I'll take the question regarding Q4, so as we've said made we feel really good about the overall business trends I know you as.

We feel great about internal execution, Dave talked about the macro backdrop is solid we look at discretionary purchases things like average ticket above $500 was over 4% growth was in the quarter.

Consumer project demand is strong in their of excitement relative to the holiday season, So I'm going to do as let bill just provide a couple of key highlights on the merchandising side that gives us confidence in Q4 I'll, let Joe also cover a couple of things in the store that also provides us with a degree of confidence within a bit achieved.

Our target salesman, Bill, but again I think that the piece for us for Q4 is that the team has not had a full year to plan for Q4. So we've demonstrated in our year categories that change the trajectory from where they were a year ago.

Being able to plan for two inventory to be able to plan for the gift center and to be able to plan for these pro deals that we put out there for black November for a little different from what we did year again, we're seeing that you don't pay off as it relates to changing in directions in some of these key pro related businesses as well.

Right and then from a store standpoint, we're really excited about what's happening with inside of our pro business. We continue into Q4.

We're excited about the per loyalties launch we have tailing. We're excited that as we continue to invite our pro customers and that we're enjoying more share their wallet.

Improved store execution store layout.

We have we feel really confident lower down for Q4, and then same you're just from a from a guide perspective, let me just kind of step back and just walking.

What we've done we've essentially taken the bottom of the range of 13 cents the midpoint up seven cents.

From a year perspective keep in mind that that includes two to three cents that we're investing in Q4 to improve.

Our performance from a long term perspective, I think this is a really.

Constructive investment that we're making that we identified late in the quarter that were incrementally investing in our store environment. Both for the long term, but the same time managing.

Nick the near term financial.

Objective that we have as a company.

Okay and my follow up it's for Marvin you've been in the seat now for over a year some ups and downs. It it seems like the scale attended or should be out of the closet by now.

You still have a few things executing in stores labor scheduling it sounds like Theres No pro systems.

So is that a fair statement and does anything in your mind change about the potential margin upside how do you think about it and the pace of margin over the next few years.

No look I think when I look back at our initial assessment of the business I would say.

The only thing that we probably under estimated the level of complexity was the E Commerce business. When we did our analyst and Investor Conference last December .

We did not have our new online president onboard so although we've spent a lot of time dissecting the business across multiple channels.

Some of the business, we're still a little bit of a mystery flaws in that industry undrilled itself. During the holiday season, when we had all the issues and we've been digging a recession.

So it yet have been ups and downs, but we were very clear to digital transformation I mean, we didn't make any bold about the fact that this is a company that had great potential, but it had been under investment under investment in supply chain.

And also leadership development so.

If I had to take a snapshot of how I feel about where we are I think we are right on track, where we hope to be.

And that is taken into account when a lot of uncertainties in the marketplace like tariffs as one that we did not anticipate that we've been managing as best we can overall I feel great I think that we have identified most of the quote unquote surprises.

Because we spent a lot of time really digging deep into the areas of the business that carry to most financial risk and the most financial benefit and we feel I've got to really have plan at into full quota in 2020.

Thanks Mark.

Thanks.

Thank you. Our next question comes from the line of Karen short with Barclays. Please proceed with your question.

Thanks, very much I was actually wondering if you could give a little bit more color on how the dotcom business impacted the.

You asked comp and then I guess looking at Fourq you wondering if you could get a little color on how the total comp will be impacted by Canada, because obviously, if close stores, we're going to be left like as you won't have that that headwind on the U.S. comp versus the total comp so any color on buses.

So look I'll take care and I'll take the dotcom question I'll, let let Dave take Canada. So if you think about the impact of dotcom to our business. It was basically.

A neutral impact we grew dotcom by 3% for the quarter. We grew us sales by 3%. So there was really no benefit I would argue that there's not a brick and mortar retail in the USA as our size that had such limited growth in their dotcom business most of us retailers dead.

I'd now.

Their comp growth for the quarter typically will have a dotcom number that starts with a 20% growth which is typical in this day at age.

We're not there yet, but we know how to get there.

And we're trying to take the right steps to fix the root cause of the issue, it's not difficult to grow dotcom sales, it's difficult to do it correctly meeting and make money and so rather than having a bunch of nonproductive promotions and other coupon in the event was shut that down.

Now it and we basically said how do we structured this business in the right way, we have a really good roadmap in place.

Wanted to be really transparent in my prepared comments just to highlight some of the fundamental things. We currently don't have in place that we will have in place in the second half of next year, but is it as a glass half full again, our store productivity is strong anytime you can deliver 3% copy of the total benefit of your brick and mortar stores in this day in.

Page is a is a very positive side, but getting our dotcom.

On the job visits going as a huge priority we make we can get there going as we enter into 2020 now let Dave talked about Canada, Yeah, Karen as it relates to stores that will be closed in Canada. They will be considered non comp. So they will not affect the clock cadence for Q4 for the company and then ill just want to clarify if you look at Q3, the $53 million non.

Cash charge that we took is exclusively within SSG and aid within our GAAP numbers.

Okay, and then just a follow up in terms of other initiatives as we went to 2020, obviously you talked about the price management system in Fourq, you, but can you give us an update on some other big initiative that we should be watching for in early 2000, Tony I think the Pos upgrade.

Is that still the me happening, but just so that you know we can track anything to me, we may need to be on the outlook for if there any risks on execution.

So let me I'll talk about one did I'll, let Joe will give you some thoughts on some really exciting initiatives pro and I know Bill has a couple of really nice merchandising issues were excited about when we think about our supply chain transformation I mentioned in my comments that we have a 1.7 billion dollar investment of a five year.

As we're committing to supply chain and that is totally transform our supply chain from a a.

Hey distribution network designed to get product from suppliers to stores.

From suppliers of distribution centers.

Et cetera should be a more of an omnichannel.

Center, that's going to allow us to Gulf install base delivered a market based delivery, we upward opening two new bulk distribution centers this year and in Threeq Cross dock terminals, which is really the foundational steps to help enough to build out the supply chain transformation. This will be significant philosophy.

It is going to take enormous pressure off the stores from being a hub for all things delivery, but is also going to give us the ability to deliver to customers' homes and pros job sites with the same efficiency that we delivered to a store that is something that we are going to be costly rolling out throughout the year and we're excited about that and relative to the price match.

Assistant, we'll get that system in place by the end of this year, but Didnt next year in the first side, we're going to integrate in that system to be rank retail analytics will be combined with that price management system, that's going to give us what a first time you machine learning it in a yet.

Kind of functionality around pricing and around scraping sort of we can be a lot more dynamic.

The initial I'll mention is that into first half of next year, we should be fully on Google cloud with our ecommerce platform and again, we're moving from a decade old platform to cloud with this up this will give us much more agility and how that Joe and bill add any additional color great. So we've talked a lot in the past about our pro focus and really throughout.

2019.

Really focused on the retail fundamentals, which we've talked about things like for staffing things like dedicated loaders job like quantities et cetera, and so we feel 29 team we have largely made a great impact there as we move forward into next year. We're really excited number one for the pro loyalty test that we.

Launch in three markets in the third quarter, the pros reaction to the per loyalty has really exceeded.

All expectations, we've had for and we continue to listen to the pros. We continue to make adjustments why were desmet. We're excited that will fully rollout per loyalties nationwide in the first half 2020.

Addition, things like total rental we feel really good about testing the waters there in the pro business you know that pro continues to give us more share their wallet and so that really exciting the pro special a bill talked about some of the merchandising and just to just to close on the merchandise in China. In addition to the cross merchandising work.

We are well wrapping up and we wrapped up in Q3 will finish up at the end of Q4 in January February the way finding signage rollout in our stores, which allows the customer navigator stores easier well also finished the refresh work that we started early last year, which will allow us to bring product categories in departments together.

Make it easier for the customer shopping to give us the kind of holding or on our end caps and in our departments that we need bringing product categories. Together. So really excited about all the way murchinson done to make our stores easier to shop.

Great. Thanks very much.

Thank you. Our next question comes from the line of Steve Forbes with Guggenheim Securities. Please proceed with your question.

Good morning.

I wanted to focus on payroll leverage right given the commentary around the completion of the labor scheduling system rollout. So maybe just remind us I guess, how that phase then throughout the year right. I mean regions were alive I guess in the first half relative to the ended the third quarter and then maybe discuss the expectations regarding payroll leverage in in.

Peter and into 2020, right because I think it would seem to appear right there sort of an.

A chance or potential right for apparel leverage to at least remain.

The current run rate as we look at the 2020. So we're just like to get your at sort of thoughts and updates on that.

So Steve this Marvin I'll kick it off again I'll, let Joe provide some additional insight I think as you look at the out years, it's just a very basic philosophy and what we're trying to do is we're trying to ships payroll from attached to service in the stores. Our first analysis when Joe arrived started looked at the business.

That we had a vast majority of our payroll in the store was doing something other than serving customers or driving sales and so joe's team built out a.

A three year kind of project plan to shift that to be a more service oriented store environment, where you do that with technology and so what you don't see the out years is the investment in technology of reduction in total hours, but in a addition of selling hours and that's one reason.

Why you have Joe gave is really interesting statistic.

In third quarter, we leverage payroll, while we improved service across all categories Pro do it yourself customers and all types of surveys internal and external and that gives us really good comfortable filling the technology implementations are working and that we're putting in payroll in the right location. So thats the out years I'll, let Joe.

Talk about what we've done so far this year. So give me a quick snapshot just for the third quarter and I mentioned some things in my prepared remarks, as Marvin said when we first arrived and evaluated the percent of payroll being spent on service versus task. It was completely inverted so we've assembled a terrific.

Our team and our store operations group, we're ahead of schedule as far as moving the needle.

More be balance of customer facing versus tasking and so just in the third quarter alone we talked about a new scheduling system. So I remind you of the first quarter. This year, we rolled out to one region the customer centric schedules to make sure we listen to the associates validated the customers and make sure chain.

As we are making were beneficial in the second quarter lead launch that two three additional regions across our northern division more seasonal we wanted to kind of pressure test our spraying in our hiring and showed in the third quarter. We have successfully rolled this out to every region a 100% in the stores in the U.S. Ron.

Customer centric scheduling as of the first day of the fourth quarter. In addition, it in the third quarter, we took action on things like our one testing we extended the one task team centralizing tasks.

Just over 1000 stores. In addition, we took action on things like our in store assembler moving to third party outsourcing our janitor, our new pricing app. So there's a laundry list of initiatives.

And we continue to execute against and at the end in today, making sure that we're doing the things that the customers expect and noticed in that the assesses appreciate it.

Thank you, but I mean, maybe just a quick follow up for Dave right modeling purposes here.

If you can write provide a little more detail around the break down of that $175 million to $225 million a cost into the various buckets. If you can split it between gross margin and.

And asking a at least or or the three buckets that you mentioned.

Listen I will come back at the end the year and ended the quarter and give it a detailed reconciliation that so you'll be able to have that from a modeling perspective keep in mind at all this is non gap, but I would look at dish.

As you certainly within Q4, I would say over 50% of those costs are due to inventory liquidation and therefore, they would hit within.

The gross margin level versus the remainder on a kind of at the SGN a level.

Best way to think about it.

Thank you.

Well.

Thank you are your next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question.

Guys. Good morning, I wanted to follow up on the cadence of the quarter and whether there are any seasonal elements to call out. Obviously you are lapping hurricanes I don't have the extended season was it was a good guy and offset that I also think there's a shift in the startup Black Friday. So anything you had called out there and in general how you feel about exiting the quarter.

Yes. This is Dave yes, we feel very solid about our plans for Q4 from a sales perspective, there was a little bit of.

I guess weather benefit as we cycle into Q3, probably in the neighborhood a 50 basis points. We also did run Black Friday week, one week earlier, so I had a very nominal probably 10 basis point impact on us. So are you cycle into Q4.

That would give you some confidence as we cycle into Q4 this.

Sales improvement from comparison perspective looks pretty good.

Okay. Thanks for that and then just in terms of the restructuring in Canada, just help us better understand what wasn't working there and then if there is a way to quantify the drag that Canada has had on margins this year or over the course of a 12 month period, just so we could sort of understand the opportunity into next year I think that's helpful. Thanks.

Maybe I'll start I, just as you can well imagine just given the performance that we've articulated over the first three quarters of this year the Canadian business from a topline perspective struggled I would say it's fair to also understand in model that it is performing operating profit perspective below the company average it certainly is.

Dragging us down and certainly dragging us down more work to improve the charges. So we will capital charges are ours.

Mrs.

Lower than.

The company average with that uplift.

Yes look set the only thing I'll add is we have great associates in Canada.

We just gave them a very complex business model.

That.

Inhibited their ability to serve customers well operating five banners all with legacy systems, all with different back end systems.

And our initial integrate integration process was overly complex.

It made it very difficult to create synergies with marketing merchandising sourcing perspective, and even in ATSI systems infrastructure. So part of what we're doing here. In addition to closing underperforming stores is ensured that we are just simplifying the business models. So we can give the customers a great experience and give our associate.

As a more simplified.

Operational process to manage and we think the decisions that we announced today is going to put us.

In a really good position to do just that so we look forward to coming back.

In our February call to provide some degree of color around 2020 in our expectation in Canada and how we take these restructuring actions that we announced today is going to really put us in a position to long term growth.

Okay. Thanks, guys appreciate it thank you.

Thank you. Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question.

Hi, Thanks, guys and two questions.

Well I just wanted to follow up on the progress on gross margin I understand it's improved sequentially from the first quarter.

But they want to make sure I get the numbers right. If if last year. The re baseline gross margin was 32.9 and this year, we're sort of down 40 or 50 bips on a like for like once you add back last year's inventory charge are we thinking about that right.

Yes, so maybe I'll give you just.

A few numbers to.

I Hope you model. This out if you looked at our gross margin performance were had improvements for about 150, some odd basis points. We're overlapping it clearance events from last year, which is kind of a tailwind. If you will have about 170 basis points.

Then have pressure from both tariff that 40 basis points supply chain at 20 in shrink. It 20. So if you think about it we have a 90 basis point improvement just in gross margin rate.

And you add on top of that improvements from a product mix perspective.

Got it that's that's Super helpful. And then maybe just a follow up on Canada bit.

We think about the charges in total the 250 million what do you guys expect the payback for that to be do we get that back in terms of profit in the next 12 months does it take three years, how quick to the these changes really take effect on the business well. Obviously these changes are going to take effect pretty quickly, but the way we've modeled this is.

Clearly over a multiple year period of which we looked at the cash flows of the business net present value of that so it will obviously this is a.

A tough decision to make but is the right decision bake economically we look at that over a multiyear period.

And last and just transition to the business a bit I want to make sure I got the guidance right on the comp.

I understand that the Canadian stores come out of the comps if I use the full year guide where it is the fourth quarter comp should accelerate to about 4% or three and a half for four to make up.

I'm missing something there that's the sort of trend that you are saying so far into November done the math correct.

And our we are in November running at that kind of rate.

Not listed as Youre about to approach one of our biggest weeks in in the year quite frankly, as we enter into Black Friday. It was probably a little too early to comment on that on a quarter I will say that we feel very strong about the programs. We haven't placed in the things that we're executing at store level the driver performance.

That's great. Good luck guys happy holidays. Thank you.

Thank you. Our next question comes from the line of Michael Lasser with <unk>. Please proceed with your question [noise].

Good morning, Thanks, a lot for taking my question. So if we train Geely your progress in a couple ways.

Wine looking at the U.S. only stacks on a 234 year basis. They did decelerate from the second quarter third quarter and if we look at the spread you U.S. only business compared to your biggest competitor. It did a reverse this quarter recognizing that a big piece to that is the performance of.

Of the their respective Dot com business is why do you think on those measures the business did take a bit of a step back this quarter versus last quarter.

Yes, Michael that's a fair question moly asses that we feel really good about our us business and to be quite honestly, we don't spend a ton of time.

Thinking about our performance versus our competitive versus our performance versus our internal expectations and relative to our expectation as we were where we thought we should be based on business investments base over year over year overlaps.

Remember Q3 was last year was a really really interesting quarter. We took a lot of actions around store closures inventory liquidations and so the year over year compares are really tricky and so we appropriately planned the business for Q3 at a certain level and in the U.S.

Well, we feel really good about exactly where we landed and as we mentioned, we actually exceeded expectations relative to the operating income. So we feel good about the business we feel good about trends.

And we have a repair plan to fix dot com, we're not trying to rush a quick fix we're going to fix it foundationally and we think thats going to give us long term growth potential and we feel good about the stuff would take into India strong as well.

And my follow up margin is in the prepared remarks, there was a comment the customers will the pro customers willingness to grow their business with us. Despite a noticeable increase in competitive promotion. So can you can you provide more detail on that who and where are you seeing those higher promotions from from.

And is there a case, where as lose becomes more successful in as low as become it makes more progress. The overall environments is going to become more promotional more competitive because because of that success.

Look I think.

We are very well prepared for a more competitive marketplace. The comments were specifically driven based on a one of our large competitors getting really aggressive.

Discounting.

Large projects going through a bidding process. This is invisible to the general public but for large customers would purchases over certain volume threshold you can submit that for additional discounts from a commodity pricing perspective, and there was more discounting in that area or a consistent period.

And then I've seen in my 14 years in this business is neither here nor there.

We just continue to compete.

And we want to just run our strategy, which is something that we're going to continue to do but we want to highlight that that competitive status.

Dramatically change in Q3, and we're going to be compared to what happened in Q4.

Let me take one more question please.

Thank you. Our final question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question.

Hey, Thanks for fitting me in could you talk about your Black Friday, cyber Monday offerings, specifically online and just given the replatforming on the site should we expect a temporary acceleration dotcom sales for the seasonal uptick in demand around the holiday or do you expect similar growth versus Q3.

So look I'll I'll give you some comments on dot com outlet villages give you some of the somebody really exciting deals we have.

For put Dotcom me, we had a pretty.

Underwhelming performance last holiday season, and so we are expecting to have better performance within that holiday period, but that holiday period does not defined the entire quarters. We don't have an expectation that we're going to see dramatic dot com growth in Q4 relative to what we've seen the last two pool.

Orders. However, we do expect to have more stability and better performance going to Black Friday appeared the only caveat to that is we gave a lot of product away online last year, we're not going to give it away. This year, we had a lot of site wide promotion that didn't make any sense.

And provide any value to the customers.

What is it gave a lot of by difficult no value to the shareholders into the company more profit perspective, so we're going to be appropriately aggressive online when we're going to be aggressive them with the standpoint of running it will be good business model, but we're not expecting robust dot com growth in Q4, no different than what we've seen the last couple of quarters.

Now, let bill highlights some of the exciting things were going to be selling in the stores. Yes. So we're super excited about what's going on for Black Friday, but as you know it starts with really Black November and so we were able to do a number of deals in special values out there for the pro ran for Black November kicked off the appliance event for Black November .

And then with the team Naveen roughly a year to be able to plan. This year's Black Friday, we've got to some super Doorbusters for Black Friday week that needs as I said my prepared remarks, a chance for.

Let me customers when trip to the Super Bowl and so we've got just 11 segment, it's going to drive folks to the loads door on on Friday. So we're excited though.

Got it and then on repair and remodel overall environment curious to hear your thoughts on the latest round of data points, particularly with existing home sales improving curious how you think about just overall category demand and whether you have any expectation of improvement as we enter 2020.

So look up.

We feel great about the macro of all of the macro indicators that are important for our business.

Born into right direction consumer confidence unemployment is low home price continue to appreciate wages continue to strengthen.

And interest rates have continued to be low to moderate so we feel really positive about all the macro indicators. There's nothing on the horizon that gives us any pause in so that goes to our confidence going into Q4, and we hope that when we provide our guidance before.

20, we will have the same confidence looking in that time period as well.

Thanks, Marvin appreciate the time.

Thank you.

Thank you we have reached the end of our question and answer session and the conclusion of today's call. Thank you for your participation. You may now disconnect your lines and have a wonderful day.

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