Q3 2020 Lowe's Companies Inc Earnings Call

Now for the holiday with a little help from loans, we will make our own magic right at home with fun inflatable starting at just 1998 and a pre lit artificial tree with color changing LCD lights that was 178 now just 149, because gifts for home bring joy to all Lowe's home for the holidays fine holiday decorations gifts and great deal at Lowe's Dotcom today.

[noise] [noise] out Lowe's home has always been and went on [noise].

[noise] and we know this year stone has meant and everything to you too.

[noise] from this holiday season, we give thanks and celebrate.

[noise] because gifts for home screen joint Oh.

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Before your index flooring job make Lowe's your first stop see the latest styles and our new flooring showroom, we care and more tile more vinyl more laminate and hardwood than ever before whatever you need and we have a job lot quantities you expect at both pricing to save you money shop and store or online and.

And for pros dotcom need materials and labor to your job sites no problem. Our protein can help you get the job done right and on time and it's just one more reason why Lowe's is a new home for pros.

[music] zone has been there for us all year long.

Good morning, everyone and welcome to Lowe's companies third quarter 2020 earnings Conference call. My name is Rob and I'll be your operator for today's call is.

As a reminder, this conference is being recorded.

I will now turn the call over to Cape from and Vice President of Investor Relations.

Thank you and good morning, everyone here with me today are Marvin Ellison, our President and Chief Executive Officer, Bill, both our executive Vice President merchandising, Joe Mcfarland, Our executive Vice President store, and Dave debt, and our executive Vice President and Chief Financial Officer.

I would like to remind you that our notice regarding forward looking statements is included in our press release. This morning, which can be found on Lowe's Investor Relations Web site.

During this call we will be making comments that are forward looking including our expectations for fiscal Twentytwenty actual results may differ materially from those expressed or implied as a result of various risks uncertainties and important factors, including those discussed and the risk factors and DNA and other sections of our annual report on form 10-K, and our other SEC filings.

Additionally, we will be discussing certain non-GAAP financial measures.

A reconciliation of these items to U.S. GAAP and can be found in this mornings press release and on our Investor Relations Web site before.

Before we discuss our third quarter results I would like to announce that we will be hosting a virtual investor update on Wednesday December nine from eight to 10 am eastern time.

Marvin will discuss several gross opportunities that are expected to facilitate further market share gains day.

Dave will discuss our opportunity to drive operating efficiencies and sustainable shareholder value and he will also provide an update and our financial targets.

After our prepared remarks, we will host a Q and a session. We look forward to speaking with you again soon with that I'll turn the call over tomorrow and good morning, everyone I like to start out by taking a mall and what to extend my thoughts and prayers to all the individuals and communities impacted bought and many wildfires hurricanes and other natural disaster.

As well as the COVID-19 pandemic, there's no doubt that this has been a very challenging year from many of us.

Although our Lowe's associates or dealing with the same challenges facing the rest of the country I continue to be inspired by their commitment to serve our customers and communities, while juggling, a multitude of pressures and obstacles and home.

Due out all the uncertainty we face we continue to be guided by three key priorities first our highest priority as a call from the will always be protecting the health and safety of our associates and customers, who were safe store environment and shopping experience and we believe and our strict and store safety and so should this.

Yes, and protocols implemented and a consistent uniform manner has built from what our customers.

Our second priority remains providing support for our community, including health care providers and first responders and.

Our third priority is financially supporting our sources during this challenging time.

And support of these priorities, we've invested an incremental $245 million and the third quarter to support our associates.

We've now invested more than $1.1 billion and covert related to support for our associates store safety initiatives and communities through the first nine months of this year.

Now turning to our results.

The quarter, we delivered total company comparable sales growth of 30.1% over the prior year.

And 40% growth and adjusted diluted earnings per share to $1.98 said.

At the same time, we're also making critical investments across our operations to position the company for long term growth.

Our us home improvement costs was 30.4% driven by consistent and strong project and man from broke the ROI and pro customers throughout the quarter.

And a continuation of trends from Q2 growth was broad based across channels product categories and geographies.

In fact growth exceeded 15% across all merchandising departments, 20% across all geographic regions and triple digits on Lowe's Dot com.

[noise] DIY comps again outpaced pro comps and a quarter driven by consumer mindset and remain focused on the redesigning the functionality of their home.

Consistent with this redefinition and the third quarter customers continue to shop and Lowe's as they took steps to shift your home to serve three primary purposes.

From school home office, and the primary location for Recreation and entertainment.

We're pleased that customers continue to choose Lowe's as a retail of choice for these very important projects.

Our pro business remained strong and the third quarter with comps exceeding 20%.

Our investments to improve our product and service offerings and overall customer experience is resonating with the pro customers.

We're seeing significant number of new pro customers rediscover Lowe's and were seeing them come back to buy from us over and over again.

We are well positioned to continue to attract new pro customers, while also growing share of wallet with existing pro customers.

We lost a significant merchandizing investment and the third quarter to reset the footprint of our U.S stores shifting to a project focus versus a product focused store layout.

We believe these changes will create a more intuitive shopping experience for our customers, especially the pro.

And we redesigned the layout of our store was to improve product Adjacencies and bay productivity with the goal of increasing sales per square foot.

Bill will provide more detail on this very important reset initiative in a moment.

From a geographic perspective, we had broad based growth with positive comparable sales growth exceeding 20% across all 15 geographic regions and all three us divisions.

Reagents and outperformed the total company comps were Atlanta.

Usten, Los Angeles, and New York.

We also continue to see strong sales trends and urban areas and five comp sales and our urban markets outperform remote rural markets by over 500 basis points.

Our strength and our urban markets reflects the improvements we've made to our product and service offerings for the pro customer as well as enhance omni channel capabilities to serve customers increasingly shop and online.

Although the stock comp sales grew 106% as we continue to see an increase and and both DIY and pro customer demand for contactless shopping options. We have made tremendous progress over the last two years with the right investments to improve our omni channel retailing capabilities, enabling us to meet the ever increasing expectations of customer.

To shop, whatever way they choose.

And we continue to invest in our supply chain network as we open new cross dock delivery terminals bulk distribution centers and E commerce fulfillment centers to expand our fulfillment capabilities.

And while we've seen exponential online growth this year.

We still have tremendous growth runway in front of us as Lowe's Dotcom business is meaningfully underpenetrated with online representing only 7% of ourselves.

Supported by modern cloud based platform, our talented dot com and technology team has a detailed roadmap towards becoming a best in class Omni channel retailer.

Turning to Canada, we posted positive comps that exceeded 25% supported by strong pro and DIY demand as well as early success implementing our retail fundamentals playbook to improve operating efficiency, while driving sales.

This was a very important quarter for us as we drove strong top line results, while continuing to make significant investments across merchandising Lowe's outcome store operations and supply chain.

It will enable us to capitalize on current trends and will position us as a company to drive sustainable growth.

2020 has demonstrated to all of US how quickly shopping behaviors can change and I'm proud of the agility that we've shown to adjust our business model to serve an unprecedented and number of customers and store and on Lowe's Dot com.

We also understand and agility will be important as we hopefully pivot to a post cobot retail environment later in 2021.

However, we understand that creating and efficient and world class Omni channel experience will determine retail winners and retail losers and the future.

Therefore, we're pleased with the current development of our omni channel strategy, thus far and remain committed to making the necessary investments to provide our customers with choices to shop and the way they choose.

And over the near term our investment thesis will remain laser focused on enhancing the growth and profitability of our core retail business.

Before I close I'd like to again express my sincere appreciation for the tremendous efforts of our associates to support our customers and communities and winning needles most the.

The country continues to face significant challenges presented by Colby day team and this is still a very unpredictable business environment. However, our number one priority as an east central business will always be supporting the health and safety of our associates and our customers.

I look forward to speaking with you again at our Investor update on December night would a discussion focused on the market share growth opportunities that lie ahead of us.

With that I'll now turn the call over to Bill.

Thanks, Marvin and good morning, everyone.

As Marvin mentioned, we posted us home improvement comparable sales growth of 30.4% in the third quarter.

Our continued strong execution combined with elevated brand and product offerings enabled us to effectively serve the sustained increase and customer demand driven by the increased importance that customers are placing on their homes.

Similar to the second quarter growth was broad based across both DIY and pro customers in store and online and across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeded 15%.

Lumber led the way again, driven by strong unit demand across pro and DIY customers supported by our continued investments in job lot quantities and the strength of our merchants and our supply chain teams in sourcing these high demand products.

In addition to lumber we delivered above average comps into core lawn and garden and seasonal and outdoor living.

Within the core our growth was driven largely by the strength in furniture, including accent furniture and accessories, along with the strong results in home organization as customers continue to update and create new spaces for home offices and remote schooling.

And lawn and garden, there was broad based strength across the business, though most notably within live goods and landscape products as customers actively engaged in outdoor landscaping and other fall exterior projects.

Our seasonal and outdoor living team also delivered comps above the company average this quarter driven by customers looking to extend their outdoor entertaining space with fire pits and patio heaters being the accelerated product category for this fall.

We continue to strengthen our position as the number one destination for outdoor power equipment with the recent addition of ego, which is the top selling brand and battery powered outdoor power equipment to our all star lineup, which includes John Deere Craftsman, Husqvarna Honda and the Aaron's brands.

And we continue to leverage our other powerhouse brands like Weber, and Charles which continues to be the top two brands and outdoor grilling.

Now turning to our online results as Marvin mentioned, we delivered sales growth of 106% on Lowe's Dot com.

With the Replatforming of Lowe's Dot com to the cloud we have been rapidly deploying enhancements to deliver a better customer experience, including enhanced online delivery scheduling so that customers can more efficiently self serve and select the delivery time that is most convenient for them or easily reschedule as the need arises.

We also made it easier to shop by product collection with over 500 collections and growing so customers can now purchase a patio set without involving a time consuming search for each individual item.

I'm also excited that we now have the capability to ship products that require special handling items like lithium ion batteries. This capability now enables us to handle online orders of ego cobalt and skilled battery powered products along with other products powered by lithium batteries or items that may require care.

And shipping and handling.

And as Marvin covered in his opening remarks, we are resetting the footprint of the store so that it's more intuitive shopping experience for our customers, especially for the pro or.

For example, the re flow of our rough plumbing and electrical aisles are two key areas for the pro that needed to reflect how the pro shops. We are now placing all of the relevant products adjacent to each other such as pipe cement next to pipe and the necessary fittings and next to their respective pipe category.

We are also eliminate and merchandising base without planning grams, we call. These junk base, thus opening up space for higher velocity higher demand items and categories that will better reflect the local market.

We are on track to have the reset complete for over 90% of our stores by fiscal year end.

And as part of this store reset there'll be two other noticeable changes first we are adding a pro flex area similar to what we did earlier this year and our seasonal areas, making it easier for the pro to grab and go.

And then second we are moving the cleaning category to the main where the first style of our stores. This is just another example of ways. We are working to improve the productivity in this highly visible area. This store.

And as we look to close out the year, we are building on our momentum around the holiday season that began with our first ever drive thru curbside trick or treating event and our stores, where we gave away candy and pumpkins to hundreds of thousands of families who are excited about the holidays, but may not have had the same door to door trick or treating available and their neighbors.

Good day as in years past and.

And we feel that this will be a holiday season like no other when our customers will no doubt be spending much more time at home.

And because of that we are helping our customers invest in that time and memories that they're creating at home and we're planning to deliver a season of savings for the holidays over an extended period to avoid creating congestion and our stores.

Consistent with our approach throughout 2020, we continue to expect reduced promotional activity compared to the prior year.

Overall, we've delivered outstanding results this year and I can't say enough about the unbelievable efforts of our vendor partners and our merchants who have worked extremely hard to keep up with the unprecedented demand. Thanks.

Thank you and I'll now turn the call over to Joe.

Thanks, Bill and good morning, everyone. This year, we faced operational challenges. Unlike anything I've encountered in my career, whether it's in response to a hurricane flood tornado or global health crisis, Lowe's Associates take pride and the role they play to keep family safe and their homes and businesses running and challenging times.

Our associates have also remained steadfast and their commitment to providing a safe shopping experience and our stores. So our customer still comfortable returning for another shopping trip to Lowe's and.

And recognition of the outstanding efforts of our team we have provided financial support to our hourly associates with two additional 100 million dollar bonuses. This quarter full time associates receive $300 and part time associates received $150 in each payment while Lowe's covered the cost of the tax gross up again.

This brings our total cove and related financial assistance to our associates to over $800 million this year.

And I'm thrilled to announce that for the third quarter and the ROE, 100% of our stores have earn their winning together profit sharing bonus totaling $104 million. Once again their efforts exceeded expectations. So this represents an incremental $31 million lowered the target payment level.

I was also really pleased to see the strong frontline associate morale reflected in their impressive level of engagement and our recent annual Associate survey our associates indicated that they feel supported by the company. During this challenging year and that they are energized by their work and we're supporting our communities through hiring as we're bringing on 20000 necessity.

It's across our us stores and distribution centers. This holiday season to support elevated levels of customer demand.

This year, we've hired over 155000 associates, there are seasonal hiring programs and many of the seasonal hires of transition to and more permanent role within the company.

The pandemic has changed the way we all live work and shop. This is evident in our increased customer demand for contact with shopping options. This year.

This quarter, we began adding touchless BOPUS lockers to our stores to complement our curbside pickup and BOPUS pickup at checkout.

We're focused on rolling out these lockers to our major metro markets by Thanksgiving.

And we are standing up dedicated fulfillment teams at our stores are already improving speed of service and customer satisfaction with our consistent focus on this important function.

We're also raising our game with the pro as we expand our brand and product offerings to meet their unique needs. We are adding to our eat and electrical product assortment, which is a go to solution for the pro working on home remodeling project and we are now the largest distribution partner for shark bite, which provides push to connect plumbing products that make projects fast.

And easy and must have for any plumbing project.

Combined with the power of Simpson strong tie to Walt Spider and Bosch brands. This brought our offering and eat and then shark bite builds out our arsenal to ensure that we have a competitive offering that meets the needs of our pros across the variety of projects that they handle.

And we've kicked off a multiyear national roll out of our total rental program to increase our relevance with the pro as over 70% of pros rent tools at least once a year in August we celebrated the grand opening of our first tool rental location and Charlotte, where we provide high quality tools for both pros DIY wise and weekend warriors their convenient.

Online platform that allows customers to reserve their tools ahead of time, we are encouraged by the early results and the strong feedback from our most frequent pro customers and the Charlotte area look.

Looking at our third quarter results I'm really pleased with the comps exceeding 20% that the pro team delivered.

We are consistently meeting the needs of our pro customers with job lot quantities that are available every week efficient service focused on getting that back on the job site quickly and the products are looking for we are winning new pro customers and they're coming back to our stores again and again.

And we continue to drive efficiency by streamlining our store operations as we leverage technology to improve customer service and alleviate the tasks and responsibilities for our Red Best Associates. This quarter, we leverage the new intuitive touch screen Pos at our registers to easily cross train and other associates on the cash or position these new touch screen Red.

Store is not only speed up cash or training from the old Green screens. They also provide our customers and the faster checkout experience. This is consistent with our store simplification approach, which leverages new technology to make our associates more productive while also improving customer service same time.

All of these store technology processes and improvements under our belt, we are well on our way to hit our target of 60% service and 40% tasking by the ended the year and it's paying off with high customer satisfaction scores as we acquire new customers and keep coming back to shop at Lowe's. Thank you and I will now turn the call over to Dave. Thank.

Thank you Joe and good morning, everyone. I'll begin this morning outlining the companies strong capital allocation program and the first nine months and 2020, we generated $10.3 billion and free cash flow driven by very strong operating performance and.

In the third quarter alone, we paid $416 million and dividends. We also announced a dividend of 60 cents per share a 9% increase that will be paid and the fourth quarter. This year.

During the quarter, we reinstated our share repurchase program and repurchased 3.6 million shares and the open market for $621 million.

I continue to expect our share repurchase program to be a significant contributor to long term shareholder value creation.

We incurred capital expenditures of $462 million as we invest and the business to support our strategic initiatives, including our omni channel capabilities.

In October we took advantage of a favorable interest rate environment to reduce our interest expense through a cash tender offer for $3 billion of our higher coupon bonds.

As a result, we recognized a loss of $1.1 billion on the extinguishment of debt.

To fund the tender offer we issued $4 billion of unsecured notes. This issuance consisted of 710 and 30 year notes with a weighted average interest rate of 2.17%, which is a record low and the company's history.

These efforts further strengthened our capital position by lowering our interest expense over the longer term.

We now have $8.2 billion of cash and cash equivalents and the balance sheet.

And combined with $3 billion and Undrawn capacity on our revolving credit facilities, we have immediate access to a $11.2 billion and funds, which we are confident is more than enough liquidity to navigate any uncertainty.

At the end of Q3, our adjusted debt to EBITDA ratio stands at 2.3 times.

Now turning to the income statement in Q3, we generated GAAP diluted earnings per share of 91 cents compared to a $1.36 cents last year and decrease of 33%.

And as I just mentioned the company incurred a 1.1 billion dollar loss on debt extinguishment this quarter.

Now my comments from this point forward will include certain non-GAAP comparisons where applicable.

In Q3, we delivered adjusted diluted earnings per share of $1.98 cents per share and increase of 40% compared to the prior year.

These results were driven by higher than expected sales volume as well as our strong execution to meet elevated customer demands can.

Q3 sales were $22.3 billion.

An increase of 30.1% on a comparable basis versus the prior year.

This is driven by transaction growth of 16.4% and comparable sales average ticket growth of 13.7% we.

We continue to see strong repeat rates from both new and existing customers.

Commodity inflation drove a benefit of approximately 340 basis points to comps and the quarter U.S.

US comp sales were up 30.4% in the quarter with continued strength from both DIY and pro customers and broad based demand across geographies merchandising departments and selling channels.

Our U.S. monthly comps were consistently strong throughout the quarter with 28.9% in August.

31.8% in September and 30% and October despite a significant reduction and promotional activity versus L.Y.

Gross margin was 32.7 percentage sales from the quarter and increase of 28 basis points compared to the third quarter of 19.

Product gross margin rate improved 65 basis points, driven by continued improvements from our pricing cost management and promotional strategies.

Favorable product mix drove approximately 35 basis points of benefit.

These benefits were offset by 30 basis points headwind from lower credit revenue.

25 basis points of pressure from inventory shrink and 20 basis points of pressure from supply chain costs.

And consistent with our long term strategy, we are investing in our supply chain as we expand our network to stand up market level delivery model for big and bulky products.

We further expanded capacity for pulse parcel shipments with the opening of a new direct fulfillment center on the West coast.

SDMA was 21.4% of sales in Q3.

31 basis point improvement compared to L.Y.

As we anticipated we incurred $290 million of cobot related expenses.

These investments included $230 million and financial assistance for our frontline associates and approximately $55 million related to both cleaning and other safety related programs.

And approximately $5 million and charitable contributions.

These $290 million of cobot related expenses negatively impacted SGN, a leverage by 130 basis points.

We also incurred approximately $100 million and a large scale strategic merchandising reset of our U.S stores, which negatively impacted SG may leverage by 45 basis points.

These incremental costs were partially offset by payroll leverage up 90 basis points related to higher sales volume and improved store operating efficiencies.

Occupancy leverage of 35 basis points.

Five basis points of leverage and employee benefits.

And advertising leverage of 25 basis points.

Adjusted operating income margin increased 55 basis points to 9.81% of sales.

The adjusted effective tax rate of 23.9% was in line with the prior year.

Now Q3 benefited from a two set timing shift into Q3 at the expense of Q4.

At $15.7 billion inventory was higher compared to the prior year levels as we stocked up on product to meet elevated customer demand throughout the quarter.

Also lumber inflation increase inventory values by approximately $250 million.

I'd now like to spend just a few minutes discussing our outlook for the fourth quarter.

While the operating environment remains uncertain and we still have limited visibility into the longer term trends I like to share my perspectives about how we're planning the business in Q4.

We expect that our topline growth will moderate from Q3 levels as outperformance and seasonal categories abates and the fourth quarter.

This is consistent with natural demand patterns of the home improvement sector.

For the quarter, we expect total and comparable sales growth of between 15 and 20%.

Consistent with the prior two quarters, we anticipate that we will incur ongoing cobot related operating expenses of approximately $75 million to support safety and cleanliness and our stores.

In Q4, we will continue to evaluate the operating environment and assess any potential incremental associate financial assistance.

We expect to incur approximately $150 million and expenses associated with the merchandising investment and our stores.

As we expect to complete the reset activity for over 90% of our U.S stores by the end of the fourth quarter.

Additionally, we will continue to invest and expanding our supply chain network.

These significant investments coupled with our fourth quarter typically be and our smallest revenue quarter should result in adjusted operating margin performance and essentially flat to prior year levels.

The effective tax rate is expected to be over 27%.

Continuing our commitment to return capital to shareholders to value enhancing share repurchases, our guidance assumes approximately $3 billion and share repurchases and the fourth quarter.

We expect GAAP and adjusted diluted earnings per share of one dollar and 10 cents to one dollar and 20 cents a share.

For adjusted EPS. This represents 22% growth at the mid point over the prior year.

We are now planning for approximately $1.7 billion and capital expenditures for the year.

With a continued focus on our Omnichannel investments.

In closing I'm extremely pleased with our outstanding results from the first nine months of the year and an unprecedented operating environment. We remain focused on serving our customers and our communities, which led to an opportunity to grow market share earlier than we expected.

I remain confident that we are making the right investments to drive sustainable growth, we have a strong balance sheet and we're committed to a disciplined capital allocation program, which will lead to a longer term shareholder value creation.

I look forward to speaking with you again soon at our Investor update meeting on December 9th So with that I. Thank you, we're now ready for questions.

Thank you.

And that will now be conducting a question and answer session.

If youd like to ask a question. Please press star one on your telephone keypad switch or your question. Please press star two.

In order to allow questions from as many individuals as possible and ask you. Please limit yourself to one question and one follow up.

And your first question comes from the line of Simeon Gutman with Morgan Stanley.

Hey, good morning, everyone.

I have a question Marvin if you step back and look at the transformation so far since you've gotten there and your ability to get to 12% to 12% margin and beyond and.

The stock's down a little bit this morning, and I think it's reflecting and be a mismatch and timing of some investments and flow through.

But it doesn't look like much has changed with your goals and the path year on but I wanted to ask you. If there's anything that you can be critical that's something that's not playing out or is your reaction you know that things should only be stronger for Lowe's.

You envision when you when you when you got the Lowe's.

Assuming and this is a very good question, we actually feel great about the transformation Green, obviously, we don't have perfect visibility to the future and we had no idea as no one day that we'd be dealing with a global and dynamic in the year 2020, but when I think about.

[music].

How far we progress in two years.

When you.

Look at the digital platform and our online business. The last two quarters growing 135% last quarter, 106% and the third quarter were at levels that we could not have even imagine.

Just 12 to 16 months ago merged.

Merchandizing initiatives supply chain I think the key for us and so we're not really concerned about the short term. We know this is a great brand we have a strong balance sheet.

And we're trying to make the right investments in the future and when I look around at the accomplishments of the team I'm exceptionally proud because we're a little bit ahead of schedule as Dave mentioned, and we think that we're going to start to lean into taking market share and at the December 9th and dress to update.

And to be a lot more specific about kind of where we are in this transformation and how we see the out years and and where we believe that we can really start to pick up additional market share, but overall I couldn't be more pleased with the progress of the state.

Okay, and then a quick follow up is I think year to date, we've incurred about a billion one of coven and assist associated benefits and additional costs. How do we think about that into the fourth quarter and into 2021.

Well I'll take the first part and Steve Dave has any additional context.

Dave mentioned, we're committed to fundamental expenses relative to cleaning and providing a safe environment for our solar system customers and our physical stores and so that is something that we are.

Committed to continuing to execute.

We're going to just monitor all the aspects of the needs from our associates and determine what if any additional investments and need to be made in the fourth quarter. We've actually follow that philosophy for the last couple of quarters and in the fourth quarter wont be any different and little Dave as anything.

And Simeon this is day, the only thing I would add to that is that obviously in November the associates will receive and.

The middle compensation and then in December our winning together program kicks in.

Thanks and to play and just given how the stores are performing and.

The vast majority of non almost all the stores are at Max payout from that so we're we're leaning into areas to compensate our associates.

And tied to their needs, but also tied to performance.

Okay. Thanks, good luck.

The next question comes from the line of Kate Mcshane with Goldman Sachs.

Hi, good morning. Thanks.

Thanks for taking my question I wondered if I could ask about Charles versus the Iwai, just if you saw and narrowing of the GAAP and performance between the two this quarter this quarter versus last quarter and how.

And maybe thinking about the pro penetration and sales next.

And next year once you reached at the store and and levers and leadership that Youve put in place last year or two.

Okay. This is really difficult for us to give you a very specific forecast on that obviously this is the most difficult environment for any kind of a financial forecasts, but I think at a high level, we anticipate that youre going to.

Ceded GAAP continue to close and new approaches will start to gain more of a penetration as we start to have less of the nesting effect. When you get to this hosts covert environment. One of the reasons were making all of these investments in the pro and as Joe and I, Both mentioned and we grew to one.

Business over 20%.

And the third quarter is because we're anticipating this post cobot retail environment and we know this customer is very important. So we expect that GAAP to continue to close as we get into 2021. The question is when and that's going to be a large part based on coal good and.

And how the nesting effect of the DIY starts to to minimize overtime and.

Kate This is Dave I just add that.

Step back and think about the financial algorithm and this company over the next several years as we've said many times, we have real strength and the DIY customer and you're seeing that and our numbers today the opportunity over time is to really penetrate and grow our pro business and I think the investments we're making both in Q3 in Q4 and really as we sign.

And your next year is really bolstering our business model around the pro and so it's not going to be like a light switch there were no just turn on the pro is going to interest elevate significantly but this is.

Each week and each month and each quarter and kind of continue to push and grind ourselves out to grow that pro business and that's the that's the objective we have here.

Okay. Thank you and if I could just ask a quick and related follow up just with the new and Laura.

This week I, just wondered if you could remind us how.

How you are thinking about and our competitive positioning with normal and so.

And.

And does that change this will change anything when you think about that supply chain investment fellows.

Oh Acadia it does not.

No I made the comment.

Earlier in my.

Prepared comments that you were committed to core retail business and when we look at our investment thesis and we evaluate will reach and gain the greatest return it is and our core business now we're going to continue to target. The MRO segment in our current pro strategy what.

Our outside sales reps for those reps are connected to the store and connected to our imessage model and we feel like that that model has the ability to scale for.

With our investment thesis our focus is improving our core business and the core business is defined as our brick and mortar stores, our dotcom platform our supply chain.

And all the other operational components that tie that together and that's our omni channel a loss of beat we feel like we're in a good position and we're going to continue to make those investments and over time.

That thesis May change, but in the short term and near term, we're just laser focused on our core business.

Thank you.

Your next question comes from the line of Scot Ciccarelli with RBC capital markets. Please proceed with your question.

Good morning, everyone and other expense related question I guess looking for some clarity and just in terms of kind of that the way to think about the cadence so pre pandemic and the low story was very heavily centered on productivity improvements SGN, a leverage obviously as Copenhagen and carried a lot and incremental expenses.

Good day and assistance rate associate obviously extra labor because the sales growth how should we think about SNA gross oh, let's call. It a per store basis or how are you going to frame. It for 21, just in terms of the way we should think about that.

Those overall levels. Thanks.

Yes, probably a little early to talk specifically about 21, but just in general I think what you're seeing is we have a very focused.

Effort around store productivity and managing both labor and cost within our stores.

Couple that with the investments that we're making in supply chain, which is ultimately creating new market market based delivery model that will ultimately put pressure a little bit on gross margin and as we take delivery out of the stores moving into the market, but relieved the stores and that burden from an EPS DNA perspective, so you'll see income.

Capital flow through and that model gets built out that's probably a 12 18 24 month process before that happens, but I think we're well on our way to continue to make investments both from a technology perspective, and an operational improvement perspective to drive productivity. So you should see has continued to get better absent the effect of coated.

The one thing that is going to go forward is probably the neighborhood of $70 million or so per quarter on incremental cost associated with safety and friendliness and I think that is here to stay for some period of time.

Hey, Scott I'm going to let Joe Mcfarland talk a little bit about our productivity initiatives.

We're extremely proud and a frac that yes, 18, plus months ago, when we did and evaluation of our payroll spin and the stores roughly 60% of all of our spend was going towards tasks and non customer facing activity and Joe is absolutely flip that equation would have store is a little bit and talk about that force.

Yes, Thanks, Mark and Scott, we're we've been very pleased with the progress we're making on our 60 40 transition as I mentioned in my prepared remarks.

We're well ahead of that schedule will hit the 60% service, 40% to task by the end of this year, but that also allows us to continue to make investments and things like our fulfillment teams.

Supervisors that we've added to the pro area of the business and the the incremental expense that we incurred there. So we're very pleased with the productivity and we will continue on net productivity March.

Okay. Thanks, a lot guys.

Our next questions come from the line of Michael Lasser with EUV. Yes. Please proceed with your question.

Good morning, Thanks, a lot for taking my question. So as you've gone through this transformation you mentioned, you're you're ahead of schedule and realizing some of the productivity or cost day.

Anything that you expected like the split between cash and service and yet now, we're seeing and maybe a bit of and acceleration in 17 and of the of the business. So art or are you entering a new phase of this transformation, where some of the low hanging fruit and.

Already been harvested in terms of the cost and at the same time and.

Since our increasing which they occur at a time, where its wallet share shift that is benefiting the home improvement category. Although the income together just that we do see a bit of IRT freshmen or some margin degradation and your key and now over the next few quarters. Thank you.

Hey, Michael This is Marvin so as Dave mentioned, we're going to have a little bit more specificity on the net December 9th and best to update but well here's what I will tell you. We don't believe we're going to get entrenched and and we believe that there is still.

A large amount of opportunity in front of us to drive productivity.

We have a multi year time line, we mapped out initiatives from a merchandising perspective operational perspective supply chain et cetera, we see productivity gains over you know.

Next couple of years to be candid, obviously, those initiatives and vary in size and scale, but we believe we still have enormous opportunity and the puts and perspective. Your comments, we've made the decision to accelerate.

This U.S. store was reset initiative because early test gave us confidence that this would tremendously benefit a pro customers and it would create a much more intuitive shopping experience for our DIY customers.

And so we took on a $100 million of expense.

And the third quarter and were taking all and roughly $150 million of expense and that's going to get roughly 90% of our store is completed.

That is an example of us not growing this business quarter to quarter.

We want to make sure that we're making the right investments that will have long term benefits and create long term productivity gains and we believe that we are doing that and that's going to be our focus and when we update you all and December will provide some perspective on how we see revenue and operational performance as well as.

Profitability in 2021, but we feel really good about our progress and we feel good about being in a position now to transition to a market share focus ahead of schedule and.

Michael I'll, just add that margins have been very important Larry said, we decided to accelerate the program. This was not an incremental program that we didnt have on our road map. This was on our road map consistently over the last couple of years since we've been here. This is now we're taking the opportunity to lean into it. So I think that the original thesis of all the investments that we put forth.

I think are very valid we see a lot of runway to continue to on those investments and drive performance going forward.

So Dave if I could just clarify that and add one unrelated question does that mean that some of those pull forward of investment will come from next year such that.

You will get a return on those dollars and you can't and being better positioned to lever your at sea and eight even though a and a tougher macro environment and then my follow up question and that is big change and the cadence of the PNM and this quarter was the discussion around lower credit revenue and shrink how long are those going and issues that.

Net way on the gross margin and and what what has caused those pop.

Pop up studying.

Yes, Hey, Michael and just as you think about the investments we are making yes, we're making these investments to improve our productivity and the years to come so I won't speak specifically to 21, but yes. The things that we're doing today will benefits benefit us going forward and then secondly, I'll talk a bit about quick credit revenue and I'll speak have Joseph probably.

And talk about the actions we've taken from us from perspective on the credit revenue side of the house, Yes, we're having a little bit of pressure there and really two things that are happening. One is we are seeing a tender shift as the us consumer is kind of pulled back on debt and you're saving rate has increased and we see net tender shift away from lower price level private label.

And that's a little bit into pin debit so that puts pressure on that line and then secondly, we are forecasting some higher.

Higher credit risks going forward, just given the macro economy and the future. So a little bit of both of those things are driving that pressure and then from a straight shrink perspective, all that margin Joe comment on that so so Michael I'll hand, it to Joe to talk about two things to do a little bit and exploration on on shrink our trends and.

Some of the initiatives to reduce it but also to give you. Another example of a pull forward initiative that.

We are in the midst of executing so Joe you can go and cover those two things.

All right. Thanks margin, so as far as the investments and give you a quick and sample discuss.

Discussed at rolling out of the buying online pickup and store dedicated lockers and so this was originally on the roadmap. This was approximately $30 million pull and expense to this year and that we had from last year. This will allow us to continue to leverage our payroll expense and continue to drive our omni.

Business. In addition, we have be it new dedicated fulfillment team. So we feel very good.

The investments, we continue to make and the business in.

In regards to shrink we have been experiencing shrink pressures over the last several quarters and we have a good sense of where that lies and we understand the challenges that we have been making significant investments from from the loss prevention standpoint from a safety standpoint, and so we feel good about the trajectory.

There were some challenges with that being in the central retailer being some of the only retailers open and during the onset of the pandemic and believe we're cycling some of that today, but again as we continue to invest in market level intelligence.

And loss prevention and safety programs, we were confident and the payback.

Thank you very much and M&A holiday.

Thanks question from the line of Chris Horvers with JP Morgan. Please proceed with your question.

Thanks, Good morning, guys and surprise and we've got and this far into a and to the go without the quarter to obligatory quarter to day question I'll phrase it a little bit differently, you talked about seasonal next being.

Driver of why you're expecting 15% to 20% comps in the fourth quarter. You you did post that 30% in October are you just simply mix adjusting for seasonal mix and that drives you and to the 15 or 22, 15, and 20% are you assuming a moderation and other categories.

And so look I will I'll take this is Chris and I'll, let either bill or or day jump and if they have additional comments.

To say this is the most difficult environment to forecast and it would be an understatement.

And I can tell you is we feel great about our early trends in November.

We feel very good about our ability to meet demand if it exceeds our 15% to 20% guidance.

And we'll have a much better perspective on Q4, when we speak to you nailed investors on December 9th but this is just our way of trying to frame up our best guess of where we think the business. It is headed and and aren't yet obviously, the most difficult and complex forecasting environment and your book.

Worked and and again I'll leave it at that and if we have more context and in more detail on December nine will be more and happy to share, but the key is we feel really good about the trajectory of our business, but this is our best estimate based on what we know today.

Understood and then a question on and.

I guess, the and medium to long term gross margin outlook previously you had talked about mid to high 32% range.

India, and the existing sort of existing sort of algorithm and and so forth.

Just 21 revert back down to this prior target and if so what are the drivers because you know year to date, we are performing very nicely and in that regard and and so is it supply chain investments that causes some near term pressures is it mix some promotional.

Normalization and then longer term, how do you think about the opportunity to get into that 30, 33% to 34% range.

And given your largest peer does have a.

The higher gross margin understood. There, so probably some efficiencies given scale, but at the same time just trying to think about structurally you know the difference is given all the work that you're doing and.

And the box and around the supply chain. Thank you.

No we feel very strongly that the opportunity is ahead of us from a gross margin perspective, we're not going to get this back specifically I will say there is some.

I'll say geography is on the PNM and we continue to work push very hard and improving and I would consider our product level gross margin performance and in part of this is just being very efficient from a promotional standpoint being very efficient from a cost management perspective at.

At the same time, we are investing and supply chain and that's going to put pressure on gross margin, but its going to relieve operating expense within our stores the flow through of that is very accretive to opt. Each so I think you'll see some geography shifts there, but theres nothing thats going to revert back its not our anticipation that we would go back to where we were prior to this year.

Understood. Thank you best of luck.

Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your questions.

Thanks, Good morning, everybody. Thanks for taking the question nice quarter.

I think investors and trying to understand and magnitude and sort of the net impact from the investments you are talking about and the pull forward. So the question is and I know, it's been asked a couple different ways today, but if comps are positive and you can sort of manage through next year from a topline perspective can you continue to expand margin rate and imply 21.

Well Seth.

We're we're not commenting and detail on 2021 at that time at this time, but as we've mentioned a couple of on a couple of different occasions. We're gonna be updating you all on December nine and we're going to have a little bit of perspective, and we're going to spend the majority of the presentation talking about.

The initiatives and actions, we're going to be implementing to improve and take market share and at that time, we'll have better perspective on 21, and we'll be able to provide a lot more context, and what we're doing today and Seth I'll just add let's let's not get hung up on where we end 20, where we and 21. The reality here is we started talking.

And of 12% operating income flow through I think we were we were very focused on delivering up on that objective I think we have very good line of sight to get to to getting to that level and and using that as just to stop and point to actually potentially go further after that so I think are the investments through and that we're making the focus that we.

I have today is really on proving that flow through over time, we still see very strong line of sight to that day and said this is more of and again the only other comment I'll make is you and we were actually a question earlier about the MRO space.

And we.

Are going to make any strategic changes based on the actions in the marketplace and one of the reasons why we're not is because we see so much upside and.

Our core business, and and we see and incredible opportunity to drive efficiency and productivity by continuing to make the right investments and merchandising systems and supply chain operations and so today's point, we see to 12% not as a pinnacle, but as a mouse.

Oh and that we will hit and then we will continue to drive.

And improve productivity beyond that point again, we'll be able to provide more context, and our investor update and December.

Got it. Okay, then we're going to take one cash.

We're going to take one more question. Please.

Sure. The next question is from the line of Elizabeth Suzuki from Bank of America.

Great. Thank you and it's a little surprised to hear that the product mix was favorable as the gross margin just given that lumber sales growth with a strong and that's usually a lower margin category can you talk about the categories that helped out from a product mix standpoint, and a corridor.

Yeah. This is Dave actually lumber did put some pressure on gross margin in the quarter as it typically does an inflationary environment, having said that I see the merchandising and the finance team has done a really nice job from and managing cost kind of across all the categories and I'd say I cash.

And call out just one category, where we're seeing improvements we are seeing improvements more or less up and down the PNM across all merchandising categories from most part.

Okay.

Great. Thank you.

Thank you.

This concludes today's teleconference. You may disconnect your lines at this time and we thank you for your participation.