Good morning, everyone, and welcome to Lowe's Companies Third Quarter 2022 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations.

Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President of Stores; and Brandon Sink, 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 website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website. Now I'll turn the call over to Marvin.

Thank you, Kate, and good morning, everyone. In the third quarter, our total company comparable sales increased 2.2%, while U.S. comps increased 3%. These better-than-expected sales were driven by improved DIY demand supported by fall nesting trends as travel slowdown and children return to school. We also saw continued momentum in Pro, reflecting the success of our Pro initiatives and the resilience of home improvement demand. In addition to strong sales growth, our persistent focus on productivity once again drove improved operating performance with substantial improvement in adjusted operating margin of 54 basis points and adjusted diluted earnings per share of $3.27, an increase of 20% as compared to last year. These outstanding results enable us to make critical investments in our most important asset, our associates. In this quarter, we announced an incremental $170 million investment in permanent wage increases for our frontline hourly associates. These increases are designed to ensure that our more tenured associates continue to receive market-competitive wages. And in further recognition of the hard work and dedication, we are awarding $200 million in bonuses to our frontline hourly associates ahead of the holiday season. At Lowe's, we make every effort to ensure that our associates share in our financial success, and I am very pleased that we are once again able to award a discretionary bonus because our performance is tracking ahead of our expectations. This is a true win-win outcome for the company, for our shareholders and for our associates. All of these investments reflect our efforts and our commitment to become the employee of choice in retail, where we continually invest in our associates and help them support their families and grow their careers at Lowe's. Now turning to Pro. We delivered growth of 16% and 36% on a 2-year basis, the tenth…

Thanks, Marvin, and good morning, everyone. In the third quarter, U.S. comparable sales increase 3%, reflecting solid core home improvement demand across both Pro and DIY customers. This quarter, we drove positive comps in our building products and home decor divisions, fueled by momentum with the Pro and improve DIY demand. In hardlines, comps were down slightly as we cycled over significant storm prep activities in Louisiana from Hurricane Ida in 2021 and that did not repeat at the same scale when flu radiances prepared for Hurricane Ian in 2022. Overall, growth was well balanced with 8 of our 15 merchandising departments above company average. Beginning with our home decor division, the fall nesting trends that Marvin mentioned led to standout performance across core interior categories, including appliances, paint, kitchens and bath and flooring. Appliance sales were bolstered by a strong Labor Day event and higher online sales as we continue to enhance our Lowes.com user experience. As an example, this quarter, we began displaying delivery dates earlier in the purchase process to highlight our improved next-day delivery options. If customer needed to quickly replace a refrigerator or washer that's just stopped working, this feature now helps them focus their attention to product that's immediately available. This is especially important for Lowe's as our appliance business is skewed toward replacement within existing homes versus new housing starts. As I mentioned last quarter, we also continue to see customers trading up for innovation, like with our new Maytag Pet Pro washer with technology that removes pet hair from clothes in the wash cycle, which is exclusive to Lowe's. This quarter, we also launched a new exclusive home center partnership with Miele, a global leader known for high-end premium appliances. This reflects our ongoing commitment to ensuring that we have new high-quality…

Thank you, Bill, and good morning, everyone. Let me begin with a heartfelt thank you to our associates. Our strong performance this quarter is a direct reflection of their hard work and dedication to providing excellent customer service. That's why we are so focused on becoming the employer of choice in retail where associates choose to stay to build their careers. At its core, that means providing good, stable jobs, comprehensive benefits, competitive wages and bonus opportunities. As Marvin mentioned, this quarter, we announced $170 million in permanent wage increases and we are awarding $200 million in bonuses ahead of the holiday season for our frontline hourly associates. This translates to up to $1,000 for eligible full-time associates and up to $500 for eligible part-time associates. As someone who started my career as an hourly associate in home improvement, I understand how meaningful this type of financial recognition can be. Our executive leadership team is passionate about rewarding our associates and taking care of our customers, which is demonstrated in the investments we make in both our people and in the communities we serve. Another example of these investments in action is the transformation of our disaster response capabilities over the last few years, which dramatically improved our ability to support communities through devastating storms like Hurricane Ian. Year round, Lowe's now has a cross-functional command center dedicated to supporting our disaster response efforts. In fact, it was these enhanced capabilities that enabled us to respond so effectively to the pandemic. We also deploy our emergency response teams to the hardest hit areas. These associates volunteer to lead their home stores, giving their colleagues in the impacted areas, a chance to focus on their families, and we go a step further to help impacted associates by deploying refueling stations and…

Thank you, Joe. I would like to begin this morning by providing additional details regarding our recent announcement of our intention to sell our Canadian business. As Marvin mentioned, despite making meaningful progress in improving our Canadian retail business over the past few years, it has continued to lag our U.S. operations and sales growth, operating profit and return on invested capital. In fact, the Canadian business represents approximately 60 basis points of dilution on our full year operating margin outlook. And during the quarter, we recorded a pretax noncash impairment charge of $2.1 billion related to this business. Looking ahead, this transaction makes us a U.S.-focused business and gives us a clear line of sight to meaningful long-term improvement of our sales productivity, operating margin and return on invested capital in particular. We are excited to share our updated financial targets at our upcoming Analyst and Investor Conference in December. Turning to our Q3 results. We generated GAAP diluted earnings per share of $0.25 compared to $2.73 last year. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. Excluding the $2.1 billion asset impairment charge, we generated adjusted diluted earnings per share of $3.27, an increase of 20% compared to third quarter of 2021. This increase was driven by a combination of top line growth, strong P&L management and disciplined capital allocation. Q3 sales were $23.5 billion with comparable sales up 2.2%. Comparable average ticket increased 8%, driven by product inflation, 80 basis points of commodity inflation and higher Pro sales. Of note, FX represented a 30-basis point headwind to consolidated comps. Higher average ticket was partly offset by comp transactions declining 5.8%. Of note, comp transactions have improved significantly as we move through the year with Q3 over 730 basis points higher than…

[Operator Instructions] And our first question today comes from the line of Simeon Gutman from Morgan Stanley.

Marvin, I wanted to maybe play devil's advocate for a second on housing. This idea that it's just taking a long time for all these pressures to catch up to the consumer in the segment. For all the reasons you cited, plus there's been some labor and product shortages. So curious how much you debate that and that there is a certain level of home price depreciation that's going to eventually weigh on this customer.

No, I appreciate the question. And here's what I would say. When we look at markets around the country where we saw an aggressive increase in home prices during the pandemic, now you can see some of those prices start to fall. Those markets are performing at the same rate of performance as other markets. So we're already seeing due to the life cycle of home price appreciation and home price declines around the U.S., signals of kind of what the broader macro may look like in months, quarters and years in the future. The great thing about operating stores in every state and in virtually every ZIP code is that you have a pretty good sample size of kind of what's currently happened, but also what future trends may look like. And we're not trying to spend the data. I mean, trust me, we're looking at this every day like you are, but from a different vantage point, trying to understand demand patterns. But the reality still remains that home prices have appreciated at record levels, as I said in my prepared comments, on average, $330,000 per home. The facts are that homes are older than they've been since World War II. And 2/3 of our business is nondiscretionary because when your house get older, things break. That's just commonplace. The facts are that we have more personal disposable income today than we had before the pandemic. And that's primarily in the bank accounts of homeowners. And the fact we saw it was still 1.5 million to 2 million homes under current demand because of the lack of home building coming out of the financial crisis in 2008, 2009. So those are just facts. And when we look at and try to forecast our business, we have to ask one simple question. historically, what data points correlate closely to demand patterns for lows. And what I just outlined to you are the data points that correlate to demand patterns, and that's what we look at.

Yes. That's a fair point. I'll jump off of housing and maybe go back to the business. If you look at the things Lowe's can be doing better, and obviously, you're executing against all the plans that you put in place since you've joined. Does it involve higher CapEx, maybe reallocation of CapEx? Or is it mostly execution in process?

Well, I would say from a CapEx standpoint, we have no expectation to go above our current capital allocation dollar amount of roughly $2 billion per year. We'll have our investor conference next month, and I can just give you a little bit of a precursor. That's what the number is going to be for next year. So as we look at things that we still have to catch up, and I'll be very transparent, we're not where we want to be. We still have a supply chain transformation process that's underway, but we can get all that accomplished and stay within that $2 billion CapEx dollar amount. We still have significant IT investments that we need to make. We made incredible improvement, but all those things also fall within that current allocation of CapEx. Bill is working to continue to improve merchandising and pricing systems. Again, those things are all mapped out. They're costed out, and we have a good understanding of it. And we feel like at $2 billion of CapEx will allow us to achieve all of these things. And again, we'll speak to those in more specificity next month in New York. But what I will say to you is, yes, are we working on execution? We are, but I can tell you right now, I couldn't be more pleased with our ability to execute at a high level and arguably the most difficult retail environment of our lifetimes. Anytime you could be a $100 billion company, and you can be so dependent on the global supply chain, and you can manage inventory with basically flat to negative units for the whole year as we have, that tells you that the degree of execution and collaboration is at a high level.

Our next question comes from the line of Michael Lasser with UBS.

Your big competitor yesterday talked about seeing some early signs of deceleration in the business in areas like grills, are you seeing any of those similar signs? And separate what do you think drove the acceleration in October on a monthly -- on a 3-year monthly stack basis?

So Michael, I'll take the first part of that. I'll let Bill Boltz come in and provide some perspective. But when we look across all of our merchandising departments. We don't have any really red blinking lights of concern relative to certain categories, certain items, certain SKUs. Obviously, when you start to get into different times of the year, we're going to have performance changing based on customer demand. So we didn't have an anticipation that grills would be a top-selling category in the third quarter. It tends not to be the same with patio. And as we spoke to a lot of detail last quarter, we do believe there was some degree of pull forward in some of these more seasonal discretionary categories. But we are not seeing anything that feels or looks like a trade down or consumer pullback. I mean, to the contrary, the third quarter was our best performing DIY quarter of the year. And that customer segment tends to be kind of the indicator for us on the overall health of our business. The Pro has been strong all year. And the good news is for the first time this year, we saw continued strength in Pro, and we saw sequential improvement in DIY. So that is something that gives us confidence that things are headed in the right direction. I'll let Bill talk about what performed well in the third quarter relative to product categories that really gave us a really strong 2- to 3-year stack for that mark.

Yes. Thanks, Marvin. And Michael, I think just a couple of things. We see -- as we go into Q3, we see a shift away from a heavy reliance on seasonal like we do typically in Q2. Yet there was still some seasonal business to be had in Q3, and that helped us as the weather was favorable. We -- as I said in my prepared remarks, our building products business continued to perform well, and we continue to see strength really across all of our Pro-related categories. And then the shift to indoor, as you see, appliances, kitchen and bath, flooring, paint, those businesses, both on a DIY and the Pro side continue to do well. And then holiday with Halloween and then the early sets of our trim and tree categories were what we saw in Q3. And then our online business continued to perform well in Q3 as well.

Michael, this is Joe. I'll add just one additional point. And that's our new MVP Pro Rewards Program that we have been discussing. And so when I look at our adoption rates being way better than expected, the new Pro CRM platform and then just a combination of our strong credit offering along with Pro loyalty gives us a lot of confidence in that business as well.

Awesome.

But my follow-up question is at the risk of pulling forward a little bit of your messaging from a couple of weeks now. Your SG&A dollars have been very well contained over the last few quarters, leading to the idea that maybe Lowe's doesn't have as much cushion in its cost structure in the event that there could be a downturn in home improvement demand, either because of housing or just a weakening labor market. Why is that wrong?

Well, I would say it's wrong based on the performance in Q1, just use that as your data point, the season broke late top line was not what we anticipated yet we still leverage operating margin for the quarter. We see that as an example of the levers that we now have in place to be agile. As I said in my prepared comments, we've got a lot of experience sitting around this table. There's very few things that we have not seen. We have a really strong playbook developed. And we think that if the market turns more negative than we may anticipate, then we have the ability to pull those levers and perform really well. As a matter of fact, we're not giving you the details, Brandon is going to spend a bit of time next month at the investor conference outlined some of those levers and the agility we built so that we can be really, really swift to react to any market conditions.

Your next question comes from the line of Brian Nagel with Oppenheimer.

Congratz. Nice quarter again. My first question, again, I don't want to have the risk of sign nitpick I mean given the strength in the business, and as Michael just pointed out in his question, the -- basically the 6 accelerating trends through Q3, and then you talked about the initial strength in seasonal with the Mummy sales. Why not lift sales guidance for the year, especially in a when you're lifting earnings guidance?

So I'll give you the philosophical perspective, and I'll let Brandon give you the financial perspective. As you know, Brian, there's a lot of unknown out there. And so we're not going to be overly bullish for no reason. You had a midterm election that still candidly hadn't been quite determined. You have aggressive action from the Fed. You have global geopolitical events happening. And so we're just being, what I'll describe as appropriately conservative. Do we have confidence in our business? Absolutely. Do we have confidence in what we're going to deliver for the holiday season, you bet we do. And we think we have a great plan for the balance of this quarter and going into next year. But in an environment where there's so much concern in the macro. We just felt it was appropriate to just be conservative. So our decision not to live guidance has nothing to do with our lack of confidence. It's just more about being prudent and not being overly aggressive in an environment where there's a lot of on asset micro questions. So I'll let Brandon add some additional detail.

Yes, Brian, this is Brandon. As I indicated in my prepared remarks, we looked at 3-year comps did see sequential improvement as we moved across the quarter. The Q3 exit rates were strong. Bill mentioned the improvement specifically in the interior DIY-related categories. The midpoint of our full year guide is flat to down 1%, which implies a slightly positive comp for Q4. And if you recall back in August, we were guiding actually to the bottom end of that range of flat to down 1%. I will cite that the commodity volatility and the impact Q3 to Q4. With lumber where it is, we've actually seen a benefit of 80 basis points to comps in Q3. If the pricing runs out into Q4, we're expecting that to actually flip to a 90-basis point drag. So that's about 170 basis point swing. Again, that's taken where we are from a benchmark perspective of below about $500 and running that out and comparing that to where lumber prices inflated round 2 of last year. So all in, excluding lumber, and the differences I just cited, the Pro comp momentum is expected to continue and the DIY trends that Bill mentioned are expected to continue through Q4.

That's very helpful. I appreciate the color there. Then my follow-up question, in separate topic. there is with regard to supply chain. So Marvin, you keep talk -- you highlighted that there's a lot of success that you've had in improving the low supply chain internally. By most measures, now the external environment for supply chain is getting better with shipping costs and such. So I guess the question, are you seeing that? And then recognizing you haven't given guidance yet for 2023, but to the extent these external supply chain issues continue to correct. Could that be a tailwind of some sort as we hit over the next several quarters?

Yes. Look, it's a great question, Brian. And without getting in front of what we're going to discuss next month, I would say that the short answer is, yes, there are elements of the supply chain that definitely will give us some cost advantages next year. Brandon is going to be very transparent and very detailed on kind of what we see going into next year. And obviously, supply chain is going to be a big component of that. In addition to just the overall cost environment for supply chain, we're going to talk about strategic initiatives as well that we're excited about because as far as much work as we've done in supply chain, as I mentioned earlier, we still see it as one of our key opportunities to improve. There's not a great retailer in the world that doesn't have a great supply chain, and we're committed to having a great supply chain.

Our next question comes from the line of Liz Suzuki with Bank of America.

Just as you think about the makeup of comp going forward between transactions and average ticket. You mentioned that in some categories where you saw inflation moderate. You saw a subsequent increase in transactions. Does that give you confidence going forward that as inflation does start to moderate it will be -- that average ticket decline or lower growth rate would be offset by a pickup in transactions?

Yes, Liz, this is Brandon. I think on the inflation front, we do continue to see high single-digit inflation this quarter, inclusive of about 80 basis points that I mentioned earlier of commodity inflation. Our consumer does continue to be resilient. We haven't seen any significant trade down. In fact, we've actually seen trade up in place across a number of categories. And our Q4 forecast, which we're focused on at this point, we're expecting that to continue at the high single-digit mark. We are going to get some relief related to lumber pricing that I mentioned earlier, so that net 170 basis point swing. But for Q4, that's the forecast is that the inflation is going to continue to lift our ticket, which is going to be the primary driver of our comp and it's going to be offset by transactions being down in Q4.

And then just looking out beyond Q4, as you think about the potential outlook for comps going forward and how that ticket versus transactions could play out. I mean, one of the pushbacks that we get is that if ticket remains -- if ticket starts to come down, but transactions remain negative, that would be a severe headwind to comp. I'm just curious how you're thinking about that outlook going forward.

Yes, Liz, we're going to hold until December to really give you a deep view there. We'll have an updated view of the macro, the comp scenarios within that and specifically the makeup of our comp and we'll plan to go into details there on December 7.

Our next question comes from the line of Zack Fadem with Wells Fargo.

So following up on the SG&A dollar question, as you've been able to take out a couple of hundred million of SG&A in both Q1 and Q2. And while Q3 was basically flat, it looks like your Q4 SG&A embeds a pretty notable step-up in trend, even excluding the extra week. So can you just help me understand the puts and takes on the SG&A line in a little bit more detail and perhaps talk through the impact of the efficiency initiatives? And then also to what extent you're able to flex up and down labor with the lower volumes today.

So Zack, I'll take the first part of that, and then I'll let Brandon and maybe, Joe, provide some additional detail. So for us, I think the key thing to understand is we have what we call PPI perpetual productivity improvement initiatives. And we're going to go into some level of detail on how this has become more of cultural process across the whole company at the investor conference next week. But specific to your question, we still believe that we have technology investments that we can make in the store environment specifically to where we can continue to drive SG&A leverage while improving customer service. But it's easier to drive SG&A leverage, if you're just pulling payroll out indiscriminately. But what Joe and his team has done we've actually improved leverage in the store from an expense and payable standpoint and concurrently drove up customer service. And that's the key. And that's really all about technology investments. So we think that there's still additional initiatives on our project road map that will continue to give us those benefits. I'll let Brandon take the more financial part of your question and then if Joe can add something else about payroll and how we can adjust it rather quickly relative to the demands that we're seeing from the consumers in our stores.

Yes, Zack, this is Brandon. The only thing I would add implied our SG&A is expected to lever in Q4. And just as a reminder, we are cycling an incentive payout from 2021 in Q4. But I would just add to what Marvin said, continuing to drive substantial PPI initiatives store tech modernization, front-end transformation, managing back office spend. So we're really proud of the progress that we've made, as we mentioned earlier, expecting to significantly outperform from an EBIT standpoint even in declining sales for the full year. And we'll tell you more about what we have in store 2023 in December.

And Zack, I'm going to let Joe talk about the activity-based model that drives our payroll system in the stores. So you can get a sense that we just don't have a blanket approach. We generate payroll based on a number of transactions and footsteps, and we think that's the best way to look at it. So Joe, you can expound on that.

Yes. And so thanks, Marvin. What I'd tell you is with our labor system that we have implemented in the last few years, this is really detailed, is down to by store, by department, by day, by time of day, in addition, as you think back in the last several years, our 60-40 initiatives to align the associates with customers and then the tasking activities. We've gone through a series of steps that continued pay go-forward dividends for us. And we have a lot of confidence in our ability to navigate to continue with the large investments we've been making. I think in 2023 will be a transformative year for us from an IT system standpoint and the ease of what we're doing.

Got it. Appreciate all the color there. And then, Marvin, you've mentioned in the past about 2/3 of your business is tied to repair and maintenance activity. And then the remaining 1/3 of your business, to what extent would you say those sales are tied to housing turnover or home price appreciation? And then considering the slowing in these housing metrics, how do you characterize the current demand environment for repair and maintenance activity, which is more stable and recurring versus sales that are perhaps more discretionary or bigger ticket in nature.

No. Zack, it's a fair question. What I will tell you is that we're seeing strength in both areas. So obviously, when you see 19% growth in Pro, 10 consecutive quarters of double-digit Pro growth, then that tells you that there's big ticket projects going on that are remodel in nature but are also what I would call upgrade in nature. We talked about trading up in place, and that is a phenomenon that we're seeing because the 1.5 million to 2 million shortages of homes in the high interest rate environment is just incentivizing homeowners to keep their low fixed rate and modify their existing home. And so because of that, you're seeing a combination of older homes getting the maintenance and repair to falls in that 2/3. But then you see the other 1/3 to simply upgrading and improving the environment, a new kitchen, finishing the basement, a new bathroom, et cetera. And so we're seeing a combination of all of those things. And as Bill walked through the different merchandising department of performance. You can see it embedded in all of those different results.

The next question comes from the line of Jonathan Matuszewski with Jefferies.

Great. Great results. My first question is on inventory. It looks like the inventory sales spread widened a bit sequentially in 3Q. From our store check, it looks like your in-stock positions are the best they've been in years. So is it safe to say that the majority of that inventory increase year-over-year is tied to average unit cost? And on that topic, how should we think about inventory levels tracking at the end of 4Q? That's my first question.

Yes. Jonathan, this is Brandon. So I would say inventory overall, we feel, is in a really solid position. Balance is up 19% and driven exclusively by product cost inflation and freight units are flat. As you mentioned, our in-stock rates continue to improve across all of our categories. We're continuing to make investments in Pro specifically in those high demand SKUs. We feel like we got the right levels to support the expected demand that we see for Q4 and into '23. And in reference to Q4, we do expect the inventory to build over Q4 with early ordering, I think for springs consistent compared to pre-pandemic levels. We are seeing a bit of unpredictability in the supply chain due to the zero-COVID policy in China. But just also as a reminder, when we look at our seasonal businesses, specifically, we do start setting south and deep south in Q4, and then we're also maneuvering around Chinese New Year, which is the latter part of January. So it's going to be critical that we're in stock for spring, and we're making those decisions based on lead times and supplier health across each of our categories.

That's really helpful. And then a quick big picture question on Pro for you, Marvin. Lowe's continues to have great traction there. It looks like the multiyear comp held up this quarter at 36%. So when you think about the recent share gains with the Pro, curious if the drivers have evolved at all. If you could talk through how much new Pro customer acquisition has been driving Pro sales versus greater wallet share from existing Pros? That would be great, and whether you're seeing any change in those 2 drivers?

Thank you for the question. We don't give a lot of external information on number of new customers down to that level of specificity. But what I will tell you is that our new loyalty program is absolutely driving new Pro customers and it's driving more return visits of existing customers, which is exactly what we wanted. And a key data point is this, when a Pro customer is enrolled in our Pro Rewards platform and credit, they shop 3x more. So that is the key data point. And so in Joe's scripted comments, he talked about the adoption rate and how it really comes down to our ability to engage the Pro. And when we engage them and educate them, they tend to adopt the program. So I'll let Joe provide a little bit more context on Pro. But we're really pleased with the progress and equally pleased that we saw the DIY customer come back strong in third quarter than we've seen them all year.

Jonathan, and then just a couple of things to add. First off, our Pro team here at Lowe's is just full of deep experience inside sales, outside sales, and they've done a really nice job. And so we're still in the early stages of the MVPs Pro Program, but very, very pleased with the adoption that we're seeing. So we've spoken a little bit in the past about our Pro CRM platform. So we have the ability to better anticipate Pro's needs and drive sales. And then this really does a nice job of what we call leveling the playing field so that every Pro is important and has the ability to earn points no matter what the size. And so things like purchase-based offers, then completing different actions to deepen their relationship with Lowe's. And so we'll continue pressing forward here, but very pleased with the Pro progress.

Thank you all for joining us today. We look forward to speaking with you at our Analyst and Investor Conference on December 7.

Thank you. This concludes the Lowe's Third Quarter 2022 Earnings Call. You may now disconnect.