Isabel Janci - Vice President, Investor Relations Craig Menear - Chairman, Chief Executive Officer and President Ted Decker - Executive Vice President of Merchandising Carol Tomé - Chief Financial Officer and Executive Vice President, Corporate Services Marc Brown - Senior Vice President, Store Operations Mark Holifield - Executive Vice President, Supply Chain & Product Development.

Christopher Horvers - JP Morgan Michael Lasser - UBS Brian Nagel - Oppenheimer Chuck Grom - Gordon Haskett Simeon Gutman - Morgan Stanley Matt McClintock - Barclays Steve Forbes - Guggenheim Securities Seth Sigman - Credit Suisse Scot Ciccarelli - RBC Elizabeth Suzuki - Bank of America Merrill Lynch Jonathan Matuszewski - Jefferies Scott Mushkin - Wolfe Research.

Good day and welcome to the Home Depot Q3 2018 Earnings Call. Today's conference is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Isabel Janci. Please go ahead, ma'am..

Thank you and good morning everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising, and Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services. Following our prepared remarks, the call will be open for questions.

Questions will be limited to analysts and investors and as a reminder please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.

Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission.

Today's discussion will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now let me turn the call over to Craig..

Thank you, Isabel, and good morning everyone. We're pleased with our results in the quarter. Sales for the third quarter were up 5.1% from last year to 26.3 billion. Comp sales were up 4.8% from last year and our U.S. comps were positive 5.4%. Diluted earnings per share were $2.51 in the third quarter.

From a geographic perspective sales were strong across the U.S. All but one of our 19 regions posted positive comps. The exception was our Gulf region, which faced tough compares associated with the anniversary of Hurricane Harvey. Recall that we're lapping almost 300 million of Hurricane related sales from the third quarter of last year.

While this quarter brought Hurricanes Florence and Michael, the scope of devastation was more compact from a geographical perspective than what we experienced in prior year. Nonetheless, these storms did inflict significant damage in our community and thoughts and prayers are with them as they begin the recovery efforts.

Our thoughts and prayers also go out to all those who are currently being impacted by the deadly fires in California. Internationally, both Canada and Mexico posted positive comps in local currency. As Ted will detail, both ticket and transactions grew in the quarter.

Pro sales once again outpaced DIY sales, but we continue to see a healthy balance in growth from both Pro and DIY customers as they shop across the store. We believe this is a testament to the overall strength of demand in the home improvement market. Our digital business continues to be another source of growth. Online traffic growth was healthy.

In third quarter, online sales grew approximately 28% from the third quarter of 2017. Customers continued to respond to ongoing investments and enhancements we're making to drive a frictionless interconnected customer experience.

For example, buy online ship to store and buy online pickup in store sales, both grew faster than the overall online sales growth rate for the third quarter. Another key component of the best in class interconnected shopping experience centers on enhanced delivery and fulfillment options.

As you know, we're in very early stages of a five year investment journey in the One Home Depot supply chain to enable the fastest, most efficient delivery network in home improvement. Today, we can reach approximately 95% of the U.S. population in two days or less with parcel shipping.

The anticipated end state of the One Home Depot Supply Chain will enable us to reach 90% of the U.S. population with same day or next day delivery capability for an extended SKU offering that includes big and bulky goods. In order to get there, we must invest in a number of different facilities to offer greater depth and breadth of SKU availability.

We told you that 2018 will be the year of the pilot as we test and learn with new fulfillment centers. I'm pleased to report that we're on track with our plan and we are live with our first few pilot facilities, with additional pilots scheduled to open throughout the rest of this year and early next year.

As we work on our long-term initiatives, we're also focused on meeting our customers' immediate delivery needs. We've made great progress with our store delivery enhancements as our car and van express delivery offerings now enables same day delivery of store goods. Since rolling out car and van delivery to over 40% of the U.S.

population we have seen increased utilization from both our Pro and DIY customers. As we continue to work towards the 2020 goals that we laid out for you in December of 2017, let me update you on some of our investments all of which focus on delivering exceptional customer service, driving productivity and simplifying operations.

We've implemented our wayfinding sign and store refresh package in approximately 700 stores ahead of our initial plan. We continue to make progress on the rollout of our redesigned front-end areas and pickup lockers among other investments.

We're also working to remove friction for our customers while helping our associates to be more productive with their time. An example of this is the deployment of our new overhead management application.

As you've heard say before, customer service starts with being in stock, but beyond just having the product in stock, it has to be on the shelf for our customers to purchase, not stored in an overhead.

Prior to the rollout of the overhead management application, the only way an associate could locate product in our overheads was to manually look for it. This new application on first stones helps associates locate product in overheads quickly and accurately saving them time, improving the customer experience and enabling better inventory management.

Turning to our outlook, as Carol will discuss some more detail, we're updating our sales and earnings guidance for the year. We now expect fiscal 2018 sales growth of approximately 7.2% and diluted earnings per share of $9.75.

We faced the headwinds from last year's storm related sales in the fourth quarter, but we believe the drivers of home improvement spend are supportive of our business. We remain excited about the investments we're making to ensure that we deliver the best customer experience in home improvement.

I want to close by thanking our associated for their hard work and continued dedication to our customers. Our associates not only record to serve our customers and our aisles, but their efforts extend to the communities in which we operate.

This quarter marked our eighth annual Celebration of Service campaign in which our associates volunteered over a 100,000 hours in support of veteran housing needs. In fact, our associates and non-profit partners have been hands on in transforming over 40,000 veteran homes and facilities since 011.

We're very proud of our associates to live our values every day. And given that Veterans Day was earlier this week, let me take this opportunity to thank those that have served our country. And with that let me turn the call over to Ted..

Thanks, Craig and good morning everyone. We were pleased with our results in the third quarter. The core of our store continues to perform well and we saw growth, with both our Pro and DIY customers. Looking at our departments, comps in appliances, electrical, plumbing, tools, décor and flooring were above the company average.

All of our other departments but lighting were positive but below the company average. The comp in lighting was essentially flat. In the third quarter, comp average ticket increased 3.5% and comp transactions increased 1.2%.

Commodity prices were volatile in the quarter, while inflation in lumber, building materials and copper positively impacted average ticket growth by approximately 61 basis points in the quarter. Today lumber prices are below 2017 levels. In addition foreign exchange rates negatively impacted average ticket growth by approximately 43 basis points.

We continue to see strength in big ticket projects during the quarter. Big ticket sales or transactions over $1,000, which represent approximately 20% of US sales were up 9.1% in the third quarter. A few drivers behind the increase in big ticket sales were vinyl plank flooring, windows, appliances and water heaters.

Once again we saw strong performance in many Pro heavy categories as pro sales grew faster than the company's average comp. Pro heavy categories like power tools, concrete and several plumbing and electrical categories all had comps above the company average.

We also continue to see a healthy and growing DIY customer as they engage with us across the store. Categories like safety and security, vanity, lawnmowers, ceiling fans and interior and exterior paint showed strong growth in the quarter. In the third quarter we hosted several events that helped drive traffic and create excitement in our stores.

We were pleased with our annual Halloween, Harvest and Labor Day events, which recorded solid growth year-over-year. As we continue to focus on enhancing the in store experience for our customers, I'd like to highlight some recent initiatives we've been working on with MET our Merchandising Execution Team.

This season team managers set integrity and execute three sets throughout the stores, bringing best in class speed to market. MET leverages advanced analytics and proprietary technology to drive productivity and efficiency in our stores.

We use real time data to understand what categories require attention and leverage our first phones to direct the work activity of our MET associates. We wanted to thank our supplier partners who continue to see the power of partnering with the Home Depot.

Our suppliers trust us with many exclusives and innovative product launches in large part because of our 400,000 plus blooded associates and the enthusiasm they bring to our aisles every day. Two recent additions to our portfolio of exclusive brands are Stanley, Hand Tools and Troy-Bilt, Outdoor Power Equipment.

Adding Stanley to our lineup of Milwaukee, DEWALT, Husky, Crescent, Empire, Wiss, BESSEY and Klein exclusive brands, makes us the number one destination for hand tools. And Troy-Bilt complements our leading lineup of exclusive Outdoor Power Equipment brands including Ryobi, Toro, Honda, Cub Cadet, ECHO, EGO, DEWALT and Milwaukee.

In fact, 14 of the 15 top rated gas self-propelled lawnmowers in the market are big fox exclusives to the Home Depot. Looking to the fourth quarter, we're excited about the upcoming holiday season. In addition to our comprehensive holiday décor offerings, we're thrilled with our 2018 gift center.

This gift center is our best yet and features a number of special buys from our leading tool and power tool accessory brands that are also exclusive to the Home Depot including Ryobi, RIDGID, Milwaukee, Makita, Diablo and Husky. With that I'd like to turn the call over to Carol..

Thank you, Ted, and good morning everyone. In the third quarter, total sales were $26.3 billion, an increase of 5.1% from last year. Recall that at the beginning of fiscal 2018, we adopted a new accounting standard pertaining to revenue recognition.

The new standard changes the geography of certain items on our income statement but has no impact on operating profit. In the third quarter, the change in accounting positively impacted sales growth by $64 million. Further, during the third quarter a stronger US dollar negatively impacted total sales growth by approximately $110 million or 0.4%.

Our total company comps were positive 4.8% for the quarter with positive comps of 6.7% in August, 74.1% in September and 3.8% in October. Comps in the US were positive 5.4% for the quarter with positive comps of 7.5% in August, 4.7% in September, and 4.2% in October. The cadence of our monthly comps in due in large part to Hurricane related sales.

In the third quarter of fiscal 2017, we experienced approximately $282 million of Hurricane related sales and the majority of those sales occurred in September and October. In the third quarter of this year, we had approximately $150 million of sales related to both the 2017 and 2018 Hurricanes. These sales were more equally spread across the quarter.

We estimate that Hurricane related sales positively impacted US comps by 60 basis points in August, but negatively impacted US comps by 80 basis points in September and 120 basis points in October. In the third quarter, our gross margin was 34.8%, an increase of 23 basis points from last year.

The year-over-year change in our gross margin reflects the following factors. First, the new accounting standard drove about $147 million of gross profit or 47 basis points of gross margin expansion. Second, higher supply chain and transportation costs caused approximately 23 basis points of gross margin contraction.

And finally the net impact of all other drivers of gross margin resulted in 1 basis point of contraction. For the year, we now expect our gross margin rate to expand by approximately 37 basis points. In the third quarter, operating expense as a percent of sales increased by 23 basis points to 20.1% due to the following factors.

First, we experienced 90 basis points of expense leverage in BAU, or Business As Usual expense. Our strong leverage in the core of our business was driven by good expense control, but also reflects some year-over-year benefit due to certain Hurricane related expenses that did not repeat this year.

Second, the new accounting standard resulted in $147 million increase to our operating expenses and caused 51 basis points of operating expense deleverage. And finally, expenses related to our strategic investment plan of roughly $164 million resulted in approximately 62 basis points of operating expense deleverage.

For the year we now expect our fiscal 2018 operating expenses to grow at approximately 131% of our sales growth rate. Our operating margin for the third quarter was 14.7%, essentially flat with last year.

Interest and other expense for the third quarter decreased by $23 million to $224 million, largely due to tax settlements that occurred in the quarter. In the third quarter, our effective tax rate was 21.4% and for the year-to-date was 23.3%, lower than last year and our guidance.

The lower rate reflects tax reform and a few other discreet items that were recorded in the quarter, including a reconcilement of the provisional tax charge we recorded in the fourth quarter of last year. For fiscal 2018, we now expect our effective tax rate will be approximately 24%.

Our diluted earnings per share for the third quarter were $2.51, an increase of 36.4% from last year. Total sales per square foot for the third quarter were approximately $434, up 5.2% from last year. Compared to last year, inventory dollars grew by $1.3 billion to $14.8 billion and inventory turns remained at 5.2 times.

The growth in our inventory versus last year reflects the investments we're making to accelerate merchandising expense [ph], higher in stock levels than we had one year ago and some pull forward of planned inventory purchases. In the third quarter, we repurchased $2.5 billion or approximately 12.6 million shares of outstanding stock.

We also received approximately 1 million shares related to an ASR program we initiated in the second quarter. Year-to-date, we have repurchased approximately $5.5 billion of our outstanding shares, and we now expect to repurchase approximately $8 billion of our outstanding shares for the year.

We plan to fund our fourth quarter share repurchases with cash on hand and with proceeds from incremental debts. In the fourth quarter we intend to replace $1.15 billion of senior notes that came due in September and we may raise additional long-term indebtedness, which will take us closer to our targeted adjusted debt to EBITDA ratio of 2 times.

Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 42.2%, 970 basis points higher than the third quarter of fiscal 2017.

Turning to our outlook for the remainder of the year, remember that we have a directionally correct but imperfect model that we use to forecast sales growth. It starts with GDP growth, which is strong, consumer sentiment remains near all-time highs and unemployment is the lowest it has been in nearly 50 years.

Housing related metrics are moderating, but the drivers of home improvement spend are supportive of our outlook. Home prices continue to appreciate, the housing stock is ageing, households are being formed and housing continues to turn over.

And while we see healthy home improvement demand, it is important to note that in the fourth quarter we are up against approximately $380 million of Hurricane related sales. Today, we're updating our fiscal 2018 sales guidance to reflect our year-to-date outperformance.

We're also lifting our earnings per share guidance to reflect our expectations for fiscal 2018 gross margin, operating expense, share repurchases and tax rate. Remember that we guide off GAAP and recall that fiscal 2018 will include a 53rd week, so the fourth quarter of fiscal 2018 will consist of 14 weeks.

For fiscal 2018, we expect sales to increase by approximately 7.2% with positive comps as calculated on a 52-week basis of approximately 5.5%. For earnings per share, we expect fiscal 2018 diluted earnings per share to grow approximately 33.8% to $9.75. With that, I would like to thank you for your participation in today's call.

And Porsha, we are now ready for questions..

Thank you. [Operator instructions] And our first question today will come from Christopher Horvers with J.P. Morgan..

Thanks, good morning. So if you - yeah, there's a lot of questions on the consumer in the home environment and housing.

If you look at your fourth quarter guidance, it seems like inflation after some benefit in the third quarter maybe flat, maybe a headwind, you also had a - have a harder comparing the Hurricane front, so you're still guiding to about 4.5 for the fourth quarter assuming that the US is going to be better than that of FX.

So what are you seeing in the business, what gives you the confidence to give that level of a guide?.

Chris, I'll give you a high level and let Carol walk you through the details. Again, we see overall the environment for home improvement is solid.

We're clearly up against significant Hurricane numbers, but as we see it basically two years stat comps would be comparable in the first half and the second half of the year as we look forward and that's really based on the strength that we see for not only the home improvement factors, but what we've lined up for the back half of the year in terms of the events and merchandise and great gift center that Ted talked about.

We're excited about where we're going in the back half..

That's right, Chris. And we get comfort from our guidance not only from what we're seeing in the macro environment, but from what we're seeing in our - in sales and we're pleased with how the quarter has begun..

Excellent, so wanted to fast forward a little bit on tariff risk, you had the experience of appliances that look like you marginally pass through those price increases, but as you think about a more broad potential tariff to next year, how would you just size up your potential risk and can you also talk about how you think about investment in sort of - in share? Some companies have commented that they would try to maintain the gross margin rate, how would you think about balancing gross margin rate versus let's say in certain categories maybe flooring trying to go after share and drive gross profit dollars..

So Chris, I'll start and let Ted jump in here. Yeah, we've seen as you mentioned a tariffs impact in laundry for example. The tariffs that have come through to date represent 1% of US purchases and we see more happen in January and who knows what's going to happen. But if the 25% were to go in place that's going to represent about 3.5% of US purchases.

And clearly we'll work to mitigate as much of that as possible, but as you saw in laundry you will see some impact in prices.

The comment that I would make as it relates to the second part of your question is, we run this business on a portfolio basis and we will do everything we can to mitigate the pressure on the customer to the best of our ability.

But don't think of us taking costs in one area and that's where necessarily retail gets applied, it's portfolio approach, we're in a project business..

Yeah, I would add to that Craig, its manageable is the term I'm using Chris. Certainly of what we've seen today is more than manageable particularly in the light of that portfolio approach that Craig described.

But a couple of comments, good news, if you look at what happened with laundry and that's generally a mad priced industry, so the industry did take that price largely attributable to tariffs, we also had stilt cost in that as well, it's just the straight laundry tariff.

And while there was an initial reaction to unit productivity is we've right now cycled through that several months our laundry sales and unit productivity is on par if not slightly better than the average of our overall appliance business.

So we were able to cycle through that and would expect to see the same again given the strength of demand in other categories as well..

Thanks, everybody..

Thank you..

And next we'll move on to Michael Lasser with UBS..

Good morning. Thanks a lot for taking my question. So it sounds like your view is that home improvement demand has been and will be decoupled from housing.

How long do you think that can persist and what level of home prices and housing turnover would make you rethink that view?.

Michael, I think I'd - and we would phrase that a bit differently. We have this directionally correct but imperfect model that we use to forecast ourselves outlook.

As I mentioned, it starts with GDP, and to that we add the benefits from a number of different housing metrics including household formation, home price appreciation, the age of the housing stock and housing turnover.

And if we look at those drivers, we think they all bode well for our outlook, now our outlook would suggest that our fourth quarter comps will be lower than what we reported in the third quarter, but that's because we are up against almost $400 million of hurricane related sales.

And while we do expect to get hurricane related sales in the fourth quarter, we don't expect to get $400 million worth of hurricane related sales, so we factor that into our outlook. In terms of decoupling, there's one metric that's gotten a lot of attention recently and that's housing turnover.

And if you look at housing turnover, housing turnover is lower than we thought it would be at the beginning of the year when we put together our directionally correct but imperfect model.

So we went back and calculated what we believe the impact of a lower housing turnover than what we had projected at the beginning of the year, what the impact has been to our outlook, and based on our model which is not perfect, but based on our model, the impact has been 13 basis points.

And then one other correlation number to share with you, at least, through the way that we look at the world, we correlated housing turnover with transactions and we don't do a smoothing approach, we do look at the actual data on a one-month lag basis. If you look at historical correlation from 2000 to now, the correlation coefficient was 0.53. Okay.

But if you go and run it again from 2010 to now, it's 0.4, and if you run it from 2015 to now, it's 0.33. So it's decoupled a bit, we think in large part because of the housing shortage in the US.

The way that we're talking about housing metrics, it's a bit like a Rubik's Cube, you just got to turn it and turn it and turn it until you form a point of view on what it means for home improvements band..

And, Carol, that's helpful, and - because you've guided for the next few years that comps will grow in the 5%-ish range.

So should we think about if housing turnover continues to decline at a similar rate and home prices start to moderate, you know, that the risk to that forecast would be in this 13 basis point type range or would not be as significant as what would be implied by the headlines from those port - from that outlook?.

Again it's a Rubik's Cube, you can't just look at turnover when you're turning the cube around. We would need to refresh our point of view on home price appreciation as well because that's been a big driver of our sales growth for sure.

We've seen since 2011, homeowners have had a 140% increase in their equity, now up to $124,000 per unit, so real wealth has been created.

Home prices are projected to increase in 2019, albeit not at the rate that we've seen this year, so we're refreshing our point of view, we're not taking ourselves from targets down because we feel very comfortable with the targets that we laid out a year ago, but in February, we will give you the specific number for 2019..

And my follow-up question is there's been a lot of well documented pressure on your many of the home improvement vendors and you have been vocal about seeing an increase in the requests for price increases for those that sell products in to you.

So putting aside their commodity inflation, are you starting to see an increase in product price inflation associated with the 90% of your sales that are related to products and you expect that that's going to continue to increase from here?.

We're certainly seeing, we are still seeing cost out but we are seeing a net cost in that we haven't experienced in the last several years and we are seeing an increase in supplier requests for cost in.

But again, I'd say, they're facing some of the same costs that Carol called out, I mean, people are facing transportation costs that's what we hear universally, again, outside, as you said, commodity or tariff, things like transportation is universal and who knows what happens going into '19, but that seems to be the theme for the cost requests for '18..

Okay, just a follow-up on that.

Since you quantify the impact the commodity inflation provides your ticket, could you quantify the impact that non-commodity inflation provides your ticket?.

What we've seen to date it's less than ticket than the 60 - the commodity that we called out the 61 basis points..

It's less than that..

Understood. Thank you very much..

And next we'll move to Brian Nagel with Oppenheimer..

Hi, good morning. Thank you for taking my questions So, I think, I want to follow up a bit at the risk of beating a dead horse here. On the macro environment, follow up to Michael's question. So, Carol, when you talk about your algorithm, which the detail you gave surprised, very helpful, thank you.

Particularly with regard to the housing turnover metrics, it sounds to me like you're talking more from acquaintance standpoint, how you're - how - shifts in these metrics impact sales at Home Depot and was in real time? Have you done any work around or any insights into how the kind of a lead lag relationship, so if we are seeing the somewhat slower housing turn data now, who knows that's going to persist or not, but could that lead - could that have a larger impact upon sales that you're at Home Depot at some point in the future?.

Well, the correlation coefficients that I shared with you on turnover were based on a one-month lag, and we haven't done a lot of leading lagging work yet, because the environment is so very different than it's been in prior cycles. So there's a lot of conversation, for example, on affordability, and we look at affordability too.

But what happened last time around when affordability started to if you will slow down is the underwriting standards loosened up dramatically and that's what led to the housing prices as we all know. Well, that's not going to happen again, because of Dr. Ike.

And so you can't look at history necessarily to understand what's going to happen in the future, you've got to kind of look at the future and what's happening. And as we look at the future and what's happening, fundamentally, you got to look at the economy and the economy is good.

People are employed, they have more income, they've got more to come with tax reform, so fundamentally, we feel very good about just the two eyebrows of the spend in our business..

Got it and then a follow-up question, there's been a lot written about, talked about, certain markets within the United States where you've seen pronounced weakness in home sales, as a result of either supply issues or housing prices whatever.

And I think you've discussed this on prior calls, but if you look at your business, whether there's areas or, you know, in the North East, West Coast wherever, are you seeing any - in those type of markets, are you seeing any impact upon Home Depot sales?.

So we believe like you that housing is very local and when you get into the areas of home price appreciation and affordability, it's really local. So we went market by market to see are we seeing any measurable impact on ourselves and we just can't see it.

Now, we're hopefully smart enough to understand that you got to stay really on top of the data, because the one watch out of course is will affordability with rising home prices and rising interest rates at some point set a market clearing price for all home price appreciation and home price appreciation stall, we're not there.

And, in fact, home prices are projected to increase next year, but we're watching this.

I'll just give you one example without giving you the numbers, because we don't want to get into a habit of calling out performance by market, but if you look at LA, the affordability index in LA is terrible, it's 59, it's the worst it's been since 2008, and ourselves and LA are very good..

Helpful as always. Thank you..

We'll next move on to Chuck Grom with Gordon Haskett..

Hey, thanks a lot. Good morning.

Just again on the housing front, Realogy spoke last week about a pretty significant slowdown and October transaction is down 6%, and it looks like your October comps were 11.2% on the stack adjusted for the hurricane, say, up 12.4% still a little bit of a slowdown year-to-date, just when you look at the month of October, is there anything significant from a volatility where the customer is buying or how they're buying?.

Well, overall, I mean, again, when you think about what happened in last year's hurricane, as Carol called out, there was more hurricane pressure that we faced in October than in September and clearly September and October combined were much more significant from a pressure standpoint than the beginning of the quarter..

And even if you ignore hurricanes, there wasn't anything dramatically different in the business other than the volatility in commodity prices. At the end of the quarter, we saw lumber prices fall precipitously, but I think, Ted, that actually was in some ways - it's a good news..

No, that's very good news. So, if you look at some of the cost pressures we're seeing on the one hand with certain commodities and tariffs, we've seen a dramatic decrease in wood fiber costs, so we went down. At one point of the year, we were 40% above the prior year; we're now 24%-ish below prior year.

And as those lumber prices have come down, unit productivity has moved dramatically and we believe kick starting more project business which is obviously great for us..

And one reason why we really are concerned about the fourth quarter from a commodity perspective is because we see this unit productivity..

Okay. That's very helpful.

And then just to switch gears in inventory levels relative to sales that widened a bit more than the past couple of quarters, curious if that was intentional as maybe look to bring in some items ahead of the tariffs or was a spillover from October? Maybe just frame out how you feel about currency and where you think you will end the year on the inventory front?.

From an inventory standpoint, Marc [indiscernible]. We feel good about the overall quality of the inventory that we had and the growth in inventory is really by design given a few factors..

Yeah. We continue to expect to see inventory productivity here at the Home Depot, but customer service begins with in-stock, so we really focus mostly on our in-stock. We have implemented tiered replenishment strategies that really provide focused investments to drive sales and in-stock where it matters the most.

And the results we're seeing from that are really very good. We've actually reduced the number of out of stocks per store by 24% in our top selling SKUs and folks bringing that to life with the new in-store processes, we feel great about our shelf availability there.

On top of that we've improved our direct fulfillment center in-stocks and service levels to the customers and setting new records in terms of in-stock there. So pleased with our in-stock levels and the investments we've made there..

The other part of that is our merchandising resets and obviously we've invested in that as well and then to your point, we did call some plant purchases forward to give ahead in terms of tariffs..

Okay, great. Thank you very much..

And next we'll move to Simeon Gutman with Morgan Stanley..

Thanks. Good morning. If we add back some of the hurricane impacts that you called out, you get to somewhere in the 5% to 6% range and I'm keeping inflation in there for now.

I just want to know is that number consistent with markets that have not been affected by any weather that year-over-year there's no benefit or compare - or tailwind - I'm sorry headwind.

And then anything changing with consumers and opening price points opting for something lower taken anything on the consumer side that that shows any cracks?.

We always look at the spread of performance by our 19 US region, and if you throw out the high and the low because those are hurricane related, one was negative and one was double digit positive, if you throw out the high and the low, the spread was the narrowest, it's been a long time it was 6.8%..

And in on the product purchase we continue to see both pro and consumers trading up with all the innovation the great products and brands we're offering in the stores, so that was extremely healthy in that progression of comp as you go up price points, in fact, if you'd look at our increase in ticket the 3.5%, the vast majority of that is driven by mix in innovation..

Right, okay, my follow-up, just two quick parts, the inventory, I guess you had extra inventory, can you tell us what categories you're investing deeper in? And then just a point of clarification, this may have been mentioned in the prepared remarks, the Q4 EBIT looks a little bit below the street, is that freight cost continuing or is there some shift of expenses that go from third quarter into fourth?.

So, I answer that first. Based on the guidance that we've given you, the expense growth factor in Q4 should be lower than what we reported in Q3.

And the gross margin expansion should be higher, that's a bit because of the 53rd week, so maybe there's some issue with the 53 week modeling, I don't know, but we can certainly offline help you with your models..

Okay and the inventory?.

As far as the inventory categories, we're not going to give specific about where we invested for a couple of reasons [ph]..

No worry. Thank you..

And Matt McClintock with Barclays, we'll have our next question..

Hi, yes, good morning, everyone. I'd actually like to ask two questions, the first one is on car and van delivery increased utilization for both Pro and DIY.

Are you seeing outsized gains in either Pro or DIY relative to the other as you roll this out and build awareness?.

Car and van, we're pleased with the rollout there, as Greg mentioned, we're up to 41% of the population with car and van available, so very pleased with that rollout. The car - as the trucks get bigger, the Pros get more engaged.

So if you think about it, our big flatbed deliveries that's very Pro focused; as you work your way down to car, that's more and more consumer focused.

We're pleased to have that option out there for all our customers, though it's an important part of the portfolio of delivery options and we think those options are important across the range to meet our customer's needs in any given occasion..

Thanks. That's helpful.

And then as a follow-up, just on home décor, I've seen the catalog this year, is there any - are you leaning into that category in any way different than what you did last year, is there any build there or is it more of the same?.

As we outlined in our investor conference at the end of last year, we said we were going to lean in to home decor and we've been doing that with the catalog and in online, this is an online and direct play for us and we're seeing nice results, the customers engaging with The Home Depot in the home related decor categories and we'll continue that through the next year, certainly..

Can I just - on the back end of that is, is there anything specific to the holiday that you think about with that category relative to the rest of the year?.

No. I mean, we do our holiday decor set in the stores, obviously, that continues to be an incredibly strong business, in fact, it's the success in that business that gave us confidence that that we could move a little more decor oriented, not product we want to bring into the store but perfectly appropriate to engage the customer online..

Perfect. Thank you very much.

And we'll move on to Steve Forbes with Guggenheim Securities..

Good morning. I wanted to start with the expense growth factor if you can. Can you help us break down the components in the third quarter? I think counting strategic investments business as usual.

And then as part of that, maybe just update us what your thoughts on the appropriate business as usual run rate given the year-to-date performance, is it still that 90%, that 4.5% comp and 75 at 6, it looks like you did a little better than that year-to-date..

Well, I think what I'll do for you is break down the components for the full year, because I've given you the dollars for the quarter and you can do the math. We're guiding on expense growth forecast of 131% for the full year, the breakdown of that is BAU is 42%, invest is 51% and the change in accounting is 38%.

And then in terms of the longer term view of our guidance, nothing has materially changed..

And then just a quick follow-up, given the build out plans within the supply chain, maybe just update us with your views around your hiring and retaining employees given the competitive workforce dynamic and obviously your initiatives on that front.

Are you having trouble or are you still finding the availability of employees to meet that upcoming need - the future need?.

Yeah, we were able to hire over 80,000 associates for spring selling season this year. Candidly, we had a little concern as to whether or not it would be more challenging, but we really didn't find that to be the case. And Mark, I don't think you've seen anything different right now on supply chain end..

No, it's been pretty much the same there, we've had no real issues there..

Thank you..

You bet..

And we'll move on to Seth Sigman with Credit Suisse..

Thanks. Hey, guys.

A couple follow-up questions, just to go back to housing, as you mentioned, the consumer is obviously very healthy right now, on the housing front there's a lot of talk about just the lack of urgency as it relates to turnover, not actual demand but there's a lack of urgency, and I realize turnover on its own is a small part of the business.

But I'm curious from a behavior perspective are you seeing any signs that the consumer is maybe taking more of a wait and see approach as it relates to bigger projects similar to how they're approaching purchasing the home?.

We're not seeing that. And Ted called out the strength in our big ticket categories which grew more than 9% in the quarter. One hypothesis is that with rising interest rates consumers are intended to stay in their home and they have wealth in their homes and their home is aging and so they're spending money on their home.

Another thing I would like to say about the consumer because we've done a lot of work in this regard and just thought we'd share it, because there was some interest about what is the impact of tax reform really meet on consumer's wallets.

And I think we all know that tax reform is really good for consumers, it's projected that $1.1 trillion will flow to consumer's tax filers over the next 10 years.

The way that's playing out in 2018 is about 43% of that benefit is flowing into paychecks today, the remaining 57% of the benefits will be realized when filers actually file their tax return next year, the other claim credits and that's how they get their benefits.

The only way they could receive that benefit today is if they have adjusted their withholding. So we looked at 300,000 Home Depot associates to see whether or not they had adjusted their withholding, and only 3,000 of those associates had adjusted their withholdings. So we believe that many consumers are going to have a nice tax surprise next year.

Now, if you are a high earner in a high state and local tax state like California or New York or Connecticut, well, that won't be the case, but high earners are actually those with $500,000 or more. Those folks, well, they're going to have a bit of a tax bill and that they haven't prepared for it is going to be a negative surprise.

But we went to our consumer insights team and said, hey, what's the average income of our customers? 97% of our customer's average income is less than $250,000. So we think the health of the consumer continues into 2019..

Okay. Thanks Carol for that color. I appreciate it.

And we'll move on to Scot Ciccarelli with RBC..

Good morning, guys.

Scot Ciccarelli, so are there any markets or even product categories where you're starting to see some trade down activity and related to that how do you think that would play out in a rising price environment because of tariffs and maybe you grant some of the price increase request that you're getting from your vendors?.

So I'll start with a comment and turn it to Ted. Even in the downturn of 2008, which was obviously the most difficult since the depression,customers were willing to spend for new innovative product..

Yeah. Ted, this is Scott. We haven't seen it yet and something I'm looking at, very closely we're looking at unit productivity by opening price point good, better, best, premium.

Making sure we're priced right at the opening price point level and making sure inventory levels are ready to go to see if we're going to see that dynamic that you just referenced and we have not seen it, now whether that comes we'll be ready for it, but today, as Craig said, people are trading up for the new innovative product.

I mean a classic example of that is you take a category like vinyl flooring, vinyl flooring was almost on its deathbed and then innovation came along and you now have vinyl plank flooring that is flying out of the stores at a premium price, it's a great value to the customer, it's easy to use, it's simple for the Pro and to install and that's a classic example of why innovation drive sales..

And to be clear on the market front, like, Carol, you already mentioned, the LA market for example, any markets where you're starting to see trade down activity maybe particularly if you could focus on kind of overheated housing markets, or what you would view as where affordability isn't great?.

I haven't seen anything like that at all..

Haven't seen it..

Okay, thank you guys..

And we'll move on to Elizabeth Suzuki with Bank of America Merrill Lynch..

Great, thanks.

Can you give any additional detail on the performance in Canada on a constant currency basis; I think you guys mentioned that the comps were positive, just curious how strong it was there?.

Canada posted positive comps in local currency.

Clearly there are pressures in Canada from a housing standpoint, the government has made a conscious decision to slow down housing in Canada and you see that in the numbers, but they delivered a great performance, we're seeing terrific online growth in Canada as a Canadian customer embraces e-commerce as well..

Okay and was there any impacts in the quarter from competitive pricing from other large players as they rationalized some inventory this quarter?.

We're certainly seeing much more promotional activity as folks have made decisions to close stores and liquidate inventory..

Okay.

You would - and then would you say that had a material impact on your sales this quarter or was it not enough to call out?.

We don't know how to measure that..

No, we never had a clue how to measure that..

Alright, thanks..

Next I move to Jonathan Matuszewski with Jefferies..

Great, thanks for taking my questions. Just to start off, last quarter you mentioned some cross functional teams focused on improving the experience online for customers, so maybe just expand on that.

What do you see as your competitive advantage today online relative to peers and with personalization a big push, have you seen a benefit in terms of average order values or transactions when the sites customized based on prior purchases?.

Yeah. Overall, absolutely, we're very pleased with the results from our initiatives as part of our investment strategy that we've laid out, supply chain is obviously a very big component of that but leaning into our online investments also a large piece of that.

And we've started to do a lot of work with our category refreshes, I think this is a virtual reset online, a lot of work on our search efficacy, a lot of work with the supply chain team as they've gotten sharper on delivery in our delivery windows, we call it dynamic ETA.

So when you're checking out, we would put before a broad brush seven to 10 days for delivery, now by zip code we can put the day that you'll be getting that product, all of these things have led to much better traffic. We had one of our strongest traffic quarters that we've seen in a number of years.

Our visits were - our absolute increase in visits was our single largest growth in the quarter in visits and then it all resulted in the comp sales of 28%, and that's also due to increased conversions.

So we're getting people to engage in to the side, the experience is getting to the right product, we're getting to the right close, all of this while more and more of the traffic moves to our mobile app in mobile devices and where we're seeing double digit increases in conversion rates and modest increase in average ticket, so very pleased with all of the initiatives..

And clearly the customer is engaging obviously in the digital world, 40% of the orders in the quarter were picked up in store at the customer's choice. So this is truly an interconnected experience going forward, leveraging all the capabilities and assets of Home Depot in both the digital and physical world..

Great, that's helpful and then just a quick follow up. Can you give an update on the store labor pilot? I believe you pointed to a sales lift in 2Q from the pilot, maybe better conversion and what not. So may be just discuss any potential uplift in sales from 3Q from the labor pilot and what's the trajectory for rolling that out ahead? Thanks..

It's easier for us to quantify the productivity that we enjoyed off of the new labor model which Ann-Marie has put into our stores. We saw 46 basis points of payroll leverage in the third quarter and a large part because of that new labor model. And we've fully rolled out -.

Great, thank you..

Yeah, we've fully rolled out across the company, so we will get the full benefit in 2019..

Porsha, we have time for one more question..

Thank you. Our final question today will come from Scott Mushkin with Wolfe Research..

Hey, guys. Thanks for fitting me in. So I just wanted to ask you Carol, if you look at the business, obviously we had a very sharp housing turn on 2008, but if we looked at the business, we just assume get a downturn because almost every investor seems to think.

How do you think the business performs through the - through an average downturn if you guys looked at that? And then also, would you guys ever consider using your balance sheet more aggressively as we got into a situation like that? So that's my first question..

So what we've done is looked through the last recession which was just a crazy recession and went back to 2000 timeframe. The culture wasn't apparently mild recession and our comps at that point were flat, so we modeled flat comps to say that's the reasonable downturn. I don't know if that's reasonable, but I think it is reasonable.

Staying true our investment plan because of the financial strength of the company, we can say true to our investment plan and we take our operating margin down to a little over 12%..

I thought you said that kind of cut down all of it..

I'm sorry, we take our operating margin down to a little over 12% in a flat comp environment staying true to the investments. And we fully scale as a competitive advantage, we use it every day. As Ted mentioned we got lots of people coming knocking on our doors asking for things and we're working through that with the power of the Home Depot..

Again as far as using the balance sheet a little bit more aggressively if we got into that downturn situation?.

Yeah, that's our scale, we had the opportunity to do that, yeah..

Alright, perfect. Thank you for taking my questions..

Well, thank you for joining us today. We look forward to speaking with you on our fourth quarter earnings call in February..

That then will conclude today's call. We thank you for your participation..