Home Depot, Inc. (The)

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at the home depot we're dedicated to helping you build the skills that get your home projects done right that's why we offer free and interactive online homeowner 101 and diy workshops set up to be a resource no matter your age or skill level during the greetings and welcome to the home depot fourth quarter 2022 earnings conference call at this time all participants are in a listen-only mode

A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Jancy. Please go ahead.

Thank you, Christine, and good morning, everyone. Welcome to Home Depot's fourth quarter and fiscal year 2022 earnings call. Joining us on our call today are Ted Decker, Chair, President, and CEO, Jeff Kinnaird, Executive Vice President of Merchandising, Anne Marie Campbell, Executive Vice President of U.S. Stores and International Operations, and Richard McVale, Executive Vice President and Chief Financial Officer. 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 Ted, 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 presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Ted.

Thanks, Isabel, and good morning, everyone. Fiscal 2022 is another record year for our business, as we achieved $157.4 billion in sales. We added over $6 billion in sales and increased diluted earnings per share 7.5% versus last year to $16.69. Over a three-year period, we have grown sales by over $47 billion and delivered diluted earnings per share growth of over 60% while investing in the long-term health of our business. Throughout fiscal 2022, we continue to face reduced friction for our customers to improve the shopping experience. As Anne will discuss, we invested in an improved customer and associate experience in our stores by implementing a new store leadership structure. We also drove productivity within the four walls of our store through our Get Stores Right, or GSR, space optimization initiative. And we've implemented new tools and technology in stores to reduce complexity for associates and improve customer service. We're also pleased with the traction we are seeing in our interconnected business. We've seen increased app engagement, downloads, conversion as we've rolled out several enhancements, including an improved online experience for our pro-loyalty program, seamless connectivity for our military program, and the launch of our new store mode feature, which makes store navigation and product interaction easier. We are very pleased with the continued progress on our supply chain build-out as we reached an important milestone earlier this year. All our appliance delivery volume is now managed through our market delivery operations, significantly improving the customer experience. In the near term, we continue to navigate a unique environment. Throughout most of fiscal 2022, we observed a resilient customer who is less price sensitive than we would have expected in the face of persistent inflation. In the third quarter, we noted some deceleration in certain products and categories, which was more pronounced in the fourth quarter This, along with the negative impact from lumber deflation, led to fourth quarter comps that were slightly softer than anticipated. We are closely monitoring our elasticities and trends across the business and believe we have the tools, team, and experience to manage in any environment. This team has been effectively navigating the unprecedented growth of the last three years, and I have full confidence in their ability to execute as we go forward. The investments in our associates, stores, Digital platforms, supply chain technology, and other strategic initiatives have strengthened our business and enabled us to grow, share, and deliver exceptional shareholder value over the long term. The most important investment we can make is in our people, which is why we are announcing that we are increasing annualized compensation by approximately $1 billion for our frontline hourly associates. We believe this investment will position us favorably in the market, allowing us not only to attract the most qualified talent, but also retain the exceptional associate base that is already in place. Today, our board approved a 10% increase in our quarterly dividend to $2.09 per share, which equates to an annual dividend of $8.36 per share. Turning to 2023, we are targeting approximately flat comp sales and a mid-single-digit percent decline in diluted earnings per share compared to last year. Richard will take you through the details in a moment. While we expect this to be a year of moderation in demand for home improvement, we believe that the long-term underpinnings of our market remain strong and that we are well-positioned to leverage our distinct competitive advantages to capitalize on compelling growth opportunities in our space. I could not be more pleased with the resilience and strength that our associates have continued to demonstrate, and I want to thank them and our supplier partners for their hard work and dedication to serving our customers in communities. Now I'm going to turn it over to Anne-Marie Campbell, Executive Vice President of U.S. Stores and International Operations. to share a little more on how we are taking care of our associates and continuing to enhance the customer experience.

Thanks, Ted, and good morning, everyone. I'm very excited to have the opportunity to spend a few minutes talking about the best team in retail and the many ways we are investing in the associate experience at the Home Depot. We know that our associates are a key differentiator and they are essential in helping us sustain the customer experience we strive for. In order to provide the best customer experience in home improvement, we must focus on cultivating the best associate experience in retail. So what does this mean to us? This means not only investing in competitive wages and benefits, but also providing tools training, and development opportunities that make working at the Home Depot an enjoyable and rewarding experience. As Ted mentioned, we are making a significant investment of approximately $1 billion in compensation for frontline hourly associates. This is a meaningful investment that we believe will position us favorably in the marketplace. But this is just one component of the associate investment story. We know that the key to an engaged and committed workforce is investing in the person, taking an interest in them and in their development. To that end, we began the year with a new store leadership structure, the first time we have changed the structure since our company was founded. The driving forces of these changes were customer service and associate development. We created new management positions focused entirely on the customer service experience, increasing the number of managers on the floor at any given time. This feeds up time for other store leaders to devote to associate training and development. The net result of all this is both an improved customer and associate experience while also creating new career paths for our associates. Another important element of a best-in-class associate experience rests on simplification. How can we simplify processes and systems in our stores to enable associates to deliver a better customer experience? and how can we simplify and streamline tasks so that an associate can spend more time serving our customers. One example we have talked about before is the work we've done to simplify order management in our stores with the Order Up initiative. Historically, our associates had to navigate dozens of systems But with Order Up, we have been able to streamline multiple systems into one that is simpler and more intuitive. We took simplification even further this year with the introduction of the new HC phone and associated applications such as Sidekiq. The rollout of our HD phone was a direct result of associate feedback on the limitations of our first generation in our devices known as first phones. For the first time ever, every associate on the floor will have an HD phone in their hands with enhanced communication features, tools, and training capabilities. This increased accessibility to real-time support is significant in helping our associates better serve our customers. In addition to enhancing the customer service experience, the new HD phone provides real-time access to tools and applications such as Sidekiq that helps associates prioritize the highest value task more effectively. Powered by machine learning, Sidekiq directs associates to key bays where on-shelf availability is low or outs exist. The HD phone empowers our associates to provide a best-in-class customer experience, increases operational efficiency, and generally makes an associate job much easier. These are just a few examples of the many ways we're investing to enhance and improve the associate experience at the Home Depot. Our associates are trusted advisors for our customers and are the heartbeat of our company. And I want to thank them for all they do to take care of our customers. We will continue to invest in them with a focus on listening to their needs, maintaining competitive wages and benefits, and continuing to enhance our tools, training, and development opportunities. With that, let me turn the call over to Jeff.

Thank you, Anne, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. During the fourth quarter, our comp average ticket increased 5.8%, and comp transactions decreased 6%. The growth in our comp average ticket was driven primarily by inflation across our product categories, as well as demand for new and innovative products. Inflation from core commodity categories positively impacted our average ticket growth by approximately 15 basis points during the fourth quarter. On lumber specifically, during the fourth quarter, we saw a significant decline in lumber prices relative to a year ago. On average, lumber prices were down over 50% year over year. Given this dynamic, comp sales were negatively impacted by approximately 70 basis points in the fourth quarter. Turning to our department comp performance for the fourth quarter, seven of our 14 merchandising departments posted positive comps. Build materials, plumbing, millwork, hardware, tools, outdoor garden, and paint had comps above the company average. Big ticket comp transactions, or those over $1,000, were up 3.8% compared to the fourth quarter of last year. While we saw big ticket strength across pro-heavy categories like portable power, pipe and fittings, and gypsum, we did experience softness in other categories like laundry, soft flooring, and roofing. During the fourth quarter, pro sales growth outpaced DIY. Pro backlog still remained elevated compared to historical averages, and we saw positive comp performance in our bill materials, plumbing, and millwork departments, as well as in certain bath-related categories. Turning to total company online sales, we are very pleased with the performance of our digital assets. Sales leveraging our digital platforms increased over 4% compared to the fourth quarter of last year. This was driven by our continued investments, which are resonating with our customers. For those customers that chose to transact with us online during the fourth quarter, approximately 45% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. During the fourth quarter, we held our Decorative Holiday, Gift Center, and Black Friday events. 2022 was a record sales year for these events. We are the product authority in home improvement, and together with our supplier partners, we continue to offer the best products at the best value for our customers every day. A great example of this is our recent partnership with Ecolab, a global leader in water, hygiene, and infection prevention solutions and services. The Ecolab Scientific Clean product line offers the cleaning solutions for commercial, industrial, and residential use that Ecolab is known for to both our pro and DIY customers, giving them access to innovative cleaning technology. And this partnership is exclusive to the Home Depot and marks the first of its kind in Ecolab's 100-year history. We're looking forward to the year ahead, particularly with the spring selling season right around the corner. We have a great lineup of products from live goods to outdoor power equipment. We continue to see an industry-wide shift from gas-powered to battery-powered tools. And as we've been discussing for some time, we have been leaning into this trend, offering a broad assortment of outdoor power equipment with cordless technology. We have the brands that matter across tools and outdoor power, including Ryobi, Milwaukee, DeWalt, and Makita. In our Spring Gift Center event, we are expanding our assortment to include cordless innovation in mowers, trimmers, blowers, and chainsaws. As an example, our Makita XGT platform will have over 125 professional-grade cordless tools. I'm particularly excited about our new 40-volt XGT mower that delivers gas-powered performance with high vacuum lift for premium cut quality. The XGT mower can cut over an acre in less than 60 minutes on two 40-volt XGT batteries. These Makita tools are exclusive to the Home Depot in the big box retail channel. One of our key focuses in the spring is to provide great value and innovation for our customers within our live goods offerings. We continually work to strengthen our relationship with key vendors throughout the industry, providing the best value, innovation, and garden performance for our customers. We have expanded our offerings in national, regional, and proprietary brands such as Vigoro, Rio, Proven Winners, Southern Living, and Knockout Rose, just to name a few. Our teams continue to look for better garden performance varieties that provide solutions for our customers. And we are excited about the upcoming spring season. With that, I'd like to turn the call over to Richard.

Thank you, Jeff, and good morning, everyone. In the fourth quarter, total sales were $35.8 billion, an increase of approximately $100 million, or 0.3 percent from last year. During the fourth quarter, our total company comps were essentially flat, at negative 0.3% for the quarter. As Jeff mentioned, lumber prices in the quarter negatively impacted comp sales by approximately 70 basis points. We had comps of negative 1.3% in November, positive 0.8% in December, and negative 0.1% in January. Comps in the U.S. were negative 0.3% for the quarter with negative comps of 1.4% in November, positive 0.7% in December, and negative 0.1% in January. For the year, our sales totaled a record $157.4 billion, with sales growth of $6.2 billion, or 4.1% versus fiscal 2021. For the year, total company comp sales increased 3.1% and U.S. comp sales increased 2.9%. In the fourth quarter, our gross margin was approximately 33.3%, an increase of seven basis points from last year. For the year, our gross margin was approximately 33.5%, a decrease of 10 basis points from last year. Gross margin was in line with our expectations reflecting planned investments in our supply chain capabilities. Throughout the year, we continued to successfully offset significant transportation and product cost pressures, as well as increased pressure from strength during the back half of the year. And we did this while maintaining our position as the customer's advocate for value. During the fourth quarter, operating expenses were approximately 20% of sales representing an increase of 32 basis points from last year. Our operating expense deleverage is driven largely by charges unique to the quarter related to litigation in California, storm-related expenses, and an unfortunate fire in one of our stores. For the year, operating expenses were approximately 18.3% of sales, representing a decrease of 13 basis points from fiscal 2021. Our operating margin for the fourth quarter was approximately 13.3% and for the year was approximately 15.3%. Interest and other expense for the fourth quarter increased by $85 million to $408 million due primarily to higher long-term debt levels than one year ago. In the fourth quarter, our effective tax rate was 22.6%, and for fiscal 2022 was 23.9%. Our diluted earnings per share for the fourth quarter were $3.30, an increase of 2.8% compared to the fourth quarter of 2021. Diluted earnings per share for fiscal 2022 were $16.69, an increase of 7.5% compared to fiscal 2021. During the year, we opened six new stores and lost a store in California due to a fire, bringing our store count to 2,322 at the end of fiscal 2022. Retail selling square footage was approximately 241 million square feet at the end of fiscal 2022. Total sales per retail square foot were approximately $627 in fiscal 2022, the highest annual figure in our company's history. At the end of the quarter, merchandise inventories were $24.9 billion, an increase of $2.8 billion versus last year, and inventory turns were 4.2 times, down from 5.2 times from the same period last year. Moving to capital allocation, during the fourth quarter, we invested approximately $900 million back into our business in the form of capital expenditures. This brings total capital expenditures for fiscal 2022 to $3.1 billion. During the year, we paid approximately $7.8 billion of dividends to our shareholders. We look to grow our dividend every year as we grow earnings. And as Ted mentioned, today, we announced our board of directors increased our quarterly dividend by 10% to $2.09 per share, which equates to an annual dividend of $8.36 per share. And finally, during fiscal 2022, we returned approximately $6.5 billion to our shareholders in the form of share repurchases, including $1.5 billion in the fourth quarter. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was 44.6% compared to 44.7% at the end of the fourth quarter of fiscal 2021. Now I'll comment on our outlook for 2023. As we think about how 2023 might unfold, we think it's helpful to look back on our performance since 2019. From 2019 through 2022, we grew sales by $47.2 billion a compound annual rate of 12.6%. During the first five quarters of this period, from the first quarter of 2020 through the first quarter of 2021, our sales were driven by significant ticket and transaction growth. This growth reflects factors unique to home improvement as homeowners spent more time in their homes and took on more projects as they saw their homes significantly increase in value over that period. The home improvement market also captured a greater share of the consumer's wallet as spending on goods outpaced spending on services during the period. Beginning in the second quarter of 2021 and continuing through the fourth quarter of 2022, we reported strong sales and earnings growth driven by tickets, while transactions steadily normalized back towards 2019 levels as the broader consumer economy shifted from goods and back into services. During this time, we continued to report positive sales growth in every quarter up to present. As we set targets for 2023, the context of the past three years led us to consider three factors that will likely influence our performance this year. First, the starting point for our target setting this year is our assumption regarding consumer spending. We've assumed, like many economists, that we will see flat real economic growth and consumer spending in 2023. Second, over the last seven quarters, we have seen our transactions gradually normalize as consumer spending has shifted from goods to services. We believe that if this shift continues at its current pace, the home improvement market would be down low single digits. And third, as an offset to this pressure, we plan to continue to capture market share. Our competitive advantages, the investments we have made over many years, and the unique advantage that our orange-blooded associates give us over our competition position us to take share in any environment. Taking these factors into account, we are targeting approximately flat sales and comp sales growth for 2023. Further, our operating margin target of 14.5% reflects approximately 60 basis points of impact from the compensation investment we announced today. Our effective tax rate is targeted at approximately 24.5%. Our diluted earnings per share is targeted to decline by a mid-single-digit percentage. Outside of this target setting, if lumber prices remain at current levels for the remainder of our fiscal year, that would equate to approximately 100 basis points of pressure to comp sales and an insignificant impact to earnings. At today's current price, this would imply more pressure in the first half than in the rest of the year. We plan to continue investing in our business with capex of approximately 2% of sales on an annual basis. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. We believe that we have positioned ourselves to meet the needs of our customers in any environment. The investments we've made in our business have enabled agility in our operating model. As we look forward, we will continue to invest to strengthen our position with customers, leverage our scale and low-cost position to drive growth faster than the market and deliver shareholder value. Thank you for your participation in today's call, and Christine, we are now ready for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question.

Good morning. Thanks a lot for taking my question. Ted, in this environment, we're all just kind of guessing, but we assume that your guesses are a lot more educated than any of the rest of us. And in that case, what do you see as the downside risk for the home improvement market in turn Home Depot this year, both in terms of the depth of a potential decline and the duration of a downturn. And in that case, how would Home Depot's earnings look in that scenario?

Well, good morning, Michael. Thanks for the question. We'll certainly address that. But before we go into a downside, you know, I'd like to set the tone on what we see that's favorable in the business trends. And We feel very good about our business. As we've just referenced, we've grown the business $47 billion over the last three years and grown earnings 60% during that time. Our associates did an amazing job focusing on the customer in this challenging environment, and there's really no way we would have captured that much share had we not been making the investments over the past few years. We also still see a healthy customer. I mean, we have good jobs, job growth, growing wages, still strong balance sheets, and most of our customers tend to own their home, which has seen a significant increase in value. But as we've said, we do see a unique environment with many cross-currents right now. Obviously, there's heightened inflation and rising interest rates, a tight labor market, and moderating equity in housing markets. So given all that, we do expect moderation in home improvement demand. Pro backlogs are still healthy, Michael, although they are off their peak from last year. And customers are still spending time at home. Homes are aging and worth about 40% more than they were before the start of the pandemic. But people are also starting to shift spend more towards services. And as we've said, we see some more price sensitivity. So given all that, we've set the stage for a moderating year in 2023, and Richard will take you through some of the downside cases that you alluded to.

So, yeah, so Michael, you know, just to recap quickly, the way that we set our target and our guidance for the year was to first start with the assumption of flat consumer spending, And then with respect to the goods sector of the economy, as I said over the last seven quarters, we've seen that shift across the consumer economy from goods to services. So we would anticipate this would put slight pressure on our market. And then we look to overcome that by taking share in the manner that we've done consistently over the past several years. So we're targeting flat. There are so many factors that influence our market right now, as Ted alluded to, But if you were to take a hypothetical situation, let's just think about that share shift that we call out. So we look at the share that we currently capture as a share of consumption, PCE, and we've tracked that through the COVID period and over the last few years. As we said in our guidance, if that share shift continued at the rates at which we have seen it behave Currently, we would expect the market to face low single-digit negative pressure. But if you were to take perhaps a more extreme case and say if that share of PCE that our market holds were to shift all the way back to 2019 levels by the end of the year, that would imply pressure of call it mid-single-digit percentages. And so that would sort of be one way to get your mind around a hypothetical case where share shift happens more rapidly than it has been.

So in an environment where the market's down mid-single digits, presumably Home Depot is going to do better than that. It'll take some market share. So can you frame out what you think the decremental margins would be in a down three or four type scenario? And as part of that, where do you think you would see this first? You're already starting to experience some challenges in areas like soft flooring and others that you outlined. Is that a precursor to weakness that you might experience in other categories?

Thank you. Well, so just to keep it simple, because share shift is not a perfect science. In a hypothetical case, and again, we're not guiding this way. This is not a downside case, but in a hypothetical situation, that share shift, if our comps were to be mid-single digit negative, we would see operating margin around 14% as kind of the corollary to that hypothetical situation.

And Michael, Jeff can give some further detail, but the price sensitivity is, while it's a bit broader in Q4 than we saw in Q3, it's still primarily those larger you know, single-ticket, more discretionary items that we've referenced before, appliances, you know, grills, patio, but still being a, you know, project-oriented business and with the pro backlog, again, albeit down, still strong, we're still seeing, you know, strong project businesses. But there is a bit more overall sensitivity, as we saw, you know, more one-for-one offset with ticket and transaction in Q4.

Yeah, thank you, Ted. So, yeah, in general, to your comments, you know, more broad than what we saw in the third quarter, but still very good project demand. If you look at the seven departments that outperformed the plumbing business, bill materials, millwork, hardware, tools, and paint, above our company average and just reflected the strength of the project business. To your point, Michael, we're watching categories like flooring very closely. We're working assortments. We're working different opportunities in the market to look at what's happening in categories like flooring. But some broader-based sensitivity, but still good strength in the overall business.

Thank you very much, and good luck.

Our next question comes from the line of Scott Ciccarelli with Truist. Please proceed with your question.

Good morning, guys. So can you please clarify your expectations for unit elasticity if we were to start to see same-sue inflation pressures ease? And then secondly, any common denominators in categories or geographies where you're starting to see some of the incremental softness? Thanks.

Sure, Scott. I think the last two years, we've had the same guidance that we're having this year, and that is that whatever inflation is represented in an average unit retail in ticket would be offset by transactions. So we start the year thinking about a balance of ticket and transaction, and that higher ticket driven by inflation would be offset with transactions. The outperformance of the prior two years was that we didn't see that much sensitivity. The consumer, our customer, was much more resilient, sort of purchased through that elasticity curve, if you will. What we are seeing now is some more sensitivity, and we had almost an exact one-for-one offset in Q4. That's what we're expecting for 2023. that there is still inflation. I mean, we are still in an inflationary environment, as we saw from CPI and PPI results last week. Although it is abating, and it's abating more, I would say, in our industry. Our costs on the table are much lower than they had been. Our wraparounds of price moves going into 23 will be much lower than they had been the prior two years. And so while we're still expecting an offset in transactions because the ticket won't be as high, the negative transactions won't be as low, but still net to that flat guidance for 2023.

Okay, thank you. And then any common denominator in terms of category or geographies where you're seeing some of the incremental softness? Is it just the ticket or is there –

Yeah, big ticket would be the ones that I called out before that have continued with softness. In the geographies, while we had a little more variability of our comp range, there's no particular geography that you'd call out other than weather-impacted ones that would show anything off the mean for us.

Got it. Thanks a lot.

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

Hey, good morning, everyone. Maybe related to the last question, we've had home prices have decelerated for about six to eight months now, and we know existing home sales are in deep negative territory. If you align your business against those trends and in markets where they're more pronounced, Is there a decoupling? In other words, the business is stable despite prices have fallen and existing home sales being down 20%, 30%. Thanks, Simeon.

On home prices, we know over a long term that our business does correlate to home price appreciation. Obviously, we've had unprecedented growth in appreciation since 2019. Home prices peaked in June of 2022. In fact, at that point, they were 45% higher than they were at the end of 2019. They have regressed by about 3% since that point, so we've seen some modest correction. But I can tell you, we have not seen an impact on a market-by-market basis since that peak. There's no relationship with comp sales and the home price appreciation or correction that we've seen. On housing turnover, there's just that interesting dynamic of what is actually happening in housing turnover. There just aren't the willing sellers out there to the degree that they have been in past eras. We're in such a healthy, our customer, our homeowner customer is in such a healthy position that, you know, you just think about their motive for selling. Did you know 90%, over 90% of U.S. homeowners either own their homes outright or have fixed rate mortgages under 5%. And so that incentive to sell and move to a higher rate mortgage just isn't there. And in fact, the incentive is really there to improve in place. So it's hard to say what the housing economy, how the housing economy might impact us. But no, to answer your first question, to date since 2022, we haven't seen a relationship.

And to follow up to a point that was made earlier, that if the share of PCE reverts back to the 2019 level, do you take a view on this or is there any confidence that it doesn't? And it's a view really on digestion. We've seen a couple of categories in real terms actually overcorrect the 2019, only two right now, but not home improvement, obviously. But how confident are you that we don't need to go back that far or that the digestion or so is done and we can hang out at the current share that we are?

You know, I think the only thing I look at really is the trajectory that we've observed. I think that's kind of the best information we can use. We're not making an assumption about whether, in your terms, there's full digestion or not.

Okay. Fair enough. Thanks. Good luck.

And, Simeon, I would say, you know, this is – we said this is a unique – period in hard to gauge on the shortest horizon. But we are just so incredibly bullish on the longer horizon for this industry. Just all the dynamics that we know about, starting with the fundamental shortage of housing. I mean, we're still, you know, whether it's one, two, three million units short, and with household formation and population growth and aging housing stocks, all the things that we talk about, I mean, that is all very much in place, and as the market works its way through PCE reversion or not, or level of that, and inflation, mortgage rates, that will all settle, and what you're left with is still a market that is underserved in housing units built, and over half the homes are over 40 years old, and as Richard said, the remaining in place with owning the home and low mortgage rates. People are going to want to make more significant improvements on those homes. So weeks remaining just couldn't be more bullish on the longer-term view of this industry.

Thank you.

Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.

Thank you for the I have a couple of questions that are both maybe more philosophical. And again, Ted, some of the comments made here about increased price sensitivity, I think, on the part of your consumers, and maybe that turned a little more severe than we saw in the third quarter. One of the big, I think, probably followed home people for a long time, one of the big, you know, positive things for your building to really understand the data. Brian, we can't wait.

Brian, you're breaking up. Can you repeat that?

Oh, I'm sorry. I'm going to move around here. So the question, I'll make it shorter. The question I'm having is, as you're looking at this, you know, the consumer behavior, you know, we're all seeking or searching right now for those signs of a weakening consumer given a tougher backdrop. But do you believe that we're still kind of in the one-off, what you're seeing is more one-off in nature, or is this really the beginnings of a weaker trend coming that could persist over the next few quarters?

Brian, it's Jeff. You know, as we talked about price sensitivity earlier, we are seeing some additional sensitivity or saw some additional sensitivity in Q4 versus Q3. But let me give you a real-time example of how we're looking at the business, and I'll go to the cleaning business as an example. As I spoke about in my prepared remarks, we launched in this quarter Ecolab, which is a premium cleaning brand in the market, which we're seeing exceptional performance. It is a trade-up category for for many consumers, many pros, and we're just really, really excited about the partnership and the long-term opportunity in that category. At the same time, we're expanding our HDX cleaning lineup, and that's just a great everyday value brand for our customers, and we're seeing a great pickup in that brand as well. So our merchants take the time by category to engineer what results they want to see, and cleaning is a great example there. At the same time, we're watching categories very closely like appliances, like patio furniture, like grills that we spoke about in Q3 and earlier today to ensure that we are positioned right for the current environment.

I appreciate the time. Thank you.

Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question.

Thanks. Good morning, everybody. Can you talk about what you saw from a rate of change in DIY versus pro in 4Q relative to 3Q? Are you seeing one side change faster than the other and how does that inform how you're thinking about the business in 23?

I don't know if we saw a rate of change, Chris. The highlight remains the high spend pro. I mean, that's still the strongest piece of the business, but I wouldn't say there was a rate of change much beyond that.

Got it. And then I guess can you share the puts and takes on the cadence of 23 from a top line perspective? You have DIY versus pro. You've got tough lumber laps in the near term, but you also have the easier spring lap. And so how are you thinking about the cadence of the year if you sort of had a did a zero in 4Q and you ran seasonal, you can get to a lot of different outcomes. So how are you thinking about the cadence? And just to clarify, is 100 basis points of lumber headwind in the top line guide?

Right. So, Chris, our guidance assumes that we'll comp slightly lower in the first half than the second half. The lumber pressure we called out is sort of outside of guidance. There's so much volatility in that that we would not want to put that in guidance. There is 100 basis points of pressure to the year. If lumber remains at current prices, that pressure exists predominantly in the first half.

And Chris, as Richard mentioned, it's been a very turbulent couple of years in the lumber market. To give you an example of what we faced in the fourth quarter on the framing side, lumber was $420 per thousand on average compared to $886 on average in 2021. To put that in retail dollar cents for everyone, a two-by-four stud, which is one of our top unit movers in the business, retailed on average for $3.40 in the fourth quarter of this year. Last year, it was over $5.00. Now, we did make some ground back on units. So you could say that, you know, when you see a lumber market depressed or normalized, you see good unit productivity and you see good overall project business. As you look forward into the front half, that same two-by-four stud was over $10. It's now $3.50. So we'll see good unit productivity and certainly an opportunity to drive more project-related business.

And, Chris, another reason we leave that sort of lumber hypothetical case outside of guidance If that pressure does exist and come through, we would not see any material impact earnings.

Right. So you're not – there could be a price headwind, but there could be some offsetting positive elasticity on that side and sort of net-net that plus the fact it doesn't hit bottom line. It's outside the guide.

That's correct. You got it.

Thanks so much. Have a great spring.

Thank you. Nice.

Our next question comes from the line of Stephen Forbes with Guggenheim. Please proceed with your question.

Good morning. I wanted to start really trying to expand on the $1 billion investment that was announced. So curious, Ted or Richard or the team, can you comment on how the investment impacts plan compensation mix for the frontline associate in 2023 on average, inclusive of how we should think about the resetting of the success sharing program?

Sure. Yes, Stephen. And Anne, we'll take you through some of the detail on the rates. But just to talk about this investment, we feel just great about doing this for our associates. Customer service at the Home Depot starts with our associates, and we believe this investment is consistent with our values and is going to position us favorably in the markets. We've been operating successfully in a pressured labor market. We all know labor's been tighter and rates have been higher. But just last year, we were able to hire 200,000 associates. But we believe this move is going to protect our customer experience for the near medium and long term. We'll be able to track the most qualified candidates and retain the exceptional associate base that we already have. So we not only increased our starting wages, again, and we'll go into some detail, but we increased wages for every single frontline associate. And there's a term in retail, you know, you get compression when you raise the starting rates with tenured associates. We addressed compression in a meaningful way in this billion-dollar investment. So our tenured associates saw real wage increases with this move. And we hope to improve retention through this. That's why we call it an investment. And it's going to improve the customer experience through a more effective associate who's just in the building longer, understands our procedures, and is much more effective engaging with the customer and selling. And we harken back to our values wheel of investing in our associates. And what our founders said that We take care of our associates, they take care of the customer, and everything takes care of itself. And that's what this investment is all about. But, Ann, you can give some more detail, please.

Yeah, thank you, Ted. First of all, the investment is incremental. So you ask about success sharing, and that is still a part of our total compensation package. One of the things I spoke about around how we think about investing in our associates, wage is one component of it. We think about it not only with wage but benefits, but also the environment we create to promote our associates from within. And I think the piece that I will say, you know, we've spoken about this before that, you know, close to 90% of our leaders started on the floor of the store. And why is that important? This $1 billion investment puts us favorably in the marketplace so we can recruit, retain, and attract the best leaders because they are the future leaders for the company. So this is an incremental investment. Every single hourly associate will receive an increase. And to Ted's point, you know, or more tenured associates who are even key when we think about going into the spring season, also got an incremental investment, a pep in their step to continue to take market share in 2023.

Stephen, while we don't disclose average wages, and we've always and will continue to be competitive on a market-by-market level, and we've been competitive. It's why we were able to hire the 200,000 people last year. But after this change, Our starting rate in any one market, there'll be no market under $15 for a starting rate, and starting rates go much higher than that, depending on the market. And then the average wage, again, particularly with the investment in every associate, including tenured with addressing compression, we have an average wage that is well, well above the $15.00.

Appreciate the color. And then maybe just a quick follow-up for Richard. I think we're sort of targeting recapturing a 60% accounts payable to inventory ratio, but maybe just clarify if that's still the goal and when we should expect to achieve that this year.

Well, while we know that global supply chains are improving, at least relative to where we were last year at this time, We're still pulling forward inventory. We still see extended lead times. And we think that 2023 is going to be a year of continued improvement in supply chains. So, you know, we are encouraged by the inventory movements in our business. You know, the year-over-year inventory increase was the smallest quarterly increase of the entire year. And so we feel good about our inventory productivity. And, again, we've been managing in kind of exceptional circumstances. But, yes, I think over the long run, you will see us heading back to convention with respect to working capital.

Thank you.

You're welcome.

Our next question comes from the line of Karen Short with Credit Suisse. Please proceed with your question.

hey thanks very much good to talk to you first question I just want to ask is looking at the relationship on sales growth versus EBIT growth and I'm actually talking about this excluding the billion dollar investment obviously EBIT growth on a one-year basis is decently below sales growth so wondering just how to think about that relationship you know including or excluding but going forward and And then wondering if you could just talk a little bit about what you're seeing on 1Q to date in terms of comp performance.

Sure. So it may be more helpful to talk about the construction of operating margin year to year just to kind of take that out. That gives you a better sense. So in a flat comp environment, we would expect to see deleverage on a fixed cost base and obviously in an inflationary environment as exists today, that deleverage is somewhere between 30 to 40 basis points. In addition, our wage investment represents about 60 basis points of movement in year-to-year wage. And then offsetting that are productivity initiatives that we expect will generate between 10 and 20 basis points. of recapture of margin. And so that's how we walk from the 15.3 to the 14.5. Over the long run, we always expect to grow operating income faster than sales. We've been managing in a unique environment, and certainly our guidance implies the wage investment that we've made today. And the second part of your question, I'm sorry, I forgot.

Oh, it was just any color you could provide on 1Q performance in terms of comps.

Well, as I shared just a few questions ago, we do anticipate that comps in the first half will be slightly lower than the second half, and our performance to date reflects that guidance.

Okay, thanks very much.

Our next question comes from the line of Zach Fadum with Wells Fargo. Please proceed with your question.

Hey, good morning. Richard, it sounds like most of the margin pressure in 2023 is expected to land at the operating expense line. And I'm curious if you could talk to the puts and takes to gross margins specifically. And is it fair to assume the inflection we saw in Q4 to slightly positive is a fairer Your rear run rate from here, just given the bulk of your supply chain investments, are running their course, and then freight and commodities could be a tailwind.

You know, there are a lot of ins and outs. There were a lot of ins and outs in 2022. You know, we basically delivered gross margin precisely where we anticipated to at the beginning of the year, and underlying that was a lot of product costs and transportation costs. offset by actions. And within that, continued supply chain investment in our downstream or delivery operations. For 2023, we're targeting gross margin that's roughly flat year over year. Again, it will be a year of several ins and outs. Product cost inflation has decreased, but does persist. above historical levels. Transportation costs should actually be a tailwind. But we still have investment in our supply chain. And look, we did see some increased pressure from shrink in the back half, right? So we've got a lot of ins and outs, but roughly speaking, we're targeting essentially flat gross margin for the year.

Got it. That's helpful. And then following up on the billion dollars in wage investment, can you talk about where this puts you competitively versus your peers? And then if for whatever reason, if your comp appears to be falling short of that flattish expectation range, would you still make the planned investments in 2023 or could you spread them out over a couple of years?

We're committed to our investment. That's that's done. With respect to how we manage our P&L, we always operate with a degree of financial flexibility. And so in any environment, we're going to assess what that environment means for us and how we should manage the P&L.

Got it. Thanks for the time.

Christine, we have time for one more question.

Thank you. Our final question will come from the line of Stephen Zaccone with Citi. Please proceed with your question.

Good morning, all. Thanks for fitting me in here. I wanted to circle back to the duration part of Michael's first question. You know, Ted, when you think about home improvement demand being a moderation this year, when you take a little bit of a, you know, more medium term outlook over the next couple of years, just since you've seen strength in the business for the last three, you know, what are you focused on with the health of the homeowner that maybe this moderation could last a couple of years in nature?

Well, you know, As we've said, we're thrilled with the share we captured and the sales we drove. And while we don't love the moderation, you can't fight the tide, if you will, with PCE spend going back to services, people traveling and whatnot. But the two main things that we're going to stay focused on to take share, one, you know, I say the consumer, the consumer writes the check for all projects, even if the pro's doing the work. But for the consumer, we are laser-focused on delivering the best interconnected, frictionless shopping experience. Retail, as we know, is all about interconnection, physical world and the digital world, and we are laser-focused, Matt Carey and his team is focused on taking out all friction in that, and as we continue to delight customers with that frictionless experience. We'll look to gain more share. And then we haven't talked much about the pro in this call, but we are still 100% focused on building out all the capabilities that pro ecosystem that is going to allow us to capture more share of wallet with the pro and move up to larger plan purchases. And extremely pleased with the results we're seeing as we continue to put those capabilities in the marketplace. That's what we're going to do to keep taking share regardless of the environment or the duration of the environment.

Okay, thanks. And then the brief follow-up I had was just a question on the promotional environment. You know, it really hasn't been that much of an issue in home improvement the last couple of years. Would you expect it to be more of a factor this year just given overall moderation and demand?

Stephen, it's Jeff. No, nothing specific to call out on the promotional environment as we head into the first quarter, further into the first quarter. We're excited about the value we're offering our customers, and our spring sets have gone exceptionally well, and we're looking forward to the spring season. But no change that we can predict in the promotional environment.

Thanks for the detail.

Thank you. Ms. Jancy, I would now like to turn the floor back over to you for closing comments.

Thank you, Christine, and thank you for joining us today. We look forward to speaking with you on our first quarter earnings call in May.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.