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Good day, everyone.
Welcome to Home Depot's second quarter earnings conference call.
As a reminder, today's call is being recorded.
Beginning today's discussion is Mr. Bob Burton, Vice President of Investor Relations.
Please go ahead, sir.
- VP Investor Relations
Thank you and good morning everyone.
Welcome to The Home Depot's second quarter conference call.
As we reported this morning, the earnings per share results for the quarter were 50 cents, a 28 percent improvement year over year and 3 cents ahead of guidance and consensus.
Joining us on the call today are Bob Nardelli, Chairman, President and CEO of The Home Depot and Carol Tome, Executive Vice President and Chief Financial Officer, together with other Home Depot executives.
Carol will review the details of the financial results, Bob will offer his comments, and then we'll take your questions.
As a reminder, the question and answer session is available to all interested parties, although questions will be limited to analysts and investors.
We will be available for media questions following the call.
This conference call is being broadcast realtime on the internet at homedepot.com.
We will also offer an internet replay of the call for a 5-day period, and a 2-day telephone replay, which is available at 719-457-0820, with a confirmation code of 784200.
Before I turn the call over to Carol, let me remind you that our discussion today will include forward-looking statements, relating to our estimates and expectations.
Additional information concerning factors that could cause our actual results to materially differ from these forward-looking statements is included in our 2001 annual report on Form 10-K.
We caution that written or oral forward-looking statements speak only as of the date they are made, and our actual results may differ materially from the present expectations or projections.
I'll now turn the call over to Carol.
- CFO, Executive VP
Thanks, Bob.
And good morning, everyone.
This morning, we are reporting the most profitable quarter in company history, both in terms of dollars and return on sales.
No matter how you look at it, from total square footage, or the number of customers we serve, or our sales, or our asset efficiency, or the profitability of our company, Home Depot's leadership in the home improvement industry is unquestionable.
Equally important, especially in today's environment, is our stellar financial condition.
We continue to distance ourselves with the best balance sheet among our peers.
All of this is a tribute to our associates, who bleed orange for this company that we call home.
Last November, Home Depot established 3-year growth targets for fiscal 2002 through 2004 of 15 to 18% top-line growth and 18 to 20% earnings growth.
For the first half of 2002, total sales increased 14% while earnings grew 31%.
While we are well ahead of our earnings target, for both the year-to-date and for the quarter, this quarter's, and therefore, the year-to-date sales gain, was below our target.
In the second quarter, The Home Depot faced a pretty tough selling environment, driven by both external and internal factors.
Externally, factors like weather, falling lumber prices, and low consumer confidence impacted our business.
Internally, we experienced a lot of changes in our store, all in an effort to move us to the store of the future.
These internal and external factors impacted sales.
We'll discuss these sales factors at length today.
As I mentioned, there were a number of very positive trends during the second quarter.
We posted the highest second quarter growth margin in our company's history, record operating returns, and earnings gains above expectations and the street consensus.
The financial strength of our company remains unsurpassed.
We ended with $5.9 billion in cash and more than $20 billion in equity.
Now, I want to take a few minutes and take a deeper dive into the numbers.
Second quarter 2002 net earnings totaled $1 billion, 182 million, up 28% from $924 million in the second quarter of fiscal 2001.
Diluted earnings per share were 50 cents, 28%, or 11 cents better than the prior year.
Sales for the quarter totaled $16.3 billion, up 12% from the prior year, driven by new store openings, and 1% comp sales gains.
A lot of factors impacted our comps.
As you know, cannibalization is an important element of our operating model.
In second quarter, we cannibalized about 24% of our stores and we estimate that this affected our comparable sales performance by approximately 4%, about the same as in prior periods.
During the quarter, we launched 7 vendor changeouts and 3 merchandising resets.
We estimate that these changes, as well as in-stock opportunities that materialized as we transitioned through our first spring season with our service performance improvement initiative, had a 2 to 3% negative impact to comps.
Also, lumber prices were depressed versus last year for much of the quarter.
And we saw sales pressure on lawn and garden categories, due to horrible weather in May and drought conditions in the East.
In our expo business, we experienced double-digit increase in customer counts but a weaker average ticket than last year, reflecting lower consumer spending for large projects.
On the positive side, we saw strengths in kitchen and bath, driven by appliances.
During the quarter we continued the rollout of our expanded appliance showroom set.
Comps in this fast-growing category exceeded 35% for the quarter.
Today, our expanded appliance program is in 292 stores, including 150 retrofits.
This year, we will accelerate the rollout to an additional 264 stores.
By the end of the year, 556 or 36% of our stores will have the expanded appliance showroom.
During the quarter, we also saw strength in two new product lines, HVAC and water treatment, that drove our plumbing category.
Customers responded to our tightly-focused, value-driven events that offered great values throughout the store.
We saw particular strength in categories like paint and flooring.
We also saw stronger performance in stores where these categories are supported by our design place initiatives.
Design place today is in 581 stores, including 251 retrofits.
An additional 204 stores are scheduled for completion by year-end.
Against a flat comp in the third quarter last year, we anticipate comparable store sales to be in the range of 2 to 4% during the third quarter.
We expect that continuing appliance gain, plus incremental sales driven by our design place and service initiatives, will provide up to 100 basis points of comparable sales for the quarter.
In support of our sales outlook, we have asked our stores to add $500 million of fresh inventory to existing levels so that we are able to capture additional sales through new product assortment and better in-stock condition.
During the second quarter, we added 47 new stores and completed the acquisition of 4 Del Norte stores in Mexico, bringing our total store count to 1,437.
The stores opened in the quarter included 45 Home Depot stores and 2 EXPO Design Center stores.
Of the stores opened during the quarter, we opened 14 in May, 16 in June, and 17 in July.
We remain on track to open 200 stores in 2002, a 15% increase over 1,333 stores at the end of fiscal 2001.
In the third quarter, we plan to open an additional 50 new stores, including 1 EXPO Design Center.
Now, turning to store productivity metrics, selling square footage increased 15% from last year to 157 million square feet.
The average square footage per store was up 0.2% to 109,000, compared to 108,800 last year.
Customer transactions grew to $323 million for the quarter, or about $25 million per week, up 9.4%.
Our average customer ticket increased to 2.5%, to $50.13, against $48.93 last year.
This average ticket is second only to our first quarter 2002 performance, and reflects gains in large ticket items like appliances, kitchen countertops and HVAC.
Our weighted average weekly store sales for the quarter were $883,000, compared to $923,000 last year.
This decline is the direct result of a heavier weighting of cannibalization in 2 of our most productive divisions.
Sales per square foot for the quarter were $421.14, versus $441.25 last year, a decrease of 4.6%.
Stores with our pro initiatives continue to generate higher productivity.
Sales per square foot in these stores were 12% higher than the company average.
Through the quarter, we added 152 stores to our pro initiative.
We now have the pro initiative in 92,1 or 64% of our stores, and expect to have this program in 1,060 stores by year end.
New store productivity was about flat to last year.
This is the best year-over-year trend since the first quarter of 2000.
Gross margin for the first quarter was 30.39%, 71 basis points ahead of the prior year, and the highest second quarter gross margin in company history.
This margin performance reflects the following:
First, we lowered our cost of goods through improvements in shrink and by continuing the rationalization of merchandise assortments, giving us the ability to optimize the product mix and fully fund the customer events we held during the quarter.
Second, our penetration of imports increased from approximately 5% last year to 7% this year.
And finally, while two rental centers continue to contribute to margin expansion, the margin impact is diminishing as the initiative matures.
At the end of the second quarter we had 527 [INAUDIBLE] centers compared to 419 at the end of the second quarter last year.
We currently anticipate that the third quarter gross margin rate will reflect modest expansion against the third quarter of 2001.
Selling and store operating expenses decreased 36 basis points to 17.26% from 17.62% last year, continuing the positive trends in payroll that we have seen since the fourth quarter of last year.
Pre-opening expenses were $23 million for the quarter, compared with $32 million last year, a decrease of 8 basis points as a percent of sales, reflecting a shorter pre-opening period.
General and administrative expenses for the quarter were 1.45% compared to 1.57% last year, a decrease of 12 basis points as we continue to benefit from organizational realignment.
As a percent of sales, this is the lowest G&A expense has been in our company's history.
We expect to continue to leverage expenses in the third quarter.
Reflecting higher cash balances, but a lower interest rate environment, net interest income was $17 million for the second quarter this year and $8 million in the comparable quarter last year.
Pretax income, as a percent of sales, was 11.64% for the quarter, up 132 basis points from 10.32% last year.
This performance is the highest operating return on sales in company history and marked the 4th consecutive quarter of pretax income margin expansion.
The effective tax rate for the quarter was 37.6%, compared to 38.6% for the second quarter last year, reflecting higher tax credits and a lower effective state income tax rate.
For the remainder of fiscal 2002, we expect the effective tax rate to be 37.6%.
Net earnings, as a percent of sales for the quarter, were 7.26%, versus 6.34% last year.
This is the highest return on sales in company history.
Diluted earnings per share for the quarter were 50 cents against 39 cents in the prior year.
The weighted average shares, assuming dilution for the quarter, were 2.363 billion shares, compared to 2.355 billion in prior years.
Now our estimates of the weighted average shares for fiscal 2002 are as follows: For the third quarter, 2.367 billion shares, fourth quarter 2.372 billion shares and for the year, 2.369 billion shares.
During the second quarter, Home Depot announced that it had authorized a $2 billion share repurchase program.
We expect to initiate purchase shares under this authorization in the next several days.
The share projections I just mentioned do not assume a fully deployed buy-back by the end of the year.
Moving to the balance sheet, cash and short term investments totaled $5.9 billion, compared to $2.5 billion at the close of fiscal 2001, driven primarily by significant improvements and working capital.
Average inventory per store was $5 million, down 13% from the prior year.
Inventory turnover was 6 times, compared with 5.9 times last year.
This turnover rate is the best second quarter performance since 1994.
Our days payable outstanding at the end of the second quarter were 43, compared to 28 days in the prior year as we moved our payment terms toward industry standards.
Long-term debt at the end of the second quarter was $1.31 billion, compared to $1.27 billion last year.
Computed on beginning debt and equities for the trailing 4 quaters, return on invested capital was 19.5%, an increase of 140 basis points, from 18.1% last year.
Capital expenditures were $634 million for the quarter.
We now own 1,000,167 of our stores, or 81%.
Our estimate for capital expenditures in fiscal 2002 remains at $3.6 billion.
As I mentioned at the outset of this call, last year we established a 3-year financial target, calling for top line growth of 15 to 18%, and earnings gains of 18 to 20%.
In light of first half performance and current business trends, we believe that our sales guidance is attainable this year.
As for earnings per share, we are comfortable with the current consensus of $1.57 for the year, which is a 25% growth rate on a 52-week basis.
We confirm the consensus estimate of 40 cents for the third quarter or 21% growth, and guide 31 cents for the fourth quarter.
We'll be glad to answer your specific questions on the quarter or the year, but before we do that, I'd like to turn the call over to Bob Nardelli for his remarks.
- Chairman of the Board, President, CEO
Carol, thanks a lot for that very, very good report.
I'd like to also thank all of our associates, our loyal customers, who helped us generate more than $1 billion in income in this quarter.
We're very proud to join Wal-Mart as only the second retailer to ever accomplish this feat.
I'd like to share my thoughts regarding Home Depot's progress to our long-term goal of operating excellence, and how the second-quarter performance really fit into that framework.
You know, within the past year, we've asked our associates to absorb many new initiatives.
Many of these were part of our SOR process that we shared with you in November, Strategic, Operating, and Resource planning.
Two of the most pervasive operating changes that have taken place in the history of this very young company, the implementation of our service performance improvement plan, or SPI, and our transition to a more centralized purchasing organization.
Now, given our culture for continuous improvement, these were not optional changes, but these were changes that basically are rooted in customer-backed, market-backed, and talking to our suppliers and many of our loyal customers.
We continue to drive for sustained and enhanced customer service levels.
We understand that we must continue to expand our merchandising assortments.
And obviously, develop efficiencies that will position us for sustained growth, not only today but in the future.
Now, I spent a majority of my time in the month of July, visiting stores.
To be exact, I walked over 165 stores through the month of July.
From L.A. to Orlando, from Vancouver to Houston to New Orleans.
And about half of these were unannounced visits, and the other half was spent arm in arm with our division Presidents.
Took the opportunity to talk to a number of our associates and also our customers.
We held formal townhall meetings and impromptu town hall meetings in the particular departments and in the aisles that the department heads and specialists had responsibility for.
From those walks, we listened, we learned, and we certainly have responded.
We had a very formal district manager walk, where we really spent an entire day with each store manager, front to back, side to side.
Now, I found some things that were obviously working extremely well, or Carol would not have been able to report on the financial success of our second quarter.
But clearly, changes of this proportion must continue to be refined.
Let me talk a little bit about that refinement and what we're doing.
Let's talk first about SPI and the SPI implementation.
Last fall, as you know, we moved our receiving to the evening hours.
We increased the number of hours available on the sale floor for customer service.
If you remember the old percentages, we really wanted to have 70% of our associate time available for transactions to engage with our loyal customers as they entered our stores.
In my walks, I saw stores that were significantly cleaner, much more shopable, and certainly safer.
Through an independent third party, proof positive data that suggests we have higher levels of customer greets and improved customer satisfaction.
We have improved our average ticket, which was one of the major objectives of SPI.
As Carol said through the first six months of this year, it represents a record for the history of this company.
So certainly SPI, in the main, is working.
But I also saw the need for some refinement.
For example, we added additional hours to support the pack-down activities.
We created a distinct department so that we have the measurability and the traceability.
We have also adjusted the relationship, the organizational structure of our IMAs, inventory associates, who are dedicated to make sure we have appropriate replenishment in place so that we have adequate stock on shelves.
These changes were made in July.
And I am confident we will continue to monitor, to listen, to learn, and to respond.
The second major transformational change was the merchandising transition, where we really developed a high-bred structure.
We really applied SPI to merchandising, bringing the task of purchasing, here to Atlanta, but really leaving the merchandising responsibility with the DSMs and the Vice Presidents of merchandising sales and service in the respective divisions.
We've seen tremendous economic benefits.
Carol reported to you higher gross margins, rationalized assortments, and again, proof positive of improved cash positions that we would not have been able to achieve with decentralized purchasing organization, where we had fragmented terms and conditions and the inability to leverage over $40 billion of buying power in our VBAs.
This has really given us full leverage in allowing us to work with our valued suppliers like we've never done in the past, as we continue to move towards industry standards in these areas.
We have eliminated thousands of duplicate and slow-moving, and quite honestly, unexciting items through some of our customer events that took place in the quarter.
Our average spew count per store is down about 12%, so the vitality of what we have is much higher.
The turnover, the frequency, the customer reaction has been very positive.
As Carol mentioned, we had several major vendor changeouts during the quarter.
These are critical, they are necessary for the continual redevelopment and innovation in our stores.
I think it bodes well for our ability, our financial strength, to reinvest in our most valuable assets, our stores and our people.
And we'll talk about that in a moment.
Major reset as you go into our store for rugs.
Exciting new hardware layout.
Some of our building supplies in the area of roof and cement, ceramics, and certainly a major reset coming in our lighting aisle.
Three major remodels in progress and continuing in the third quarter.
Millwork.
If you haven't seen it, I would suggest you visit our stores.
It is very, very customer-friendly.
It talks about all the features and benefits of the materials and the products that we have available.
Appliance.
The appliance rollout.
Almost a carnival atmosphere.
Exciting.
Associate excitement and passion.
The design place.
Much more fashion-forward.
Much more improved relative to customer shopability.
All of these are providing a foundation for innovation, quality products.
It really suggests, I hope, to all of you, our resolve in the area of continuing to be the #1 supplier in home improvement.
Now, similar to the investment in SPI and merchandising, we're continuing to invest in our associates.
We recognize the importance of training and development.
In the second quarter alone, we put as many as two to three kiosks in every store that will be used for distant learning.
This is an all-time record of deployment of hardware and a growing commitment to a key core curriculum for product knowledge training and selling.
This really reduces the variability of training by having a central organization, developed a core curriculum, and really provided to an associate, who now has the opportunity to test in, and opt out.
We really feel it reduces the variability that existed based on the capabilities of the field training.
We've also created a very, very comprehensive immersion program for all district managers and store managers.
We'll bring every district manager in for a solid week of training this quarter.
And we plan to do the same thing for every store manager, which will be done on a regional basis, but completed by the end of the year.
Store leaders are being supported in their efforts to build associate strength.
Full-time, salaried HR managers have been added to every store in our company, who now have the professional wherewithal and the skills to attract, motivate, and retain a high-performance work force.
We're adding and growing the most qualified associates to continue to be true to the culture of this company and continue to differentiate ourselves in the area of customer service.
Now, like many companies, our associates are feeling the effects of the stock market, as well as some of the economic effects that Carol talked about.
They are concerned about the value of The Home Depot stock, and as well as their own assets.
You know we have a very long and proud tradition of associate stock ownership in this company, through the 401K, our unique employee stock purchase program, and this program goes down to the assistant store manager.
It provides a tremendous sense of ownership, commitment, and passion for this company.
So as I told you before, we are acting on opportunities to build that relationship throughout our organization.
This is the first time in the history of the company we have success sharing, where every associate has the opportunity for cash incentive rewards based on the performance of their stores -- --
Okay.
I apologize for that.
I guess we did pay our electric bills.
I think we got cut off at success sharing.
Let me try and pick up the momentum.
Where we were talking about our reinvestment in our associates with success sharing.
First time in the history of the company, part-time we have added benefits, we've accelerated tuition reimbursement, and again, I think it bodes well for our commitment to invest in our associates, to appreciate their value while obviously we depreciate the physical structures.
Now, we've talked about the financial strength of Home Depot and how it allows us to really make major strategic investments.
And let me point out how this will really impact us in the third quarter.
We're demonstrating our commitment to the appliance business by expanding our assortments, investing in our stores, and offering free delivery for customers.
We are increasingly convinced that this not only represents a very strong short-term, but long-term growth opportunity, as we continue to become destination locations for appliance and appliance products.
We're reaching out to new customers through design place and pro , with over 900 to 1,000 stores being reset.
Carol mentioned to you how our pro initiative is faring in each of our stores.
We're getting tremendously favorable response from our pros, as we increase the convenience, job lot quantities, and the shopability and the reliability the job lot quantities are there in time of need.
Our service initiative continues to perform.
I'm particularly encouraged by some of our new service programs.
With strong growth and innovative areas like HVAC up over 560%.
Our shed program, for example, up over 86%.
Just two examples, I think, of how we are providing innovation in improved margin merchandise for our customers.
Our stores are laying in $500 million of fresh inventory.
We're able to do that because of the success of the clearance event that took place in the quarter.
You'll see new assortments in our stores.
Portable lamp sets.
Vanities, faucets, millwork, rugs.
A plethora of merchandising innovation that again, allows for margin enhancement, new selection, and continuing to establish Home Depot as the #1 home improvement company and attraction in the community.
Now, we're also using our financial resources to support remodeling in our stores.
Major repair spending will double by the end of this year.
Maintenance spending is up over 35%, as part of our SPI initiative, where we went back and did an inventory, looking at every store, from an outside-inside perspective.
Parking lot, awnings, floor, new lighting.
Carol mentioned that we remain squarely on target for 200 stores this year with a very balanced, if you will, implementation plan of over 50 stores in the coming quarter.
Our operating model does include deliberate, deliberate cannibalization.
This quarter, for example, 24% of our stores were cannibalized with an aggregate impact of 4% on comparable sales.
Now, we've had many discussions about this collectively and individually.
And and let me just try to put in perspective for you why we believe that this is the right thing to do, both short term and long term.
Let me give you one market I visited personally, where we reported a negative 2% comp, but an 18 percent growth in the market.
A second area I visited just last week, negative 12% comp for the quarter, but a whopping 45% improvement in market growth.
To me, this talks about strategic positioning both for the short term and the long term.
Now, comps are critical.
We understand the importance.
But we also understand the importance of gaining strategic position for the long term.
It has served us well in the past.
It will continue to serve us well in the future.
We'll always balance long-term market share gains against short-term comparable sales metrics.
We want to continue to use the strength of our balance sheet to gain competitive position.
For example, this quarter alone, we concluded negotiations to purchase 10 former K-Mart sites, ranging from 84 to 112,000 square feet.
We'll open these early next year.
This shows us again the opportunistic opportunities of having the cash, the wherewithal, the strategic positioning, and the ability to move quickly and decisively on key geographic sites.
Carol announced our $2 billion share repurchase program.
Again, proof positive of the confidence that the board of directors, the leadership team, and the associates have in this company, which represents a tremendous value, a tremendous value, for our shareholders.
Now, my overall conclusion is this: In a tentative economic environment, Home Depot remains a remarkably sound company.
In these days of increasing scrutiny, and as we go through the final process towards certification, we certainly take a great deal of pride in being recognized as #1 in quality of earnings by an independent third party.
That evaluation was based upon visibility, transparency, and the sustainability of our numbers.
We know where our future lies.
We know as the market leader of home improvement, we have to continually challenge ourselves to improve upon everything we do.
We have great opportunities to grow and expand in this area, building on the nation's commitment to its homes.
The long-term trends in home value and home ownership bode well for Home Depot and our business model.
We have great associates, tremendously loyal customers.
As a matter of fact, we have customer activity for the quarter of over 323 million.
Which exceeds the current consensus population of 281 million.
That averages about 25 million transactions a week, just to give you in perspective the volume and the dynamics of having over 1400 strategic locations in over 300,000 dedicated associates.
We have great vendor support and great market position.
And at this point, I think we're ready for questions.
- VP Investor Relations
Brenda, are you still there with us?
Yes, I am, sir.
- VP Investor Relations
That's great.
We're ready for those questions.
Thank you.
The question-and-answer session will be conducted electronically.
If you would like to ask a question, please press the star key, followed by the digit "1," on your touch tone telephone Once again, if you would like to ask a question, please press star 1 now.
And we will go to Dan Weaver with CIBC World Markets.
Carol, I wanted to follow up on your comment about 15 to 18% revenue growth target.
I was confused.
Were you saying that that remains the goal for this year or that you say that it's achievable for the next three years?
- CFO, Executive VP
Well, Dan, of course we see it as achievable for this year.
We have not changed our guidance for '03 or '04.
For the long-term growth objectives we set forth back in November, have not changed.
What needs to happen, besides better economy to reach that 15 to 18% top line target?
- Chairman of the Board, President, CEO
Dan, this is Bob Nardelli.
I think we talked about a couple of initiatives that we feel very good about in the third and fourth quarter or second half of this year.
Certainly a much more aggressive appliance rollout.
And we've seen very favorable customer response.
Quite honestly, we've more than doubled the level of transactions in the quarter, and therefore, I think positions us well for the acceleration of an appliance rollout.
We will complete significant number of remodels, with not only the millwork, but in decor.
We will continue to accelerate the pro initiative.
We're bringing new innovative products, for example, in portable lighting.
If you think about services, and again, the opportunity now, what I shared with you, were some service initiatives, albeit in a limited market rollout, that we'll bring across the country.
So we are encouraged that some of our experience to date in these areas will continue to compound in the third and fourth quarter.
Now, Bob, I was thinking about like the next two or three years, what needs to take place to get to that 15 to 18% target?
Either in terms of square footage growth, new store productivity?
What has to happen, do those numbers look a bit high?
- CFO, Executive VP
Well, Dan, as you know, when we came out last November with our growth targets, we talked about growth in three big categories.
New store growth, and we plan to add 200 stores per year for the next three years.
And we very much like what we seen in terms of new store productivity.
As we pointed out in our comments, new store productivity is the best it's been year over year since the second quarter of 2000.
That's a key element of our growth and one that we're very excited about, actually.
The second element is the improving comps within our existing stores.
While we continue to canibalize and that's the right operating model, through the new merchandising initiatives that Bob just shared with you, and there are a lot more we didn't talk about today, that will also drive sales on the top line.
When adjacency businesses include things like Mexico.
You know, Mexico today, we have nine stores, where a year ago, we had none.
We're very pleased with our Mexican business, both in terms of sales and profitability.
Great.
I'll follow up.
Thank you.
- CFO, Executive VP
Thank you.
And moving on, we will go to Aran Mousinson with Bank of America.
Thanks, Bob.
I appreciate the candid remarks.
You mentioned July and some of the things that you learned from being in the stores in July, and therefore some of the things you had implemented or making refinements to.
Can you tell us, are there any programs that you've decided not to implement as a result?
Those refinements might have yielded some changes in initiatives that have yet to be implemented.
That was the first and I have one follow-up.
- Chairman of the Board, President, CEO
To be honest with you, the answer is no.
We really didn't see any one of the initiatives that we launched that we needed to abort.
Look, you and the rest of the group on the phone are in the stores just like we are.
I think it's important that we recognize, you know, and the most challenging thing is to change what you may have put in place because of the ownership and the passion.
But this is a company, this is I culture that certainly challenges the status quo.
And this is an organization where the associates are encouraged to speak out and talk about changes we've put in place.
Some of which they embrace totally.
Some of which we heard we needed to modify, whether it be the pack-down issue, whether it be the structural alignment, relative to inventory replenishment.
Some of the things that we've learned relative to our new sets, to make sure that we are doing them more efficiently, more productively, less disruptive in the third quarter than some of what we saw take place in the second.
Quite honestly, those are the things that I was looking for.
One week, I did seven cities, seven days, six to seven stores a day.
So you can't help but get immersed in what's happening across the country and therefore be better positioned to provide the strategic and operational direction that we need to have.
This follow-up is on the merchandising side.
You mentioned you made changes in the quantity of inventory, the IMAs, the ordering, I guess a little bit more to the local market.
What are you doing on the product selections standpoint?
It seems as if -- it seems like it's become a little more whimsical than in the past.
Whether it's televisions on endcap with the laundry detergent, things like that.
Can you just give us a sense of the direction of merchandising and where you'd like to see that head?
- Chairman of the Board, President, CEO
Sure.
And let me make one comment, and then Jerry Edwards is in the room with us.
Let me just put in perspective, when you think about our core business, if you think about, you know, where we're rooted in the area of building materials, lumber, et cetera, we are not moving away one inch from the fundamentals that have made this company successful.
As a matter of fact, we are enhancing job lot quantities.
As Carol mentioned, we'll have somewhere between 900 to 1,000 stores reset with the pro desk.
Three to five professionals behind that pro desk, reaching out to the pro customer.
We'll continue to provide quality merchandise to the do-it-yourself customer.
We'll continue to have the local training sessions.
For example, installing tile, or actually doing the plumbing.
We're excited about the new array of merchandise and the availability, for example, with our acquisition of Your "other" Warehouse, where we've continued to see significant growth because of selection and convenience, with 24-hour response.
Now, some of the products that you've eluded to, are clearly there in an attempt to get spontaneity.
These are pickup items.
These are items where our merchants have been able to use the totale of our buying power in 1,400 stores to get a host buy.
They're quick in, they're quick out.
And again, some of them are thematic, relative to seasonality, where we'll be in and out.
Let me just put in perspective, a buck a cart is $1 billion.
A buck a cart.
And these are impulse items.
They are not in lieu of the fundamentals of this company.
But customers ask, and we test.
That's what retail is all about.
Taking a swing.
Some are good.
Some are not so good.
And therefore we're not going to put them in again.
But Jerry, do you want to comment?
I would just add, Bob, that we are seriously committed to our strategy, which has been on-going since the formation of the company.
Is that we will be top of mind awareness for home improvement products, period, paragraph.
That we will have the lowest price in the market, so we haven't altered our EDOP strategy.
We continue to have the best prices in the marketplace and to provide the best service.
Anything that we buy as an experiment, and, as you say, as an add-on in a shopping cart does not detract from our core strategy of being top of mind.
I thank you for the response.
Good luck, guys.
- Chairman of the Board, President, CEO
Thank you.
And moving on, we will go to Gary Balter with Credit Suisse First Boston.
Carol, a couple of questions.
I'll start with one.
Dan asked about the sales guidance, what does that imply, first of all, in terms of comps for the fourth quarter?
It implies the pickup in the second half sales to obtain the 15 to 18.
Then combined with that, earnings guidance for Q4, you're projecting 31 cents versus 30.
Obviously you lose a week and that's impactful.
Could you help us with why it's such a conservative guidance for Q4?
- CFO, Executive VP
Sure.
Maybe I'll start there.
If you'll recall, last year, we did have a 53-week year.
And that extra week in the fourth quarter was worth 3 cents.
So if you back that out, the earnings per share number for the fourth quarter would have been 27 cents.
And based on our guidance of 31%, that's a 15% year-over-year change.
So hopefully, that's helpful.
We are conservative in the fourth quarter, granted, because we are up against a 5% comp last year.
If you'll recall, last year, the weather was fabulous in the fourth quarter.
Now, we have been conservative, that is true.
There is also some tailwind, if you will, that perhaps we haven't factored into our forecast.
And that relates to what is going on in the refinancing market.
I took a look at refinancing.
There are some interesting statistics that have come up recently.
You know, as mortgage rates have fallen and home values have risen, what we're finding is that refinancing applicants are actually taking money out when they refinance.
60 to 70% of the refinancing comes with that higher mortgage rate.
And pursuant to what Freddie Mack is telling us, it means about a $100 billion is flowing out this year. $50 billion has already come out.
So maybe another $50 billion for the remainder of the year.
So we haven't put that in the forecast because I think you know we're conservative from the forecasting perspective.
But that's some tailwind there.
In terms of the comps for the remainder of the year, I think the guidance we gave you in the third quarter would hold for the fourth quarter, and that gets us to the top line sales that we need.
Okay.
And then a question for Bob or for whoever would like to address it.
You talked about changes in July.
And you sound positive based on those changes.
Are you seeing specific results from having those meetings with the IMAs and other efforts in the stores to get refocused on the merchandising and in stock?
And could you address any of that, any trends that you want to discuss, in August?
- Chairman of the Board, President, CEO
Gary, let me be right to the point.
We are absolutely seeing the benefit relative -- as measured in inventory, in inventory replenishment.
It is -- we are seeing it in the numbers.
We are seeing it on the shelves, not only relative to the order rate, but also as Larry Mercer and the team have worked in creating a separate pre-standing department with pack-down, we are seeing it.
We are anticipating that it will continually get better throughout the quarter.
And then one last thing and I'll let you go.
The deal you signed with Dunkin' Donuts, are you worried that's going to bring your average ticket down?
- Chairman of the Board, President, CEO
Dunkin' Donuts.
Gary, I think what you're referencing is some of the locations up in the Northeast, where we've entered into that agreement.
That really is a convenience for the pro.
If you're familiar with contractors, they go somewhere every morning.
And we'd rather have them gather at our store as we're filling out their list, their building materials, and loading their trucks.
So that one is not a big issue relative to margin deterioration.
Quite honestly, that's just a fee-based arrangement to provide a convenience for the contractors.
I'll be there.
Thank you very much and good luck in the second half.
- Chairman of the Board, President, CEO
Thank you, Gary.
And moving on, we will go to Bud Bougatch with Raymond James.
I just really have one question.
Can you quantify for us what the gross margin would have been without the yellow tag clearance, what the drag was on the clearance in the on-course margin in the quarter?
- CFO, Executive VP
You know, we were very pleased to post gross margin improvement of 71 basis points, given the customer events that we had in the store.
I understood that.
I was wondering what was the cost of the customer events in terms of basis points?
- CFO, Executive VP
We were able to cover the costs.
I know that.
But do you have any feel -- was it 30, 40, 90 basis points?
- CFO, Executive VP
You know, Bud, we don't give out that kind of information on our gross margins.
The good news is we were able to cover the cost and post great gross margin gains.
All righty, thank you.
- CFO, Executive VP
You're welcome.
- Chairman of the Board, President, CEO
I think we have time for one more question.
And finally, we will go to Danielle Sachs with JP Morgan.
Thank you.
I'm wondering how you've addressed some of the labor scheduling issues that affected service levels during peak selling periods?
And then if you could also discuss how your use of part-time workers has affected service levels.
- Chairman of the Board, President, CEO
Well, Dana, we did a couple of things.
Quite honestly, we took a swing at p-time, full-time, in an attempt to improve weekend coverage.
And we made some progress in that area.
Quite honestly, as we went out and tried to move through this aggressively, we found some bumps in the road, relative to the ability to train a p-time associate as efficiently as some of our full-time associates.
So we've moved the needle, relative to the percent mix of full-time/part-time, if you will, or p-time associates.
But we've learned some lessons, and we think we'll be better positioned next year to handle the seasonality.
And the whole purpose of this was to enhance weekend coverage, particularly in the lawn and garden area, where we know we really get tremendous customer response Friday, Saturday, and Sunday.
So we feel good about a portion of that initiative.
We've learned some valuable lessons.
We'll be better positioned to handle it next year.
Okay.
And one other thing.
You mentioned profit-sharing in your comments.
I'm wondering what sort of incremental financial incentives, if any, you're offering store managers and sales associates as they grapple with all this change at the store level.
I wasn't sure if the profit-sharing was new or if the targets had changed at all?
- Chairman of the Board, President, CEO
No.
Where we are on that again, we announced that at the early part of the year, the full fiscal year.
And we went through a lot of detail.
But fundamentally, it's a two-pronged approach.
It's talking about sales and profitably at the store level.
This is not new in the quarter, it's new for the year.
And it offers the associate the opportunity to win with us.
If we win, they win.
And we think it's very, very appropriate.
As I mentioned in my comments, we do have a very extensive stock option program that goes down to the assistant store manager.
And we think that that really bodes well for our culture in giving them ownership in our company.
And we don't plan to move off of either of those two at this time.
Okay.
Thank you.
- Chairman of the Board, President, CEO
Uh-huh.
And that concludes the question-and-answer session.
Mr. Nardelli, I'll turn the conference back over to you.
- VP Investor Relations
This is Bob Burton.
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And that concludes today's conference.
Thank you for your participation.