家得寶 (HD) 2002 Q3 法說會逐字稿

Good day, everyone.

Welcome to today's Home Depot third quarter earnings release conference call.

As a reminder today's conference call is being recorded.

At this time, I'd like to turn the call over to Mr. Bob Burton, Vice President of Investor Relations.

Please go ahead, sir.

Thank you, and good morning, everyone.

Welcome to The Home Depot third quarter conference call.

As we reported this morning, the earnings per share results for the quarter were 40 cents, a 21% improvement year-over-year and in line with guidance and consensus.

Joining us on our call are Robert 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 begin the call with the details of the financial results and then Bob will offer his comments.

Then we'll take your questions.

As 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 www.homedepot.com.

We will also offer an Internet replay of the call for a five-day period and a two-day telephone replay which is available at 888-203-1112, with a confirmation code of 264706.

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.

Now I'll turn the call over to Carol.

Thanks, Bob, and good morning, everyone.

I'm pleased to report that The Home Depot continues to demonstrate financial strength and strong earnings performance.

For the quarter we reported earnings of 40 cents per share in line with our expectations at the beginning of the quarter.

We met our bottom line commitment but we didn't get there the way we had projected.

Going into the quarter, we were fairly optimistic because we planned to increase our inventory levels and add new product offerings and merchandise presentations.

What we didn't anticipate was a disruption in customer traffic.

And we'll talk about this more in a few minutes.

While our sales were below expectations, we posted the highest third quarter gross margin in our company's history.

Record third quarter operating returns and a 21% earnings gain, very strong performance for any company.

The financial strength of our company remains unsurpassed.

We ended the quarter with $4 billion in cash and more than $20 billion in equity.

Now, I want to give you some more color regarding our sales.

Sales for the quarter totaled $14.5 billion, up 9%, or $1.2 billion from the prior year, driven by new stores.

Comparable sales were negative 2%, and there are a number of reasons why.

During the third quarter, we increased inventory levels in our stores, and increased advertising spend by 12% over the prior year.

While we experienced 286 million customer transactions during the quarter, customer traffic was below our expectations and as a result, we didn't get the inventory sell-through that we had anticipated.

This impacted comps.

As we said at the end of the second quarter, we are pursuing an aggressive reset campaign in our stores to bring the best product offerings to our customers.

We averaged 14 resets per store during the quarter.

We believe that the negative impact to comp sales from these changes was more than 1%.

While resets have a short-term impact on our sales, we are making the necessary investments to position our stores for future growth.

Lumber prices were depressed versus last year.

We also saw sales pressure on mill work, resulting from slower sales of windows and exterior doors as we anniversaried last year's energy conservation demand spike.

The combination of these factors had a negative impact to comps of approximately 1%.

In the third quarter, we cannibalized 22% of our stores, and we estimate that this affected our comparable sales performance by approximately 4%.

Now, in the third quarter, we saw strength in kitchen and bath driven by appliances.

During the quarter, we continued the rollout of our expanded appliance showroom sets.

Comps in this fast-growing category exceeded 37% for the quarter.

We also saw solid performance in plumbing, paints and flooring, as customers responded to new product assortments and great value.

Driven by flooring, our service businesses continued to grow at strong levels gaining 28% over the prior year.

In the fourth quarter, we're facing last year's unusually warm weather and a line-up of promotional events.

This year, our commitment is to maintain our focus on the basics of everyday low price, stronger, broader assortments and excellent service.

As Bob will discuss in a minute, we are staying on strategy.

And consequently expect that sales for the quarter will reflect the impact of this decision.

Our view of the economy also remains cautious.

Against 5% comps in the fourth quarter last year, we expect our comparable sales performance to be negative in the range of 3 to 5% for the fourth quarter.

New stores are another driver of sales.

During the third quarter, we added 34 new stores, bringing our total store count to 1,471.

This is slightly below our target, but is only due to timing.

We remain on track to open 200 stores this year, a 15% increase over the end of fiscal 2001.

The stores opened in the quarter included 29 Home Depot stores, 2 EXPO Design Center stores, and three Home Depot Landscape Supply stores.

Of the stores opened during the quarter, we opened 9 in August, 7 in September and 18 in October.

In the fourth quarter of 2002, we plan to open an additional 58 new stores.

Now, turning to store productivity metrics, selling square footage increased 13% from last year to 160 million.

The average square footage per store of 109,000 was about the same as last year.

Customer transactions grew to 286 million for the quarter, up 6.5%, reflecting my earlier comments.

Our average customer ticket increased 1.3% to $49.66, against $49.03 last year.

This average ticket is the best third quarter performance in our history.

Average ticket increased in 8 of 11 selling departments.

Our weighted average weekly store sales for the quarter were $754,000, compared to $805,000 last year.

This decline is due to cannibalization rates above 30% in some of our most productive divisions, including New England and the west coast.

Sales per square foot for the quarter were $360.41, versus $384.28 last year, a decrease of 6.2%.

Gross margin for the third quarter was 31.64%, 146 basis points ahead of the prior year and the highest third quarter growth margin in company history.

This margin performance reflects the following: First, great inventory control driven by our centralized merchandising group and enhanced focus from our operations team.

As a result of our efforts, we are experiencing our lowest shrink in eight years and tremendous year-over-year improvement.

We have a continued reduction in the cost of goods as we rationalize vendors and SKU assortments.

We have increased our direct import penetration from 6% last year to 7%.

And realized continued contribution from tool rental centers.

At the end of the quarter, we had tool rental centers in 559 of our stores, or about 38%.

As Bob will discuss, this gross margin expansion is not coming from higher retail prices.

We remain the home improvement price leader.

We currently anticipate that the fourth quarter gross margin rate will reflect modest expansion against the fourth quarter of 2001.

Despite a negative comp environment, we continue to invest in our stores and our customers.

As a result, we did not leverage total expenses.

On a per store basis, however, total expenses in the third quarter were the lowest they have been since the fourth quarter of 1998.

Selling and store operating expenses increased 66 basis points to 19.43% from 18.77% last year.

We are experiencing continuing pressure in workers' compensation and general liability expense due in part to rising medical costs.

Resets and store renovation comes with the costs as we invest in new signage, fixtures and general maintenance.

And as I mentioned earlier, we increased our advertising spend over planned levels.

We also invested labor into our stores, both in terms of selling associates and store leadership positions, to ensure better in-stock and customer service and prepare us for long-term sustainable growth.

Preopening expenses were $19 million for the quarter, compared with $28 million last year, a decrease of 8 basis points as a percent of sales.

This reflects fewer store openings in the third quarter this year compared to last year and a shorter pre-opening period.

General and administrative expenses for the quarter were flat to last year, at 1.74% compared to 1.73%.

Now, given our sales guidance and our commitment to staying on strategy, we do not expect to leverage expenses in the fourth quarter.

Reflecting higher cash balances, but a lower interest rate environment, net interest income was $11 million for the third quarter this year and $10 million in the comparable quarter last year.

Pre-tax income as a percent of sales was 10.41% for the quarter, up 88 basis points from 9.53% last year.

This performance is the highest third quarter pre-tax return on sales in company history, and marks the fifth consecutive quarter of expansion.

The effective tax rate for the quarter was 37.6%, compared to 38.6% for the third 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%.

Third quarter net earnings totaled $940 million, up 21% from $778 million in the third quarter of fiscal 2001.

As a percent of sales, net earnings for the quarter were 6.49%, versus 5.85% last year, diluted earnings per share were 40 cents, 21% or 7 cents better than the prior year.

The weighted average shares assuming dilution for the quarter were 2.343 billion shares, compared to 2.352 billion in the third quarter last year.

Our estimates of weighted average shares for the purpose of calculating diluted earnings per share for fiscal 2002 are as follows: For the fourth quarter, 2.312 billion shares, and for the year 2.336 billion shares.

As announced in the second quarter, Home Depot authorized a 2 billion share repurchase program.

We initiated purchases under this authorization immediately following our August earnings release.

And purchased shares actively on the open market over the next 30 days.

In total, we repurchased $1 billion, or 30 million shares.

We expect to continue these repurchases in the market as our trading activity allows.

The share projections I just mentioned assume a fully deployed buy-back by the end of the year.

Now, moving on to the balance sheet, cash and short-term investments totaled $4 billion compared to $2.5 billion at the close of last year, driven primarily by significant improvements in working capital during the year, but also reflecting the 1 billion share repurchase I just mentioned.

Average inventory per store was $5.7 million, up 1% from the third quarter last year.

Inventory turnover was 5.6 times compared with 5.4 times last year, solid improvement considering slower-than-expected top-line growth.

Our day's payable outstanding at the end of the third quarter were 50, compared to 33 days in the prior year, reflecting the changes we made to move our payment terms to industry standards.

Long-term debt at the end of the third quarter was $1.32 billion, compared to $1.26 billion at the end of the third quarter last year.

Computed on beginning debt and equity for the trailing four quarters, return on invested capital was 19.7%, an increase of 140 basis points from 18.3% last year.

This represents the third consecutive quarter of improvement compared to last year.

Capital expenditures were $681 million for the quarter.

We now own 1,199 of our stores, or 82%.

Our real estate ownership position supports our long-term strategy of market dominance.

Our estimates for capital expenditures in fiscal 2002 is now $3.3 billion, reflecting lower-than-anticipated land acquisition costs and a shift in the timing of some technology spending.

As for earnings per share, we guide 31 cents for the fourth quarter, which results in $1.57 for the year, a 25% growth rate on a 52-week basis.

Now, I'd like to turn the conversation over to Bob Nardelli for his remarks.

Thank you, Carol.

I'd like to start this morning with some of my experiences in visiting over 75 stores this quarter.

You, know I've seen some stores that certainly were struggling with the change and the rate of change that we're making in our business.

But I've seen absolutely wonderful Home Depot stores that are blowing away their sales plans with enthusiastic associates who are dedicated to serving our customers.

They're doing this by staying in stock, greeting our customers and making our stores the real attraction in our community.

This quarter, Home Depot continues to demonstrate a great ability to deliver both value and values.

Value through growth and reincreasing and increasing our returns on capital, and values by increasing our community involvement, and reinvesting in our associates at an accelerated rate.

I'm disappointed in my sales performance.

But I'm proud of our associates.

And their ability to perform through this very aggressive period of transformation.

Now, as Carol said, the operational programs we set in place a year ago are continuing to show improvement through expanding gross margins, effective expense control and working capital efficiencies. .

Now, they weren't all perfect, but they're moving in the right direction and it sure is better than doing nothing.

Our biggest opportunity is staying on strategy by enhancing the shopping experience in our stores, expanding our product selection, and driving great values for great customers.

Over the next several quarters, all of our efforts will be directed towards supporting our stores in these initiatives.

Home Depot continues to invest in our stores and our people.

As Carol said, we will stay on strategy and open 200 stores this year as we indicated we would do last November.

We will add over 40,000 new associates at a time when many other retailers are retrenching.

And as reported just last week, over 80,000 employees laid off in the retail sector.

In our business, the key to market leadership is really very simple.

It's great customer service.

It's broad and dominating assortments, and everyday low prices.

Let me start with the price equation.

Home Depot is and will remain an everyday low price business.

Our approach to the customer is founded on the conviction that every day we have the lowest prices in the industry.

We survey our stores frequently to ensure that our prices remain competitive, and I guarantee you they have been.

This year, we'll make millions of price changes to lead our markets and to give our customers the best values available.

At the same time, we've also been consistently offering our customers industry-leading values in key categories, both our core and emerging, like appliances, flooring, portable power tools where our sales and market share gains have been very solid.

We will manage our promotional calendar to emphasize great and sustainable value for our customers.

We will not put our price image at risk as our promotional activities represent less than 5% of the product assortment that were carried in our stores today.

As always, our merchandising organization will get great buys as a result of volume and price and we're committed to continue to share it with our valued customers.

We'll continue to be very competitive in areas like lumber, appliances, flooring, and where our improved purchasing leverage as a result of one of the most pervasive changes this young company has taken on in the centralization of merchandising, gives us the ability to take market share and offer great customer values like free delivery or low-cost financing.

We have a new marketing icon in John Costello who has joined our senior team in November.

Over the next several quarters, you'll see a powerful reinforcement of The Home Depot brand.

Shoppers and home owners today recognize that The Home Depot is the brand of home improvement and we intend to preserve, covet and build on that relationship and reputation.

Now, last January, we held a very successful yellow tag sale that cleaned hundreds of millions of dollars of old and slow-moving inventory.

I'm proud to say that our inventory today is cleaner, fresher, and has a higher velocity than it's had in many, many years.

And today, therefore, we do not see the need to repeat a clearance event in the fourth quarter.

Our business requires customer confidence and reliance on our brand and our everyday low price guarantee, and we are committed to staying on that strategy.

Now let me turn to assortments.

Home Depot has always been known for two things, one, great product assortments under brand names that give customers confidence.

Our assortments are emphasizing great brands in the business like 3M, American Standard, Armstrong, Bear, Black and Decker, GE, Maytag, Phillips, Rubbermaid, Southern Wire, Shaws, Scotts and Stanley.

Each of whom are merchants recognized recently at a grand supplier appreciation day.

And we're adding new brands and growing our assortment, names like John Deere, Anderson, Disney, which will be exclusive opportunities for our customers at our stores.

The 146 basis points in gross margin improvement we reported are delivered by combining The Home Depot's purchasing volume as a result of the reorganization and centralization and working in harmony and partnership with our suppliers.

Allowing both of us to leverage the supply chain and realize cost efficiencies.

It is and continues to be one of our key initiatives this year and going forward.

Two, innovative product introductions that created excitement in our store.

Let's talk about that now.

We're seeing success with exclusive proprietary brands like GE water coolers, Hampton Bay lamps, Glacier Bay faucets, Riobi power tools.

For example, at our recent supplier appreciation day, Riobi was the first supplier to be awarded what will now be an innovation award.

One single SKU and the sales that resulted from that SKU would have qualified it alone as a top 100 supplier.

I think you get a feel for the size and strength of product innovation within The Home Depot.

You know, the power of The Home Depot is that we have the ability to experiment.

We expect to continue to try new merchandising ideas and let our customers vote with their hard-earned dollars on the outcome.

We're gaining higher penetration from our global products which we share with you as a second key initiative of the year.

By the way, these gross margins have been substantial enough as I'm sure you're aware for Home Depot to show gross margin expansion even as we cleared approximately $1 billion of slow moving inventory over the past 11 months.

Our commitment is to continue to reinvest in our stores, and the assortments we are offering our customers.

During the third quarter, we added back over $1 billion in new products as we promised.

And our out of stock position has improved through the quarter reaching over 97% as of today.

We have demonstrated our commitment to the appliance business by expanding assortments, investing in our stores, offering free delivery for our customers.

This is a great natural category for home improvement and our company has demonstrated our commitment to gaining appliance market share faster than any other retailer.

Comps in this category grew 37% for the quarter, they're up 32% for the year, as we continue to gain share.

We're now the third largest appliance retailer in the country.

In a relatively short period of time.

Today our showroom appliances are offered in 588 stores, we expect to have 675 stores in this format by the end of this fiscal year.

And our goal is to have a full appliance set in almost every store by the end of next year.

We're improving Home Depot's shopping experience for all of our customers through initiatives like, Design Place.

Today, Design Place is in 746 stores with 120 more in process by year end.

Our stores with these resets are giving us higher sales per square foot.

Our Pro Initiative which is in 1072 stores is a unique competitive differentiator and true to the core of this business.

But it's still young.

More than half of these stores received the initiative this year and have yet to mature.

Bringing our customers these exciting new products and services has pressed a high level of change onto our stores as resets of this size and scope can be expected to impact customer traffic.

The disruption was evident during the second and third quarter, and will be evident again in the third quarter to come.

We average more than 14 resets per store through the third quarter.

Today, we remain committed to proceeding with these resets but we're refining our approach to make sure that it is less and less disruptive to our stores, as we've come more experienced and more efficient in doing these vital and necessary rollouts and resets.

Finally, let me discuss what lies at the center of our special relationships with customers, our service levels.

We know our customers have high expectations.

We've set the bar extremely high with customer relationships.

Our success is based on our ability to meet and exceed those requirements.

Our customers expect Home Depot associates to be knowledgeable, and available.

We have seen strong improvement in customer greets as a result of our Spy initiative again, which is the second most pervasive change we have undertaken this year.

We're expanding our training by having distant learning devices, touch screen computers in every one of our stores, for our associates.

To have core competencies and core curriculum development that now can be moved expeditiously to the stores and to the associates.

We have introduced our first wave of over 600 store leadership candidates.

This is a brand-new emerging program within The Home Depot.

It's in our field organization, and each of the store managers have responded extremely positively to these 600 new potential store associates, store manager associates.

We continue to invest hours into our stores.

We've committed additional hours as we've shared with you previously on packdown to assure shopability of the 8-foot strike zone in our stores.

Our strong financial conditions allow us to continue to invest in the shopability of our stores, spending an increasing amount on maintenance, displays, fixtures.

They're running well ahead of last year's rate as Carol shared with you.

We're improving our signage.

We're adding to our visual merchandising, our store organization and easier-to-shop fixtures are part of improving The Home Depot shopping experience.

Now, during the quarter, we saw selling and store operating expense rise as a percent of sales.

In this environment, where others are cutting back on people, cutting back on development, we're investing.

People, our associates, are our most important assets, and we're investing at them at this time at an accelerated rate.

This is not the time to pull back and demonstrate lack of confidence or jeopardize customer relationship.

In the third quarter, we completed a DM form with every district manager in our company, an executive leadership and week-long training seminars.

The district managers are now holding week-long store manager forums in their respective division.

Myself and the entire executive staff have actively participated at the DM forums and the store manager forums.

We've launched two new leadership development programs for our high potential associates and executives.

Home Depot associates continue to be the best in the business.

We're not just investing in people, we're also investing in systems and processes under the umbrella of store simplification and a better customer experience.

We'll see additional improvements in the store efficiency next year.

Among the visual changes that you'll see will be self-checkout stations at the front end.

As a demonstrated way to improve efficiency, save our customers time, and making the shopping experience shorter, simpler, and easier.

In addition, we're building values by investing in the communities we serve.

For example, in the third quarter, we completed our 100th Kaboom playground and we've now committed to build 100 more.

Before closing, I'd like to discuss a couple of new business investments.

We announced earlier that we were developing a new format for Home Depot called Home Depot Landscape Supply.

An extension of our already dominant lawn and garden areas department 28.

Opening three stores in the Atlanta market, we really have aimed at the high-end, do-it-yourselfer pro and commercial accounts.

The initial results are far exceeding our expectations, with sales above plan.

Additional stores are for Atlanta, Dallas, and some of the sunbelt areas.

I'm pleased to announce that we have also closed the acquisition of our flooring installation company, which we are now branding as Home Depot Builders Solution.

This is an exciting new vertical channel for us that represents an opportunity from a market backed situation, to now leverage an already dominant capability in providing carpeting and flooring, so that we can provide better pricing to the fast-growing new large home builders, while at the same time using our financial strength to grow geographically across the country and serve the building trade more efficiently and more quickly.

My final point is this.

Home Depot is growing our business, delivering gross margin, and gaining tremendous experience in driving both the bottom line and improving returns.

Now, obviously, I will not meet the projected three-year forecast on the top line of 15 to 18% this year.

However, as Carol did point out, we are exceeding our earnings forecast and our cash generation.

Despite our increasingly cautious view, I believe we continue to be well positioned and repositioning to catch the benefit from increased consumer activity when it emerges.

With that, I would like to close out again by saying we have great opportunities to grow and expand.

We have great associates, loyal customers, and active and supporting suppliers.

With that I would now turn it over to Bob for questions.

I think we're ready to poll for questions.

Thank you.

At this time, if you would like to ask a question, simply press the star key followed by the 1 on the touch-tone telephone.

If you are using a speaker phone, please remove the mute function to allow your signal to reach our equipment.

Once again, that's star 1 to ask a question.

Our first question today comes from Budd Bugatch.

Good morning, Bob.

Just a couple of questions if you would on kind of the fourth quarter comp guidance.

Could you kind of go through maybe your thinking in terms of where you think traffic count will be, and with the effective cannibalization and resets are on the fourth quarter, maybe also lumber?

Yes, Budd.

I can.

I'll give you a brief overview and then I'll turn it over to Carol.

But as we said in our comments, Bud, and you know we're facing a 5% comp from last year.

Second, as I indicated, we do not have the need for a large clearance yellow tag event which again, added to the top line last year, helped us clean out slow-moving inventory, but the merchants and the organization have really done a really good job this year of not letting that creep back into the system.

We will open 58 stores in the fourth quarter.

Again, those will have significant cannibalization impact.

Carol indicated in some areas, and we've gone back just for cleanliness and looked at where competition is not a significant factor, we in fact are negatively comping but growing in some cases 11 to 15% to the marketing area.

So those are some of the things, Bud, that we quite honestly are looking at and facing the reality of looking at it from the standpoint of the way they are versus maybe the way we would like for them to be.

But Carol, would you want to add anything to that?

Sure.

Just a couple of other comments.

As Bob mentioned, we are staying on strategy and by staying on strategy that means we will continue our reset program.

As Bob mentioned, we want to have the expand appliance offering in 675 of our stores by the end of the year.

That's an increase and we understand with this reset, it is a bit disruptive to our customer transactions.

So that customer transaction disruption has been factored into our comp guidance for the fourth quarter.

As for lumber prices, who knows where they're going to go.

They have been depressed.

I think they'll stay low.

We certainly aren't anticipating any price lift in the fourth quarter.

Sure.

I understand.

I'm just trying to get some idea of the magnitude -- I mean, cannibalization has been running about 400 basis points depressing on comps.

Do you think that's the number that continues or with the increased number of stores, does that go up to 500 basis points or have you thought it through that way?

We have thought it through.

Our projection is that it should stay in the 400 basis point area.

And resets were about 100 basis points... impact, you said you are going to be more thoughtful or careful as to how you do them.

Does that go down then in the fourth quarter?

We're not anticipating that Bud, from a conservative perspective.

Okay.

And in the case of lumber, uhm, last year, just about now, the prices were about as low as where they are right now but they did ramp in the same quarter last year.

So that should be a depressed.

And again, just looking at it if prices stay as they are.

So that --

You're absolutely right.

Okay.

And I'm just trying to see when do you think you'll start to come positively?

You have a 5% hurdle again in the first quarter?

If I remember right, --

That's right, Bud.

And as we look at the resets.

And we didn't spend too much time talking about this, but once the resets are in and start to mature, we do see a lift in sales that gives us some momentum for the first quarter, but I think we're generally cautious, aren't we, Bob?

Correct.

Just my last.

You had 14 resets in this quarter.

Do you have the same in the fourth?

We averaged 14 resets per store in the third quarter.

And if we look at our anticipated resets, we'll be doing about 5,000.

It's not quite as many on a per store basis, but it's still a pretty good number.

Thank you very much.

Thank you.

Our next question today comes from Dana Telsey with Bear Stearns.

Good morning.

Can you talk a little bit about 2003?

Any thoughts on initial targets for 2003, either top line or bottom line?

Also, the use of part-time employees as a percent of the total.

How's that been trending?

And any customer service metrics that you would like to expand upon?

Thank you.

Okay.

A couple of comments about '03 first, was your first question.

I think Carol said and I said that we remain cautious on the outlook for '03.

We are not giving any specific guidance, numerical guidance today relative to '03.

That was point number one.

If I could just interject, Dana, we are completing our STORE 2002 and you'll recall STORE stands for Strategic Operating and Resource plan.

We are in the midst of that planning process and as soon as we are complete with that process we'll have something to talk to you about.

Thank you.

The other question that you asked about full-time, part-time.

We're now seeing more like a 60/40 ratio in our stores.

That's 60 full time.

60% full time.

So again, that tends to fluctuate as we modify the index in our stores based on seasonality and other operating factors.

And in terms of customer service metrics, I think the easiest metric is to look at just greet, saying hello to customers when they walk in our stores.

And we're very pleased with what we're seeing in that regard.

We believe Spy really is helping improve the customer experience in our stores because our customers are being greeted.

And anything on competitive cannibalization in terms of what you're seeing out there?

Well, in the markets where we directly compete, we like what we see.

The biggest impact to our sales is ourself.

That's why we pointed out in some of our most productive divisions we have self cannibalization in excess of 30%.

Thank you.

With Banc of America we have Aram Rubinson.

Thanks, guys.

I had two questions.

One, I'm trying to understand how you reconcile I think you said that SG&A per store was down to the level it was about the level it was four years ago.

How do you reconcile that with what you're calling the accelerated investment in the stores?

It seems that the SG&A would have to go up as a ratio pretty good in the fourth quarter to get that up versus the prior year.

Sure, Aram.

I think the key component that is missing in your question is wage rate.

We have talked to you about this before.

We have done a fabulous job of managing wage rates better than we ever have before.

Now, we pay above market deliberately.

Nothing has changed from our pricing philosophy of viewing payroll as an investment and paying above the market.

But as we have talked about in prior quarters, we have done some things like managed off-cycle increases, using a better distribution of rating in that adhering to our merit increases along those ratings.

Payroll as you know is our biggest expense so hopefully that helps you reconcile the difference.

And just a follow-up on the store leadership program I'm just curious if you could detail that and a little bit more -- I don't think we're terribly familiar with that just yet.

Yeah, Aram.

I'm going to ask Dennis Donovan to talk about it.

I would only tell you that it is a phenomenal concept that is being totally embraced across the organization as we look at tremendous opportunity to inject talent across each of our stores.

Dennis?

Yes.

This is a two-year program that we have looked at external and internal hires for the program and what we do in that two years is give them rotations in merchandising and operations.

At the end of their first year, they'll be in an assistant store manager.

Some will accelerate to a store manager before the end of the two-year period.

But we're planning for all of them to be store manager-ready at the end of the two years.

We use a career forum format to go after these individuals.

It's a day and a half, you get a lot of involvement from the field.

We have had 33 career forums.

We have had over 100,000 applications into this program.

And have interviewed over 1600 people.

As Bob mentioned earlier, we've got about 600 people that are currently on program.

About half of those are junior military officers.

And interestingly enough, we have about 100 academy graduates that are on the program.

Now, this is really to supplement, not supplant, the promotions of our internal people that are demonstrating performance, leadership and potential.

As a matter of fact, we've promoted more than 1600 department supervisors year-to-date and close to 500 assistant store managers.

But what we're trying to accomplish here is have a pipeline of some of the best talent in the world to come in to supplement our hiring to be store manager-ready, people that are going to help take us into the future, along with some of the direct hires we're making on a fast track program as well as internal promotion.

I think it's all about our commitment to being a diverse and inclusive organization, which means you have to look both internally and externally to get the best, the brightest, to attract, motivate and retain a high-performance workforce.

Thanks, guys.

Thank you.

We'll hear now from Wayne Hood with Prudential Securities.

Bob, I had 3 operating questions.

One, I was wondering, what are some of the tactics that you are putting in place to improve the communications to the store?

In other words, new items coming in, can you communicate with them better when they're getting them, where they're placing them?

And then on the exit strategy, when they should get out and who eats the margin on that in a centralized environment?

So that's one.

Let me ask the other two after you answer that please.

I'm going to give you an overview, Wayne, and then I'm going to ask Jerry Edwards to comment on some of the others.

Let me address communications first broadly.

Wayne, are you still there?

Yes, I am.

Okay.

Address communications broadly.

We are doing more today than ever in an attempt to communicate to 300,000 associates.

We understand that this organization is probably the ultimate in a self-directed workforce and that we are basically entrusting the brand to 300,000 associates every morning.

And they have an awesome responsibility in carrying the weight of a $60 billion corporation.

We do it in a number of fashions.

We do it electronically and Jerry will talk about the gatekeeper process for notification on merchandising.

We have a weekly what we call QMI, quick market intelligence, that at the end of that Monday meeting, we send out a note to every store manager.

Wayne, we now are able to, through our HDTV station, we repositioned all of our satellites and we're beaming continuous 7 x 24 messages to every store every training room, every break room.

I could go on at length here about communications and the importance of communications.

But your specific question, I think, about new products and how we position new products both on the in and outside, I'm going to let Jerry address.

Good morning, Wayne.

First of all, we -- when we first did the centralization of merchandising, we left most of the store planning capability in the field.

We have since collapsed that and brought all the store planning people into Atlanta.

And we have just recently added some very high caliber people, merchandising people, to each department that are then responsible of taking a handoff from the product merchants and to completely have a complete implementation strategy to put any kind of new product or any kind of new program into the stores.

So we have a much more focused direction in terms of communicating and implementation in the field than we have ever had before.

Then as far as exit strategy, in terms of products, it works in concert with this new group.

Anytime that we have a reset in a store, we will have a very defined exit strategy for any products that -- any residual products that are remaining in the store.

It's all part of the new store planning process.

And, Wayne, I think the last part of your question relative to in and out, again, Jerry and the store and the division presidents work very closely.

You asked the specific question about markdowns and exits.

And that is mutually shared.

We have pretty good running guidelines of -- if in fact it's an issue at the store, the store handles the markdown, whether it be for damage, et cetera.

If it's part of a merchandising program, Jerry and the centralized merchants will handle that.

And then just quickly, the other two questions, I was curious about on the packdown issue, when inventory is sitting outside that stripe zone to bring it down, how are you -- how are the stores knowing where it's sitting?

On some high velocity items it's sitting outside the stripe zone.

What are you putting in place so they know where that inventory is rather than looking out and saying it's out of stock?

And the last question I had, is there any experiment going on in looking at payroll dollars as opposed to hours to give the stores better metric on the labor model?

Yeah.

Let me take your first question and I'm going to -- it's a great question.

It's going to allow Troy Rice and Bob DeRhodes who have really partnered in the last couple of quarters.

As a result of this, and one of the things that I certainly talk about as I visit stores is looking at some of our internal reports that identify stock-out situations.

And then we also have the Monday morning walk which we've instituted.

And we've instituted as a result of some of Bob DeRhodes quick response capabilities in the systems area.

So I'm going to ask Troy to start first, who heads up our central store ops organization, talk about what he is doing in concert with the [INAUDIBLE] and Bob you may want to comment about some of the technology response that as you have been able to isolate dollars and people for quick response along with some of the major platform introductions we're doing in our business.

Troy?

Wayne, what we're doing here is we rolled out approximately a month and a half ago to all of our stores a system process to create a packdown list in the stores.

As you are aware of, formerly we were doing all of this manually writing down a list and asking our associates to find this product.

Today thanks to Bobs' efforts, we have instituted a mobile ordering floor walk where we can walk and scan the product if there is a hole in the shelf and we create a packdown list that we in turn hand to our associates.

And we put a 24-hour life cycle on the this packdown list to get the product on the shelf.

And in regards to locating the product that's up in the overhead, we are making efforts today to tag the overheads, to label every overhead so we know where that product is on the overhead.

As it goes up, we can identify the bay it's in and when we're creating our packdown list, we identify where that product is.

The associate doesn't have to guess where it is.

Bob, would you like to expand on the mobile ordering---

Yeah, thanks, Troy.

Wayne, I would just like to tell you that you know, we're committed to providing automation to the stores and we are continuing to expand on our building blocks, fundamental systems that many merchants already have that we are currently going about developing.

Concurrently we have dedicated what we call an "A Team" to supporting the stores day to day and creating technology that we believe will improve both our ability to replenish, to identify inventory outs, and to identify locations.

So we have a big program going in support of the store ops group.

And finally, Wayne, let me just share with you, I had a session just last week here in Atlanta with 156 store managers as part of the store manager forum.

I'll be meeting with the group in Dallas later this week.

Myself along with the executive staff and so forth.

Troy and his team have about five or six different pilots that they are looking at right now and I'm not going to go into each up with of them.

But let me just answer your question specifically that Troy and the Ps division presidents are certainly open to respond to our customers' issues of whether it's faster checkout, higher service level, and those departments that require more specialization.

So I don't have an answer as to exactly what we will do, but I will tell that you we're running five or six specific experiments in various divisions, continuing to refine the model that we have in place.

Thank you, Bob.

Okay, Wayne.

Thank you.

Our next question will come from Mary Ann Cotis with Munder Capital Management.

I'm just wondering if that inventory reduction that you took on those slower moving items has affected the traffic, whether you are doing exit interviews with customers who go out empty-handed and if they're failing to find the things that they need even though they are slower moving items.

And then I have a question about accounts payable.

Let me take a first shot at that and then Jerry can jump in and talk to you specifically, but I can't tell you, I looked at of SKU, but I looked at a lot of them as part of this clearance event and we went through, obviously as any good merchants, and I'll give you an obvious example is, you know, you certainly wouldn't eliminate gutter nails because they weren't moving fast because you need them to sell the gutters.

So we looked at the adjacency of some of these products but in some cases, it was an over assortment, in some cases absolutely slow-moving.

You know, we took a swing and we missed on some of the products that we brought in.

So you got to take them down and clear them out.

So I would tell you in the main that these were products that did not particularly affect, you know, customer traffic.

I would tell you that part of the customer issue is our own doings in the resets that we have taken on.

Now, again, we need to do better.

We need to be able to be faster and handle more changes more quickly.

But these are things we must do.

These are areas where we have not freshened fashion forward in some of our decor areas.

These are things that we must do based upon market back, customer back surveys.

Jerry, you want to expand --

We really haven't taken out any essential SKUs out of any assortment.

And, as a matter of fact, in the last 120 days, about 12 to 15% of our existing SKUs are brand-new merchandise.

And this is merchandise that we have identified that the customers are asking for.

But we haven't taken out any essential SKUs at all.

We continue to have product dominance just as we have always had, and now our stores are a lot more attractive as we complete these remodels.

They're a lot more attractive, and a lot easier to shop than they were historically.

I guess, let me just right to the point here, is we will not trade inventory turns for top-line growth.

Okay.

As I put down in my notes and you can correct me if I'm wrong, but your days in accounts payable went from 33 to 50?

Is that correct?

That's correct.

And how far do you think you can push the vendors on that?

Well, we have been working with our vendors, vendor by vendor, to move them to industry standards.

And we've moved the needle in a very long way as you can tell by just the days payable extension.

Are we done?

No, we're not done.

Will you see the kind of improvements continue?

No.

But there are more days to come.

You think about import vendors.

We haven't even talk to them.

Commodity vendors.

We are just starting to talk to them.

Our goal is just to be at the industry standard.

Mary Ann, I would ask to you look back and make sure you are doing seasonal adjustments.

If you look first quarter, second quarter, third quarter, as we get into the second quarter, I want to make sure you're looking at the impact of seasonality, particularly on live goods, that affected the second quarter payable as opposed to first quarter, second quarter, third quarter, on an average basis.

I think you would see less of a dramatic impact from the 30 to 50 days you reference.

Okay, thank you.

Sure.

I think we have time for one more question.

Thank you.

And that question will come from Danielle Fox with JP Morgan

Thank you.

Actually, uhm, I do have two questions.

But how did the 4% cannibalization hit this year compared to last year?

And how does what you're seeing affect your views of future square footage growth beyond '02?

Well, Danielle, we went back and looked at cannibalization from 1998 forward.

We could have gone back 23 years but we just went back to 1998.

And on average, the impact to our comps has been about 4%.

We have seen it peak as high as 6%, but the average is 4.

So if you look at it versus last year, that's where we were 4%.

And in terms of the question of saturation, we don't see that we're there at all.

No, Danielle.

I mean, uhm, again, as I said, I'm disappointed in my sales for this year.

And therefore, we will not make the 15 to 18% range.

We will exceed the 18 to 20% earnings growth.

We will exceed on an accelerated basis the cash.

But we will stay on strategy with 200 stores this year, 200 stores next year, just as we told you last November.

Okay.

And just one final question.

If you could give a little bit more detail on the expense outlook for the fourth quarter.

You're looking for a negative 3 to negative 5% comp.

Should we expect to see more deleverage in the fourth quarter than the third quarter?

And if not, you know, why not?

Danielle, as we guided we do not expect to leverage expenses for the quarter but our view right now is that the expense deleverage should be in the area that you saw in the third quarter.

Okay.

Thank you.

All right.

Thank you.

This is Bob Burton.

Thank you for calling in this concludes our conference call.

Let me remind you that Home Depot will also offer an Internet replay of the call for a five-day period and a two-day telephone replay and I'll give that you number again, 888-203-1112, confirmation code 264706.

Thank you for calling in.

Good-bye.