家得寶 (HD) 2003 Q3 法說會逐字稿

Good day everyone and welcome to today's Home Depot third quarter earnings conference call.

As a reminder today's call is being recorded.

Beginning today's discussion is Ms. Diane Dayhoff, Vice President of Investor Relations.

Please go ahead.

Thank you, Brenda and good morning to everyone.

Welcome to The Home Depot third quarter 2003 earnings conference call.

Joining us on our call today are Bob Nardelli Chairman, CEO and President of The Home Depot, Carol Tome, Executive Vice President and Chief Financial Officer, John Costello our Executive Vice President of Merchandising and Marketing and Bob DeRodes our Executive Vice President, Chief Information Officer along with other Home Depot executives.

Bob Nardelli will begin today's discussion and review his outlook for the business.

John will then provide us with insight into our merchandising and marketing efforts, while Bob DeRodes will discuss the progress of our technology transformation.

Lastly, Carol will round out the prepared statements with our financial results.

Following our prepared statements, we will take questions.

Question and answers will be limited to the analyst investors and as a reminder would we appreciate it if the participants would limit themselves to one question with one follow-up please.

Our media relations department will be available for media questions following the call at 770-384-4646.

This conference call is being broadcast realtime on the Internet at www.homedepot.com with links on both our home page and under Investor Relations for the replay.

Before I turn the call over to Bob, let me remind that you that our discussion today will include forward-looking statements relating to among other things our estimates and expectations for sales and earnings growth, new store openings, store initiatives and capital expenditures for fiscal 2003.

These statements are subject to various risks and uncertainties that may cause actual results to differ materially from the company's historical experience and its present expectations.

These risks and uncertainties include but are not limited to fluctuations in and the overall condition of the U.S. economy, stability of costs and availability of sourcing channels, conditions affecting new store development, our ability to implement new technologies and processes, the company's ability to attract, train, and retain highly qualified associates, unanticipated weather conditions, and the impact of competition and regulatory and litigation matters.

Undue reliance should not be placed on such forward-looking statements as such statements speak only as of the date on which they are made.

Additional information regarding these and other risks are contained in the company's periodic filings with the Securities and Exchange Commission.

Now, let me turn the call over to Bob Nardelli.

Diane, thanks and good morning, everyone.

I'm pleased with the progress that we've made in the third quarter.

And I would like to thank all of our associates who have worked so hard, and delivered strong financial performance.

Now, we are continuing to make significant progress in our business transformation through our continued focus on sales and service and execution.

If you take a look at from a net income standpoint, we have certainly seen strong sales growth which helped us achieve a net income of $1.1 billion in the third quarter.

This is the first time in our history that we've earned more than a billion of net income in the third quarter.

Our earnings per share of 50 cents were 25% higher than last year, and I'm pleased to report four cents ahead of First Call consensus.

Our sales of $16.6 billion were $2.1 billion higher or a 14.7% increase over the same period last year.

Same store sales or comps of 7.8%, I'm pleased to say, were the best quarterly comps we've seen since the fourth quarter of 1999.

We experienced strong sales performance in every region of the country, including Canada.

In some of our most competitive markets, we drove double digit comps.

Let me give you a few examples.

Charlotte grew 17%, Asheville, North Carolina, 17%, Washington, D.C., 17%, and in Indianapolis, we achieved a 12% comp.

We're continuing to build the momentum and we're staying on strategy by enhancing the shopping experience in our stores, and expanding our merchandising selection.

From a merchandising perspective, we saw strength in the majority of our categories.

I'm pleased that our average ticket increased to the highest level in our company history.

Our marketing continues to drive great visibility of The Home Depot brand.

Since 2001, we've made significant investments in modernizing and improving our stores.

Now, as a group, the merchandising categories that we have touched have outperformed the company for the first nine months.

Now, John Costello will give you more details on our merchandising and marketing accomplishments.

In the area of technology and customer service, we continue to put a high priority on improving the customer experience and service through the application of new technology.

Let me highlight just three.

First, at the end of the quarter, we had 760 stores with self checkout stations.

Customer checkout wait time has been reduced by 40% and the cashier hours that we freed up were redeployed back into the store.

We're introducing cordless scan guns, which will enable faster checkout and improved accuracy.

And our new POS technology for all front-end registers will drive efficiency and speed.

You will hear more about our progress with respect to technology from Bob DeRodes later in this call.

Let's talk about service.

Our service business put in another very solid quarter with sales growing again over 45% year-over-year.

We continue to see great opportunities for this market.

The services market saw an increase in a number of areas.

For example, HVAC, over 80%, countertops, over 25%, sheds, over 50%, and our new fencing line, grew 300%.

In the third quarter, we completed the acquisition of IPUSA and just last week, we announced the planned acquisition of RMA.

Two companies that provide installation services for our customers.

These acquisitions position us very well for future growth.

And we are continuing to build on our Home Depot supply business, such as Your "other" Warehouse, and Maintenance Warehouse.

And collectively, in the third quarter, these companies grew faster than the total enterprise.

We now have over 1,640 stores in key locations throughout North America.

And we continue to provide unparalleled access for home improvement customers.

Our real estate locations are a key strength and we continue to build on our strong foundation.

So let me just give you two additional examples.

During the quarter, as you know, we announced plans to open two stores in midtown Manhattan next year.

Currently, we have 78 stores in the greater New York market more than four times as many stores as our nearest competitor.

And last week, I'm very pleased to say we celebrated a real milestone with the opening of our 100th store in Canada.

In this highly competitive environment, Canada continues to perform superbly.

Looking ahead, we're encouraged about the strength in the home improvement sector.

Home Improvement Research Institute recently revised upward their forecast for home improvement sales to 6.8% for 2003.

And they've also predicted that the long-term outlook for home improvement products market is an average growth of 4.6%, over the time period of 2004 to 2008 which is ahead of the growth forecast for the total retail sales.

We believe we're very well positioned to grow in this environment.

At The Home Depot, we're working hard to provide jobs to local communities and we expect to create an incremental 40,000 net new jobs this year.

Last year, we introduced the store leadership program, and have nearly 600 participants to date.

We've placed over 250 in-store leader positions which compliments the strong leadership we already had in our stores.

We have also seen a decline in voluntary turnover in our stores at all levels.

And I'm proud of the performance of our current store leadership team and the commitment to the investments we're making now in the leadership development.

In March of this year, Home Depot updated the military leave policy to provide associates with supplemental pay and benefits for up to six months.

Earlier this month, we further updated our policy to provide associates on active duty with up to 12 months of benefits.

And we stayed in touch with 1800 of our active duty associates.

And we care for these associates who continue to serve for a longer time than we expected.

These associates are working hard for us to maintain the freedom that we all enjoy here in the U.S.

I'm pleased to say that we were honored to receive the Homefront Award in Washington last week from President Bush, and the National Committee for Employee Support of Guard and Reserve, ESGR which was recognition of our employee support for guard and reserve personnel.

We're encouraged by the significant progress in our business, the transformation, and our focus on sales, service, and execution.

We are staying on strategy by investing in our associates, our stores, and technology as well as returning earnings to our shareholders.

I would now like to turn the call over to John Costello, for his comments on merchandising and marketing results.

Thank you, Bob and good morning, everyone.

Our objectives in merchandising and marketing are very focused to leverage the power of our brand leadership, the power of our merchandising organization, and the power of our 300,000-plus associates to enhance the customer experience.

And it's working.

Our third quarter results reflect strength from our core businesses, new initiatives, marketing momentum, and in-store execution.

In our core businesses, we continue to strengthen our merchandising position by offering innovative products in a compelling value proposition for our customers through an unsurpassed combination of well known national brands, which make up over 80% of our assortment, exclusive brands like John Deere, and proprietary brands like RIGID, Ryobi and Hampton Bay.

Lumber was a big driver of sales for the quarter impacting comp sales by about a point and a half due to increased commodity prices and positive unit sales trends.

Lawn and garden was another strong category for the quarter with comps in the low double digits.

This was led by outdoor power equipment including continued momentum from John Deere in the riding mower category, which posted 60-plus comps in the quarter, and carried over to snow throwers as customers prepared for potential winter storms this year.

Generator sales were also strong.

During the quarter, we also held annual planning meetings with all of our supplier partners in the U.S., Canada, and Mexico.

Our supplier partners are invaluable in our growth.

We recognize the best in merchandising innovation, differentiation in service, and laid the foundation for continued growth together.

New initiatives are also paying off.

Our new paint department color solutions center continues to attract and inspire customers with both interior and exterior paint comping strongly.

In early October, we launched our new RIGID line of professional power tools.

We introduced 30 products with price points ranging from $50 to $600 that match or exceed best in class products in all hardware categories.

We're off to a good start with strong acceptance from professionals.

In the third quarter we also added 285 appliance centers into our stores for a total of 1250.

According to the Stevenson Company, we increased share sequentially in core appliances this quarter, more than any other competitor.

Our integrated marketing and advertising program is supporting our merchandising efforts. "You Can Do It, We Can Help," is working in driving customers to our stores, and building our brand.

We're also working together in a more integrated fashion to support our stores.

This includes a wide range of initiatives including our program to capture summer wrap-up projects, an early start on fall, indoor and outdoor projects, the continued success of our "Do it Herself" clinics which have attracted over 140,000 women to date, a fall tool focus including the launch of our new RIGID professional line, and the launch of the new home page for Home Depot.com.

Momentum is continuing into November when we drop the first ever holiday gift guide and holiday gift catalog.

Our brand remains a key asset and is one of the most recognized and admired in the world.

Our associates are connecting with our customers and our in-store merchandising and marketing efforts are beginning to pay off.

All of our store have been touched by some level of our transformation this year, including resets, remodels, and a new signing package.

Collectively, the categories that have been touched are outperforming the company.

We completed the quarter with over 1400 stores with design place, 1250 stores with our appliance reset, and about 750 stores with tool rental centers.

We're pleased with these efforts to date and are working hard to make further improvements in the future.

In summary, our third quarter results reflected strength from our core businesses, new initiatives, marketing momentum, and in-store execution by our associates.

Let me now turn the call over to Bob DeRodes who will update you on our technology initiatives.

Thank you, John.

Good morning, everyone.

Our technology strategy over the last year and a half has been to deliver some important short-term successes while moving our company toward long-term solutions that will significantly improve our technology capabilities.

While we are executing a multi-year plan, I am pleased to say that during the quarter, we have delivered several advancements which are driving efficiencies and providing a better customer in-store experience.

As Bob mentioned, we now have self checkout systems in 760 stores, going to 800 by year-end.

In our stores, with self checkout, over 30% of all customer transactions are processed through these machines.

During the quarter, we had more than 40 million self checkout transactions and we expect to see the 100th million transaction through self checkout sometime the first week in December.

Concurrently, we are installing cordless scan guns for our cashiers.

These new devices are scheduled to be deployed at all registers in early '04 and will help us provide faster and more accurate checkouts, drive productivity, and have the added benefit of improving the work environment for our cashiers.

We have made significant progress this year in renewing our store technology infrastructure by installing 80,000 new terminals and PCs, and completing all the store wiring necessary for future business applications.

Our new POS software is rolling into the stores as we speak, and was in 527 stores at the end of October.

New POS will be in all stores early next year providing many new features that will enhance cashier productivity.

We have also begun the installation of realtime video camera technology in all of our stores.

This system is digitally linked to our new POS system providing the ability to match sales transactions with video footage.

We are providing more automated tools to our store managers and assistant store managers than ever before.

A suite of new systems like work load management, HR information portal, store desktop tool set and labor scheduling are enhancing their ability to run their business more effectively.

While we are making short-term improvements, we are also delivering on Enterprise Y capabilities that build a foundation for future growth and change.

Let me provide you with some examples.

A data warehouse, which is becoming an important source for our analytical needs.

New analytical tools for merchandising has helped optimize sales per square foot and managed gross margin performance.

A new human resource system, which was launched using a new Home Depot portal.

This allows our associates online system access to help them better manage their career, while providing management with improved information reporting.

In addition, we are in the midst of implementing our new core financial systems with our go live scheduled for the middle of next year.

And last we have become a member of UCC Net and have joined with other key retailers to digitally link our system to those of our vendors.

This will improve both the quality and the accuracy of data between The Home Depot and its largest suppliers throughout the supply chain.

In summary, our commitment to technology investments is unwaivering and we will continue to deliver incremental improvements while transforming the major systems of the enterprise.

I would now like to turn the call over to Carol who will take you through our financial results.

Thank you, Bob and good morning, everyone.

Let's take a deeper dive into the numbers.

Bob mentioned strong sales across the country.

Eighty four markets, which includes some of our most competitive markets, posted double digit comps in the quarter.

Comp sales for the third quarter were 7.8% and each month posted strong results.

Our comps were 5.4% in August, 9% in September, and 8.7% in October.

Now, our sales momentum continues two weeks into the fourth quarter.

Our comps are running better than what we experienced for the third quarter.

As you know, cannibalization is part of our operating model.

This quarter we cannibalized about 15% of our stores.

Cannibalization had a negative impact to third quarter comp sales of about 2.4%.

Without cannibalization comps would have been double digits for the quarter.

As Bob mentioned for the quarter our total sales grew 14.7% from $14.5 billion to $16.6 billion driven by new stores and comp sales.

During the third quarter, we added 36 new stores, including one Home Depot Landscape Supply store and one Home Depot Floor store bringing our total store count to 1,643.

Of the stores opened during the quarter, we opened seven in August, eight in September, and 21 in October.

Today, we own 83% of our stores.

In the fourth quarter, we plan to open 89 new stores, including one Home Depot Landscape Supply store.

To remind you, this is an aggressive opening schedule, with 57 stores set to open in January.

Our selling square footage increased to 10% from last year, to 176 million and our average square footage per store is now about 107,000.

Customer transactions were 313 million for the quarter up 9.4% from the third quarter last year and our average customer ticket increased 4.9% to $52.10 from $49.66 in the third quarter last year.

Our average ticket increased in nine of our 11 selling departments.

Our weighted average weekly store sales for the quarter were $775,000 compared to $754,000 last year an increase of 2.8%.

Sales per square foot for the quarter were $375.45 versus $360.41 last year, an increase of 4.2%.

This performance reflects a significant improvement and reverses 13 quarters of negative trends.

Our gross margin for the third quarter was 31.29%, 35 basis points below the prior year.

On a year-to-date basis, our gross margin was 31.45%, up 62 basis points from the prior year, and consistent with the gross margin guidance we gave you at the beginning of the year.

Now, for the quarter, our gross margin performance was predominantly the result of lower volume rebates as compared to a year ago.

Last year, you may remember that we were building inventories which drove volume rebates.

On a per store basis, we did not repeat that increase this year as inventories are at adequate levels.

While increasing sales penetration by lumber caused some slight deterioration to our gross margin, this was offset entirely by a change in the mix of higher margin category.

Now, moving to expenses, the power of positive comps and good expense control drove strong expense leverage in the third quarter.

Our selling and store operating expenses decreased 92 basis points as a percent of sales to 18.51% from 19.43% last year.

The decrease in selling and store expenses was driven by a number of things, including higher labor productivity, or sales per labor hour and reflects some incremental benefit from our new private label credit program with Citicorp.

Our preopening expenses were $20 million compared to $19 million for the same period last year reflecting two more stores opening in the third quarter this year versus last year.

Our general and administrative expenses for the third quarter declined six basis points as a percent of sales to 1.68%.

We reported no net interest expense or income for the third quarter compared to net interest income of $11 million in the third quarter last year.

This decrease was due to lower short-term interest rates as our cash is held in short-term money market securities.

Operating margin for the third quarter increased 65 basis points to 10.98% of sales up from 10.33% in the third quarter last year.

Third quarter consolidated net earnings totaled $1.1 billion, up 22% from $940 million last year.

As mentioned, our diluted earnings per share was 50 cents, up 25% from last year.

The diluted weighted average shares for the third quarter were 2.287 billion, compared to 2.343 billion in the third quarter last year.

The reduction was due primarily to the effect of our share repurchase program.

In 2002, we completed a $2 billion share repurchase program.

In 2003, we announced a $1 billion share repurchase program.

And through the third quarter, we have purchased 27.2 million shares for approximately $890 million at an average price per share of $32.72.

Now, moving on to the balance sheet, cash and short-term investments totaled $5 billion.

Since the end of the year, our cash balance has grown by $2.7 billion, even after giving effect to capital expenditures of $2.5 billion, $890 million for the repurchase of common stock, and $436 million in dividends paid.

At the end of the third quarter, average inventory per store decreased by 3.1% from the prior year, but to put it in perspective, that's about $170,000 per store.

Third quarter year-to-date inventory was 5.2 times as compared to 5.6 times last year.

While down from last year, inventory turnover of 5.2 times was equal to the inventory turnover reported at the end of the second quarter of 2003.

This is a year-to-date calculation.

And with improving sales trends, we believe we can show improvement here.

Our days payable outstanding was 51 at the end of the quarter, about the same as the third quarter last year.

At the end of the quarter our debt to equity ratio remained the lowest in our industry at 6.1%.

Computed on beginning long-term debt and equity for the trailing four quarter, return on invested capital was 18.8% compared to 17.8% in the second quarter of 2003.

Now, excluding cash and short-term investments, our return on capital was 23.2%, up 160 basis points from the prior year on an equivalent basis.

Our year to date capital expenditures were $2.5 billion as compared to $2 billion last year.

Capital expenditures in 2003 reflect investments in new stores, in store remodeling and resets, in technology, and other initiatives.

Our full-year forecast for capital spending is $3.6 billion.

We had a good third quarter with positive comps, strong operating leverage, strong earnings growth, and great associate morale.

Our outlook for the fourth quarter is positive as we continue our transformation.

We are reiterating our annual guidance to grow our top line or sales by 9 to 12% and are raising our earnings growth guidance.

For the year, we project earnings per share growth of 15 to 17%.

Thank you for your participation on today's call and operator, I believe we are now ready for questions.

Thank you.

The question and answer session will be conducted electronically.

If you would like to ask a question, you may do so by pressing the star key followed by the digit one on your touch-tone telephone.

If are you are on a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, if do you have a question, please press star one now.

We'll go next to Gary Balter of UBS.

Thank you.

First of all, very nice quarter.

The question I have, I'll take a bit of a more macro view.

As you're starting to see the improvements, the worry that the market now is worried about is the re-fi dollars may be slowing down, and rates may start to go up a little bit, and Bob, if you could talk about in that environment, your outlook for the business, and your outlook into next year.

Well, I think two things, Gary.

As Carol mentioned, our comps through the first couple of weeks in the fourth quarter is running stronger than the third quarter.

We're continuing to see customer reaction to the investments we're making in store modernization, new merchandising, new systems, new technology, and it is based upon that that we took our full-year up, Gary.

I think if we look next year, obviously we are watching all of the indicators that we had shared with you at previous analyst gatherings here in Atlanta.

We're very sensitive to consumer confidence, we're sensitive to housing turnover, we're sensitive to unemployment.

And we're in the process, as you know, of pulling that all together.

And we will be in a position to share that with you in January, as we look at 2004 in total.

Just following up, this is a somewhat different question but we will call it a follow-up.

You mentioned or Carol mentioned that the Citigroup deal is helping SG&As.

Is that something we should continue to see now for at least the next three quarters?

Gary, I think that first of all, as you know, we did make a switch.

Uh-huh.

And I would just reinforce that the transition went flawlessly.

We're very pleased with our relationship with Citi.

I think that they are certainly addressing our private label credit card.

We're very pleased with the growth that we've seen in the third quarter with new private label card subscription, and therefore, we would anticipate to see that same benefit in 2004.

Great.

Thank you.

And we will go next to Budd Bugatch of Raymond James.

Budd Bugatch, CFA: Good morning, and my congratulations as well on the quarter.

Can you maybe, if John could touch a little bit more and give us a little more color on some of the categories.

I know you talked about how many appliance resets there are and what you expect for the rest of the year, but can you give us maybe the market share data and some of the highlights on that and maybe talk a little bit about paint and cabinets as well, as to how they did in the quarter?

Sure, Budd.

John, would you handle that, please?

Sure.

Paint and cabinets did well in the category.

As we touched on before, we saw strength in lumber, garden, building materials, paint, and kitchen cabinets were all contributing positively in the category.

As we had touched on earlier, we actually saw positive comps in nine out of our 11 departments, so we saw broad-based growth by both department and geography.

Budd Bugatch, CFA: Could you quantify any of that, where the lumber and garden, were those were the ones you mentioned, they above company average for sales or how would you characterize that?

Just to give us an idea of the strength.

Yes, they were.

I think you see that lumber, garden, building materials and paint were all above company averages.

Budd Bugatch, CFA: And lumber, what do you expect that to be for comps for the -- what impact would you think that would have in comps for Q4?

We have not given specific guidance for Q4 on that.

Budd Bugatch, CFA: Okay.

Thank you, John.

We'll now move to Mark Mandel of Blaylock and Partners.

Thanks, good morning.

I'm just looking at the expense line.

Could you address how you're attacking, you know, the key line items that are giving you the most challenges, such as worker's comp, healthcare, general liability?

And then relatedly, the credit card earnings, is that an offset to SG&A?

Mark, why don't we let -- Carol, why don't you address the specific line item expenses that were mentioned and then we will address the second half of the question.

Sure.

I think it is very important to take a broad look at our expenses, Mark and if you think about it, payroll is the biggest expense that we have, it's the biggest investment that we make.

In fact, our payroll represents more than 50% of our operating expense.

We saw great productivity on the payroll line.

Interestingly enough, we had more hours on the floor of our stores in the third quarter this year than we did last year, and our selling associates are more productive.

In fact, they were $10 per hour more productive this year than last year.

Which is I think is proof positive of the benefits of our new learning programs, and other initiatives that we have in the floor of our store to drive productivity.

On some of those expense lines that are in some ways out of our control, like rising medical costs, all companies are facing that, of course.

What we have done, however, is address that through program redesigns.

We started our program redesigns several years ago, and that's helping us offset the pressure that many companies are faced with.

That holds true for other line items like worker's compensation and general liability.

And I think addressing your final point, what I would like to make clear is that the benefit we're getting from the transfer in private label credit cards in the third quarter, if I understood your question, was not used to offset G&A, but was used to invest, and significantly promote additional private label credit card customers, and we're very pleased with the program we had in the third quarter, and so specifically, we're using that to grow our business, not to offset expenses.

I think that's a great point, Bob.

And just as another data point for you, Mark, our private label penetration is about 23% of our total sales.

So it's a very important driver for our company.

Budd Bugatch, CFA: Okay.

Thank you very much.

Thank you, Mark.

We'll get go next to Bill Sims of Smith Barney.

Good morning, thank you.

Two quick questions.

One the cannibalization impact on comps is 2.4% was lower than original guidance.

Was there a shift in where you were opening new stores, you know, relative to previous expectations or did you change your new store opening strategy?

And in line with that, can you comment on new store productivity and your experiences of the gut remodels?

We sure can, Bill.

I think just -- and I'm going to ask Carol to address that, but clearly in the third quarter we saw two things.

One was the strategic location of new store opening, and second, we are very pleased with a new store opening strategy that we have put in place very consciously to make sure that we're getting all of the benefits and robustness of a new store opening in the community where we're creating great jobs, we're creating a great tax base, and we have gotten tremendous response, as a result of that new campaign.

Carol, you want to give more specifics?

Sure, a couple of data points.

Last year, we cannibalized 326 stores, this year we're cannibalizing 246 stores.

Hopefully that is helps you in your modeling.

If you want to move to new store productivity.

Please.

We saw an increase in new store productivity quarter-over-quarter because of the seasonality of our business.

We think that's the right way to measure it.

But if you look at sequential trends we reversed the negative trend that we had seen in new store productivity as well, so we're very, very pleased with what we're experiencing there.

And then I think your last question spoke to remodel.

Yes, the gut remodels.

Yeah, and let me tell you about that.

We are very pleased with the performance in our gut remodels, if you will.

We've completed seven, we've got 46 in the queue and every month they get better.

Excellent.

Thank you.

You're welcome.

Danielle Fox of JP Morgan has our next question.

Thanks.

I have a quick question.

I'm wondering why you've edged up EPS guidance by a little bit but you haven't changed the sales guidance?

And then I have another question on sort of the broader gross margin outlook.

Well, first of all, again, we did reiterate the sales forecast.

I think what we've seen is pretty strong performance in the second and third quarter.

We're encouraged with the start of the fourth.

I don't think it's a surprise that we had a soft first quarter.

And we don't see in the fourth quarter the ability to make up for the softness in the first quarter, Danielle.

But I think everything we've talked about today says that when you get the kind of top line growth that we got in the quarter and the kind of leverage that we're getting from that growth through good cost control, strong productivity performance at the store level, from the store manager, down to the associate, we felt it was appropriate to take our guidance up for the year on EPS.

And you know, we're very excited about that.

I think it bodes well for the transformation and hopefully is well received.

Okay.

And then I just have a quick follow-up question on the gross margin outlook.

Should we view this quarter as a bit of an aberration in the gross margin being down year-over-year because of cyclings, the rebates?

And also if you could speak to maybe what you're seeing from shrink on the gross margin line, because I would think with the installation of some of these, you know, video surveillance cameras and people to verify the receipts at checkout, you might actually see a benefit to the gross margin in the future from shrink improvement.

If you could just give us a sense of the outlook.

Yeah I'm going to address one or two of your points and I would ask Carol then to comment further.

Let me say that I'm very pleased with the progress that the entire company, Troy Rice, the store managers, have put in place over the last 18 months, with a very strong emphasis on shrink across the board from supplier through store, and through customers.

So we are seeing as Carol has mentioned in previous calls, we are seeing favorable performance, better control, and a broad range of areas, UCC and coding, the work that Bob DeRodes is doing, certainly with the self checkout, the cordless scan gun, the new POS, all bode well for improvement in shrink.

And so we're pleased with that progress.

I think beyond that, Carol can comment on gross margin, where we have seen just like in operating margin sequential improvement over the last 18 to 24 months.

And we're pretty pleased with the direction we've got for the balance of this year and year in total.

Yes, our annual gross margin guidance, Danielle, you will recall is moderate growth -- gross margin expansion, we are anniversarying 114 basis point improvement in the fourth quarter but we are very comfortable with the guidance that we've given for expansion for the year.

Thank you.

You're welcome.

We'll now go to Eric Bosshard of Midwest Research.

Eric Bosshard, CFA: Good morning.

A question for you, Bob.

You mentioned at the outset of the call markets where you're seeing very strong comp growth rates.

You also talked about categories where you're seeing very strong comp growth rates.

Can you give some further color on why you're having the success in those markets and in those categories and where we might proceed from here in expanding that more across the chain?

Sure, Eric.

I think John Costello mentioned this.

Carol mentioned it.

We tend to cover it in a broad term called store modernization.

Whether it's -- as mentioned earlier the gut remodels, but beyond those, we are also seeing a variety of remodels in our stores.

Second, we're seeing major resets.

If you look at the resets in the design place, John mentioned about appliances, if you look at color solutions, if you look at outdoor power, if you look at hardware, we are systematically now, as a result of centralization of store planning and design, I believe we're getting tremendous leverage and consistency throughout our 1,643 stores.

We are also, through month in the box, getting tremendous execution by our store managers, and our DMs and RVPs for consistency.

I think the national advertising that you're seeing, certainly we're seeing tremendous response to the call, click or visit campaigns that we're running that you've seen with things like power washers and sprayers, and so I just think overall, what you see is very good momentum, very good support in ownership with the transformation.

Eric Bosshard, CFA: Can you see between the haves and the have nots in terms of those markets and categories performing well versus those that are performing less well?

Is there a clear delineation of either stores or categories you've not touched?

Or is there another factor that help explain the markets doing extraordinarily well versus the others?

Well, I think a couple of points.

Clearly, we're not where we need to be across the board.

We see growth potential in a number of stores, obviously to get them up to the company average.

And we have dedicated resources, from Troy Rice in operations, in merchandising, in logistics, in the technology area, and I think that goes a little bit to the question that maybe Gary answered earlier, we still think there is plenty of opportunity for same store growth performance, just given the improvements that we're seeing in those stores that we have touched and to those categories we have touched.

Eric Bosshard, CFA: Great.

Thank you.

Brenda, we have time for one more question.

And we'll take our final question from David Schick of Legg Mason.

David Schick, CFA: Hi, good morning.

Good morning, David.

David Schick, CFA: I guess this is sort of follow-up to the last question.

Could you, and I will sort of spare my follow-up in case you can't, could you give us those two categories you said nine out of 11 selling departments had an increased average ticket, what were the two that were not?

Yeah, I -- we certainly can.

And the two that were not, Carol can give you specifically.

Let me just say that one of them represents less than 2% penetration.

And is going through probably the most expansive reset that we have going on in our stores today.

Carol, would you agree with that?

That's our decor category which includes blinds and wallpaper.

And the other category was flooring and we had a lot of promotions last year in our flooring category which we did not repeat this year and we believe that contributed to the softness.

Now, it's just soft and we see some positive momentum right now in flooring.

David Schick, CFA: Okay.

Thanks.

That's very helpful.

Sure.

Thank you to everyone for joining us today and we look forward to talking to you next quarter.

And that concludes today's conference.

We thank you all for your participation.

You may now disconnect your phones.