家得寶 (HD) 2004 Q2 法說會逐字稿

Good day, everyone.

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

As a reminder today's call is being recorded.

Please hold all of your questions and comments until the end of today's presentation.

Please do not signal for a question or comment until instructed to do so.

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

Please go ahead, ma'am.

Thank you, Amber.

Good morning, everyone and welcome to The Home Depot second quarter earnings conference call.

Joining us today on our call 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, Executive Vice President and CIO, along with other Home Depot executives.

Bob Nardelli will begin today's discussion with a review of our business.

John will provide insight into our merchandising efforts while Bob DeRodes will take us through technological enhancements recently completed.

Carol will conclude our prepared statement with a discussion of our financial results.

Following these comments, we will open the lines for questions.

Question and answers will be limited to analysts and investors and as a reminder, we'd appreciate if a participant will limit themselves to one question with one followup, please.

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

This conference call is being broadcast real-time on the Internet at HomeDepot.com with links on both our home page and under the Investor Relations section.

The replay will also be available on our site.

Before I turn the call over to Bob, let me remind 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 2004.

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 the overall economy of the U.S., stability of costs and availability of sourcing channels, conditions affecting new store development, the Company's ability to integrate the businesses it acquires, our ability to implement new technologies and processes, the Company's ability to attract, train and retrain 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 of -- as of the date on which they are made.

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

Now let me turn over the call to Bob Nardelli.

Thanks, Diane.

Good morning, everyone.

Let me say that we completed a strong quarter with very solid financial results.

This was the first quarter in the Company's history where we achieved $20 billion in sales for a quarter.

This is a major accomplishment made by only seven other companies in the Dow.

Now, before I get into second quarter results, it's only appropriate that I take a moment to thank all of our associates, particularly our associates in the southeast who have worked tirelessly to serve our customers and the communities in which they live and work during the recent hurricane this past weekend.

The Home Depot associates have a tradition, you know, of shining their brightest when others are experiencing their darkest hours.

Now, let me talk a little bit about the second quarter, starting with our sales results.

Sales for the second quarter were up $2 billion over last year, an 11% increase.

We continue to gain market share and our same-store sales were up 4.8%, which made this the best second quarter performance in four years.

We had positive comps in every geography across North America, with strength in markets such as Vancouver, British Columbia, Portland, San Diego, Tijuana, Mexico, San Antonio, Miami, Philadelphia, Indianapolis and Puerto Rico just to mention a few of our highlighted areas.

Additionally, we recognized double-digit sales growth in our Home Depot Supply business and we continue to feel very good about the positioning for growth in the future.

Our net earnings, quite honestly, with strong sales growth and gross margin expansion and good expense control helped us achieve record net earnings of $1.5 billion.

Our earnings per share were 70 cents or 6 cents ahead of First Call.

Our financial performance, I think, is a direct result of the dedication and customer service focus of our more than 300,000 associates and I'm very proud of the accomplishments we've made as a team to date.

Our continued solid financial results together with our strong balance sheet support the board's recent decision to increase our share repurchase and authorize an additional $1 billion.

So, over the past two years, $7 billion have been authorized for share repurchase.

We are focused on increasing return to our shareholders and we believe that we have shown this with our actions.

This year alone, our share repurchase program coupled with dividends paid out has returned $2.8 billion in cash back to our shareholders.

Now, Carol Tome will take you through additional financial metrics a little bit later.

Our focus on enhancing the core is centered in four key areas.

We've talked about store modernization, distinctive and innovative merchandise, technological improvements and investing in our associate leadership, all of which is resulting in improved customer shopping experience.

And based on our recent survey, we have seen significant increase in 15 of 16 customer satisfaction ratings.

So, in a few mim -- minutes, John Costello will further discuss merchandising and store modernization with you and Bob DeRodes will provide a technology update.

This year alone in store modernization and technology we'll spend nearly $2 billion in both capital and expense, continuing our unprecedented level of reinvestment back into The Home Depot.

Now, in addition to building momentum in our stores, we're also extending the business and expanding our markets by developing new channels for growth.

Almost 60% of consumer survey said that they're planning a home improvement project in the next three months.

Our service business grew 27% in the quarter and continues to capitalize on the growing do-it-for-me market led by such services as carpet, HVAC, our countertop business, kitchen, windows and roofing all were leading the way.

In June, we completed our acquisition of White Cap, which is now part of The Home Depot Supply business.

White Cap, with 74 branches, serves large and mid-size professional contractors and provides a vehicle to expand into an entirely new channel for The Home Depot.

This acquisition brought with it talented leadership, strong customer relationships and new suppliers.

We are very pleased with the smooth integration to date and the synergistic opportunities with their customers and supply base.

In the second quarter the acquisition of Home Mart in Mexico, coupled with new store openings, added 24 stores to this very important region.

We're excited about the opportunities this acquisition gives The Home Depot and we now have 42 stores in this $15 billion Mexican market.

In September, we'll be opening our first Manhattan store located on 23rd street.

Now, this store is a great illustration of the leadership position we maintain in this industry when it comes to innovation across every element of our business.

Virtually everything about the store from its design and layout to our merchandising selection to our logistics infrastructure and use of technology were all specifically designed to meet the specific needs of the Manhattan shopper.

It will provide New Yorkers with the best convenience and price for their home improvement needs.

Additionally, this quarter we announced plans to enter the nearly $50 billion retail home improvement market in China, which is estimated to be growing at double-digit rates.

Now, let's switch for a moment and talk about Home Depot and the fact that it is all about people and community.

Two weeks ago, to celebrate our 25th anniversary, we gathered all of our store managers and other leaders throughout the entire enterprise to recognize our proud past and importantly share our vision for the future.

Let me assure you that the passion and the entrepreneurial spirit is alive and well at The Home Depot.

Our solid results were delivered by our associates and I'm pleased to announce that 52% of our stores and 4 store support centers qualified for success sharing in the first half of the year.

In early September we will be issuing checks totaling $30 million to these associates.

That's almost twice that of what we paid out last year.

Our associates are delivering, also, at the Summer Games in Athens, Greece.

We're proud to sponsor 71 athletes who have qualified and now participating in the Olympic and Paralympic games, which is more than any other company.

Now I'd like to turn the call over to John for his comments on merchandising results.

John?

Thank you, Bob and good morning, everyone.

Our merchandising and marketing objectives remain focused on winning customers and driving profitable sales.

Our solid results are driven by the following three areas.

First, broad growth across our core merchandising categories, second, continued growth from new innovative and distinctive products introduced both this year and in 2003 and third, the continued positive impact from our store modernization initiatives.

Let me review each area.

First, growing our business across our core categories.

Our unique selection of national brands, exclusive relationships and strong propriety brands continues to provide value for our customers and differentiates The Home Depot.

Well-known national brands comprise over 80% of our mix and are enhanced by exclusive brands like John Deere, Toro, Lithonia Lighting, Ralph Lauren paint and Basic Solutions by Ortho, as well as propriety brands like Ridgid, Ryobi and Hampton Bay.

The Home Depot remains focused on being the low cost by offering distinctive and innovative merchandise average ticket increased by 8.2% to $54.73 in the second quarter.

While commodity price inflation did impact our average ticket, we experienced average ticket growth in every department.

Our second quarter sales were strong across a broad range of merchandising categories and regions, 9 out of 11 departments posted positive comp sales performance.

Let me give you a few examples.

Lumber and building materials continued their strong growth this quarter.

Commodity prices have increased for certain merchandise categories such as steel, copper and lumber, contributing approximately 200 basis points of comp sales for the quarter but we continue to use our scale and buying power to minimize the impact of these changes to our customers.

We also saw strong sales performance in kitchen and bath, mill work and plumbing as customers responded to our differentiated assortment and strong values.

We're pleased with the growth in special orders and we've seen real strength across a number of categories such as fans, lighting, windows and faucets.

Seasonal lawn and garden comp sales were essentially flat against strong 2003 results.

We're encouraged, however, that seasonal sales increased in the first two weeks of August, prior to the hurricanes and believe that the outlook for seasonal sales in the second half of 2004 is good.

Our merchants' logistics and spore -- store support teams have been working together around the clock to support our dedicated store associates and make sure that our stores in the areas affected by the hurricanes have ample supply of emergency related merchandise, including plywood, generators, lights and batteries for our customers in their time of need.

We have a well defined process designed to get ahead of the needs in these tough times for customers.

The second factor was continued growth from new and distinctive products.

We continue to introduce a steady stream of new, distinctive and innovative products.

For example, since the beginning of this year, over 20 of our products have received recognition for innovation, value and performance by a number of independent organizations.

Our new Ridgid line of professional grade power tools introduced in October, 2003 continue to deliver strong sales performance driven by growth of the original lineup and the introduction of new products.

For example, we expanded the Ridgid line into other job site categories this quarter with items such as air compressors and tool storage which has generated positive customer acceptance and sales performance.

According to independent third party research, Ridgid was the fastest growing power tool brand in the U.S. market for the quarter.

New Husky products, including hand tool sets, saws and work knives also helped drive above Company performance.

Our momentum in appliances also continued as this category produced double-digit comps driven by five factors; a compelling merchandise assortment, new items rolled out in the quarter, the impact of our new appliance showrooms in virtually all of our stores, our associate know-how and strong marketing.

According to another independent third party research company, The Home Depot has grown year-over-year market share faster than any other retailer.

We're also in the process of rolling out three new appliance lines which are exclusive to The Home Depot;

GE Adora, which provides great style and an attractive value, the new Hotpoint metallic series, which provides a stainless steel look at a lower price point, and the value positioned Americana line.

We will continue to roll out additional new appliance items on these brands in the third quarter.

New exclusive brands such as Branded Decking and Hampton Bay patio furniture were introduced in the first half of the year to capitalize on the trend toward outdoor living and are delivering strong sales performance.

Within decking, Branded is being recognized as a leader in composite decking products.

In addition to veranda decking, we recently announced an exclusive arrangement with Trex, the leading commercial supplier of maintenance free decking.

In outdoor living and patio furniture, the success of our Hampton Bay patio line illustrates the power of our innovation as well as our mega brand as we expanded our propriety Hampton Bay brand beyond fans and lighting into other adjacent categories.

Our carpet business also posted strong results for the quarter with the introduction of our exclusive Stainmaster Platinum Plus carpet.

To ensure the best availability of merchandise to our stores and customers, we've formed a cross-functional team to take a comprehensive look at our distribution and supply chain capabilities.

Let me now turn to store modernization.

Continued investment in store modernization is providing a distinctive, easier to shop environment and continues to deliver strong comp performance.

Collectively, our reset categories are out-comping our Company average.

For example, our Color Solutions Center that was rolled out in spring 2003 continues to gain momentum and generate above average comp sales performance in both interior and exterior paint categories.

Our exclusive brand of Bear Paint continues to maintain its strong consumer demand after having been recognized as a top performer by independent testing organizations.

Our Design Place Showrooms, which were rolled out in 2003, delivered strong sales performance with particular strength in countertops and in-stock and special order kitchens.

We are on plan to touch all of our stores within three years with store modernization that includes new signing, lighting, paint and floor finishes.

Our more centralized store modernization programs are less disruptive than in the past and are making a difference in the overall shopping experience and customer response.

To support our Pro Focus, we now have tool rental centers in 925 stores, making us the number one tool rental center in terms of locations.

With our Pro Desk now in over 1400 stores, our focus on the Pro has never been stronger.

And just a few comments on our summer marketing campaign.

Our marketing and merchandising plans were tightly organized around compelling product messages and key seasonal themes.

As you know, we also re-launched HomeDepot.com late last year and are experiencing strong growth in this space.

The site was recently selected as providing the best customer experience in home improvement by an independent research group.

And, as we announced yesterday, we have signed an exclusive multi-year agreement to be in the Mover's Source Program, offered through a strategic alliance between the U.S. postal service and Imagitas, Inc., which will give us unrivaled access to the 40 million plus people who move each year.

In summary, the second quarter of 2004 reflected strength from three areas; growth across our core merchandising strategies, continued growth from our program of new innovative and distinctive products and store modernization.

Thank you and let me now turn the call over to Bob DeRodes.

Thank you, John and good morning, everyone.

This morning, I will update you on the progress of our technologies initiatives to digitize The Home Depot.

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

I'm pleased to say that during the past two quarters, we have implemented several advancements that are driving efficiencies, providing better customer instore experience, and delivering more timely and detailed information with which to operate our business.

We now have self checkout systems in more than 830 stores, including our introduction of self checkout into Canada.

Customer acceptance of this new technology continues to grow as we have seen over 100 million customer transactions through self checkout this year.

And nearly a quarter of a billion customer transactions since we introduced this new technology.

This industry first technology continues to play an instrumental role in improving customer service while having the added benefit of placing hours back onto the selling floor.

We continue our technology investment in the front of the store through the rollout of our new digital camera CCTV system to over 1500 stores and by adding new POS capabilities like online receipt lookup.

This new feature allows returns desk to find an electronic version of your receipt and validate your purchase in case you no long over have the original receipt.

We've also completed the rollout of nearly 40,000 new two-way cordless scan guns, the latest technology for Symbol, that have resulted in reduced customer checkout times as well as higher cash uraccuracy(ph).

We've validated these benefits through our new cash or metrics reporting system, which is derived from our new enterprise warehouse.

In May, we introduced to 20 stores our first instore electronic sales kiosk.

This new technology is being used to extend our selection of faucets and shower heads to over 14,000 special order items available from The Home Depot Supply through overnight delivery.

Like we did with self checkout, we will continue to pilot this new technology to find the best way to provide improved customer service and greater product selection through an endless aisle.

We continue our efforts to automate and re-engineer the backend processes of the store through the initiative we call BEAR.

We are piloting our new scan receiving systems and processes and we are completing the work to automate our return to vendor processes.

In advance of the full rollout of the BEAR projects, we are currently replacing the wireless network in every one of our stores with the latest wireless technology from Cisco.

To concur with this change, we are upgrading the technology on our mobile ordering carts for the first time since they were deployed.

This new infrastructure positions us to deploy newer wireless applications like customer call boxes and instore mobile communication systems for our associates.

In order to increase the effectiveness of all these new tools, we are making important strides toward enhancing our electronic links with our suppliers.

We anticipate that our top 60 suppliers will be linked through a new vendor gateway by the end of this year.

Over the next 24 months, we will use this new gateway to link with our top 600 suppliers representing nearly 80% of our transactional SKUs.

This is just one of many activities under way to improve the accuracy of our vendor and product information, which is required to manage our supply chain more efficiently.

In the first half of this year, we completed the implementation of 2 enterprise-wide software platforms.

The successful rollout of the both the PeopleSoft and SAP systems is a milestone that few companies have achieved in this short time frame, let alone concurrently.

Both of these systems are delivered to our associates through our new Home Depot Intranet portal, which provides easy seamless access to the myriad of new systems which are being used in our stores and support centers.

Today we have over 300,000 associates and managers using PeopleSoft to maintain their Home Depot records as well as access their career and performance management history.

Prior to this implementation, these records are maintained manually in paper files throughout the enterprise.

Since the first quarter, we have processed over 1 million online human resource transactions.

For the month of June and the quarter-ending July, we used SAP's financial systems to close our books and generate our financial reports.

We now have greatly improved automation in the areas of financial planning, reporting, analysis, fixed asset accounting, non-merchandise purchasing, payables and project accounting.

Through SAP's business warehouse system, we now provide multiple online views of financial data for our stores and business functions alike.

And finally, three weeks ago we announced plans to open a technology center in Austin, Texas.

This investment further reinforces our commitment to technology.

This additional site creates a new beachhead for us in a high technology area and provides us access to the resources necessary for continued growth and expansion.

The center will be open later this year and will house such functions as system and network operations, help desk, design and engineering, and software development.

In closing, I think it's evident that we're making solid progress on our commitment to digitize The Home Depot.

We continue to work closely with all functions and operational areas within the Company and we remain committed to enhancing our business through the effective use of technology.

We will continue to stay on strategy and deliver incremental improvements while transforming the major systems of the enterprise.

I would now like to turn the call over to Carol.

Thank you, Bob and hello, everyone.

The Home Depot remains focused on its strategy to enhance our core, extend our business and expand our markets.

Our strategy is working as evidenced by our financial performance.

In the second quarter our performance exceeded our plan.

Let me take a few minutes to review the details of our financial results.

Comp sales for the second quarter were 4.8% with comps of 6.6% in May, 4% in June and 4% in July.

Like many retailers, the first part of June was the softest in the quarter and while we don't like to sound like a weather report, we think this performance was weather related.

Two weeks into the third quarter and excluding the hurricane our comps are running considerably ahead of our second quarter performance.

We continue to grow our leadership position in the home improvement industry.

Consistent with our operating strategy, in the second quarter we deliberately cannibalized our stores in order to gain share and provide convenience for our customers.

This quarter we cannibalized about 15% of our stores and this had a negative impact to second quarter comps of approximately 2%.

Excluding the impact of cannibalization our comps would have been over 7% for the quarter.

During the second quarter, we opened 48 new stores, bringing our total store count to 1,788.

We opened 4 stores in May, 31 in June and 13 in July.

Sales from new stores and stores that have been opened for less than one year as well as sales from our new businesses contributed 6.2% of our top line growth in the second quarter.

Selling square footage increased 9.8% from last year to 190 million and the average square footage per store was 106,000.

Customer transactions were 359 million for the quarter, an increase of approximately 3% from last year, reflecting new store growth.

As a reminder, new store cannibalization impacts customer transactions in our comp stores.

Our weighted average weekly store sales for the quarter were $860,000, flat to last year.

Sales per square foot for the quarter were $419.77, an increase of 1.1% from last year.

This is the fourth quarter of year-over-year improvement in this key productivity metric, demonstrating solid progress in the transformation of our business.

I want to briefly mention the impact of EITF 0216 on second quarter results.

Due to EITF 0216, which changed the way we account for certain vendor allowances, we no longer net certain advertising co-op allowances against advertising expense.

The result is an increase in selling and store operating expenses with a corresponding decrease in cost of merchandise sold.

In the second quarter the total impact to net earnings was $27 million or about 1 cent per share.

We anticipate the full year impact of EITF 0216 will be 5 cents, most of which we've already recognized.

In our press release, we provided you with a comprehensive table that reflects the impact of EITF 0216.

Our gross margin for the second quarter was 33.37%, an increase of 221 basis points from last year.

Our gross margin expansion can be explained by the following factors.

First, 122 basis points or $244 million was directly related to advertising co-op allowances, which we now account for as a reduction in the cost of merchandise sold.

Second, lower shrink than we experienced one year ago contributed 32 basis points of expansion.

And finally, our gross margin reflects a change in mix, as you heard from John, offset in part by a cost of our deferred interest program.

As we told you last quarter, one of the ways we provide value to our customers is by offering no interest, no payment programs through our private label credit card and the cost of these programs is reflected as a cost of merchandise sold.

In the second quarter, total operating expenses as a percent of sales increased 138 basis points to 21.06%, excluding advertising expense which we now reflect on a gross basis pursuint to EITF 0216, we leveraged total operating expenses by 5 basis points, due to gains and operating efficiency.

These efficiencies were driven by a number of factors, including higher sales per labor hour, benefits from our private label credit card and new technology.

The expense leverage is notable because we, like many companies, are facing pressure from rising health and benefit costs.

And as we continue to do the right thing by investing in our business, depreciation is rising at a rate faster than our sales growth.

One of the ways we're investing in our business is through new technology as you heard from Bob DeRodes.

I want to spend a moment discussing our SAP financial systems implementation.

This was the largest implementation of SAP's core financial systems in history.

While this project was challenging, it was well worth the effort as it will improve our processing efficiency and provide our Company with more operating flexibility and analytical functionality.

I want to thank the members of our finance and IT teams who worked so diligently to make this project a reality.

This project was completed on time and on budget and as a reflection of the power of team work.

Operating margin for the second quarter increased by 83 basis points to 12.31% of sales, the highest operating return on sales in our Company's history.

Earnings per share were 70 cents, up 25% from last year, excluding the impact of EITF 0216, earnings per share were 71 cents, up 27% from last year.

Diluted weighted average shares for the quarter were 2.2 billion shares, compared to 2.3 billion shares in the second quarter last year.

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

Now let's review some other metrics.

At the end of the quarter, total inventory increased 14% from $8.6 billion last year to approximately $9.8 billion this year, reflecting new store growth and inventory in our newly acquired businesses like White Cap.

On a per-store basis, inventory levels were flat to last year.

Year-to-date inventory turnover was 5.2 times, equal to a year ago.

Computed on beginning long-term debt and equity for the trailing four quarters, return on invested capital was 20.4%, up 260 basis points from last year.

Excluding cash, return on invested capital was 26.3%.

Our cash position remains strong.

We ended the quarter with $3.7 billion in cash.

Year-to-date, this reflects strong cash flow from operations, offset by $1.5 billion in capital expenditures, $712 million used to acquire new businesses, $346 million in dividends paid and $2.4 billion used for the repurchase of common stock.

At the end of the second quarter we had repurchased $6 billion under our share buyback program, representing about 184 million or 8% of our total outstanding shares.

We continue to strategically balance our capital allocation with our efforts on reinvesting in the business and returning cash to our shareholders.

On August 6, our board authorized an additional $1 billion in share repurchases, bringing the total authorization to $7 billion.

Based on our financial results for the first six months of year, as well as our outlook for the balance of the year, we now expect our 2004 ending cash positions to be approximately $2 billion.

While there's been a lot of discussion about external factors and the impact they might have on our business, today we believe our performance and our ability to execute is all up to us.

We had a solid second quarter with improvement in every key metric.

Based on our results for the first six months of the year, we are confirming our 2004 sales growth guidance of 10 to 12% and are listing our 2004 earnings per share growth guidance from 10 to 14% to now 14 to 17% growth for the year.

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

Amber?

Thank you.

The question and answer session will be conducted electronically.

If you'd like to ask a question, please press star, 1 at this time.

Please keep in mind if your mute button is turned on, please turn it off so your signal does reach us.

Once again that is star, 1 if you'd like to ask a question or if you do have any comments.

We'll first hear from Budd Bugatch with Raymond James.

Good morning and congratulations.

Thank you!

Very impressive quarter.

I guess since I live in Florida and, you know, had dodged the hurricane last week and feel for the people on the west coast who are not as fortunate as we were in Tampa, can you talk a little bit about what's going on down there and what -- maybe what financial impact that might have?

Well, Budd, let me say first of all I -- I can't thank our associates enough who worked tirelessly in the preparation of, during and obviously now post-hurricane.

We -- we have a wonderful group here that takes over our crisis center.

We had literally hundreds of trucks re-diverted and staged in preparation for the hurricane.

We've mobilized our associates, we have probably over 500 associates that we've moved into the area, through a series of chain networks we have identified and found 92% of our associates to date.

We're making a very concerted effort to make sure we identify and locate all of our associates.

We've put emergency funding in place for them for food and shelter, et cetera.

Obviously our -- our number one priority is to meet the needs of the people that live in that area.

We are -- have and are continuing to expedite, but as you would imagine, all of the materials necessary for containment, felt, tarps, roofing, and -- and we'll continue to do that, our experience, of course, I guess 12 years ago with Andrew, suggests that this is going to be a long-term process.

We'll put in Pro Centers, we'll put in the necessary facilities and manpower to support not only material needs, but as part of our new at-home services business, we're re-diverting resources down there for roofing, siding and windows.

I calculated about 30 stores in the path of -- of Charley.

Is that about right?

Budd, that's correct.

We had 33 stores affected but again, they stayed open as long as local government would let us stay open.

I -- I'm amazed and applaud the efforts, we had every store open Saturday, we had mobile generators in place, I -- I couldn't be more proud of these associates.

Every one of the stores was open.

We work closely with FEMA and state regulators that allowed us to keep our stores open and at least be able to receive post-curfew so that we were restocked and ready to go first thing in the morning.

So it was an unbelievable mobilization of the associates down there, Budd.

Okay.

Thank you.

One last question.

One metric I look at on a different vein is transactions per average store, which is a calculated number that we do and that continues to decline a bit.

Do you have a feel as to when that number -- or when that metric will start to flatten out or start to turn up in terms of traffic and when you -- when we should see that?

I think two points and then I will ask Carol to reinforce, Budd.

Obviously as Carol said, new stores, by design, cannibalize our -- our same-store sales and therefore will cannibalize transactions at the same time.

So, we're sensitive to it.

We're very pleased with the continued progress we're seeing in average ticket.

We're very pleased with the progress we're seeing in sales per square foot and John Costello and the merchandising team will continually monitor to make sure that we have the transactional merchandise and the marketing to support that.

But fundamentally we're going to stay on strategy, but we'll obviously be sensitive to consumer demand and we'll respond in kind.

But Carol, you have some more data.

Well, just to amplify what Bob said, the impact of cannibalization directly impacts transactions in our comp stores.

As we've told you on the call, we -- today we've cannibalized about 15% of our stores and the impact is about 2%.

Yeah, I understand that.

Yep.

Okay.

Thank you very much and congratulations.

I will let some others talk.

Thank you, Bud.

And we'll now take a question from Bill Sims with Smith Barney.

Good morning, thank you.

Can you comment on the changes you've seen in the growth of large ticket items versus small ticket items?

And a followup to the earlier question, over the last several quarters have we seen a noticeable pickup in traffic?

Or is average ticket still driving the growth and comps?

Thank you.

Bill, let -- let me just give two quick comments, then I'll turn it over to John Costello.

But we have had a very focused effort in the last two years, I would say, in our merchandising group.

I couldn't be more proud of what they have accomplished by bringing in distinctive and innovative merchandise that is really providing tremendous value.

Our consumer data continually reinforces that our customers are looking for gratification, they have higher aspirational desires and we're fulfilling that through, again, distinctive, innovative merchandising, a combination of nat -- national and exclusive brands, each of the departments are now reviewing through our innovation console.

We have development centers where we're reviewing and presetting in a off-site location.

So, I think it's the result of a very focused strategy and excellent execution, John, and you may want to comment some more.

You know, our strategy is to provide the best combination of innovation and value and we experienced average ticket growth across every one of our merchandise departments.

While there was some inflation impact in commodity areas, as I touched on in my remarks, we're also seeing broad-based increase in average ticket across a range of categories, like appliances, kitchen and bath, molding, lighting and fans, as customers continue to look for ways to improve their homes to get the homes that they desire.

So, we're particularly encouraged by the breath of our average ticket growth and the fact that it's being driven by product features and product innovation.

Just a quick followup, how sensitive are your sales to the higher fuel prices?

Are you seeing any shift in ticket to less lower tickets and more larger tickets or are you seeing very little impact?

Two things, Bill, one, overall, obviously, if, in fact, higher fuel prices are affecting the consumer, they're doing it in a fashion that is supportive for us, which means they would stay home and what we would see is more home improvement projects.

So, we -- we kind of see the reciprocal benefit of that in -- in the fact that, as you know, housing turnover has been significant in the last two years.

Therefore, the installed base is there and we think through very selective and lasered marketing, advertising and merchandising, people are doing more home improvement projects and -- and therefore I think we're benefiting from it.

John, you may want to comment on the commodity side.

It's true, you know, we will see some impact on the commodity side with those kind of prices but as Bob touched on, we think there is also a strong opportunity presented by that, not only are our customers home-focused but they're more interested than ever in the range of energy-saving products that we provide in our store, a wide range of energy star products and it's everything from energy-saving appliances to digital thermometers to insulation.

So, yes there is some impact on inflation, but also increased customer demand for energy-saving products.

Thank you very much, congratulations.

Thank you, Bill.

And we'll now hear from Dan Wewer with CIBC.

Bob, question regarding the installation business.

I know in Canada you changed the model separating the design and selling responsibilities from project management and the results have been impressive.

Just curious as to what the plans are in the U.S. market, either for the orange boxes or for the EXPO division.

Well, I think there's two or three parts to your question, Dan.

First of all on a broad basis, we're continuing to see very good growth in our home services business.

As I mentioned, Carol, 27%.

Frank Blake is in the room and I'm going let him comment in a moment, but I think the team there is, again, doing a very good market focus, customer back identification and each of the national programs that we're putting in place is the direct result of customer driven data on what they're looking for.

We're very pleased with the acquisitions that we have made to give us platforms and then use our financial strength to grow geographically, for example, in the areas of roofing, siding and windows, HVAC, some of the items that I mentioned in my comments.

We obviously are continuing to look at the best way to deliver those in the most efficient manner both internally and the most effective manner for our customers.

Just one comment on EXPO, we have developed a separate project management center here in Atlanta and we have recently approved the rollout in two more selected cities because of the success we're seeing in that project management business.

Frank, you may want to comment a little bit more in -- in regards to go-to-market and some of the national programs.

Sure, I -- just as you said, we are focused across-the-board on how we improve our performance on fulfillment.

In addition to EXPO and Canada, we have a call center here in the U.S., in fact, we have several call centers here in the U.S., focused on improving our fulfillment as well as our front-end performance.

We also, as you know, bought two service companies last year with precise objective of getting additional project management and fulfillment capability.

I think we're seeing that in our numbers, we continue to see improvement on our customer -- customer satisfaction scores as well as, obviously, on our sales growth.

And, Frank, just as a followup on the inventory, Carol noted that the inventory per store was about flat yet your sales per foot are up, so those trends appear favorable, but it looks like there may be an opportunity to get the inventory levels down in the acquired businesses.

If you could elaborate on that and if so, what would be some of the strategies?

Yeah, I'll let Carol elaborate, Dan, but as Carol said, they're flat.

Obviously it represents an opportunity but clearly we want to be sure as we exit one season and start to enter another that we're fully, fully equipped, you know, that we have plenty of merchandise in the store, that we're well stocked, but -- but, look, we have opportunities to get better, we have programs in place, we have initiatives in place and I think you'll see that in the future, as we get more expertise in our logistics and inventory management.

Bob talked a lot about the systems deployment, which will give us much more quickly, more accurate POS and the opportunity for quicker replenishment with our suppliers.

And part of it is just timing, Dan, as you can appreciate.

We just consolidated the companies that we acquired, so, you throw in all the inventory that you acquire on the day of consolidation and we just got to work it through the system.

So, this will take care of itself over time.

Yeah, that's a good point.

Say, thanks a lot.

Thank you, Dan.

Amber, we're ready for the next question.

Thank you, that will come from David Schick with Legg Mason.

Hi, good morning.

Congratulations, as well.

Hi, David.

Question on the guidance, you -- you talk about -- you're raising earnings guidance and you're keeping your sales guidance and you made the comment that sales look good late in the quarter and good early this quarter, so, could you just talk about the decision making there and, you know, how you're thinking about that?

Then I have a followup.

Yeah, sure, David.

I mean, I think if you remember we started the year under GAAP accounting at 7 to 10.

Last quarter we took it up 10 to 14.

We're taking it 14 to 17.

If you exclude the impact of GAAP, that's 16 to 20.

I think it is reflective of the continuing performance of the Company in driving operating efficiencies, it's something that, you know, we've been talking about for a couple of years now as part of the transformation.

There isn't a piece of the business that isn't working on improving everything we touch.

It's our core purpose from HR to operations, to technology, to merchandise -- there's not a piece of the business that isn't working towards driving efficiency which ends up improving customer satisfaction.

So, that's really the whole -- that's really the whole basis on -- on why we've taken it up and we wanted to give pretty clear guidance as to where we saw the balance of the year going and then the full year, Carol?

Anything else?

Bob, I think that's exactly right.

Okay.

Okay.

So that -- but the delta between sales and earnings, is that from any particular trend?

I mean, you know, you talked about shrink and that's helping growth and, you know, what are sustainable things that we can think about that's driving that delta and you're taking earnings guidance up faster than sales?

Carol?

Well, let me give you a couple of things to consider.

First of all is gross margin.

We have given guidance that we expect modest gross margin expansion for the year and we've certainly seen that year-to-date.

So, we're doing exactly what we had said on the gross margin line.

As it relates to expenses, what we've told you is that in a flat comp environment we don't plan to leverage expenses because we are reinvesting in our business.

But in a positive comp environment, we do plan to leverage expenses, so, those two factors are given rise to the fact that our earnings will grow faster than our sales.

And finally, and it's important to note, we were enjoying some EPS accretion through our stock buyback programs.

The programs are creating economic value for our shareholders.

Thanks a lot.

Thanks -- thanks, thanks, David.

And we'll now hear from Jack Murphy with CSFB.

Thanks, good morning.

Hi, Jack.

A little bit more on the gross margin and the comments you made there.

On the advertising co-op allowances, as we look forward, are the co-op allowances a contributor to overall profit growth in the next couple of quarters?

Or is that really just sort of an offset between the SG&A and the gross margin, how it's treated from an accounting perspective?

Jack, let me jump in real quick on that and John can comment, but I -- I think this is a very important question that you're asking that has tremendous moral and ethics implications.

When we work closely with our suppliers, we do it -- we do it obviously with a tremendous resolve and commitment to use those precious dollars to drive sales.

And it is very important to me, from a corporate governance and ethics standpoint, that that is in fact what we do.

I can assure you that there isn't a dollar that we -- that we acquire, you know, working with our suppliers, that John and -- and the merchandising advertising doesn't turn right around and redeploy.

But, John, is that -- ?

That's correct, Bob.

We reinvest all of the co-op and marketing funds that we work with our suppliers on and the changes you're seeing are due entirely to EITF 0216.

Okay, great.

And then just a followup on the remaining drivers of gross margin, the shrink and the mix, and then the offset on deferred interest.

Should we look for kind of similar levels of -- of magnitude in -- on a go-forward basis?

Or is it too early to say?

Jack, what we've guided for the year is modest gross margin expansion.

Year-to-date, excluding the impact of EITF 0216, we've recognized 54 basis points of gross margin expansion, so, hopefully that helps you think about the balance of the year.

Okay.

I -- I just want to comment again because this is really a commitment from one fulfilled by many.

If you think about what you heard on this call, Bob talked about BEAR and our operations team.

Again, our strategy is pretty transparent, customer back, you see it in our advertising, more home and family kinds of -- of projects.

Bob talked about tremendous improvement in the front-end, we're moving that technology to the backend.

Carl Liebert and the division presidents are working very hard to drive efficiencies.

I -- you heard us talk about productivity per square foot, sales per associate, getting better.

I think those all speak volumes for the fact that we have a well articulated strategy and that our associates are supporting, again, our core purpose of improving everything we touch.

Okay, thank you.

Thanks, Jack.

We'll now hear from Eric Bosshard with Midwest Research.

Good morning.

Good morning, Eric.

Two things I wanted clarification on.

First of all, sales, the re-acceleration of momentum it sounds like you've seen at the end of July and continuing or improving in August, any categories or color you can share with us that's driving that better sales performance?

I -- I think, Eric, again, John or -- or Carol can -- what -- what we're seeing the first couple of weeks is pleasantly across-the-board.

I mean we're seeing it in all departments and we're seeing it in all geographies and I -- I want to just reinforce, in case anybody missed Carol's comment, well before the hurricane, this is not -- this is not hurricane driven performance.

This was performance we were seeing before the impact of the hurricane, which, again, is isolated, as Budd knows, into our south - southeastern and particularly the 33 stores in the affected path.

Yeah, I would reinforce that, that the growth was broad-based across both department and region of the country during what is often a transitional period in home improvement, as well.

And then the second question I had was the gross margin performance in the second quarter, especially when considering that seasonal sales were flat.

Can you just give us some more color on how you're accomplishing what you're accomplishing in gross margin?

And why you're taking what appears to be a more conservative outlook on gross margin in the second half relative to the strong first half performance?

Well, the merchants have done a fabulous job of continuing to take cost out.

That's a big driver of gross margin expansion, obviously.

And then as John commented, we are seeing a change in mix in the products that we sell and we're selling some higher margin categories.

And so it's a wonderful compliment of what our customers want and what our merchants are doing.

Great, thank you.

Thanks, Eric.

And we'll now hear from Aram Rubinson with Banc of America Securities.

Hey, everybody.

Heck a job on the quarter.

Thank you.

I had questions related to information and, I guess, since Bob DeRodes is on the line it might -- it might dovetail with that.

If you were to look at information, can you just fill us in a little bit on what impact it's having so far on merchandising, i.e., SKU selection, space allocation, replenishment and things like that?

I know you mentioned there was some technology putting into the mobile ordering carts, but just in general, I thought that information would help the gross margin rate and I guess that wasn't included in the gross margin benefits.

Where are you in information helping the gross margin rate?

Yeah, I -- I -- I think Bob will answer it in detail, but let me just say overall if you -- if you listen to where we've spent a lot of our money early on, SAP, to get, as Carol mentioned, a faster, less cumbersome way of working through our financials, you heard Bob talk about our PeopleSoft.

We think it's important to know where 300,000 people are, when they show up for work and kind of their individual performance records and so forth.

We've done lot in the front end to drive efficiencies and improve customer satisfaction.

We're on the very early stage, I think Bob and John Costello would agree, we're getting some initial benefits out of our systems' implementation there, but we see a lot of opportunity as we go forward now with these mega platforms and developing retail systems and so forth.

So, I think there's more in front of us in that particular area than we have realized in -- in the functions of let's say finance and human resource.

Bob, would you comment on that?

Yes, good morning, Aram.

I would just reinforce the fact we're working hard to -- to get our large data stores built, our enterprise data warehouse, get our sales information from the new POS system, get that loaded realtime and then link with our suppliers to improve both vendor and product data, the gateway that I mentioned earlier.

Those are all going to have an impact on improving the data, which will then be the source feeding our new tools which we're providing to our merchants.

We're early - we're very early in that process working with them on new assortment planning, price optimization tools, which we're just beginning to roll out, but as our data matures and as we mature as an organization, we're going to get much more effective in the implementation of those tools.

Yes, this is John.

As both Bobs mentioned, we are early in the process, but, you know, are seeing the opportunities in everything from plan-o-grams, assortment planning, markdown management, pricing optimization, as the tools and the data rollout and as we increasingly incorporate those into the day-to-day operations.

Thanks and good luck.

Thank you.

Amber, we have time for one more call -- or question.

Thank you.

That will come from Danielle Fox with Merrill Lynch.

Thanks, I have just one question.

I was wondering if you could talk a little bit more about expense pressures and opportunities?

Carol, you mentioned that you have some latitude with regard to spending depending on how sales were coming in.

You, obviously, have very good current trends, tough comparisons, so, I'm wondering how you're planning expenses for the second half?

Well, we are -- are planning expense leverage for the full year.

As you know, we don't provide quarterly guidance, we just look at the full year and we are planning expense leverage based on the sales growth guidance that we've provided you.

And now we're doing that by a number of things.

Most of it is just driving productivity.

Productivity everywhere.

I mean, SAP is a good example of how we drove productivity in the finance organization and you see it everywhere throughout the Company.

That productivity is a wonderful thing to have because we do have some expense pressures.

For example, we were one of the first companies to start expensing stock options.

That's an expense.

This year alone,in second quarter, $44 million versus $15 million last year.

So, those put pressure on our ability to expense, it's the right thing to do, however, and we will find ways to cover it through productivity.

Thank you.

Well, thank you for joining us today and we look forward to speaking with you next quarter.

Conference, thank you for your participation.

You may now disconnect and have a great day.