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Operator
Good day everyone and welcome to today's The 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.
- Vice President, Investor Relations
Thanks Laura.
Good morning everyone.
Welcome to The Home Depot third 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; and John Costello, our Executive Vice President of Merchandising and Marketing 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 and Carol will completed our prepared statements and discuss our financial results.
Following our prepared statement we will open the line for questions.
Questions and answers will be limited to analysts and investors and as a reminder we would appreciate it if the participants would limit themselves to one question with one follow-up, please.
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 and the overall condition of the U.S. economy, stability of costs and availability of sourcing channels, conditions affecting new store developments, 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 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 is contained in the company's periodic filings with the Securities and Exchange Commission.
Now let me turn the call over to Bob.
- Chairman, President, Chief Exec. Officer
Thanks, Diane, and good morning, everyone.
Our third quarter results reflect a continuation of our strategy to enhance the core, extend the business and expand our markets.
In this quarter we are reporting record sales and earnings and I would like to thank all of our associates who worked so hard to deliver this very strong financial performance.
Our associates and our suppliers spent countless hours helping those impacted by a record number of hurricanes and subsequent flooding and power outages.
In the midst of the substantial damage our associates worked tirelessly to serve our customers and our communities.
In support of their colleagues, more than 2,600 associates arrived from around the country to Florida and Alabama to take shifts in our stores.
In some communities we were the only store open,.
Dedicated associates served our customers from stores with no power and in makeshift tented stores in our parking lots.
We also pledged more than $4 million in charitable contributions to the hurricane relief and rebuilding efforts, aiding customers and associates affected by storms.
I'm really proud of our associates.
They shown their brightest when others were experiencing their darkest hours.
Now sales for the third quarter increased by 2.2 billion, or 13% over last year to 18.8 billion.
Gaining market share our same store sales of 4.5% were a solid gain on top of comp sales of 7.8% in the third quarter of last year.
In addition to Florida, sales increased in all geographies with strong comps in markets like Sacramento and Los Angeles, California;
Wichita, Kansas;
San Antonio, Texas;
Washington, D.C.; and New York metro.
Both Mexico and Canada had a solid quarter.
And in addition our Home Depot supply business achieved double-digit sales growth and are well-positioned for continued growth.
Strong sales growth along with gross margin expansion helped us achieve record third quarter net earnings of 1.3 billion.
Earnings per share were 60 cents, an increase of 20% over last year.
Uh, Carol Tome will take you through our financial metrics later on in the call.
You will hear from John Costello a little later in the call about our merchandising accomplishments.
We saw strength across the store and increasing financial returns from our investments in both store modernization and technology.
Our commitment to store modernization is paying off.
Self check out systems is close to 880 stores and new lighting and flooring and signage programs are improving the convenience and shopping experience for our customers.
Compared to one year ago our customer survey data shows that The Home Depot is performing significantly better in our key customer satisfaction categories with the strongest gains in speed of check out, helpfulness and availability of store associates and the general shopping experience.
Beyond building momentum in our stores we are also extending our business and expanding our markets by developing new channels for growth.
Our service business, excluding merchandise, grew by more than 26% to 957 million in the quarter, capitalizing on the growing do it for me market.
We saw strength in installation services such as carpet and in countertops and kitchens and windows just to name a few.
We have over 23 national installation programs and we install more than 11,000 projects each day.
This is an important and growing piece our business and we are entering the fourth quarter with continuing strong growth.
You will recall that we acquired White Cap earlier this year.
Now, White Cap is a pro distribution business that provides a platform for future growth in the $400 billion large and mid-size professional contractor markets.
Sales are strong.
The integration is going well.
And we are enjoying purchasing and other synergies.
Since we acquired the company we've made three small bolt-on acquisitions and have grown organically by adding seven branches, bringing our total to 77 in 17 states.
This business is exceeding my expectations.
We continue to see a real growth opportunity in Canada and Mexico.
Our Mexican business is strong with double-digit comp growth.
The integration and rebranding of the Home Mart stores have gone extremely well.
Today we have 10 stores in Mexico City and 42 stores throughout the country.
Housing is a clear priority in Mexico and based upon my recent trip there I'm confident that we are well-positioned in this $16 billion market.
I'm equally pleased with our performance in Canada.
Today we have 110 stores with plans to open 25 more through the end of 2005.
This quarter we opened two unique urban formats on both coasts of North America.
We opened our first Manhattan store located on 23rd Street.
The store is off to a great start as the groundbreaking entrant of The Home Depot in New York City.
We look forward to opening our second Manhattan store on 59th Street.
Now looking to Canada and Vancouver, British Columbia, we opened another successful urban store in Park Royal.
Virtually everything about these stores from their design and layouts, their merchandising selection and use of technology was specifically designed to meet the specific needs of their local communities and provide us access to an almost entirely new and untapped customer base.
I believe these stores demonstrate another opportunity for new store growth by bringing The Home Depot to previously underserved customers and markets.
Our commitment to creating shareholder value and building our core values have never been higher.
In September Home Depot markets inaugural week of service.
Our Associates volunteered and donated more than 260,000 hours that week alone, touching more than 1,200 communities and 1 million people throughout North America and China.
We remain committed to do our military personnel and their families, both active and veterans.
This year we launched in cooperation with the Department of Defense, Operation Career Front.
And I'm proud to say that we've hired more than 10,000 veterans this year.
We were honored to have been recognized by the employers support of guard and reservists and the Department of Defense with the Freedom Award.
And just last week we were ranked number one as the most military-friendly employer by GI Jobs magazine.
Lastly we continue to be very encouraged by the current economic environment with positive trends towards higher home ownership, and a growing population, along with strong payroll increases and improving consumer confidence.
Consumers continue to express strong interest in doing home improvement projects.
These strong signs give us the confidence for the long-term prospects of home improvement and the continued momentum within our company.
So now I'd like to turn it over to John for his comments on merchandising results.
- Executive Vice President of Merchandising and Marketing
Thank you, Bob, and good morning everyone.
Our merchandising and marketing objectives remain focused on winning customers and driving sales with a great customer experience.
The Home Depot team delivered on these objectives this quarter, even in the face of the challenging weather patterns that Bob mentioned.
Partnering with our store operations teams and our suppliers we were able to quickly adapt to the changing needs of our customers.
Thanks to all of our team internally and externally for their hard work and extraordinary effort.
Our results for this quarter were driven by the following three factors: First, growth across our core merchandising categories.
Second, continued success from new, innovative and distinctive products at great values.
And, three, the continued positive impact from our store modernization initiatives.
Let me review each area.
First, growing our business across core merchandising categories.
Our third quarter sales were strong across a broad range of merchandising categories.
Nine of 11 departments posted positive comp sales performance.
As expected we experienced large comp increases in building materials and hardware due to the hurricanes affecting the southeast.
Our company practice has always been to freeze retail prices during natural disaster to protect our customers and do the right thing.
Let me highlight some areas for you.
Building materials had the strongest comp increase with a double-digit gain as we experienced strong sales in gypsum, concrete, roofing and other products.
We also saw strength in sales of sheeting, tarps, buckets and tape.
Strong sales of generators, fasteners and portable power equipment contributed to strong comps in hardware.
As you may have heard we reached out to states as far west as Washington to secure generators and other products for our customers in the southeast.
Our store associates, suppliers and store support personnel around the country and in Canada and Mexico worked tirelessly to provide affected customers with emergency supplies.
These efforts not only helped customers prepare for the storms but also are aiding them in repairing and rebuilding.
The real story, though, is that lumber, building materials and hardware continue to perform well nationally as we continue to serve both the pro and do-it -yourself customer.
Lumber pricing contributed approximately 90 basis points to comp sales for the quarter.
As we began to anniversary record high lumber costs we are beginning to see some commodity costs decline which makes home improvement projects more affordable for our customers.
We experienced strength in kitchen and bath driven by appliance sales, bath fixtures, vanities and sinks.
According to an independent third party, our core market share of appliances grew 40% to 8.6%, the largest increase versus last year among major retailers.
Great product assortment, dedicated hours, associate training and improved in-store merchandising all contributed to this performance.
We saw strong sales in flooring and mill work as customers responded to do our differentiated assortment and strong values.
Seasonal lawn and garden comp sales were essentially flat against very strong 2003 results.
Sales of chain saws and accessories, portable gas cans, gas trimmers and cleaning and chemical supplies were in high demand and drove category comps.
We continue to see strength in outdoor living areas.
Offsetting this sales of live goods and fertilizers were obviously dampened by the storms.
Through special orders we were able to offer our customers a broad assortment of merchandise.
Special order sales executed in-store and through our new catalogs and the Internet continue to perform very well as we leveraged through other warehouse to quickly fulfill orders and take advantage of continued technology improvement.
For example our newest lighting catalog contains an additional 800 exclusive designs at great values to supplement the over 1,000 lighting and fan styles in our stores.
The Home Depot remains focused on being the everyday low price leader.
By offering distinctive and innovative merchandise our average ticket increased 6.6% to $55.53 in the third quarter, a new record for the company.
While commodity price inflation did impact average ticket, we experienced average ticket growth across the store because of our enriched merchandising mix of innovative and distinctive products.
We continue to be very focused on offering the best combination of product benefits and value.
There's been a lot of talk in the industry about price and value.
Providing unsurpassed value has been part of our core purpose since our founding in 1979.
In fact so far this year we have lowered prices on over 5,000 items while increasing product value.
And last week you may have noticed our advertising which highlights the great values you can find at The Home Depot.
This advertising reinforces our strategy of offering our customers quality distinctive products from well known brands at great values.
The second area driving third quarter performance is the continued success from our new innovative and distinctive products across the entire store.
Some examples of these new products include our Clopay (ph) Coachman series garage door program, DuPont real touch laminate flooring, the new Ryobi air grip laser level, Rigid titanium coated saw blades, new Kohler Cimarron toilets, Charmglow outdoor fireplace products, Porter Cable pneumatic combos, new Hampton Bay interior lighting and ceiling fans, Trex (ph) composite decking, Jenn-Air dual fuel ovens, Silestone (ph) counter parts, countertops and many, many more.
Our merchandising team is focused on driving sustained innovation across all categories all year long.
Strong comp sales of appliances were enhanced by the roll out of three new appliance lines exclusive to the Home Depot.
G.E.
Edora (ph), providing great style at an attractive value, the new Hotpoint metallic series offering a stainless-steel look at a lower price and the value positioned Americana line.
Third, moving on to store modernization.
Our continued investment in store modernization is delivering a distinctive easier to shop environment.
Collectively our reset categories continue to outperform the store.
For example, we recently invested in resetting our kitchen sink, in-stock tile and countertop departments.
Our new Ralph Lauren color center and our exclusive new interior wood care center.
Also as Bob mentioned in the third quarter we opened the first two of three planned new urban store formats.
Two in Manhattan and one in Park Royal in West Vancouver, British Columbia.
These unique stores demonstrate our ability to adapt The Home Depot for new customer segments and new markets.
We also continue to benefit from the strength of a tightly integrated merchandising and marketing plan behind 'You can do it, We can help'.
I'd also like to take a moment to congratulate the 76 OJOP athlete associates who competed in the Olympics and paralympic games this past August and brought home 41 medals.
We are very proud of your accomplishments.
So in summary the third quarter reflected strength from growth across our core merchandising categories, continued success from our new innovative and distinctive products at great values and the continued positive impact on the customer experience from store modernization.
Thank you and let me now turn the call over to Carol.
- Chief Financial Officer, Exec. VP
Thank you, John, and hello everyone.
This was very strong quarter for The Home Depot.
We stayed on strategy and achieved sales growth of 13% and earnings per share growth of 20% in the third quarter.
Comp or same store sales in the third quarter were 4.5%.
As Bob mentioned, in the third quarter we were up against a tough comparison from last year so we were pleased with our comp sales.
Hurricane Ivan and Jean were the two most powerful hurricanes in the string of storms to hit the United States.
The impact of these storms positively impacted our third quarter comp sales by approximately 100 basis points.
While hurricanes help to drive sales they also came with a cost.
Expense items like freight, merchandise and store damage and employee expense.
This was the biggest hurricane relief effort in our history and as John mentioned we pulled product from shelves as far west as Washington state.
Expenses associated with the hurricanes offset the contribution from the related sales so we experienced no earnings benefits from the hurricanes in the third quarter.
During the quarter we opened 38 new stores bringing our total store count to 1,826.
We opened nine stores in August, 13 in September and 16 in October.
Sales from new stores and stores that have been open for less than one year as well as sales from our new businesses contributed 8.6% of our top line growth in the third quarter.
We continue to grow our leadership position in the home improvement industry.
Consistent with our operating strategy we deliberately cannibalized our own stores in order to gain share and provide shopping convenience.
This quarter we cannibalized about 16% of our stores which impacted third quarter comps by 2%.
Excluding the impact of cannibalization our comps would have been over 6.5% for the quarter.
Customer transactions were 324 million for the quarter, an increase of 3.5% from last year, reflecting new store growth.
As a reminder, our cannibalization strategy impacts customer transactions in our comp stores.
Selling square footage increased 10.2% from last year to 194 million, and the average square footage per store was 106,000 square feet.
Our weighted-average weekly store sales for the quarter were $767,000, a slight decline from the same period last year.
Sales per square foot for the quarter were $374.97, flat versus last year.
Our sales per square foot reflects our 42 stores in Mexico which have lower sales per square foot than the average store.
Excluding these stores, sales per square foot increased by approximately 1%, demonstrating solid progress in our core.
Similarly excluding our recently acquired stores in Mexico new store productivity increased.
In Mexico we expect our store productivity to improve as we become more established in the market.
Gross margin for the third quarter was 33.3%, an increase of 201 basis points from last year.
Our gross margin expansion can be explained by the following factors: First, 133 basis points, or $251 million, was directly related to advertising co-op allowances which we now account for as a reduction in the cost of merchandise sold consistent with EITF 0216.
Second, lower shrink than we experienced one year ago contributed 30 basis points of expansion.
And finally our gross margin reflects margin benefits from a change in mix as you heard from John, offset in part by the cost of our deferred interest programs.
As we have talked about before, 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 in our gross margin.
In the third quarter total operating expenses, as a percent of sales, increased 204 basis points to 22.35%.
Excluding the impact of advertising expense, total operating expenses increased 68 basis points.
In addition to hurricane related expense, this was due to several factors.
First, given our strong sales performance we experienced higher expenses in connection with sales incentive programs like our store associate success sharing program.
Second, our planned investment in store modernization and new technology caused remodel expenses and depreciation to rise at a faster rate than sales growth.
We continue to believe that investing in stores and technology is the right thing to do and will generate higher returns in the future.
Third, as you know, we were one of the first companies to expense stock options and we grant stock options to all salaried associates including our assistant store manager.
In the third quarter our stock option expense increased 52% as compared to last year.
Finally like many companies we are experienced rising energy and healthcare costs.
In the third quarter these rising expenses were partially offset by benefits we received from our private label credit card program.
Operating margin for the third quarter was essentially flat to last year at 10.95% of sales.
Our income tax provision rate dropped to 36.1% from 37.1% in the third quarter last year.
The majority of this reduction was due to the reversal of a $31 million valuation allowance as we are now able to recognize capital losses for which no benefits had been recorded.
For the year we anticipate our income tax provision rate to be 36.8%.
Consolidated net earnings totaled $1.3 billion, and diluted earnings per share were 60 cents, up 20% from last year.
Diluted weighted-average shares for the quarter were 2.2 billion shares, compared to 2.3 billion shares in the third quarter last year, reflecting the impact of our share repurchase program.
Now let's review some other metrics.
At the end of the quarter total inventory was $10.2 billion, an increase of 13.3% from last year, reflecting new store growth and inventory in our newly acquired businesses like White Cap.
On a per store basis inventory levels of $5.4 million were flat to last year.
Year-to-date, inventory turnover was 5.1 times.
Computed on beginning long-term debt and equity for the trailing four quarters our return on invested capital was 21.4%, up 260 basis points from last year.
Excluding cash, return on invested capital was 27.2%.
Our cash position remains strong.
We ended the quarter with $3.4 billion in cash.
Year-to-date this reflects strong cash flow from operations and the net proceeds of $495 million from our recent [INAUDIBLE] offerings.
This was offset by $2.8 billion in capital expenditure,$727 million paid for acquisitions, $532 million in dividends paid, and $2.5 billion in share repurchases.
We remain committed to appropriately balancing our reinvestment in the business and returning cash to our shareholders.
Moving into the last quarter of the year we plan to complete our full year capital spending program of $3.7 billion and anticipate further share buy-backs under our $1 billion authorization.
Since inception, we have repurchased slightly more than $6 billion under our $7 billion share buy-back program representing about 186 million shares.
The Home Depot remains on strategy as we continue to execute our business plan, invest in our future and drive improvements in key metrics.
Two weeks into the fourth quarter our comps are running in line with our plan.
Based on our results for the first nine months of the year we are confirming our 2004 sales growth guidance of 10 to 12% and are lifting our 2004 earnings per share growth guidance from 14 to 17% to now 19 to 20%.
Thank you for your participation on today's call.
And operator, I think we are now ready for questions.
Operator
Thank you.
The question and answer session will be conducted electronically today.
If you would like to ask a question, please signal us by pressing star one on your telephone keypad.We'll take as many questions as time permits.
And again please press star one if you do have a question.
We'll turn first to Dan Wewer with CIBC.
- Analyst
Bob, it's been awhile since you've updated us on some of the changes in distribution
- Vice President, Investor Relations
Dan?
- Analyst
Yes.
Hello?
- Executive Vice President of Merchandising and Marketing
Hello, Dan?
- Analyst
Yes.
Operator
Just one moment while I check his line..
- Analyst
Can you hear me?
Hello?
Can you hear me?
Operator?
Hello?
- Vice President, Investor Relations
Laura let's go to the next question.
Operator
Okay.
We will turn next to Budd Bugatch with Raymond James.
- Analyst
Good morning, can you hear me?
- Vice President, Investor Relations
Hi Budd?
- Analyst
Can anybody hear us?
- Executive Vice President of Merchandising and Marketing
Hello?
- Analyst
Hello.
- Chairman, President, Chief Exec. Officer
Hey Budd?
- Analyst
Yeah, I'm here can anybody hear me?
- Chairman, President, Chief Exec. Officer
Yes we can Budd.
- Analyst
Alright.
Good morning, Bob and good morning Carol congratulations to you all on a very good quarter.
- Chairman, President, Chief Exec. Officer
Thank you.
- Analyst
Carol, maybe if you would, you went over some of the causes of the SG&A increase, can you kind of give us maybe orders of magnitude of them, and, uh -- for the 68 basis points as much as you're willing?
- Chief Financial Officer, Exec. VP
Yes, I'm happy to do that.
First let's talk about the increase that we are seeing in our sales incentive programs.
Budd, as you know we are tracking to have our best comp performance since 1999 and we are delighted to share the success of that performance with our associates.
That was the biggest cause of G leverage in the third quarter followed right after that by the investments that we are making in store modernization and technology and we believe those investments are paying off as evidenced by our increase in return on invested capital.
- Analyst
Okay.
And stock options and energy, how -- how do they rate?
- Chief Financial Officer, Exec. VP
Stock options and energy, energy really was a slight impact into the third quarter.
Let me give you stock option expense.
I think this will help you frame it up.
This year in the third quarter our stock option expense was $33 million as compared to $22 million last year.
Year-to-date stock option expense for our company is $92 million compared to $46 million a year ago.
That helps put it into perspective, I hope.
- Analyst
Alright, thank you, yeah.
One quick follow up, Bob, I know you started an initiative in China.
Maybe if -- could you give us any idea of when we will either get some information as to what your China plans might be or maybe if you would like to give them we'd love to hear them?
- Chairman, President, Chief Exec. Officer
Yeah.
Budd I think at this point we -- as I said before, we felt it would be far better to announce our intentions to go to China rather than have to deny speculation on every call or every encounter.
We have moved our senior team to China, they are in Shanghai as we speak, and we will, Budd, let me just say we will follow a very similar model and approach that has worked in Canada and has worked in Mexico looking at both organic and inorganic.
We are not in a position to talk much more about it at this point but I think it's the performance we've gotten out of both of those models, Canada and Mexico, that gave us the confidence and the momentum to now move into China.
- Analyst
Okay, well I look forward to that and thank you and congratulations.
- Chairman, President, Chief Exec. Officer
Thank you, Budd.
- Chief Financial Officer, Exec. VP
Thank you.
Operator
We'll turn next to Dan Wewer with CIBC.
Please go ahead
- Analyst
Thank you.
Bob, can you hear me now?
- Chairman, President, Chief Exec. Officer
Yes Dan, I can.
Okay.
Thank you.
- Analyst
It's been awhile since you've updated us on some of your new distribution strategies.
I know you made a change in leadership there a year ago.
But, maybe if you could update us as to what you're doing in the way of maybe moving toward some kind of centralized model going forward?
- Chairman, President, Chief Exec. Officer
Yeah, Dan, it's a great question and we have been spending a lot of time on it.
As you know we basically took our logistics team and we broke it into two significant areas.
One, we turned all of the existing logistics responsibilities to Carl Liebert who's -- who's here in the room with us today and Karl, from an operating standpoint, is working closely with the division president's to maximize all of the efficiencies that we can get out of our international distribution centers, our cross docking transfer centers, our carton distributor centers, our seasonal distributor centers, et cetera, and what we are finding again is opportunity for consistency and best practice sharing across that network.
And we are seeing progress there and we are pleased with the progress.
So that's point one.
Point two, we told you we've asked John Campea, who is part of the merchandise team with John Costello to really take on and lay out, what will a logistics model look like for a $100 billion company.
We have engaged outside support to help us with that.
We have -- we have staffed that team.
We are having regular progress reports on definition.
And we are encouraged with the early indications of being able to utilize some of the existing resources and the opportunity that it presents just like we are making progress, Dan, in technology, we think there is significant opportunities for us to enhance our competitive advantage in both of these categories.
And Carl, I don't know if you want to comment briefly on the facilities we have at hand.
- Senior Vice President - Operations
Yeah, I will just speak up, Dan.
We -- as we recently told you we began to roll-out auto replenishment on our existing distribution centers to our stores and we are seeing improvement there from a perspective of not only getting the right product on the shelves at the right time but also from the flow of our facilities and level loading those facilities to distribute.
So, we talked about that, we've actually implemented that and began rolling that out in advance of further opportunities we are continuing to seek.
- Analyst
Great.
And, Bob, just as a follow-up question, in the past you've discussed the balance between stock buy-backs and cash dividends with the stock acting well now trading in excess of four times book value, if you think that pendulum may e shifting towards cash dividends as maybe more attractive than buy-backs?
- Chairman, President, Chief Exec. Officer
Well Dan, let me say, I think Carol mentioned in her comments, obviously I think our past track record since I've been here we've more than doubled our dividends.
And in fact if you look at over $6 billion against the $7 billion board approval would suggest I think there is no reason that you should see anything different going forward than what we've done in the past on that side.
Carol mentioned that we will fully utilize the $3.7 billion of capital redeployment which we think is a very important part of balancing and delivering on the short term but continuing to invest for the long-term.
And certainly if you look at our return on invested capital of over 21% with cash, 27% ex cash, I would hope, Dan, that our past -- our past processes or our past performance will really set the tone for what we will do in the future.
Carol, anything else on that?
- Chief Financial Officer, Exec. VP
Yes, we think it's appropriate to look at the total cash return paid to shareholders looking at both dividends and share repurchases.
As you know for the three-year period ended 2003 our total cash return represented 46% of our cumulative earnings.
We are tracking to do better than that in 2004.
And we compare ourselves to best in class companies.
Those best in class company's pay anywhere between 30 and 70%.
We are tracking right in the midpoint there.
We think that's a very good place to be.
- Analyst
Right, great.
Thanks and good luck.
- Chief Financial Officer, Exec. VP
Thank you.
- Chairman, President, Chief Exec. Officer
Thank you, Dan.
Operator
We'll take our next question from Eric Bosshard from Midwest Research.
- Analyst
Good morning.
- Chairman, President, Chief Exec. Officer
Good morning, Eric.
- Analyst
Can you talk a little bit about the margin progression?
The last few quarters we've seen leverage on the SG&A line and you did a good job of explaining why it went the other way this quarter.
But can you talk about how we should think out perhaps over the next two years what you have left to accomplish in gross margin and what we should be thinking about taking place within the SG&A line over time?
- Chairman, President, Chief Exec. Officer
Year, Eric, I'm going to let Carol give you, obviously, the financial expression of that.
But let me just say that the more we learn about our business the more opportunities we think we have.
I couldn't be prouder of this staff and the team who are embracing, you know our core -- our core purpose to improve everything we touch.
And we are having much more granular and robust discussions across our entire company, certainly in the logistics area, certainly with technology, with what Bob DeRodes is doing and the enhancement we have there of either being able to return valuable hours to the sale floor or, you know, to reapportion those somewhere else and in merchandising.
So, I -- I'm continually encouraged as we look forward relative to the opportunities we are finding in our company, again, to improve everything we touch.
And Carol can give you a more granular financial expression of that.
- Chief Financial Officer, Exec. VP
Sure, Eric.
Let's take your question into two pieces.
Let's talk about gross margin and then SG&A.
On the gross margin side as you've seen we've had very nice margin expansion this year.
Ex. the accounting change.
We are very pleased with that and that's really driven by a couple of big -- big ideas.
First is the reduction in shrink and we are not at best in class.
We've moved the needle considerably but we are not at best in class.
So there's opportunity there.
And secondly, are the margin benefits that we are enjoying as John and the merchandising team bring in innovative, distinctive and new merchandise, let me just give you one example.
In the third quarter alone, interior lighting contributed five basis points of gross margin expansion for our total company.
We are bringing in new products with great attributes for our customer and great margin value for us.
On the SG&A line year-to-date we've leveraged expenses by 10 basis points and for the year based on our earlier guidance as well as our commitment to reinvesting in our stores and in technology you should expect flat expenses as a percent of sale.
Going forward we haven't given guidance in the outer years but you heard from Bob and Carl talk about the opportunities that we have to drive productivity in our company.
- Analyst
Great.
Thank you very much.
- Chairman, President, Chief Exec. Officer
Thank you, Eric.
Operator
We will now take a question from Goldman Sachs', Matthew Fassler.
- Analyst
Thanks a lot and good morning.
- Chairman, President, Chief Exec. Officer
Good morning, Matt.
- Analyst
A couple questions if I could.
First of all it seems like your non-retail businesses away from the orange box, like White Cap, are becoming a bigger piece of the business and just for the sake of helping us measure it because it gives us a better lens on the composition of your business and on retail productivity, would you be able to give us a sense as to what the sales dollars associated with those are today and importantly what kind of rates they are growing at?
- Chairman, President, Chief Exec. Officer
Matt, let me just, uh, and I appreciate the question because we are, we are changing, if you will, the way we view the market.
If you remember at the last meeting we said we really have defined our playing field to about a $900 billion market opportunity.
Our strategy of enhancing the core I think is recognition that our priorities and ur heavy investment, has in fact been, enhancing the core and I think you are seeing the results of that through our same store sales comp and customer satisfaction index.
But we also talked about extending and expanding and I think equally you are seeing quarter after quarter as we color in the mosaic of how that strategy is coming to life through very selected and strategic acquisitions that help us fulfill this from foundation to finish.
We are very pleased with the, not only the acquisitions, but the integration and I think we all understand it isn't over when you sign, it's just starting.
And we've got some great integration teams and as I said I couldn't be prouder when I saw the conversion of Home Mart stores in Mexico last month when I was there.
White Cap is exceeding our expectations.
You heard John Costello talk about how we are leveraging the business model which is what we bought in your other warehouse.
It was not the revenue.
It was the business model that allowed us to extend sales in the store through special order and John will be passing out our new catalogs, Carol talked about the gross margin growth.
But when you see the distinction and the innovation in the product I'm telling you, this is going to be a home run.
And so we are excited about these opportunities of broadening our playing field, expanding our portfolio so that we have quite honestly the opportunities of seasonality and economic trends.
Carol, you want to put some more meat on that?
- Chief Financial Officer, Exec. VP
Sure, let me size it for you, Matt.
Today that non-retail piece of our business represent about 3% of our total sales.
And is growing at three times the company growth rate.
- Analyst
You're saying 3% of total sales would be non-retail including things like White Cap and the home builder businesses?
- Chief Financial Officer, Exec. VP
That's correct.
- Analyst
Okay, thank you.
A quick follow-up
- Chief Financial Officer, Exec. VP
And growing at three times the company rate.
- Analyst
A quick follow up.
Carol in prior calls you from time to time have given us kind of the sales progression through the quarter.
And I was wondering if you could do that for us today for the third quarter?
- Chief Financial Officer, Exec. VP
I would be happy to.
Sales in August and September, our comp sales in August and September were north of 6%.
They dropped down to about 2% in October.
If you recall we were up against some very tough comp in October last year.
So we were really pleased with our October sales, it was ahead of our plan.
- Analyst
And how does the October comp compare to the fourth quarter compare that you are facing.
- Chief Financial Officer, Exec. VP
We are up against a 7.6% comp in the fourth quarter.
We are actually running ahead of how we exited the third quarter, if that helps you.
- Analyst
Gotcha.
That is sure helpful.
Thank you so much.
- Chief Financial Officer, Exec. VP
Okay.
You're welcome.
Operator
We'll turn next to Aram Rubinson with Banc of America Securities.
- Analyst
Thanks.
I had a question for John and than a follow-up for Carol.
John, I was hoping you could just illustrate to us the improvements that you get on the store modernization, to what extent the store modernization enables you to sell the higher ticket merchandise better than it does in other stores, so in other words I guess your mix of merchandise in those stores, and would that then precipitate any kind of acceleration in reset if you want to continue to enjoy those merchandising gains.
- Executive Vice President of Merchandising and Marketing
We have a systematic plan of merchandising but what we are finding in our resets is we are providing a broader assortment of best, better and good merchandise presented in a way that makes it easy to shop.
You know, for example, we are getting continued momentum out of our color solutions center introduced in 2003 which has Glidden, Bear, Walt Disney and Ralph Lauren providing a range of finishes, colors and price points.
As Bob mentioned we continue to make great progress in our lighting and fan assortment.
We are providing a greater assortment of merchandise at higher price points backed with a great value.
Our exterior wood care center not only provides an extended range of finishes but also provides the know-how to help customers select the right finish for themselves.
So we are really seeing that systematically across the store.
We are also increasingly integrating special orders into our sets that provide greater assortment.
And finally, we are implementing a call quicker visit strategy that enables us to leverage core merchandising.
So, here again using lighting and fans as an example, we provide a great assortment in our store that's also supplemented by the catalogs Bob referenced as well as an extensive on-line assortment.
- Analyst
Are your 4-foot sections in your stores now kind of plug and play throughout, do you have a finite number of planograms or is it still catch as catch can?
- Executive Vice President of Merchandising and Marketing
We are continuing to roll those out and we are continuing to optimize each 4-foot section in addition to the major resets that we have planned.
- Chairman, President, Chief Exec. Officer
Aram, I want to -- I'd like to just step back for a moment before you ask Carol the next question and just make sure we reframe the fact that we are on plan to reinvest $1 billion back into our stores in the form of modernization.
And that's full remodels.
It's refresh and it's resets.
And just to reinforce John's comments, you know, I think the store planning group along with merchandising as we touch about a third of the bays going forward have been and going forward will develop a routine now where that will be the norm.
We will continue to refresh and reset and we are making great progress in productivity gains working between John's organization, John Costello, and Carl Liebert and the p's we are finding an ability to do this, to use your term, with these plug and plays, through state of the art and patentable fix stream for our company.
Carol, do you want to add any more to that?
- Chief Financial Officer, Exec. VP
Bob I think --
- Chairman, President, Chief Exec. Officer
Go to Aram's second question.
- Analyst
Let me ask it, actually.
The question I guess is the SG&A stuff that you talked about earlier seems a little sticky in nature.
I'm just curious if you look forward over the next year or two what kind of comp it is you think you need to start leveraging the expenses?
Is there a -- I don't need your comp guidances explicitly but what you think you need to leverage?
- Chief Financial Officer, Exec. VP
No, It's a great question.
It's a question that we're asked all the time.
And, you know, we have a very interesting business model here because we can dial down expenses and leverage.
But our vision and as Bob's strategic vision is to invest in the company for future growth.
So we will do that because we know that that will pay huge dividends in the future.
- Analyst
6%, 2%?
- Chief Financial Officer, Exec. VP
(Laughter from many) We could help you build your model if you'd like.
- Chairman, President, Chief Exec. Officer
Aram, let me say -- let me -- I would share this information.
If you look at our capital reinvestment, and Carol, you jump in here, but traditionally when we were investing almost singularly in new store growth it had a certain depreciation schedule.
If you look at where we are investing today, relative to over $500 million in technology and $1 billion in store modernization, our very conservative policies are to depreciate three to five years.
So in fact, Carol, I think I'm right in saying that, Aram, you should factor that into your model that depreciation expenses not only are up relative to increasing our overall capital significantly from four years ago but the depreciation schedule is more accelerated.
Carol, you want to quantify that?
- Chief Financial Officer, Exec. VP
I think it's a great point, Bob.
This year of the $500 million that we will be spending on technology that will be amortized over a three-year period.
So that's a very short life.
And when you think about the store modernization that's taking place in our stores most of that is being depreciated over a very short life as well.
So that puts increasing pressure on the expense line but it's the right thing to do.
It's the right thing to do.
And as we continue with technology and rolling out initiatives like auto replenishment not just for the products that we source from our distribution centers but for all of the products that we source, think about the productivity gains, Aram, you know, you've been in the back end of our stores, think about the productivity gains that we have ahead of ourselves.
- Chairman, President, Chief Exec. Officer
I -- I -- Aram , if I could just take another minute and expand on that question cause I think it's presents an opportunity for both Carol Liebert and Bob DeRodes to comment back to my earlier statement for as much we've accomplished is as many opportunity I see in front of us in this company to continue to distance ourselves from the competition and continue to gain a competitive advantage.
If you think about 880 self checkouts.
We are continuing to see productivity, and in this case, reapplying those critical hours to the sales floor.
But Bob DeRodes, Bob, you may want to comment on some of the things that we'll see roll-out in the fourth quarter that is a continuum of what you talked about in our last earning call.
- Executive Vice President & Chief Information Officer
Yeah, Bob, thank you.
On the heels of a real strong delivery in the first half of the year we are continuing to roll-out self check out as Bob indicated.
We are completing all the closed circuit television camera systems in all of our stores.
We are making maximum improvements to HomeDepot.com.
We are deploying, as Carl mentioned, some new inventory management tools.
And I'm really glad to say that we are going into pilot here in the next 30 days with our new special order system for flooring.
- Analyst
Thanks a lot.
I appreciate it.
- Chairman, President, Chief Exec. Officer
Thanks, Aram.
Operator
We'll take our next question from David Schick with Legg Mason.
- Analyst
Hi, good morning, congratulations.
- Chairman, President, Chief Exec. Officer
Thank you David.
- Analyst
Just a question, you are obviously still quite early in Manhattan but you mentioned you are pleased with the results.
And you were clear in touring the store that it's got a lot of expo in the store.
What does it mean in terms of -- or how are you thinking about what urban stores could bring back into the orange box from expo or just kind of layout your thoughts of what you are thinking?
- Chairman, President, Chief Exec. Officer
David, thanks and I will make some comments and the other team may want to jump in here.
Let me say again we are not pleased, we are very pleased with Manhattan and the 23rd Street.
I toured 59th Street last week and I'm equally excited about the assortment and the presentation and the innovation just in those two stores alone.
We had a great grand opening up at Park -- Port Royal -- Park Royal up in Vancouver.
Again we are getting tremendous response from the customers there.
I think the most important point here, David, is that this gives us new formats, new stores and new geography for extension of The Home Depot brand into underserved markets and underserved customers.
I think that is the most exciting evidence from our success in just these initial openings and Frank Blake is in the room but we are as you would imagine looking at other opportunities now to -- to, you know, take this successful model across the country.
That's point one.
Point two, if you look at 23rd Street, I think you and I would both agree that you know, the vignettes that we see there in the mezzanine and the utilization of space certainly gives us cause to reflect on how we might emulate that in other stores, you know, everything from the high tech stainless to the European influence, cobalt, and all of the accessories that go on there, the light cloud certainly was a prototype for things to come in 2005.
If you think about the way we are presenting some of our flooring and some of the things that John talked about that we will be rolling out in 2005.
So we are excited about the proof-positive performance that the decor merchandise in 23rd Street will allow us to in other urban areas and equally in our existing store format.
So, I don't know if there's any other comments Frank you want to make from a real estate perspective?
- Executive Vice President, Business Development and Corporate Operations
Sure, just to -- David, just to build on Bob's comment on how this enables us to reach customers who we're now under serving we've done a fairly detailed analysis of that and there are over 100 of what we call voids, that is areas where we are under serving.
We in urban-type areas, a market opportunity of between 2 and $3 billion.
So we are very excited about what we are learning in Manhattan and the ability to extend that to other areas.
- Chairman, President, Chief Exec. Officer
You know building on -- building on Bob's comments, our customer-driven modular approach to merchandising not only let's us tailor our stores more precisely to urban and non-urban markets but also provides an ongoing laboratory for us to test new ideas and expand them throughout the system.
So a lot of the things that you're seeing in kitchen and bath, appliances, countertops, hard and soft flooring, lighting, and in seasonal and even on the hard hard line side of the business have application not only in new urban formats like 59th Street and Park Royal but also in our suburban stores as well.
So, we are gaining a lot of experience in these stores that's going to enable us to tailor our stores even more precisely market by market.
- Senior Vice President - Operations
David this is Carl, I also think on the operations side it's allowed us to test and put some new technology in there such as the expanded self check out.
We now have portable registers and portable PDAs where our managers can order on line to help serve customers.
So it's been a great laboratory operationally for us to continue to enhance the customers experience and I think those are going to be leverageable to many other stores as Frank articulated.
- Chief Financial Officer, Exec. VP
And finally from a financial perspective we love what we are seeing.
These stores are well positioned to generate higher returns on capital than our core.
- Chairman, President, Chief Exec. Officer
So, David, that's more than you asked for. (Laughter)
- Analyst
That's great.
- Chairman, President, Chief Exec. Officer
I guess you would register that as everybody is pretty excited about it.
- Analyst
I guess I got that full treatment answer because I show up on a weekly shopper list there. (Laughter) Thanks very much.
- Chairman, President, Chief Exec. Officer
Thanks, David.
Next question?
Operator
That will come from Steve Chick with J.P. Morgan.
- Analyst
Thanks.
- Chairman, President, Chief Exec. Officer
Good morning.
- Analyst
You guys, there was a question earlier about the non-retail piece of the business and, you know, it's growing I guess at three times the sales of the rest of the company.
Can you speak to what the margins are of that business and how much lower they may be relative to the rest of the company.
- Chairman, President, Chief Exec. Officer
We sure can.
Carol you want to cover that?
- Chief Financial Officer, Exec. VP
Sure.
Well as you can appreciate this business is different than the retail business and both the gross and operating margins are less than the retail business.
But the, these businesses are also considerably less capital intensive.
So from a return on capital perspective they are well-positioned to generate higher returns and they leverage the core business that we have.
What we are seeing as we get into these businesses, our purchasing synergies not just within the businesses that we've acquired but purchasing synergies that we can actually bring back to the retail business.
So we just think it's a win win for us.
- Chairman, President, Chief Exec. Officer
One of the real disciplines we have monthly review, integration reviews, and one of the simple is we do a paired comparison on SKUs, SKU cost of goods, and obviously to Carol's point, we are getting great synergies there, we are getting enhanced category expansion because there were unique SKUs offered in particular channels to serve those customers, so we are seeing benefits on the merchandising side, John and his team are both on the logistics side we are able to see leverage there and equally important as we grow our in-the-box pro through CRM we are finding commonality in customer accounts and being able to expand share of wallet.
We are early in that process, but Joe DeAngelo with Frank Blake are seeing tremendous upside potential there.
- Executive Vice President, Business Development and Corporate Operations
Also our growth on the services side of the business is very much a driver of core merchandising revenue as well as we broaden our ability to meet the do-it-for-me in addition to the do-iter -- do-it-yourself customer.
- Analyst
Okay.
Great.
That's helpful.
One other thing.
Did, can you speak, I think you mentioned that you had lowered pricing in the store on 5,000 items.
- Executive Vice President, Business Development and Corporate Operations
Yes.
- Analyst
Can you speak to that, that was the first time I had heard that actually?
- Chairman, President, Chief Exec. Officer
Let me, -- John answered that but again I think we in fact recently in one of our ads talked about this year alone in excess of 5,000 prices we've permanently rolled back -- rolled back those prices.
But it's something that's core to our business since -- I mean it is the foundation I think of our success since 1979.
- Executive Vice President of Merchandising and Marketing
Providing great value has been an ongoing effort of The Home Depot, not just in new initiatives, so we are consistently working with our supplier-partners to look for ways to provide greater value for our customers and then sharing that.
We are also beyond every day prices continually looking for opportunities to make special buys and bring those into the stores.
So what you are seeing is a very disciplined approach across all of our product categories in addition to rolling back prices we are also looking for opportunities to provide greater value by providing increased product benefits.
So for example in areas like some of the product innovations with Rigid and Ryobi tools, some of the new lighting and fan styles, Bob and I mentioned earlier, we are providing enhanced style on the decor side and enhanced product features for both do-it- yourselfers and pros at great values as well so value will remain a key focus going forward.
- Analyst
Okay, thanks.
- Vice President, Investor Relations
Laura, we have time for one more question.
Operator
Thank you.
That question will come from Alan Rifkin with Lehman Brothers.
- Analyst
Okay.
Thank you very much.
Bob, your enthusiasm is pretty evident on the call and for good reason, after all, earnings up 20% in the quarter, up almost 22% year-to-date.
Yet your guidance for the year implies fourth quarter earnings growth of only 14 or 15%.
Is that just conservatism on your part or do you see some greater head winds going forward?
And I do have a follow up.
- Chairman, President, Chief Exec. Officer
Yeah, Alan, let me just say that I think most importantly we talked about top line of 10 to 12% and we are certainly looking more at the upper end.
- Analyst
Okay.
Okay -- fair enough.
And then one question for Carol.
Maybe provide some color if you can, you know, with the remodeling focus becoming evermore important can you maybe provide some color on some of the returns of the more recently remodeled stores versus once earlier in the program?
- Chief Financial Officer, Exec. VP
Oh, gosh, you know, we've learned as we've gone on this program and our experience is so much better than when we first started from our ability to execute and John you can add to this.
- Executive Vice President of Merchandising and Marketing
I think it's a good point.
Beyond the sales and financial return that we see from our remodels I think we continue to make solid progress in minimizing the disruption to the stores during that process.
So to Carol's point I think we've learned a lot about optimizing the return from these as well as minimizing store disruption and it continues to improve.
- Chief Financial Officer, Exec. VP
We are pretty judicious about our capital allocation and we certainly wouldn't be committing $1 billion if we didn't like what we saw.
- Analyst
Okay.
But you are seeing returns of later stores being even greater than returns earlier in the program.
- Chief Financial Officer, Exec. VP
We are very pleased with what we are seeing Alan.
- Chairman, President, Chief Exec. Officer
Yep.
- Analyst
Okay.
Thank you.
- Chairman, President, Chief Exec. Officer
Yeah, Alan, let me just saying in closing here, your comment about the enthusiasm.
I just want to close, I couldn't be more proud of what these 300,000 associates have accomplished but I'm even more excited about the discovery and the opportunities we see in front of us as we become much more disciplined and much more focused on our strategy and gaining momentum on operational excellence and execution.
So thanks for that comment.
- Analyst
Yeah.
- Vice President, Investor Relations
Thank you everyone.
We look forward to talking to you next quarter.
Operator
And with that we'll conclude today's program.
Thank you everyone for your participation.