家得寶 (HD) 2005 Q1 法說會逐字稿

完整原文

使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主

  • Operator

  • Good day, everyone, and welcome to today's Home Depot first-quarter earnings conference call.

  • As a reminder, today's call is being recorded.

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

  • Please go ahead.

  • - VP of IR

  • Thank you, Felicia, and good morning to everyone.

  • Welcome to the Home Depot first-quarter earnings 2005 conference call.

  • Joining us on our call today are Bob Nardelli, Chairman, CEO and President of the Home Depot;

  • Carol Tome, Executive Vice President and Chief Financial Officer;

  • John Costello, Executive Vice President of Merchandising and Marketing; and Tom Taylor, Executive Vice President, Store Operations; 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 Tom will discuss Home Depot's store execution.

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

  • Following our prepared statement we'll open the lines for questions.

  • Questions 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 second -- section.

  • The replay will also be available on our site.

  • Before I turn the call over to Bob, let me remind that today's press release and presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

  • These statements are subject to risks and uncertainties.

  • These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the Securities and Exchange Commission.

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

  • - Chairman, CEO and President

  • Thank you, Diane, and good morning, everyone.

  • Thank you for joining us today to discuss our first-quarter results.

  • In the first quarter, we delivered sales of 19 billion, and achieved solid earnings growth.

  • I want to personally thank our dedicated associates who effectively managed the business and drove improvements in key customer satisfaction metrics.

  • Our net income was 1.2 billion, and our diluted earnings per share were $0.57, an increase of 16%.

  • Our strong earnings growth was a result of our focus on operational excellence.

  • Our comp sales of 2.1% were below our expectations, but I'm really pleased with how our Company stayed on strategy and drove solid financial results.

  • Carol Tomé will take you through our financial results in more detail later on this call.

  • Let me talk a little bit about our strategy, starting with enhance.

  • Our strategy of introducing innovative and distinctive merchandise like new Hampton Bay patio sets, our Ducane grills and Price Pfister faucets was evident throughout the store and was met with good customer acceptance.

  • Our unique ability to broaden assortments throughout the store allowed us to achieve record average ticket, and John Costello will talk more about some of the exciting product assortments that we have and will have.

  • In the area of technology, we continue to drive operational excellence through our technological initiatives.

  • These initiatives enable process efficiency and enhance our customer service.

  • For example, in the first quarter, we opened a new data center in Austin, Texas, which is our second major site to support our growth and provide operational flexibility.

  • This was a big and important initiative for our Company, and it went very smoothly.

  • Tom Taylor is going to update you on some of the technological initiatives that are favorably impacting our stores today.

  • In the area of extending, our service business experienced 16% growth in the first quarter.

  • In addition to offering our 23 national programs to serve these customers, we're testing many other national and regional programs based on feedback from our customers.

  • As we move to expand, the Company did expand its growth within Home Depot Supply.

  • In February, White Cap Construction Supply, a leading professional distribution company, expanded its presence in the eastern part of the U.S. through its acquisition of Greenwald Supply, a construction, building and specialty material supply company.

  • Today, White Cap has 80 branches in 19 states; and during the first quarter, our building solutions group, the largest installer of flooring and cabinets to the professional home builders completed the acquisition of Grand Floor Design, primarily a flooring installation company with 11 locations in northern California and Nevada.

  • And in April, we announced our intent to acquire Landmark Interiors Inc., a design center serving home builders in the Phoenix market.

  • Builder solutions has 31 branches in 15 states.

  • Home Depot Supply expanded its presence into Canada through the acquisition of Litemor, which was a leading lighting distributor and Home Depot Supply reported double digit sales growth in the quarter.

  • We also added stores outside the United States, further strengthening our leadership position in both Mexico and Canada.

  • And currently we have 165 stores in those countries.

  • In Mexico, we experienced strong double-digit growth due in part to the integration and conversion of the Home Mart stores.

  • Now, just last week we opened our 11th store in Mexico City.

  • And our stores in Canada posted double digit comps in the majority of their markets.

  • During the quarter, we continued to focus on returning value to our shareholders.

  • We recently increased our dividend by 23%.

  • Over the past four years, we have more than doubled our dividends paid out.

  • In February, our board approved an additional $2 billion for share repurchase.

  • This is in line with our balanced approach to capital allocation, reinvesting back into our business for growth, and returning cash to our shareholders.

  • Now, over the past four years, we've returned more than 55% of cumulative earnings to our shareholders; and at the end February, we announced the appointment of Tom Ridge, the former Secretary for Department of Homeland Security and former governor of Pennsylvania to the Company's Board of Directors.

  • We're pleased to have Tom on our board and believe his unique global experience and insight will be invaluable to our Company and our shareholders.

  • Tom's addition brings the total number of board members to 13. 11 of our 12 outside directors are independent.

  • Now I'd like to share an announcement with you about EXPO.

  • As you know, we have 54 EXPO stores; and this morning, we announced that we're planning on converting five of those stores to the Home Depot store format.

  • In addition, we'll be disposing of our interest in the underlying real estate of 15 EXPO stores.

  • And at some point in the future, these stores will close.

  • This action will improve the overall profitability of the EXPO operations, and the remaining 34 EXPO stores will continue to operate.

  • During this transition, we'll assist the affected customers by utilizing our store base in those markets.

  • And we will provide impacted associates with job placement assistance, and they'll be able to explore other job opportunities within the Home Depot family.

  • So in conclusion, we achieved solid earnings growth in the quarter, and now I'd like to turn the call over to John Costello.

  • John?

  • - EVP of Merchandising and Marketing

  • Thanks, Bob, and good morning, everyone.

  • Our Merchandising and Marketing objectives remain focused on driving sales and delivering an in-store experience that meets our customers' needs.

  • Our dedicated associates delivered on these objectives even in the face of challenging weather patterns.

  • Influenced by rain and the late arrival of warm weather in a number of markets across the U.S., our seasonal businesses experienced a slower start in the first quarter compared to last year.

  • As an example, a December snowstorm in early April caused store closings.

  • On the flip side, in areas with seasonal temperatures we experienced strong sales.

  • We partnered with our store operations teams and our suppliers and adapted to the changing environment.

  • Overall, we continued to experience growth across our core merchandising categories, continued success from new innovative and distinctive product,s and the positive impact from store modernization.

  • Let me review each area.

  • First, growth across our core merchandising categories: 7 of our 10 departments had positive comps.

  • One was flat with lumber and seasonal categories posting negative comps.

  • Given commodity price declines and excess supply, we didn't get the lift from lumber sales that we experienced last year where we had double-digit positive comps.

  • While our seasonal categories were weighed down by the weather factors we described earlier, performance was helped by strong sales in a number of areas.

  • Such as our enhanced line up of Vermont Castings, Weber, and new introduction of Ducane barbecue grills, expanded line of Hampton Bay patio furniture, and good growth in our cleaning categories.

  • We were pleased to see that Vermont Castings and two John Deere tractors were rated best value by a consumer rating organization.

  • Building materials had the strongest comp increase with a double-digit gain due to continued strength in several commodity classes including gypsum, roofing, insulation and concrete.

  • Kitchen and bath showed strong performance driven by both in-store and online appliance sales, as well as sales of countertops, vanities and kitchen and bath installations.

  • We continued to gain momentum in Appliances as we grew market share faster than any other leading retailer.

  • According to an independent third-party, on a rolling 12-month basis, our core market share increased 180 basis points to 8.5%.

  • Our results were driven by a steady stream of innovative appliances and an attractive shopping environment.

  • As we previously announced the introduction of LG Appliances will add increased breadth and innovative to our assortment beginning this summer.

  • Paint performed well as we remain an authority in the space through our assortment brands and innovative color solutions centers.

  • Sales were driven by interior paint projects.

  • Our exclusive brand of Behr paint has been recognized again as a top performer by an independent testing organization.

  • We saw strong sales in millwork and flooring as customers responded to our differentiated assortment and strong values.

  • And finally our lighting department experienced ongoing success as we continued to implement our successful strategy of exceptional styles and great value.

  • Second was success from new innovative, and distinctive products.

  • Working closely with our supplier partners, we continued to introduce innovative new and distinctive merchandise to differentiate the Home Depot and drive sales.

  • Let me provide a few examples.

  • Sales of our exclusive new Ryobi One+ portable power system continued strong.

  • This uniquely flexible system enables a customer to buy a starter combo kit and then add up to 15 additional tools and accessories that operate off the same power platform.

  • This system provides our customers with multiple options at tremendous value, and provides the Home Depot with the opportunity to build a long-term relationship by steadily introducing new features and new products to the system.

  • The laser level category remains strong and is another great example where our product innovation appeals to both the pro and the serious do-it-yourselfer.

  • A strong combination of products from RIGID, Ryobi, Black & Decker, Irwin, and Milwaukee will continue this momentum throughout 2005.

  • Customer transactions were 320 million for the quarter, an increase of 1.3% over last year.

  • Transactions were impacted by both cannibalization and the weather.

  • We're encouraged that our average ticket reached a record high in the first quarter of $58.25, as customers continue to respond to our innovative products, complete assortments, and in-store service.

  • Third, the positive impact from store modernization.

  • We're moving forward with our store modernization plans as we add new signing, brighter lighting, updated floors, and refresh categories to our stores.

  • Customers like what they see and customer satisfaction is up as you'll hear more about later from Tom Taylor.

  • We'll continue to invest in our stores as we strive to provide the best shopping experience for our customers.

  • We also continue to be pleased with the effectiveness of our advertising and marketing efforts as we implement innovative ways to communicate the Home Depot's unique message to key customer groups with new initiatives like the launch of our exclusive new movers and AARP 50 plus programs.

  • So in closing, our performance for the quarter was driven by the following three factors: growth across our core merchandising categories; continued success from new, innovative, and distinctive product offerings; and the positive impact from store modernization.

  • Now I'd like to turn the call over to Tom Taylor for his comments.

  • Tom?

  • - EVP of Store Operations

  • Thanks, John.

  • Let me update you on the progress we're making in our stores.

  • As some of you may know, I have responsibility for execution across more than 1700 U.S. and Mexico Home Depot stores.

  • Through some of the changes we've made to our store organization structure, our business today retains the entrepreneurial spirit of the Home Depot, matched with the benefits of a centralized leadership team.

  • Partnering with the division presidents and regional vice-presidents, one of the first things we enhance is how we communicate with our stores.

  • Similar to other best-in-class retailers, we created a weekly internal broadcast that we call The Same Page.

  • Every week, we partner with John Costello and the merchandising and marketing teams, along with Carl Liebert and the operations teams to lay out our execution strategy.

  • The broadcast is creating better alignment among our businesses in all areas and allows the teams to focus on the priorities of our business.

  • As we walk stores each week, we see first hand how our regional teams are putting their plans into action.

  • The Same Page broadcast is just one of many operating levers that our field teams have today that did not exist back when I was a regional vice president.

  • Our teams in the field have stronger tools and visibility into our business.

  • We have a better focused leadership team, and we're seeing more consistency in our stores.

  • The coordinated effort helped us to deliver solid results this quarter, as we were able to better manage to the environment.

  • Let me take a minute to reach out to our store associates and thank them for their focus and determination ion seeing this quarter through despite the unseasonal weather we experienced.

  • We were the best prepared for spring that we've ever been, and I know our associates are ready to take care of our customers.

  • Let me review with you the top three priorities for our stores.

  • One, customer service, two, execution, and three, operations progress.

  • Our customer service strategy places a lot of emphasis on people, both customers and our associates.

  • In order to deliver best-in-class customer service, we have taken a metrics-driven approach to solving problems.

  • Through our voice of customer surveys, we are able to identify areas of opportunity for our stores based upon benchmarking across our platform.

  • Comparing the voice of customer scores for the first quarter of 2005 to the voice of customer scores in the first quarter of 2004, our data shows that the Home Depot has seen noted gains in the overall satisfaction, availability of associates, speed of check out, and the likelihood that customers would recommend the Home Depot.

  • Through the combination of voice of customer, independent third-party shops, and my own personal observations, our associates are doing a better job of engaging with customers which results in higher sales per labor hour.

  • Customers continue to express their satisfaction with our self check-out option at the front of our stores.

  • We continue to refine the mix of self check-out stands and cashiers to meet our customer needs.

  • We now have self check-out in almost 1100 stores with a goal of nearly 1300 stores with self check-out by the end of the year.

  • In stores with self check-out, we continue to see a good mix of transactions flowing through these registers.

  • Best-in-class customer service also requires the development of our people.

  • This year we'll spend another 23 million hours in associate training.

  • We continue to train our store associates.

  • As an example, more than 98% of our stores have at least two associates who have become certified lawn and garden specialists.

  • Our stores are definitely ready when the weather breaks.

  • Execution, we have greatly improved our store readiness.

  • As I touched on earlier, we are better able to respond to changing market conditions and will continue to improve under our new structure.

  • We are better focused on key business drivers.

  • Our consultative sales efforts are an example of how we are focusing on the changing needs of the customers.

  • Store managers today are more in tune with the needs of the customer and are improving their ability to focus on selling the complete project.

  • In the garden area, we work with our vendors to develop a pay per scan program.

  • This program was launched in Florida and continues to roll out to all of our stores.

  • The beauty of a pay per scan is that we do not take inventory until it's sold at the register.

  • We continue to reduce the complexity of our in-store staffing model.

  • This quarter we were able to improve our execution of labor scheduling.

  • Simplification will benefit the customer experience, drive accountability, and improve associate job satisfaction.

  • Lastly in terms of execution, we continue to make solid progress in shrink, as our inventory management programs and process improve.

  • Shrink was ahead of our internal plan and was a positive contributor to gross margin, which Carol will review a little later.

  • Operations progress.

  • We're working to improve progress in our operation areas to impact tasking activities and take tasks out of the store.

  • Overall, these efforts are improving the back end of the store so that we can continue to focus on the customer.

  • Auto replenishment is currently in 1,890 stores.

  • Today we support approximately 9% of the store sales through this process and will continue to add more SKUs.

  • We're seeing improved in stock percentages and fill rates as well as more accurate on-hand inventory counts in the stores.

  • We have teams focused on increasing the effectiveness of our current distribution system.

  • We're working through a proof of concept for regional distribution centers, and now believe that the first center will open next year.

  • Through our back-end automated receiving, or BEAR initiative, we now have 39 stores in pilot.

  • So far results look good, and we're experiencing faster and more accurate receiving.

  • We will begin rolling this out this summer.

  • Similar to self check-out, this is another case where we can use technology to eliminate tasks in order to redeploy hours to the selling floor.

  • So in summary, our focus and commitment on execution has never been higher.

  • Thank you.

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

  • - EVP and CFO

  • Thank you, Tom, and hello, everyone.

  • As Bob mentioned, in the first quarter, our sales grew 8.1% to $19 billion.

  • Against a 7.7% comp in the first quarter last year, comp or same-store sales for the first quarter of this year were 2.1%.

  • And while we don't like to sound like a weather report, weather did impact our business.

  • During the first quarter, we opened 21 net new stores.

  • Two stores were opened in February, four stores in March, and 15 stores in April, bringing our total store count to 1,911.

  • At the end of the first quarter, 9% of our stores were located in Canada and Mexico, as compared to 7% last year.

  • In total, we own 86% of our stores and believe our real estate ownership strategy is a competitive advantage.

  • Sales from stores that have been opened for less than one year, as well as sales from our newly-acquired businesses contributed 6% to our top-line growth in the first quarter.

  • Now, as you know, we strategically cannibalize our stores in order to grow market share and top-line sales.

  • In the first quarter, we cannibalized 15% of our stores which had a negative impact on comps of 1.5%.

  • Excluding the impact of cannibalization, comp sales would have been 3.6%.

  • At the end of the quarter, selling square footage was 203 million square feet, a 9% increase from last year.

  • The average square footage per store was 106,000, down slightly from last year reflecting the changing mix in our store formats as we expand into new geographies and size our stores to meet the needs of the market.

  • Reflecting the sales environment, for the first quarter, weighted average weekly store sales and sales per square foot were both down about 2% compared to the same period last year.

  • Gross margin was 33.5% for the first quarter, an increase of 62 basis points from the same period last year.

  • First-quarter results were impact by the following factors.

  • First, as Tom mentioned, our inventory management programs continue to drive improvements in shrink; and lower shrink than we experienced one year ago contributed 32 basis points of gross margin expansion.

  • Second, two key factors drove the remaining 30 basis points of gross margin expansion, and we had some pluses and some minuses.

  • First, a lower penetration of lower margin categories like lumber and a reduction in our overall cost of goods increased our gross margins.

  • Second, the cost of our deferred interest credit program and $20 million of markdowns, taken in connection with our EXPO announcement reduced our gross margin; but the net of these items was 30 basis points of expansion.

  • Now, as you know, we are very pleased with our private label credit card program.

  • Since we relaunched the program with Citibank, our penetration of private label sales has grown from 21% to now 26% of our sales; and we've received some questions about our private label program, so let me take a moment to give you some more information as to how this program works.

  • First, the credit program is you know written by Citibank so they own the receivables.

  • Second, when we offer deferred interest financing programs, the cost of those programs is reflected as a component of cost of merchandise sold.

  • The interest rate charged to the Home Depot is fixed, and varies by type of program offered.

  • Third, we share in the profitability of the portfolio.

  • And based on certain defined parameters, we receive fees from Citibank reflecting our share of the profits.

  • We account for our portfolio profit-sharing arrangement as a reduction in expense.

  • The portfolio itself has little exposure to rising interest rates because within the portfolio the funding is primarily fixed rate.

  • In the first quarter, the net impact of deferred interest and profit-sharing was not material to the Company's earnings.

  • In the first quarter, total operating expenses as a percent of sales were 23%, about flat compared to last year.

  • A couple of things to note that were unique in the quarter.

  • First, we adopted a policy of recognizing breakage in our gift cards based on our own historical experience.

  • As a result, in the first quarter, we reduced our gift card liability to reflect breakage and the cumulative impact resulted in $43 million of other income and selling expense.

  • Going forward, we will have ongoing benefit, but not of this magnitude.

  • Second, with respect to our EXPO announcement, we recorded $86 million of expense associated with the real estate disposition in addition to the markdowns I previously mentioned.

  • We expect to incur an additional $13 million of expense as we complete the final disposition of the real estate during the remainder of this year.

  • Excluding the expense related to our EXPO announcement, we leveraged expenses by 41 basis points in the first quarter.

  • This demonstrates our ability to react to changing business conditions.

  • Our operating margin for the first quarter was 10.5% of sales, a company first-quarter record.

  • Consolidated net earnings totaled $1.2 billion for the quarter, and diluted earnings per share increased by 16% to $0.57.

  • Now, as you will recall, over the past four years, our board has authorized $9 billion in share repurchases.

  • In the first quarter, we repurchased $1.4 billion, representing 36 million shares.

  • Cumulatively through the first quarter, we have repurchased $8.1 billion representing 237 million, or over 10%, of our outstanding shares.

  • Now let's review some other metrics.

  • At quarter end, total inventory was $11.3 billion, an increase of 11.8% from last year, reflecting inventory growth due to new stores and newly-acquired businesses in the Home Depot Supply.

  • On a per-store basis, inventory levels were $4.7 million, flat to last year.

  • Inventory turns were 4.7 times.

  • Return on invested capital, which is computed on beginning long-term debt and equity for the trailing four quarters, was 22%, an increase of 160 basis points from last year.

  • Excluding cash and short-term investments, return on invested capital was 27%.

  • We continued to drive increasing rates of return on the capital we deploy using a portfolio approach.

  • Our financial condition remains solid.

  • We ended the quarter with $42 billion in assets, including $3 billion in cash and short-term investments.

  • This is an increase of $800 million in cash from the fourth quarter, which reflects strong cash flow generated offset by $821 million in capital expenditures, $138 million paid to acquire three businesses, $217 million in dividends paid, and $1.4 billion spent for the repurchase of common stock.

  • First-quarter earnings showcased our operating flexibility.

  • Now more than ever before, we are able to manage our business while staying on strategy.

  • I think it is clear that our performance reflects our continuing ability to execute; and so today, we reaffirm our 2005 sales growth guidance of 9 to 12% and our earnings per share growth guidance of 10 to 14%.

  • Thank you for your participation on today's call.

  • And, Felicia, we are now ready for questions.

  • Operator

  • [OPERATOR INSTRUCTIONS].

  • Bill Sims, Citigroup Smith Barney.

  • - Analyst

  • Good morning, thank you.

  • - Chairman, CEO and President

  • Good morning, bill.

  • - Analyst

  • Good morning.

  • I have two questions.

  • My first question is regard to selling expense.

  • You did a fabulous job really cutting back on selling expense as the sales environment slowed.

  • How much of that selling expense do you cut back?

  • How much of it will you have to spend into the second quarter, and what type of drag potentially will it have on the remainder of the year?

  • - Chairman, CEO and President

  • Let me say, Bill, that Carol will go through the specifics, but I just want to reinforce the comments that have been made.

  • I think the team demonstrated a tremendous ability to do a sales adjustment as we went through the quarter across the entire Company, from store to store support center; and I'm pleased quite honestly, with the -- with the speed in which they were able to do this.

  • And as Carol said, I think it demonstrates a unique capability to manage through a variety of different economic environments.

  • Carol, do you want to add anything to that?

  • - EVP and CFO

  • Yes, Bob.

  • Thank you.

  • Hi, Bill.

  • In the first quarter, we leveraged payroll.

  • Payroll is more than 50% of our expenses, and we leveraged payroll.

  • We leveraged our operations expense.

  • Our bonuses were in line with our sales.

  • We leveraged worker's compensation and general liability, so as Bob pointed out, we did an excellent job of managing our business to the sales environment.

  • - Analyst

  • So then we shouldn't expect any material pick-up in expenses in the second quarter?

  • - Chairman, CEO and President

  • No, Bill, you should not.

  • - Analyst

  • Second question is in regards to your guidance.

  • Back in January, you originally provided EPS guidance of 10 to 14%.

  • Since then you announced a $2 billion additional share repurchase program and you produced solid upside to [inaudible] consensus expectations in the first quarter.

  • Has -- ex share buy-backs and the upside that you've produced today, has your outlook gotten more conservative -- more conservative, or are you just being conservative?

  • - Chairman, CEO and President

  • No, I think couple of things.

  • One is the stock buyback was in the guidance for the year relative to -- I'm sorry.

  • The new stock buyback came after our guidance, Bill.

  • Okay?

  • I want to be clear.

  • - Analyst

  • Sure.

  • - Chairman, CEO and President

  • That board meeting happened after our February -- our analysts meeting so that was outside the guidance.

  • And as Carol talked about it, it's 1.4 billion in the quarter over 8 billion now of the 9 billion that's been approved.

  • So we feel -- we feel comfortable reaffirming our earnings guidance for the year at 10 to 14.

  • - EVP and CFO

  • Thank you for acknowledging performance in the first quarter.

  • We're 15 weeks into the year, and we think it's prudent to confirm our earnings growth guidance of 10 to 14%.

  • - Analyst

  • Very good.

  • I appreciate it.

  • Thank you.

  • Operator

  • Matthew Fassler, Goldman Sachs.

  • - Analyst

  • Thanks a lot, and good morning.

  • I guess the first question I'd like to ask is, in fact, about the progression of business through the quarter.

  • Historically, over the past couple quarters at least, you've given us some monthly numbers and clearly March seemed to be the toughest month for the sector.

  • If you could give us any color as to the progression that you saw and how that relates to your comparisons and to the weather environment, and how that influences your outlook as we enter the second quarter?

  • - EVP and CFO

  • Matt, this is Carol.

  • Because we don't give quarterly guidance, we believe it's not appropriate to call out our monthly sales.

  • But let me simply say that for the first quarter, our comp sales were V-shaped, and March was absolutely the softest month in the quarter.

  • - Analyst

  • Fair enough.

  • Secondly, not to come back to kind of a issue that I hope we got rid of a year ago, but EITF 02-16, last year hit your earnings in the first quarter by roughly $0.03, and as I understood it, that impact was going to be nonrecurring and, in fact, last year after that hit you would have earn $0.52.

  • I just want to make sure that as we analyze this year's P&L against last year's P&L are there any items on the P&L particularly on the expense line that we need to think about as we try to draw up a true apples-to-apples compare?

  • - EVP and CFO

  • Well, as we told you, we would have no impact of EITF 02-16 in 2005 and that is correct.

  • So I don't think there's anything from an apples-to-apples comparison that you need to be concerned about.

  • If you go back to the first quarter of 2004, the gross margin expansion in the first quarter of 90 basis points was directly related to EITF 02-16, so it's appropriate to compare that gross margin rate to what we recorded this year so the expansion that we reported is a true gross margin expansion.

  • There's nothing on the expense side.

  • - Analyst

  • Fair enough, thank you so much.

  • - EVP and CFO

  • You're welcome.

  • Operator

  • Colin McGranahan, Sanford Bernstein Equity Research.

  • - Analyst

  • Good morning.

  • - Chairman, CEO and President

  • Good morning, Colin.

  • - Analyst

  • Two questions.

  • First on EXPO, can you talk about the 20 stores that are closing?

  • What similarities those have, obviously not making money being the main one, but any geographic similarities, or anything like that.

  • And of the remaining 34 EXPOs that will be open, if you could just provide us any insight into the profit margins, the return on capital; and can the chain, after the closings, now have a chance of earning its cost of capital?

  • - Chairman, CEO and President

  • Collin, I think the simple answer is we have been sharing with you for probably a year that we've been looking at EXPO.

  • The fact is the 34 remaining stores generate very good revenue and profitability and meet our hurdle rates.

  • Those that we have announced this morning did not.

  • And in some cases they represented a single store in a market and in some cases they represented an over storing in a market.

  • And we've -- we've looked at that.

  • We've analyzed it.

  • I think we've made the right decision.

  • We're confident that the revenue in the affected stores will transfer into the market.

  • And we're confident that the five stores that we will convert to Home Depot will equally generate significant sales and meet our hurdle rates.

  • - Analyst

  • Okay.

  • And then second, a follow-up question on the proof of concept.

  • I think originally that was scheduled for the third quarter.

  • Can you just give us an update on what you're learning as you go through the process of looking at your distribution and what led to the delay of pushing that now into next year?

  • - Chairman, CEO and President

  • Yeah.

  • Colin, we have -- Carl Liebert is in the room with us, and you'll recall he talked about that at our annual analysts meeting.

  • Let me have Carl expand.

  • - SVP of Operations

  • Sure.

  • Collin, what we talked about at the analyst is that we wanted a proof of concept up and running by the end of the year in order to validate some of the assumptions we're putting into the base model.

  • As Carol alluded to and Tom talked a little bit, we're seeing some improvement in operating our existing logistics platform in anticipation of that proof of concept.

  • And that proof of concept will allow us to lead into next year to put a facility in place.

  • So we feel very good about our logistics progress, and we see continue opportunity with our existing platforms as well.

  • - Analyst

  • Thank you.

  • Operator

  • Eric Bosshard, Midwest Research.

  • - Analyst

  • Good morning.

  • I wanted to get a little bit of color, perhaps from John, on what you're seeing go on with progress with merchandise mix and opportunities with merchandising, certainly in light of higher fuel cost and higher interest rates.

  • I'm interested in how you're having success getting the customer to perhaps trade up and broaden merchandise.

  • - EVP of Merchandising and Marketing

  • Thanks, Eric.

  • I think overall we're very encouraged by the improvements in our merchandise assortment.

  • The merchandising team working closely with our supplier partners has increased the pace and impact of innovation.

  • We've also -- I think they've also done a great job of providing opportunities for our customers to trade up.

  • While fuel prices may affect trips, we have not seen an impact of fuel prices or any other factors on our average ticket.

  • In fact, our average ticket, as I touched on, hit an all-time high this quarter, and importantly that was a function of people trading up, not of increased prices in those goods.

  • So overall, we're very encouraged by that trend, and we're not seeing barriers to that in the future.

  • - Analyst

  • And then if I can, just one follow-up.

  • Seasonal you commented briefly that weather certainly had an impact but can you talk about how the seasonal performance has been as we've gotten into April and May and where we've seen weather break, how that has performed once we get out of underneath the poor weather impact?

  • - EVP of Merchandising and Marketing

  • So far we're seeing the business respond very well when the weather is hot and dry.

  • So we remain optimistic that as weather improves, customers will respond.

  • So, so far where the weather's been good we've seen customers respond quickly.

  • We think that -- in some cases, like preemergent chemicals and things like that, there may be a time value, but we're going into the heart of the season right now.

  • - Analyst

  • All right.

  • Thank you.

  • Operator

  • Dan Wewer, CIBC World Markets.

  • - Analyst

  • Thank you.

  • You had called out the ability to leverage your expenses during the first quarter; and further, you're not expecting to increase that investment in 2Q, yet at the analysts meeting this year you indicated that SG&A would probably go up as a percent of revenues this year despite the potential for 4 to 7% comp sales growth.

  • I guess it begs the question does that original guidance now look way too conservative?

  • - EVP and CFO

  • Dan, I think what we said at the January analysts conference is that we wouldn't get much help from expenses in 2005.

  • What we're finding, particularly with Tom's leadership over the stores, is an ability to be more nimble and to react to business conditions and that's very, very exciting for us.

  • Further, in our guidance I think it's fair to note that you may have seen that there's been a delay in the accounting standard regarding stock options.

  • That's FASB 123R.

  • We had told you back in January that the implementation of FASB 123R was going to cost us about $65 million.

  • Because that implementation has been delayed, that's an expense we won't incur this year.

  • - Analyst

  • So you're going to wait until first quarter of next year to implement?

  • - EVP and CFO

  • Whenever the rules come into play, we will implement it.

  • - Analyst

  • Okay.

  • And just as a follow-up on EXPO.

  • I was curious if you can talk about what the potential profit contribution will be from closing those stores, and until they're closed will it be reported as a discontinued operation?

  • And then also, Bob, I was curious as to what you see as being the long-term growth opportunities for EXPO.

  • - Chairman, CEO and President

  • I'll let Carol -- I'll let Carol report on the accounting on this, Dan, but let me just reinforce and restate that the remaining stores, the 34 stores, we think both geographically and operationally are very viable and represent a good on going opportunity.

  • We'll continue to look at customer mart -- customer feedback and the market penetration, and we're very comfortable with the decision we've made on keeping those open both in the short term and long term.

  • Carol, you can comment about -- about the cost impact on -- I think we've covered the 86 million on real estate and the 20 million on markdown.

  • - Analyst

  • But I was thinking more in terms of the contribution from eliminating those unprofitable stores going forward.

  • - EVP and CFO

  • The contribution, we believe, is going to make the EXPO model extraordinarily attractive model from a financial perspective.

  • Clearly, we have to get through expenses that we've just taken so the year will be a little distorted, but if you look out into 2006, it's a -- it's a very profitable business for the Company, with high returns.

  • Because the sales are going to transfer to other stores, this will not be treated as a discontinued operation.

  • - Analyst

  • And you're not going to tell us how much you were losing in those stores, it doesn't sound like.

  • - Chairman, CEO and President

  • Probably not, Dan.

  • - Analyst

  • I was going to ask.

  • Thanks, anyway, thanks a lot.

  • - Chairman, CEO and President

  • Okay.

  • Thank you.

  • Operator

  • Gregory Melich, Morgan Stanley.

  • - Analyst

  • Hi.

  • Question, Bob, or whoever wants to take it.

  • Is -- how much concern do you have with square footage growing at 9% versus revenues at 8, or is this something that as you expand into other areas such as commercial and White Cap and Home Depot Supply that you're just -- you're not that concerned about fundamentally?

  • - Chairman, CEO and President

  • Well, let me -- a couple of points.

  • Let me say that -- that we're taking a multidimensional approach to this thing; and clearly, we know in retail square footage growth is very important.

  • And profitable square footage growth is important.

  • I think John talked about the initiatives in the first quarter in driving average ticket, and Tommy talked about the importance of and our emphasis on conversion, so we're clearly committed to growing square footage as we said.

  • And opening new stores this year.

  • We are equally passionate and committed to increase sales per square foot.

  • I think it's that combination that has given us -- has given us the performance we've seen to date.

  • - EVP and CFO

  • One other observation, if you look at the self-performance in the first quarter versus our square footage growth, if you just look at seasonal categories alone, had the seasonal categories been on, we would have had sales growth in excess of our square footage growth.

  • - Analyst

  • Okay, So that implies that there doesn't seem to be any sort of structural productivity issue, you're really -- the weather in March was the key suspect.

  • - EVP and CFO

  • Absolutely.

  • That's absolutely right.

  • - Chairman, CEO and President

  • I mean, I think -- I think to Carol's point, if you look at -- if you look at our categories by department and you look at 28 which is lawn and garden, and then you look even below that, you'll see outdoor power.

  • And if you look at outdoor power, it really gets down to tractors.

  • And quite honestly, what we're seeing is a customer shifting away from the traditional national brands to more feature and appearance and price competitive points.

  • So that's why we're so excited about the new Ryobi tractor and the success we're seeing with Murray.

  • - Analyst

  • Great.

  • And then just a quick one on the pay on scan with inventory.

  • How much would that reduce the inventory year-over-year?

  • The move to lawn and garden pay on scan?

  • - EVP and CFO

  • Greg, the pay per scan benefits were dwarfed by the weather, so we'll come back later in the year and tell you about the benefits.

  • - Chairman, CEO and President

  • We feel very strongly that there's some real benefits with pay by scan in terms of increased assortments, reduced shrink and an over all better customer experience, but as Carol mentioned, clearly affected by the weather.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Budd Bugatch, Raymond James Associates.

  • - Analyst

  • Yes.

  • I have a -- just two questions.

  • Good morning.

  • In the -- in the release, Tommy, you talk a little bit about some changes to the org [ph] structure in the stores.

  • Is there anything that we don't know about, or anything more recent?

  • - EVP of Store Operations

  • No, Budd.

  • It's the announcement that we made at the beginning of the year with my leadership over the stores, and the team put together to help run the stores under one alignment.

  • No changes --

  • - Analyst

  • Nothing incremental there.

  • - EVP of Store Operations

  • No.

  • - Analyst

  • Second question, is -- if I did my math right, it looks like Home Depot Supply and White Cap did about $333 million in the quarter, up from, I think 135 last year.

  • Carol, can you kind of give us -- if I impute that, it looks like maybe half a cent to penny a share improvement from that.

  • Is that about right?

  • - EVP and CFO

  • Budd, Home Depot Supply is much bigger than Builder Solutions Group or White Cap, and we don't break it out for competitive purposes.

  • - Analyst

  • But if you do math on ticket times transaction, you can kind of come to the back end of that.

  • Is my math any where near right, or you're just not going to comment?

  • - EVP and CFO

  • There's other items that you need to consider like deferred revenue and other things, so really we'd like you to think about our business as a portfolio business.

  • - Chairman, CEO and President

  • Let me just say, ex your math, we are very pleased with the progress Home Depot Supply is making.

  • I think is why I wanted to comment and give you some color on the number of branches, for example, in White Cap in the states.

  • We're very pleased with the geographic growth which was exactly on strategy where we would buy excellent platforms and use our financial strength to grow geographically.

  • And we think it's going to continue to become an ever-increasing part of our portfolio.

  • - Analyst

  • Thanks, Bob.

  • - VP of IR

  • Felicia, we have time for one more question.

  • Operator

  • Thank you.

  • Rick Ludwig [ph], John Levin & Co.

  • - Analyst

  • I have two questions.

  • Respecting -- with respect to the reduction in the shrink, what is your overall shrink level as a percentage of sales?

  • - Chairman, CEO and President

  • Rick, we -- as you know, we don't disclose that.

  • We had talk about at the -- at our analysts meeting, I think we gave you some directional and feel for the progress we made over the last couple of years.

  • I just want to reinforce Tom's comment is we had favorability in the plan and the team exceeded that.

  • I tell you, I couldn't be more pleased with what they've accomplished in the last couple of years, and we are really starting to see the benefits of our Six Sigma initiative, not only as it relates to shrink, but across the Company, which is contributing, I think, to the gross margin.

  • We just had a -- one of our reviews on Six Sigma initiatives, and the team had a magnificent series of report outs from logistics to shrink to accounting.

  • Across the entire business it's gaining tremendous momentum.

  • - Analyst

  • Terrific, thank you.

  • And secondly, what's the size of the liability associated with the gift card breakage, because you mentioned that came down something like $48 million or something like that.

  • How big that is liability?

  • - EVP and CFO

  • The liability is reflected on our balance sheet in other current liabilities.

  • At the end of last year, it was about 500 million.

  • - Analyst

  • 500 million, terrific.

  • Thank you.

  • - VP of IR

  • Well, thanks, everyone, for joining us today.

  • We look forward to talking to you next quarter.

  • Operator

  • And that does conclude today's conference call.

  • We thank you for your participation.

  • You may disconnect at this time.