家得寶 (HD) 2005 Q3 法說會逐字稿

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

As a reminder today's call is being recorded.

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

Please go ahead.

Welcome to the Home Depot third quarter earnings conference call.

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

Carol Tome, Executive Vice President and Chief Financial Officer;

Tom Taylor, Executive Vice President of Merchandising and Marketing; and Carl Leibert, Executive Vice President of Home Depot Stores.

Today's discussion will begin with a review of our business by Bob, Tom will provide insight into our merchandising efforts, and Carl will update us on our store operations initiative.

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

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

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

This conference call is being broadcast realtime on the Internet at homedepot.com with links on both our home page and investor relations sections.

The replay will also be available on our site.

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

Thanks Diane.

Good morning, everyone.

I'm pleased with the progress we've made on the strategy that we've laid out over the last four years.

Our third quarter results demonstrate our ability to sustain and continue the execution of our strategy to enhance the core, extend the business, and expand our market.

Delivering both growth and tremendous value.

This quarter, we're reporting record third quarter sales and earnings with sales of 20.7 billion, an increase of 10.5% from last year, and earnings per share of $0.72, a 20% increase from last year.

I'm also pleased with the amount of value we've been able to return to our shareholders.

Since the inception of our share repurchase program in late 2002, we have repurchased about 12% of our outstanding shares, amounting to 272 million shares, or $9.5 billion of our $11 billion Board authorization.

During this same period, we have more than doubled the dividends paid to our shareholders, so together, this represents over 60% of our cumulative earnings that we've returned back to our shareholders over that time frame, demonstrating our ability to sustain growth and deliver value.

And Carol Tome will take you through our financial results in greater detail in a moment.

This quarter we experienced what has proven to be the most destructive hurricane season in modern U.S. history with three major storms having an enormous impact on our communities, including the Home Depot customers and associates.

After each of these hurricanes, we took extraordinary measures to ensure that we took care of our customers and our associates.

In most communities, we were the last to close and the first to open.

Our response shows our nimbleness as a company to react to different market conditions.

And I can't tell you how proud I am of our associates who always shine their brightest when communities are facing their darkest hours.

Our strategic focus on enhancing the core resulted in the continuation of value, innovation, and distinction.

We reported an average ticket of almost $59, the highest average ticket in our company's history.

We did this by expanding our assortment and introducing several new exclusive products that Tom Taylor will talk about.

Our technology initiatives are helping to drive operational execution for the third quarter in a row.

We've leveraged expense, a real competitive advantage.

In addition, with technology, we've improved our customer in-store experience as evidenced by the positive customer feedback we've received in some key areas.

You'll hear from Carl Leibert about scanned receiving, certified vendor programs, centralized auto replenishment, self checkout, and other initiatives involving technology.

So when you add it all up, including the investments that we're making in new technology, as well as infrastructure spending, like telecommunications, we are spending over $1 billion a year on technology.

We opened 37 new stores and closed the quarter with a total of 1,972 stores, including 175 stores in Canada and Mexico.

In the fourth quarter we'll open our 2,000th store, including our 50th store in Mexico which we opened just last week, now, both significant milestones for the Home Depot.

In the last five years we've opened over 900 net new stores.

We are the number one home improvement retailer not only in the United States but also in Canada and now Mexico.

Our second key strategy to extend our business resulted in our services business growing 21% to 1.2 billion during the third quarter.

We saw strong growth in installation categories such as HVAC, kitchens, countertops, windows, and roofing.

We continued to extend our product offering through in-store special order.

Homedepot.com and our new inspirational catalogs.

We've seen an increase in on-line purchases as we start the holiday quarter.

Now, during the quarter we continued to execute on our third key strategy, that is to expand our business by leveraging a key customer, the professional contractor, who shops both in our retail stores as well as the Home Depot Supply.

Today this customer makes up 30% of our retail store sales.

Now, within the Home Depot Supply, we saw double-digit sales growth in the third quarter, through both organic and inorganic expansion.

Collectively, the Home Depot Supply businesses are about 5% of our total sales.

The Home Depot Supply operates on three major platforms.

Maintenance repair and operations, MRO, builder and professional supply, serving about a $410 billion market.

In our professional supply platform, for example, White Cap expanded its presence in California and Hawaii, through the acquisition of West Tool and Wire Products of Hawaii.

At the end of the third quarter, White Cap had 94 branches in 23 states.

Now, this compares to the 70 branches in 17 states when we acquired White Cap just a year ago.

In August, we completed our acquisition of National Waterworks, the leader in water and waste water transmission products.

In October National Waterworks expanded its regional presence through the acquisition of magnum pipe, a water and waste water distribution system company in Florida.

Through the Home Depot Supply group of companies we're realizing some some significant synergies.

As a result of our buying power we've seen savings in merchandising, freight, health benefits, and year to date these savings have exceeded our expectations and our pro forma.

As a result of the active hurricane season, we have and will continue to see opportunities within Home Depot Supply group of companies.

For example, White Cap played an integral roam in preparing sites for temporary housing.

Our MRO businesses provided a multitude of products to multifamily housing and hospitality facilities.

The combination of Home Depot Supply stores and the home depot supply company represents a more diversified and operationally nimble company than we've ever had before.

We're better positioned than any company to serve the rebuilding efforts.

We're truly focused on delivering financial value and enhancing our company's values.

And I'd now like to turn the call over to Tom Taylor.

Thanks, Bob, and good morning, everyone.

We have some exciting things to share with you today from a merchandising perspective but let me start by talking about the effects of this season's hurricanes.

First, I would like to thank our associates, merchants, and vendor partners who worked countless hours to ensure that our customers in the hurricane affected areas were taken care of.

The flexibility in providing our customers with the merchandise they needed would not have been possible without all of your support.

What was interesting about this hurricane season was the different product demand due to the nature of the various storms.

In New Orleans after Katrina the merchandise our customers needed was very different than what we would traditionally have expected due to massive flooding they experienced as opposed to typical wind damage.

Although we saw unprecedented demand for core products like generators, tarps, extension cords, flooding drove different customer needs with demand ranging from insecticide to appliances.

Because the situation in New Orleans is so unusual we're continuously learning about our customers' needs and adapting to ensure we're providing them with the necessary products to rebuild their homes and lives.

In Florida and Cancun, Mexico, Wilma unexpectedly created more devastation than anyone anticipated.

After the initial recovery period we saw strong sales of generators, tarps, chain saws, and roofing materials.

Our number one priority from a merchandise perspective was to service our customers.

We are seeing strong comps throughout the Gulf and Florida region as people have already begun the rebuilding effort.

We believe that the southeast will continue to benefit through the rest of this year and into 2006.

Now let's talk about the business.

Customer transactions were 329 million for the quarter, an increase of 1.5% over last year.

For both our pro and do-it-yourself customers, we know that value matters, and that impacts transactions.

For example, in paint, our units are down but our gallonage is up.

Our average ticket for the quarter was 58.92, a 6.1% increase over the previous year and a company record, driven by innovation and distinctive merchandise.

During the quarter we introduced a line of new and exclusive Makita and Milwaukee litheon ion power tools for the pro and serious do-it-yourself customers.

These tools are unique to the market and offer more power, less weight, and longer run times.

We also broadened our assortment in paint, introducing a vibrant color pallet named Colores Origenes, featuring over 70 colors designed to appeal to the changing customer trends.

We introduced the Ryobi multitask kit laser level, an enhanced version of our Ryobi air grip adding functionality such as a magnetic plate and light.

This was the first full quarter with LG appliances in all of our stores.

The launch has gone very well and sales across all brands of appliances are exceeding our expectations.

Our core market share grew on a 12-month rolling basis by 130 basis points, a 9.2% increase for the quarter, in addition one out of every four appliance shoppers in the third quarter visited a Home Depot store before making their purchase, representing a significant shift in channel preference.

Finally, due to expected higher heating costs this winter, we have been providing our customers with knowledge on how to take costs out of their homes through energy conservation clinics.

Energy related merchandise, like weatherproofing products, insulation, energy star qualified compact fluorescent lamps, white temp programmable thermostats, General Electric water heaters and caulking have done well and we expect continued strength in this area.

Now lets talk about sales per category.

We saw strength in kitchen and bath driven by appliances as well as kitchen installations.

As Bob mentioned, kitchen installations were one of our fastest growing installation businesses in the third quarter.

In pro categories, we saw strength in electrical, plumbing, and building materials across the country.

Outdoor living and the entire seasonal category remains strong.

Hampton Bay patio furniture and our broad assortment of patio grills have been the cornerstone of this business and continued to post strong double-digit comps.

In the third quarter we saw a very solid business in paint as customers responded very well to our broadened assortment.

Finally, in lumber, commodity priced deflation caused the category to post negative comps in the quarter but the impact to our total company's comps was less than 30 basis points.

It is clear that our merchandising and operational alignment have never been better at the Home Depot.

While I like to think it's all about the products, I know it's also about execution.

From a store modernization perspective we continued our program.

In the U.S., one of our most exciting pilots is our new lighting showroom.

By redesigning the way we present lighting we're able to increase the number of both stock and special order products, expand the assortment, and enhance the customer shopping experience.

We used our learnings from Manhattan to refine our assortment.

The Manhattan store showed us that our customers have an appetite for higher end products.

As a result of the successes in our kitchen programs at both the Home Depot and EXPO we have learned that our customers want more countertop options.

Based on those learnings we're expanding our special order countertop solution center, providing a broader assortment across all price points.

Another success is our expanded millworks showroom.

By improving the displays we have given customers a broader offering of both windows and doors to improve both interior and exterior of their home.

By the end of this year we will have spent over 500 million in capital in support of our store modernization program.

Moving into the holiday season we have a strong offering supported by solid marketing and merchandise programs.

To maintain our average ticket momentum we will continue our market back approach responding to our customers' needs.

We will also continue to support the rebuilding effort in the communities we serve and focus our efforts on ensuring that customers get the best value any home improvement retailer can offer.

I'd now like to turn the call over to Carl.

Thanks, Tom, and good morning everyone.

During the quarter we continued to focus on operational excellence and execution as Tom mentioned.

Our more centralized division structure provides direct communication with our store managers in better aligning associate execution with our customer service initiatives.

I'm going to update you on three of our initiatives that focus on improving the customer experience in our stores.

One, reduction of tasking in the stores, or task out, as we like to call it; two, in-stock improvement; and three, simplification of our store staffing model.

Number one, reduction of the tasking in our stores.

Reducing task in our stores allows us to redeploy associate hours to the selling floor especially allowing us to spend more time serving our customers.

We are already seeing positive results from our back end automation and reengineering initiative which we call BEAR.

BEAR is a multigenerational platform that utilizes technology to reduce human error and increase operational efficiency and effectiveness.

As we have discussed before, the first phase, back end scanned receiving, is now in all of our U.S. and Canadian stores.

This allows associate to use a scan gun to receive product and have the information fed directly into our inventory system rather than use pencil, paper, and unnecessary key strokes.

We are now in the next phase of BEAR, which involves certifying our suppliers for direct-to-store product deliveries.

Certified receiving allows our associates to scan a bar code on a freight bill once and then begin to unload rather than scan products individually.

By fiscal year end, we expect approximately 50% of our store cost of goods sold to be certified.

Our vendors are also very excited about this rollout because it simplifies their task as well.

Another operational improvement is centralized automated replenishment.

This initiative has simplified and streamlined our replenishment in the stores.

Currently 11% of our sales are automatically replenished instead of requiring an associate to review and order the product.

We expect 20% of our sales will be automatically replenished by year end.

SOSI, our special order and services pilot for flooring is now in 146 stores.

This initiative adds speed for project delivery and reduces errors through the use of technology, delivering a better customer and associate experience.

We are expanding this pilot to another hundred stores in the fourth quarter.

And self check-out, which is now in 1,205 stores.

We are continuing to see higher voice of the customer ratings in stores that offer self-checkout.

In addition, self-checkout has enabled us to redeploy tasking hours back onto our selling floor to serve customers.

Secondly, I want to talk about our in-stock improvement.

We've upgraded the technology and functionality of our mobile cart platform paving the way for needed flexibility as we migrate to a centralized auto replenishment.

One application currently being installed streamlines the inventory management process which will expedite restocking.

This technology is currently in over 100 stores and will be in all stores by year end.

The back end automation and reengineering and centralized auto replenishment initiatives will continue to improve our in-stock position and reduce tasking hours.

These initiatives will allow us to redeploy a minimum of 40 to 60 hours per week, per store, back on to the selling floor.

Thirdly, let's talk about the simplification of our store staffing model.

We are making positive changes in our store staffing model.

Specifically, we are rolling out new labor standards to all U.S. stores which will provide several key benefits.

First, the new staffing model will better align our associate hours with our customer service needs.

Second, to further enhance our associate availability, the new model will provide a base level of staffing coverage throughout the store.

This base coverage will enable us to simplify the scheduling process and provide better visibility to our staffing needs.

So how do our customers think we're doing?

Almost 1 million customers per month give us their opinion through an on-line voice of the customer survey. in the third quarter the biggest improvements we saw included associate availability, ease of checkout, and the ability to find and buy the product the customer came in to purchase.

The Home Depot's investment in technology and processes are paying off.

Through these investments we are driving improved customer satisfaction.

Lastly, I'd like to say a few words about our response to the recent devastating hurricanes.

The Home Depot transported associates from neighboring markets to assist those stores in the strike zones, providing relief for exhausted associates, many of whom who were personally affected by the storms.

In total, more than 3,000 associates volunteered to relieve their coworkers.

These associates worked to ensure the stores remained open around the clock to serve customers, closing only when evacuations or curfews were imposed.

As of today, only two stores remain closed.

I would like the to thank our vendors, merchants, and associates who served our customers and communities during the recent hurricanes.

Thank you.

Now we'd like to turn the call over to Carol.

Thank you, Carl, and hello, everyone.

As you have heard from Bob, Tom, and Carl, this was a very solid quarter for the Home Depot.

In the third quarter sales grew 10.5% to $20.7 billion.

Consolidated net income totaled $1.5 billion, and diluted earnings per share were $0.72, an increase of 20% compared to the third quarter of 2004.

Against a 4.5% comp in the third quarter of 2004, and a 7.8% comp in the third quarter of 2003, comps or same-store sales were 3.6% for the third quarter of this year.

Of this, 93 basis points were contributed by the Home Depot Supply.

Sales from stores that had been open for less than one year contributed 4.2%, and sales from our newly acquired businesses contributed 2.7% of our total sales growth in the third quarter.

As we have discussed, this quarter was the most active hurricane season we've ever experienced.

While meaningful to the region, the storms' impact to our third quarter comps was approximately 37 basis points.

Our gross margin rate for the third quarter was 33.57%, an increase of 27 basis points from the same period last year.

The following factors impacted gross margin in the third quarter.

First, 65 basis points were directly attributable to our relentless focus on cost-out, as well as a change in mix, including a higher penetration of certain higher gross margin categories like fasteners, and a lower penetration of lumber.

Second, in preparation for the fall selling season, and to provide space in our stores for our strong holiday presentation, we held a clearance event in our stores.

While we have experienced tremendous sell-through on the items we marked down, the event decreased gross margin by 38 basis points.

And finally, our gross margin reflects our evolving business model.

As we have discussed, our Home Depot Supply business has a lower gross margin than our retail business.

For the year, we expect moderate gross margin expansion.

Our expense story continued to be a good story.

Total operating expenses as a percent of sales were 21.65%, or 70 basis points lower than last year, due to a continued focus on cost take-out initiatives and driving productivity throughout the business.

During the quarter, we drove expense leverage in most of our major expense categories, and continued to see a benefit from our private label credit card program.

One final comment about expense.

While hurricanes helped to drive sales, they also come with a cost.

Hurricane insurance deductible cost in the third quarter of this year were approximately $17 million, similar to what we experienced in the third quarter last year.

In the third quarter, net interest expense was $21 million, as compared to net interest income of $4 million last year, primarily due to interest expense associated with our $1 billion bond offering issued earlier this year.

Operating margin was 11.92%, an increase of 97 basis points compared to the same period last year, and a third quarter company record.

During the quarter, we opened 37 new stores, and as of the end of the third quarter we owned 86% of our stores.

As we have said, we strategically cannibalize our stores in order to grow market share and top-line sales.

In the third quarter we cannibalized 17.8% of our stores, which had a negative impact on comps of 2.1%, excluding the impact of cannibalization comp sales would have been 5.7%.

At the end of the quarter, selling square footage was 208 million square feet, a 7.2% increase from last year.

Our average square footage per store was 105,000 square feet.

For the third quarter, weighted average weekly store sales were $765,000.

Sales per square foot were approximately $377, up slightly from last year.

Now let's move to the balance sheet.

At quarter end, total inventory was $12 billion, an increase of 18% from last year.

Ordinarily, we don't like to grow inventory at a faster rate than our sales, but the year-over-year growth is partly reflective of our growth in Home Depot Supply.

At the end of the quarter we had approximately $560 million in inventory at the Home Depot Supply, and these inventories have almost doubled year-over-year, reflecting our acquisition activity.

On a per store basis, inventory grew 7%.

As we have previously told you, in the second quarter we deliberately increased our merchandise levels in anticipation of an active hurricane season, and we maintain those levels in support of the rebuilding efforts in affected areas.

We feel very good about the quality of our inventory.

Total company inventory turns were 4.9 times, down 2/10ths of 1% from the third quarter last year, but still the highest in our industry.

Return on invested capital, which is computed on beginning long-term debt and equity for the trailing four quarters, was 21.8%, an increase of 40 basis points from last year, excluding cash and short-term investments, return on invested capital was 25%.

We manage return on capital through a portfolio approach.

While our Home Depot Supply businesses are less capital intensive than our retail business, the acquisition premiums paid causes their current return on capital to be about 10 percentage points less than the retail business.

We will pay for the acquisition premium over time with synergies, and in the short term, we'll subsidize the dilution with increasing returns coming off of our retail business.

We are a financial powerhouse, and are using our strong cash flow to invest in the business and return cash to our shareholders.

We ended the quarter with $1.4 billion in cash and short-term investments.

Year to date, this represents strong cash flow from operations, and the net proceeds of our $1 billion bond offering offset by $2.9 billion in capital expenditures, $2.3 billion paid to acquire new businesses, $645 million in dividends paid, and $2.8 billion spent for the repurchase of common stock.

In the third quarter, we repurchased 21.8 million shares.

Since our share repurchase program began in 2002, as Bob said we have repurchased 272 million shares and spent $9.5 billion under our $11 billion authorization.

Year to date, we have spent $2.9 billion on capital projects and currently project our fiscal 2005 capital spending to be $3.9 billion.

Our strategy of enhancing the core, extending the business, and expanding our markets is delivering solid financial results.

The fourth quarter has started out very strong for us.

We are lifting our fiscal 2005 sales growth guidance from 9 to 12% to now 10 to 12%, and we are lifting our earnings per share growth guidance from 14 to 17% to now 17 to 18%.

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

Thank you. [OPERATOR INSTRUCTIONS] We'll go first to Steve Chick with JP Morgan Chase.

Thanks.

A couple of questions.

Carol, you said that you started the fourth quarter off pretty strong and you've raised your sales guidance for the year.

I was wondering if you could be a little more specific in terms of the comps relative to the comp that you just reported for this quarter?

Well, Steve, as you know, we don't provide quarterly comp guidance, but let me just reiterate what I said in my closing comments.

The fourth quarter has started out very strong.

Okay.

And what -- left over from the wallpaper liquidation from the last quarter, I don't know how material it might have been, but how additive might that have been to the current quarter comp?

Steve, as you may know, wallpaper is a very, very small category in our business, so the sell-through of that inventory was not material to the third quarter comp.

Okay.

That's helpful.

Last thing, if I could, Carol, I know you said what your CapEx guidance is for the year.

CapEx for this quarter, it looks like it was down, while D&A was up pretty substantially, and I don't know if you could speak to the disparity, but more importantly, what is your D&A guidance for the year?

Well, as we've talked about, part of our capital investment is an investment in technology.

This year we'll be spending about $350 million in technology capital projects, and our depreciation for technology capital projects is also about 350 million, because we write off technology over a three-year period.

We have a very aggressive stance as it relates to technology.

So we have guided that our depreciation and amortization will grow at a faster rate than our sales.

Okay.

Thanks.

You're welcome.

We'll go next to Matthew Fassler with Goldman Sachs.

Thanks a lot, and good morning.

Just want to ask you a couple of questions.

When you think about your expense control, in the past you've made very aggressive mid-quarter adjustments.

Would you consider the terrific results that you produced this quarter to be a function of that, given the storms and your reactions to rising gas prices, or should we view this as sort of a sustainable run rate on the expense front?

Let me, I think, both Carl and Carol mentioned in their comments, we have been working on this the last four years.

Carl has dubbed it task out.

We've been using technology to help us get task out of our business.

This is a company that has had phenomenal growth, and a relatively young company.

We now have the opportunity to step back and digitize a number of our operations.

Point one.

Point two, as we become more technology focused and driven, it's working its way across marketing, merchandising, our returns in those categories are improving, so, our commitment is certainly to continue as has been said already, a very strong focus on becoming much more, I guess, nimble, more efficient in the execution of our company.

So I hope that answers your question.

It does, Bob.

Thank you.

Just by way of follow-up, I was particularly interested in one of the areas that Carl focused on, which is automated replenishment, which seems to be getting to some critical mass.

So, Carl, if you could talk to, what kind of technology you currently have in place to facilitate that, the pace of the rollout that you would expect, and where we can see that impact the P&L and working capital lines.

Matt, I'll speak to the first part, we'll let Carol take the second part.

I think on our side is, we're leveraging our current technology, the mobile order cart and our inventory system, we still think there's a lot of runway with our existing processes to take tasks out, costs out, and improve efficiency.

So we're leveraging what we have, and we're finding ways every day to improve efficiency.

So as we ramp to 20% on centralized auto replenishment we know that's going to free up time in the stores for our IMAs to focus on serving customers and make sure that as Tom rolls out new sets, that we're much tighter, and we're much more ready to serve customers as they come in the stores.

We're linking that with several Six Sigma projects that we're doing in the business to take out process steps so that we can improve speed and velocity to be able to do that as well, so we see that, number one, as a customer enhancement because it's going to improve in-stock at the customer eye level, but number two is it's going to free up our associates to serve customers more.

Clearly on the working capital side when you use algorithms at the point of sale to set the weeks of supply that will then optimize the total weeks of supply that we have in the store.

Just finally, Carl, do you have the technology in place to ramp that up to a larger proportion of the mix at this point?

Yes, I think -- we had -- our existing technology is terrific for what we're leveraging it for, and I think with some of the partnerships that Bob DeRodes has been able to bring to the table for down the road in the future we'll be able to leverage that technology as well.

But between Tom and I on the supply chain side, we feel like we have some opportunity left with what we have, and our job is to really take advantage of that opportunity, to put it in place.

Thank you so much.

Matt, again, I want to reinforce the journey we've been on here, in that Carl mentioned it, self-checkout, 40 to 60 hours per week per store.

The back end automation, another 40 to 60 hours a week per store.

In general, those reinvestments equate to about $0.01 a share, when you consider from an associate standpoint.

So we are absolutely committed to reinvesting in the core, we're convinced that by putting hours back on the floor in consultative selling is why we're seeing the benefits, Tom mentioned about kitchen and some of the special orders.

We think this is the right reinvestment to make in our company, delivering on the short term and continuing to position us for a steady and sustainable, and predictable return in the future.

Thank you, Bob.

We'll go next to Danielle Fox with Merrill Lynch.

Thanks.

Good morning.

I was wondering if you could talk a little bit more about the recent sales and profitability trends at National Waterworks and some of the other acquired businesses?

It may be a little early but is National Waterworks seeing any incremental demand from post-hurricane rebuilding in Louisiana, Texas, and Florida?

I think you'd mentioned that overall you expected to see a lift in sales.

Just more broadly when we think about the long-term financial outlook should we be thinking that strategic acquisitions will contribute to growth in a similar way as it did this year, adding about maybe 2 points to the top line?

How should we be thinking about it long term?

Danielle, let me just give a brief overview, then Joe DeAngelo is in the room, and I'm going to ask him to comment specifically.

It's his business.

Couple of points.

But I think a couple of points, number one, as Carol and I have mentioned, the overlap on the customer is very, very important to the strategic direction.

In other words, many of the customers that we've already been serving in our retail box, our orange box, this strategic acquisition gives us extension, and so we can continue not only to be destination in our stores but then we become destination in our branches for that same customer.

So the adjacency of this strategy I think is very important for me to reinforce.

Point one.

Point two, we're seeing tremendous overlap relative to our supplier partners in the areas both within our retail box and with our acquisition.

So my comment in the opening here is, again, we're able to then bundle our purchasing leverage, our supply chain, et cetera, so again, this is a glove fit strategy using the strength of our orange box and adding these new vertical channels.

So I just want to keep coming back, because this is new.

I want to continue to reinforce the eloquence of the strategy as it relates to our operational rigor, and Joe can comment specifically now on the benefits of not only National Waterworks, but White Cap, which we have grown geographically, thanks to Carol's comments about the financial strength, when we acquire platforms, we're able to get geographic reach because of our strong financial position.

Joe, you want to comment more than that?

Yes, sir.

Just the first point is that if you look at the businesses that we're acquiring, we buy business to grow the businesses.

So in every case, every business that we have purchased to date is growing faster, now that we've purchased them, than before.

So their run rate of growth has increased since we've acquired them.

Secondly, every single business in our total Home Depot Supply portfolio is outperforming the markets in which we're participating.

So we know we're gaining share in every single one of our markets.

So it is a growth story, and it's a growth story driven by what Bob said, was every business brings to us sourcing synergies, so we have more buy from the same supply base, brings customer access, so these are all customers that we're buying from the orange box.

They may have been buying just on a 7-Eleven type convenience basis, or they may have been primary, but they're all customers that we know and they all bring knowledge and results that we can transfer across the business so we couldn't be more pleased with the sales growth and the profitability of these businesses.

All of them are exceeding the pro formas that we pitched when we bought the deal.

Danielle, again, I think the important thing here is that the leadership team is unique and distinct from the standpoint of they all bring commercial and industrial experience to broaden our leadership breadth, both at the senior level and at the operational level.

I think that that's a big point.

I think secondly my comment that we're opening our 2,000th store this quarter, again, this is something, kind of been there/done that, as we've gone from 0 to 2,000 stores we certainly know how to roll up and roll out.

So this is something that the Home Depot knows how to do, and so we're taking the experience of the core and applying it to the expand portion of our strategy.

Thanks.

That's helpful.

Just one final follow-up question.

It sounds like you are making very good progress.

Any thoughts about providing some additional disclosure on the -- kind of the magnitude of acquired revenues in any particular quarter or breaking out Home Depot supply more explicitly so that we can really see the magnitude of the growth in the improvement?

Yes, I think, Danielle, at the -- certainly at the appropriate time, we're going to take a look at that.

I think Carol's comments, we talked a little bit about Home Depot Supply as a percent, and as we get -- as we get more momentum and it becomes a significant portion of our total revenue, one will do it obviously -- we'll be required to do it.

Thanks.

Very helpful.

We'll go next to Dan Wewer with CIBC World Markets.

Carol, you had indicated in the call that the return on capital from the acquired Home Depot supply businesses is running about 1,000 basis points lower than retail, that sounds considerably different than what we talked about at the analyst meeting.

If you could talk about why that has changed, and if it might make sense to slow down the pace of acquisitions until you can demonstrate earning back those acquisition premiums.

Well, Dan, what I attempted to do today was to provide a bit more color on the return on capital of the acquired businesses.

These businesses are less capital-intensive than the retail business.

So if you look at the return on capital before acquisition premiums, their return is north of 25%.

We do pay an acquisition premium, as you know, to get into this space.

And on the day that we pay the acquisition premium that will dilute the return on capital, and it's -- on a relative basis, it's causing the returns to drop down now to about, 12%.

Over time, we will pay for that acquisition premium.

So over time they will come back to be a higher earning business than the retail business.

But in between then, we will offset that dilution with increasing returns coming off of our retail business.

That's what we attempted to say on the second quarter earnings call.

I'm not sure it came clear as we had hoped it to do, so today hopefully that clarifies it.

Just as a follow-up, I believe you had indicated that inventory per store was up 7% if you exclude Home Depot Supply inventory.

That was chiefly to support the hurricane impacted areas.

Could you remind us on the number of stores that you're needing to run these higher inventory levels and what the growth in inventory may look like in markets outside of the affected region?

Well, we gave you a per store number.

The bulk of the inventory ahead of sales growth is in the southeastern part of the United States.

So that's where the inventory is.

Dan, let me just say, again, I think our organization, in anticipation, we took very seriously the forecast that this season was going to be broader and deeper with more devastation, and a credit to our merchants and our operating team, we loaded up our hurricane disaster DCs.

And as a result of that, as I said, we were able to be the last to close and the first to open.

And both Tom Taylor and Carl Leibert have spent enormous amount of time in the Gulf states, Florida, and Carl just returned from Mexico and visiting our sites down there.

So I'm very comfortable with the quality of our inventory and the fact that the repair and rebuilding efforts will be extensive over a period of time.

So I think we're well positioned.

Yes, we have a lump right now, but we'll sell through that, Tom or Carl if you want to comment.

I'd echo the comments.

I think that's exactly right.

The inventory is where we want it, and it's in the categories that we want it in.

Carl and I both have spent significant time down there.

We are setting ourselves up to be able to take care of the customers' ever changing needs.

Thank you and good luck.

Thank you, Dan.

We'll go next to Colin McGranahan with Bernstein.

Good morning.

Couple questions.

First, just on the top line, I might have missed it, can you quantify the impact on your same-store sales from the hurricanes, then the all-in i inflation building materials net of the deflation in lumber?

Colin, the hurricane impacted comps in the third quarter by 37 basis points.

Okay.

And then building material inflation?

We looked at lumber deflation, which was less thatn 30 basis points, it was actually 29 basis points negative impact to sales, to comp sales.

But like increased pipe and concrete, have you quantified that at all?

We haven't.

I'll tell you, within the Home Depot Supply companies, which are much more exposed to those categories, commodity inflation has increased their sales by about 1 percentage point.

Okay.

Secondly, to Carl's comments on the new staffing model, and ability to detask the stores to some degree, can you just talk about what your year on year change in labor hours per store is and how you see that going forward, and then any comments on labor productivity as well with the new standards?

I think, Carl, let me just again preface -- and Carl will jump in here -- he'll talk about not the specifics of hours per store but he'll certainly share with you, give you some color on some of the task eliminations, how we're going to, for example, in some of our new prototype stores, how we're going to zone staffing and some of the benefits we're seeing, like in Ada, Oklahoma store we were down there a couple of months ago visiting that new 62,000 square foot model.

Carl, you want to provide some intimate color here?

Carl, you want to provide some intimate color?

Yes, I think, Colin, we've taken a step back and taken a much more engineered approach to service in the departments in partnering with Tom's team in understanding what type of service we want to do in each department, and we determined the department, is it a self-select type of department, an assisted sale type of department, or a consultative selling area.

And what we're doing with technology and the process improvements that we've seen with self checkout, with BEAR, with certain centralized auto replenishment, and several of the other enhancements that we've rolled out, as we're taking those hours and deploying them to places in the store where service is required.

Specifically, as talked about, kitchens, and the redeployment of hours we've put in that area of our stores, appliances growth and some of the opportunities we have there.

We're also able to move hours into the pro desk, in the pro area where we can serve that customer segment, which Bob alluded to, is about 30% of our customers now.

So we want to put hours on the sales floor where service is required and so far that strategy is working pretty well for us, and we think there's a lot more opportunity for us to continue to do that.

So your sales per labor hours should be going up nicely as you're deploying labor to those higher revenue, bigger ticket purchases.

Should we also expect the, as you go through this process of rezoning the labor hours per store to grow below the rate of same-store sales, and did that happen in the third quarter with, say, a 2.7% same-store sales comp on Home Depot Supply?

I'll have Carol answer on the -- but certainly on your first point about sales per associate have and continue to increase.

We're very pleased with the productivity that we're seeing from our in-store sales associate, Carol.

Right.

The sales per labor hour are record highs and it's just reallocating the labor from the tasking activities to the selling activities.

I think, Colin, we shared with you what we were going to do last year at the analyst conferences that in our consultative areas is actually put performance metrics into measuring sales per hour, specific consultative sales associates.

We see this as a big, big opportunity for us with some runway left.

Let me give you kind of the broad answer to this thing.

What we have set out on over the last four years, and we'll continue, is a view of selling hours versus tasking hours.

And I would tell you I'm very pleased with the transition of not taking hours out of the store.

You could always do that and improve the bottom line.

As I said, some of these initiatives are worth $0.01 a share.

But we've made a very conscious decision to reinvest.

So we're seeing selling hours on the floor go up, we're seeing general tasking hours, whether it's in receiving, whether it's in self-checkout, whether it's through auto attendant, help us on the selling floor.

I would say, Colin, the output of that metric, Tom and I are sitting here talking is really, you look at our appliance department, last year that's where we've focused initially.

Tom alluded to that as our growth in that category.

That's attributable to us putting the right staff in that department to take care of customers.

Final question here, some of the vendors have commented on their commodity-driven cost increases in passing through some of those price increases early next year.

How are you looking at that, and do you think you have the ability to pass that through to the customer next year as well?

Tom, would you handle that for us?

I will.

Look, our vendors are our partners, and any vendor that comes with a price increase, we will look at it and understand why the price increase would have to be considered, understand the components of the products, and how costs are rising in those components, and if the vendor comes in and they have a legitimate story, then they're our partners, and we're going to listen.

Our end game is to get our customers the best value they can have, but it's not carte blanche.

Like I said, we're going to take a very serious, educated look across the category when that does happen.

Fair enough.

Thanks.

We have time for one more question.

Thank you.

We'll go next to Dave Strauser with Banc of America.

I just wanted to turn a little bit towards the future, looking at China, sometime during the quarter you got approval to invest -- to open stores there.

What are you thinking there?

Is it -- how seriously are you looking at that?

Is it something that we could see in the real near future?

Let me try and respond and see if I can answer that.

We announced that we were going to China.

Now, we have had tremendous success from China, certainly on the merchandising side with offices in Shanghai and in Shinzen.

Beyond that now at the retail platform let me just say that we will replicate the success that we've had in our company.

Our model and our approach to China will be very similar to the success we've had in Canada.

Certainly most recently our phenomenal success in Mexico.

What does that mean?

That means that we'll do -- we'll look at potential acquisitions to get a platform, then use our financial strength.

Joe talked about we only make acquisitions of growth.

But if we could get a platform that provides infrastructure and a jump start, just as we did in Mexico with Ricardo, we'll take the same approach.

It has been successful, it works for us, and that's our view towards China, and we are very focused on it, and I'd like to think we're making progress.

Would you do a really big acquisition to get a foothold in China?

Well, there really is no big acquisition in China.

There's a series of small players, and so -- obviously, we all know who they are, and those would be representative who we might look at.

All right.

Thanks a lot.

Okay.

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

Thank you, everyone.

That does conclude today's conference, and you may now disconnect.