家得寶 (HD) 2006 Q3 法說會逐字稿

Welcome to today's Home Depot third quarter earnings results conference call.

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

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

Please go ahead.

Thank you, [Bill], and good morning, everyone.

Welcome to the Home Depot third quarter earnings conference call.

Joining us on our call today are Bob Nardelli, Chairman, President, and CEO of the Home Depot, Craig Menear, Senior Vice President of Merchandising, and Carol Tome, Executive Vice President and Chief Financial Officer.

Today's discussion will begin with a review of our business by Bob, Craig will provide insight into our merchandising efforts, and Carol will complete our prepared statements with a discussion with financial results.

Following our brief discussion the call will be open for analysts' questions.

Questions will be limited to analysts and investors and as a reminder we would appreciate if the 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 the investor relations section.

The replay will [technical issues].

If we are unable to get to your question during the call please feel free to call our Investor Relations department at 770-384-2387.

Before I turn the call over to Bob let me remind you that today's press release and the 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.

Well, in August we predicted that the third quarter was going to be soft, and it was actually more challenging than we anticipated.

We felt the impact of the U.S. retail home improvement market slowing significantly.

However, during the quarter, we did stay on strategy by accelerating our investment in our core retail business and growing our Supply businesses.

In the third quarter, consolidated sales were $23 billion.

That's up 11% from last year.

Our diluted earnings per share were $0.73.

That's up 1%.

While consolidated net income, earnings were $1.5 billion, down 3%.

Carol will walk you through the specifics of the financial results later on.

Our total retail segment grew by 1.1%.

The softness in sales was a result of continued deterioration in the U.S. home improvement market.

The slowdown accelerated through the quarter and Carol will describe that to you later.

While part of our sales performance is due to the fact that we were lagging -- I'm sorry, we're lapping, really, two years of active hurricane season, we were with some tough comparisons.

We believe that the slowing housing market was really the biggest contributor.

Relative to other players in home improvement sector, we feel more pressure given the number of stores that we operate in slower housing markets, such as the northeast, California, and certainly Florida.

We saw softness in most categories but especially in discretionary projects and certain big-ticket items.

Particularly in kitchens, soft flooring, windows, and hurricane-related products like generators.

Despite this, during the quarter we did gain market share in some key categories like tractors, patio furniture, and appliances.

We'll continue to focus on gaining share in other categories by creating a compelling shopping environment through our accelerated retail investment program.

Despite the negative environment, we're continuing to invest in our merchandising resets, our store appearance and our associates.

By the end of the year we will have completed rapid refresh, resetting 100 bays in over 500 stores.

Craig will describe the early indications from these resets which are positive.

Year-over-year, we'll increase spending on store maintenance and appearance by more than 20%, and Carol will discuss this.

We'll complete the rollout of self check out in all of our U.S. and Canadian stores by year end.

Our labor staffing model will continue to be richer than it was a year ago, and we recently introduced our orange juiced incentive program.

This program rewards associates in stores for great customer service.

Our orange juiced program will pay out $30 million this year alone.

So I want to thank our associates for their hard work and focus on taking care of our customers.

Every week we hear from 250,000 customers through our voice of customer survey.

We've seen significant improvements in our survey results.

Key customer service attributes including customer engagement, waiting to check out, find and buy, likelihood to recommend, and associate availability were up over last year, and showed sequential improvement this quarter.

Overall satisfaction with our company as measured by scores of 9s and 10s is up over 2004 and 2005 levels.

We're making a lot of investments into our core business, and we didn't expect an immediate return, but we do expect that we'll see a return over time.

We're encouraged with the customer feedback to date.

Now let's take a look at other parts of our business.

Mexico.

Mexico had a strong and very strong performance of any division in the Company during the quarter posting a double-digit comp.

As the market leader today, we have 58 stores in Mexico, and we'll end the year with 62 stores.

We had strong sales in Canada, and by year end we'll have 155 stores throughout the country, and we'll continue to be the market leader.

Our catalog and Internet business, Home Depot Direct, continues to exceed our expectations, and it's on the way to becoming a billion dollar business by the end of this year.

Our services revenue, which is included in the retail segment, grew by over 11% in the quarter to $1 billion.

Leading categories included countertops, HVAC, and exterior patio.

Additionally in the quarter we acquired Jubilee Home Solutions, which is a full-service bath remodeling business based in Kansas City, Missouri, and we want to welcome Jubilee associates to the Home Depot family.

Now let's turn to HD Supply.

As you know, our strategy with Supply business is to extend the strong relationship with the pro customer who is shopping our stores and accounts for about 30% of our retail sales today.

The combination of over 2,000 stores and over 950 supply branches positions us to serve the pro market better than anyone else.

Now, in the third quarter, sales in our supply segment grew by 159%, while organic growth was up about 7% from last year, supply experienced some deceleration in organic growth from prior quarters due to the slowdown in residential construction.

So anticipating this, we focused on driving synergies across all of the supply businesses, shifting our focus from residential to commercial construction where we continue to see strength.

We're pleased with the integration of Hughes business, and we're exceeding our acquisition pro forma and realizing synergies ahead of schedule.

So, for example, by the end of the year, Water Works, which is the largest business within supply, will be completely integrated under one common operating platform with one common payroll system.

Further, the branch network within Water Works will be fully rationalized.

The Home Depot made three acquisitions that will be integrated into Home Depot Supply.

We'd like to welcome Grasston Utility Supply, Edison Electric Supply, and the Burrus Contractors Supply into the Home Depot family.

This quarter we launched the rebranding of all of our HD Supply businesses.

The supply businesses will now operate under one brand to unite the various brands that resonates with our diverse customer segment and conveys our value proposition, and market differentiation in a simple, but compelling way.

Finally we'll continue to return cash to our shareholders.

Since 2000 we have more than tripled our annual dividend, increasing from the $0.16 to now $0.60 a year.

Since the inception of our share repurchase program in late 2002, we have repurchased approximately 16% of our outstanding shares, using about $13.3 billion of our $17.5 billion authorization.

So over the past five years, we have returned about 65% of our cumulative earnings to our shareholders in the form of dividends and share repurchase.

Before I turn it over to Craig, I just want to comment on our new organizational structure.

It's only been in place 30 days, but I couldn't be happier with the focus, alignment and speed of decision making we've gained as a result of de-layering.

I have a great and experienced team.

I'd like to introduce Craig Menear, our Senior Vice President of Merchandising.

For those of you who haven't met Craig yet, he's a seasoned merchant with over 25 years of retail experience, and nine of those with the Home Depot.

Craig?

Thanks, Bob, and good morning, everyone.

Several factors pressured our business during the quarter, including faster than expected deceleration in housing, the absence of hurricanes, commodity pricing, and the softness in discretionary projects in some big ticket items.

We saw softness in most departments across the store.

Lumber prices are at the lowest level since 2003 which had a negative impact to the department sales.

For the third quarter, lumber price deflation negatively impacted comps by 68 basis points.

The lack of hurricanes and tough year-over-year comparison resulted in negative comps in hurricane-related products like generators, roofing, flashlights, and batteries.

We also saw softness in big ticket items, particularly kitchens, soft flooring, and windows.

This affected both our transactions and our average ticket, average ticket was $58.33, down 1% year-over-year.

From a merchandising perspective, we remain focused on providing our customers with the best merchandising and a compelling shopping experience.

We saw strength in certain repair/remodel categories and gained market share in key categories.

Our repair/remodel business was driven by enhanced services for the pros, building materials, hand tools, power tool accessories, plumbing tools, wire, conduit, pipes and fittings all performed well, driven by whole project selling as well as increases in commodity pricing.

The pro is an important customer for us.

We're always focussed on improving our production and services for our pro customers.

We're extremely pleased with the progress we've made with our business toolbox program and the introduction of our cobranded MasterCard, two programs that are available only at the Home Depot.

In addition, in partnership with our suppliers, we introduced a bid room for our larger professional customers being serviced in our stores through our pro desk.

This bid room allows us to provide better service and value for our customers.

In the face of a slowing home improvement market, we gained share in key categories including hand tools and accessories, tractors, patio furniture, hard flooring and appliances.

I'm going to share with you some market share statistics which all came from an independent third party based on a rolling 12 months.

We saw continued strength in patio furniture during the quarter as a result of our broadened assortment, enhanced quality, and great values through our proprietary Hampton Bay brand.

Our patio furniture market share increased 220 basis points to 10.7%.

In hand tools and accessories, we gained share due it to the introduction of innovative products including the expanded assortment of proprietary tool sets and Stanley's fat Max Extreme tool line.

Our hand tool and accessories market share increased 60 basis points to 16.2%.

In tractors, we gaped share in a shrinking market as a result of our comprehensive lineup of tractors, including John Deere, Cub Cadet, and Toro.

We are the only home improvement retailer to carry these three national brands in our stores.

Our tractor market share increased 110 basis points to 14.8%.

Our momentum in appliances continued as we grew market share and hit our highest draw and close rates ever.

Core market share increased 110 basis points to 10.3%.

Results were driven by our merchandising assortment and our knowledgeable sales associates.

Customers continue to respond to innovative and distinctive products.

During the quarter we rolled out the exclusive wild cherry red LG Steam Fresh Laundry with LED displays.

We were first to market with the new Maytag Epic front load laundry pair.

And we also introduced the GE Adora appliance suite in a new graphite metallic color which will you only find at Home Depot.

We have been challenged all year in flooring but are making progress.

In the third quarter, we introduced new fashion-forward merchandise in every category, included in hard and soft flooring.

In wood and laminate we introduced new finishes and plank sizes through Thomasville Wood Flooring and Dupont Real-Touch Elite flooring.

As part of our accelerated capital investment in the stores we will reset ceramic tile in 500 stores, and wood and laminate in 1,000 stores by year end.

We're very pleased with the initial results and we have seen market share gains in laminate flooring.

In soft flooring the introduction of Puress carpet, which reduces odors in the home, and Sonora, which offers superior stain resistance -- have been well received by our customers.

We continue to help our customers reduce energy costs inside their homes.

As the energy star retailer of the year we have a comprehensive program including clinics that teach our customers how to reduce costs in their homes through the use of energy efficient products.

In October, which was Energy Awareness Month, we held weekly clinics in each of our stores.

We offer over 2500 energy efficient products including everything from home ceiling products such as attic insulation, windows and doors, to interior lighting.

This year we expanded our holiday decor assortment.

We have a broader selection of energy efficient light sets, prelit artificial trees, and other holiday items.

We also added new merchandise like decorative accessories for the home and ornaments.

This year we set holiday early, and we're very pleased with the initial results.

During the quarter we began implementing our rapid refresh which resets 100 bays in over 500 of our highest volume stores.

Today we've touched over 30% of the targeted stores and expect to complete the program by year's end.

While still early, we're very pleased with the initial results.

The reset stores customer satisfaction scores are increasing at a faster rate than the control stores as measured through our voice of customer surveys.

In the fourth quarter we have a number of new products that we'll roll out to the stores, geared mostly towards our pro and serious do it yourself customers.

We'll be introducing some new low maintenance products like new styles of fiberglass doors and composite fencing.

The fiberglass doors come pre-finished.

They have the look of real wood and will not rust, dent, or peel.

We will also introduce pre assembled composite fencing with the look of real wood that requires no painting or staining.

In the fourth quarter, our exclusive commercial electric brand of recessed cans will have new unique features that make installation easier and faster for our professional and do it yourself customers.

These products offer exceptional quality at great value.

Demonstrating our continued commitment to innovation, in the fourth quarter we'll add to our Ridgid lineup with the first aluminum twin stack air compressor in the market.

It delivers longer lasting, reliable performance, has 20% more capacity than comparable units, is lighter, and guaranteed to be corrosion-free.

Collectively my merchandising leadership team has over 300 years of retail experience, which over half has been at the Home Depot.

I'm proud to lead this group.

It's knowledgeable, it's energized, it's engaged, and we're focused on the basics, bringing the right merchandise to our stores at the right view.

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

Thank you, Craig, and hello, everyone.

As Bob mentioned, our total company sales grew by 11.3% or $2.3 billion, to $23.1 billion in the third quarter.

Of the $2.3 billion in sales growth, $217 million came from our retail segment, and $2.1 billion came from our supply segment.

In the third quarter, sales in the retail segment were $19.7 billion, a 1.1% increase over the same period in 2005.

This sales increase was driven by the addition of new stores.

Against a retail comp of 2.7% in the third quarter of 2005, comp or same-store sales were a negative 5.1% for the third quarter of 2006.

At the beginning of the quarter, we expected that softness in the economy would have a negative impact on our business.

And we projected that our retail comps would be down slightly.

August comps met our expectations at a negative 1%.

But comp sales in September and October were much softer with negative comps of 4.3% and 8.7% respectively.

The last two weeks in October were very soft, as we anniversaried last year's highly successful clearance event and sales arising from hurricane damage.

As Bob said, the retail home improvement market has slowed significantly.

Our transactions grew by 1% in the quarter to $332 million.

On a comp store basis, customer transactions fell by about 4%, due in part to our self-cannibalization strategy.

As a reminder, we strategically cannibalize our stores to take pressure off of high-volume stores and to support market growth.

In the third quarter, we cannibalized about 16% of our stores, which add negative impact on comp of approximately 1.9%.

Sales in the Supply segment were $3.5 billion, up 159% over the same period in 2005.

Now, we look at sales growth in the segment from an organic and an acquired perspective.

Excluding 2006 acquired sales, total revenues at Supply grew by 33% in the third quarter.

And for the businesses we owned as of the end of the third quarter last year, the year-over-year organic growth rate was approximately 7%.

The Supply organic growth rate, while very good, has decelerated from the first two quarters in the year, due primarily to negative growth in residential construction.

In the third quarter, consolidated gross margin was 32.6%, a decrease of 92 basis points from the same period last year.

Given the growth in our Supply segment, we are experiencing a higher penetration of lower Supply gross margin dollars.

In the third quarter, 12% of our gross margin dollars came from supply, as compared to 6% last year. 81 basis points of the consolidated gross margin decline in the third quarter was a result of higher penetration of Supply business, as well as a drop in its gross margin rate due to a change in the mix of businesses owned.

Supply's gross margin rate was approximately 26.5% in the third quarter, down over 350 basis points from last year.

In the retail segment, the retail gross margin rate dropped 11 basis points to 33.6%, and the year-over-year decline is directly attributable to an increased penetration of appliance sales.

As Craig mentioned, we continue to gain share in this key category.

The gross margin on appliances is less than 20%, so as it grows, we will experience slight gross margin pressure in the retail business.

In the third quarter, expenses grew faster than sales, and consolidated operating expenses increased by 30 basis points to 21.9% of sales.

As Bob mentioned, at the beginning of the quarter we launched an accelerated reinvestment program in our retail stores.

We stayed true to that plan despite the economic head winds that came our way.

In the retail segment, our operating margin was 11.4%, down 80 basis points compared to last year, reflecting the lower gross margin I just mentioned, as well as expense de-leverage due to soft sales and our accelerated retail reinvestment program.

In this segment, we de-leveraged expense by 69 basis points, of which 50 basis points was directly attributable to our richer labor staffing model.

Now, on a personal note, I am really excited to be leading our store operations teams, who are doing a great job.

Let me give you some examples.

By the end of the year, we will have remodeled 400 restrooms, restriped over 1,000 parking lots, painted over 400 storefronts, relamped about 300 stores with brighter and energy efficient lighting, refinished the floors in over 300 stores, and replaced the cashier check-out stands in over 200 of our stores.

This activity, among others, demonstrates our commitment to continually improve the customer shopping experience.

In the supply segment, we leveraged expenses, but our operating margin decreased by 136 basis points to 6.9%, consistent with our expectations given the change in mix of businesses owned and the integration of Hughes.

Consolidated operating margin for the third quarter was 10.7%, down 122 basis points from the same period last year, reflecting both the sales environment and our evolving business model.

Net interest expense was $92 million in the third quarter, up $71 million from the third quarter last year.

In support of our acquisition and share repurchase activities, our outstanding indebtedness at the end of the third quarter was $5 billion higher than last year.

And our long-term debt-to-equity ratio at the third quarter was approximately 24%.

In the third quarter, our income tax provision rate was 37.3%.

And for the year, we expect our income tax provision rate to be approximately 38%.

Consolidated net earnings totaled $1.5 billion for the quarter, a decrease of 3.1% from the third quarter of 2005.

Diluted earnings per share increased by 1.4% to $0.73 per share.

Diluted shares for the third quarter were 2.05 billion shares, compared to 2.14 billion shares at the end of the third quarter of 2005.

The reduction in outstanding shares is due to our share repurchase program.

In the third quarter, we repurchased 24 million shares and cumulatively since 2002, when the program began, we have repurchased 372 million shares and spent $13.3 billion under our $17.5 billion authorization.

Now I'd like to share some of our operational metrics.

During the third quarter, we opened 26 new stores, including one relocation, with two new stores in Canada and one new store in Mexico.

Approximately 10% of our store base is found in Canada and Mexico.

We own 87% of our retail stores.

In the Supply segment, we lease most of our locations, and today we have over 950 branches in the U.S. and Canada.

At the end of the third quarter, selling in retail square footage was $221 million, a 6.3% increase from a year ago.

The average square footage per store was 105,000 square feet, same as last year.

Retail sales per square foot were approximately $351 for the quarter, down 6.9% from last year.

New store productivity was down about 5% from last year, but flat to what we experienced in the third quarter of 2004.

Now turning to the balance sheet, at the end of the quarter, total inventory was $13.7 billion, an increase of $1.7 billion or 13.9% from last year.

Inventory turns were 4.9 times, flat to last year.

Of the $1.7 billion increase, $1 billion came from acquired businesses in our supply segment.

On a per-store basis, inventory was down about 1% from last year.

Computed on beginning long-term debt and equity for the trailing four quarters, return on invested capital was 22.3%, an increase of 50 basis points from last year.

We ended the quarter with $53 billion in assets, including $617 million in cash and short-term investments.

This is a reduction of approximately $190 million in cash and short-term investments from the end of fiscal 2005, reflecting cash flow generated by the business of approximately $6.9 billion, along with the net proceeds of $4 billion from financing activities, offset by $4.2 billion paid to acquire new businesses, $3.5 billion paid for share repurchases, $2.5 billion of capital expenditures, and $936 million in dividends paid.

In August, we told you that we thought we would grow our 2006 sales and earnings at the low end of the guidance we gave in January.

Given the current challenging housing environment, we think our comps will be mid single-digit negative in the fourth quarter.

We are staying true to our strategy of accelerating reinvestment in our retail business despite the softness in the top line.

As a result, we expect that fourth quarter earnings per share will decline by as much as 12 to 16% from last year.

Based on our performance for the first nine months of the year, and our fourth quarter forecast, we now believe our fiscal 2006 sales will grow by approximately 12% and diluted earnings per share will grow in the 4 to 5% range.

The market is challenging, but we are committed to taking care of our customers and driving operational excellence in both our retail and supply businesses.

The Home Depot is using its stellar financial position to invest in the long term for our customers, our business, and our shareholders.

So thank you for your participation in today's call.

And, Bill, we are now ready for questions.

Thank you. [OPERATOR INSTRUCTIONS].

We'll take our first question from Matthew Fassler, Goldman Sachs.

Thanks a lot.

Good morning.

Just a couple of very quick questions.

First of all, you guided to just now, Carol, mid-single-digit negative comp for the fourth quarter coming off, I guess, negative 9 for the month of October, and also going up against a somewhat tougher comp in the fourth quarter of both the one and the two-year basis.

I guess the question is what gives you the conviction to assume some sequential improvement in Q4 numbers from where you were in October?

Well, Matt, it's a great question.

I will tell you for the first three weeks of the fourth quarter we are seeing improvement from how we exited the third quarter.

We have got a number of really interesting merchandising things that are happening on the side of our stores, particularly if you think about holiday.

We have got an expanded assortment of holiday hitting our stores now.

If you are in the stores you'll see that expanded assortment of holiday.

Based on everything we're seeing with our current sales trends, the merchandising initiatives we have underway, we are predicting a mid-single-digit negative comp.

From the year-over-year comparison November is our toughest compare.

Not to put too fine a point on it, but is the improvement essentially in line with that guidance for the quarter?

In other words, have you improved to the mid single-digit negative declines?

We have.

Okay.

To follow up on that, is that ticket or traffic driven, so far as you can tell?

We're seeing strength in categories we saw weakness in the third quarter.

And just to follow up finally on the hurricane impact, if you could, now, with the prospective of the year of distance and having watched the patterns in the hurricane impacted regions, when do you think you saw the greatest hurricane impact, and how long -- how long do you think that lasted, and how deep do you think the impact was on your comps last year?

Well, if we look at the hurricane impact in comps for Q3 last year, we think it was about two points of comp that we didn't get this year.

And would you say that that impact lasted through 4Q or beyond 4Q?

At what point should we stop thinking about that as something that's making your comparisons even tougher?

Clearly we saw some of that carry into the fourth quarter.

And into the early part of this year as well?

A little bit, yeah, absolutely.

But less so.

Thank you very much.

Our next question comes from Budd Bugatch, Raymond James.

Good morning.

I just have a couple of questions as well.

Can you give us any flavor of where you think gross margins and expenses will be, Carol?

You said obviously got a lot of activity going on into putting more activity in the stores, more effort into the stores.

Do we think gross margins still trend negatively and operating expense de-leverage as well obviously with negative comps?

Yeah, Budd, based on the accelerated investment in our retail stores as well as increasing penetration of Home Depot Supply we're projecting in the fourth quarter the gross margin will decline and that we will de-lever expenses.

Okay.

And Bob, can you give us any thought on sales and kind of a longer outlook now in terms of where you think 2007 and when you will get through some of the housing related issues?

I know that's a tough crystal ball right now, but any overarching help you could give us on that would be appreciated.

Budd, I'd be happy to share my perspective on this thing.

I think I said on the last call that I thought this thing was going to be, certainly was going to be challenging.

As I said, it certainly came faster and deeper than we thought.

I still continue to believe that as Carol has indicated, we'll have pressure in the fourth quarter.

I think that it will continue throughout all of '07.

I know there's a lot of points of view out there, but I still think we have deeper to go than we've seen.

If you think about just the loss of jobs in the home improvement market, I mean, in the home construction business, it's at unprecedented levels.

My 35 years of experience, when I see home builders basically writing off earnest money and liquidating land, I just know the ability to remobilize, starting with the purchase of land, getting framing crews, and trimming crews back in line, we're starting to see a lot of that unemployment find its way over to the small repair and remodel contractors in our stores.

I think that Joe de Angelo, whether it it's on the retail side or certainly the wholesale side of residential, is seeing the pressure.

So I would say we haven't -- we haven't on the home improvement retail portion of this business -- I don't think we've seen bottom yet, and I don't see anything that says it's going to get significantly better in '07.

Okay.

And my final question is if that remains the case, how much more are you willing to kind of go and stretch the balance sheet or move the balance sheet to maybe use it to the acquire some shares on the marketplace?

Well, I think two points, Bud.

Certainly, as I indicated, we still have a pretty significant outstanding balance of what the Board has approved, over $17 billion.

I think we've demonstrated over the years, and certainly have committed, that what you've seen in the past certainly is fair to model going forward.

I think our resolve in the third quarter, whether it be on share repurchase or accelerated reinvestment, both on the capital side and the expense side, we've stayed true to our commitments, pretty exhaustive list Carol shared with just store appearance and enhancing the shopping environment.

We're blessed to have a great balance sheet and we certainly would use that as one of our competitive advantages.

Thank you.

I would agree with what you're doing on those scores.

Thank you, Bud.

Our next question comes from Chris Horvers with Bear Stearns.

Good morning.

Joe, I was wondering if could you perhaps bucket the supply business.

You talked -- Carol mentioned that water is the greatest piece of it.

Could you bucket it between water MRO and then residential housing related businesses, and how the organic growth in those businesses trended in the current quarter?

I'll take you through what the portfolio configuration.

We look at it in terms of the way the cycle of execution goes.

So if you're looking at our infrastructure businesses, water and utilities make up 36% of our portfolio.

All the construction businesses, anywhere from the construction supply businesses due to plumbing, electrical, and interiors, the mix of 43% of our portfolio, maintenance is 16%, which is our facilities maintenance business and our industrial P V S, and repair and remodel and international make up, our balance is 6% of the businesses.

When you look at that time overall portfolio in aggregate we have about 20% of the portfolio that is directly home building residential, as the lumber and building materials business and the interiors business and when you look at in aggregate about 43% of our business is residential construction.

So we've got a good mix of businesses in there.

I think the strength of the portfolio is exactly that.

Having diversified portfolio allows us to see what's happening throughout every cycle, and we can adjust to the as it happens, and then I think in every case we have been able to be very successful in terms of gaining share.

I will just give you one example.

If you look year-over-year in our lumber and building materials business that operated out of Georgia this is just the Williams Brothers business, since that's the only one we own, year-over-year we were down about 2%.

That's in a marketplace where the prices have dropped for structural lumber about 24% and panels have dropped about 48%.

So incredible pricing pressure, and it's a marketplace where housing starts have been down.

So if you combine those two, and to be only down 2%, I think a significant job of gaining share.

So ups and downs throughout the portfolio but in every case we're growing faster in the markets we're participating in.

So would you say that the Supply business and the multifamily MRO showed growth in the quarter, and does Supply include -- didn't you acquire National Waterworks last September?

Yes, we did.

If you look at the multifamily business, the multifamily business was up strong double digit, which tends to run counter cyclical to the residential construction.

So homes aren't being built, and family will be moving into apartments.

Consistently we have been able to execute well there.

As well as perhaps the portfolio.

We only had one month of Water Works, and it was -- it was a flat execution this year because we had incredible comps relative to PVC commodity increases and we did have a lot of hurricane growth in there.

So the business again took share in that marketplace.

Thanks very much.

You're welcome.

Our next question comes from Eric Bosshard, Cleveland Research.

Two things.

First of all, in terms of inventory management, can you talk a little bit about where you think you are and what you're trying to do at the retail level and also how promotional you and the market might become in 4Q in the softer environment?

Carol, why don't you handle the inventory?

Well, we've got a number of things underway from an inventory management perspective Eric as you know, from how we order inventory to how we receive inventory, and to how we ship inventory from our suppliers.

From an ordering perspective today about 26% of the inventory is ordered off of our centralized auto replenishment program.

The rest is either ordered from the host here at the store support center or through our inventory management associates.

And we will continue to add products to our centralized auto replenishment program over time.

From a receiving perspective, we reengineered the back end, introduced our automated receiving process last year, and that's helping drive productivity on the back end, allowing us to put hours on the floor of the store for session.

And then from a supply chain perspective we're delighted to have Mark Holyfield on board with us.

Mark is working through his plans for 2007, right now there's a lot of blocking and tackling going on from a supply chain perspective but I think over time you'll see some changes in our supply chain, and when we're ready to talk to you about that we will.

From a promotional perspective I'll turn it over to Craig.

Eric, when we look at our pro possessional strategy in the fourth quarter we're really looking to stay on our strategy.

We're focused on making sure we're trying to provide compelling, attractive values to our customer across our entire line segment, and then we, as always, will continue to match and deal with any competitive offers that come up in the marketplace.

Does that mean promotions on a year-over-year basis up, flat, down?

Do you have a sense of that?

For the fourth quarter or in the third quarter?

For the fourth quarter.

Are you thinking about it at this point?

Eric, hard to predict at this point.

We certainly, as Craig said, have a strategy, but obviously we'll be -- we'll have to be responsive to what's occurring in the marketplace.

I think the focus on this thing has really been to provide -- and where we have gained share, great value, great pricing, every day low pricing has continued to be one of our mainstays.

So it isn't our intention to go out and be overly promotional, but we also won't be -- we won't be put at a disadvantage.

And if I could just jump in to give you some color for the third quarter we use our private label credit card as a promotional tool because our customers love it.

The penetration of the private label credit card was 28.5% in the third quarter, and our everyday value proposition is no interest, no payments, if you spend $299 on the card.

From time to time we offer 12 months no interest, no payment programs.

In the third quarter we had four more days of credit offerings than we did a year ago.

So it wasn't a significant change.

Bob, one question for you as you think about the '07 sales environment.

Can you talk about how you're thinking about capital investment within the business including the number of stores you're thinking about opening and the softer 2007 you described?

I would say Eric we are obviously in the process of putting together our CapEx plan for '07, but as I indicated to Budd earlier, I wouldn't see us coming off the strategy of continuing to invest, particularly in our core business.

As you know, Eric, we did take, over the last couple of years, our new store growth from -- let me use a round number -- around 200, down to 100.

We said at the last analyst conference that that would kind of be the range we would use over the next three, four, five years.

So at this point, I don't see a change, number one, in that.

Two, I would tell that you we'll continue to -- of our capital plan, continue to spend a significant portion, a significant portion on reinvesting in the core.

The resets that we see going on today certainly give us confidence that we'll be accelerating that in '07.

We'll be looking at the next 100 days en masse.

But we have continual resets going on.

For example, we're very encouraged with the laminate performance that Craig talked about.

It is on flooring, the fastest growing segment over soft.

We have introduced a new large tile set.

We're very excited about that.

We're excited about the success we're seeing with the capital investment in our mezzanines to expand our appliance showroom capability.

So I think, Eric, what you would see as a continuation of those capital investments that enhance the customer experience, expand the sales per square foot in the store, as really the driving force in '07.

And if I could just jump in, we are also looking at continuing our investment in technology.

We've got a big technology budget, as you know, and that will be increasing in 2007, as well as supply chain.

So for modeling purposes while we haven't finalized our numbers yet, you should expect that capital will increase -- this year we're spending $3.8 billion.

Next year we're going to spend a bit more.

Perfect.

Thank you.

Okay.

Our next question comes from Mark Rowen, Prudential.

Following up on the pricing question, given the severity of the downturn in the market, I'm surprised that either you or your competitors aren't lowering prices to try to stimulate sales.

Could you just give us a sense of whether you think that will need to be done as we go maybe deep into the downturn?

Let me just say this, Mark.

Obviously pricing discussions are probably out of bounds for the call here.

I would tell you that, Craig and the merchants are doing a great job in working with our suppliers.

Our suppliers, I couldn't be more appreciative of the partnering that's going on with them.

Craig talked about lumber pricing.

We certainly see it in some of the other building commodities.

So our position would be to make sure that we're priced sharply to the market that we're working with our suppliers, and as prices, commodity costs, fluctuate, we're making sure we're passing those on to our customers to maintain that brand loyalty and shopping experience.

Craig, I don't know if you want to comment anything more than that.

In total, Bob, we're constantly looking at market pricing across the country to make sure that we're competitive every day, and we'll continue to do that, and really focus on driving the best value for our customer every day.

Okay.

And then on the rapid reset program, you said that your customer satisfaction scores were way up in the stores that you had implemented it in.

Can you give us a sense of any movement on sales or any improvement in sales in those stores?

Mark, I think two points, just to be real clear.

What we talked about is that overall customer satisfaction, or voice of customer, as we call it, is up across the entire network of stores.

And that's the 250,000 customer shopping experiences that they go on-line and call and score us on associate availability, ability to find and buy, et cetera.

So we have seen a sequential improvement month over month in the third quarter for sure and we would expect the same thing to continue in the fourth quarter.

In other words, the customers that are scoring us 9's and 10's.

So that's one point, and let's set that aside for a moment.

And then I would let Craig talk about specifically what we're seeing early on in the resets, the 100 bay resets in the 500 stores.

Mark, as you look at the -- as you look at the customer satisfaction scores, while as Bob mentioned they're up across the board, in the stores that we are going in in these categories and resetting we are seeing those scores outpace the total, and likewise, when we look at the overall performance, as I mentioned we're pleased with the results that we're seeing with the sales performance of the reset stores in comparison to the control stores.

I think it it's important to note we are seeing a lift in those categories that we are touching.

We'll take our next question from Gary Balter, Credit Suisse.

Thank you.

Just a few questions.

First of all strategically it sounds like you're moving in a direction that makes a lot of sense, but how do you measure whether you're actually gaining or losing market share versus your competitors?

Well, Gary, as you know, we use external data.

There's an outside firm that a number of us contribute to.

We are able to get that data on a quarterly basis that looks at the various classes within the various -- within our departments, and, for example, we can look at flooring, we can look at interior paint, et cetera, et cetera, and so Craig and the merchants, along with the rest of us, look at that data, look at market expansion, look at our growth relative to that, and we're able to determine share gain or share loss.

And is your sense that you're holding on to your share?

Well, as we said, in some cases, as Craig mentioned, we've seen share gain.

For example, in the categories he mentioned, like outdoor patio, tractors, appliances, and in some cases, Gary, as we said, over the last couple of calls, we certainly are not pleased with soft flooring.

While getting better, still not where we want to be, and clearly that would represent a share loss.

Could you talk about the strategy to carry televisions?

You're getting bigger in consumer electronics for this Christmas.

Sure, but I'll let Craig handle that.

But, again, let me just be clear to you and everyone on the phones.

We really see this as an in and out.

An opportunistic.

We know that it's a highly sought after commodity, particularly in the holiday seasons, and again a couple of holiday events throughout the year.

Therefore, we want to go out.

We have the strength of our buying power.

We're able to purchase right.

We pass those great purchasing values on, whether it be on Black Friday and Thanksgiving holiday, and so our strategy at this point is kind of an in and out on consumer electronics, particularly the flat panel, plasma TVs and consumer electronics.

Craig, you want to to add anything to that?

No, Bob, I think that pretty much describes it.

Craig or Bob where, are we on the returns?

Because Costco, which has been big in this category and has been hurt a lot by the returns.

Again, to date, Gary, we have not seen that as a problem.

Again, because of the quantities certainly are not of the order of magnitude of someone that is in consumer electronics as a mainstay, so we bring them in on container loads, we distribute those, we pass on great purchasing opportunities to our customers, and we're kind of in and out.

So at this point, Gary, we have -- I can tell you we have not seen returns as a -- as an issue for us.

We'll take our next question from Colin McGranahan, Bernstein.

Good morning.

First as a follow-up for Joe.

Joe, you talked about the deceleration in organic growth in Supply and pointed to the slowdown in residential construction as we would expect.

Looks like in the second quarter it was about 12% organic growth, down to 7, so a five percentage point decline.

I think you said that residential construction is maybe 20% of the business today.

So am I thinking about that correctly, which would imply about a 25% drop in your aggregate residential construction businesses, or roughly in line with what we're seeing in the overall home building marketplace?

No, that's not correct.

The correct math is that 43% of our business model is residential construction related 20% is direct residential meaning that all they do is residential.

So the lumber business and the interiors business is 100% and combined there about 20% of the portfolio, 100% residential.

But if you look at all the pieces across the construction, the water works, the utilities, all the residential components, you aggregate all that it's about 43% for the portfolio in total.

So that would then say down more like 5 to 10%.

That's right.

Okay.

So White Cap has a pretty good chunk of residential construction in its business.

That's correct.

When you look at our mix, we are in the great high-growth mark, the high-growth market cool down significantly faster than everything else, so you see a disproportionate touch on that.

But White Cap for example year over year was down about 2%, of which probably 7 or 8 in residential but picking up in construction to bring it up to the negative 2.

Okay.

Then just on the commercial construction, the non-res, obviously there's multifamily and true commercial, I think McGraw Hill, their Dodge reports predicted some deceleration in '07.

How should we be thinking about the organic growth rate going forward?

When you look at it, we've got another couple weeks before we get that data.

We'd be better positioned I have to go clean look at that.

We're working at data that's 90 days old.

We look to still see that as a growth market in the 6ish range.

So when you blend the businesses together it's almost a flat outlook for the market for HD Supply in aggregate going into next year.

Obviously we'll have organic growth because we'll gain share.

Second question for Carol, how much of the incremental store reinvestment have you been able to offset from expense control elsewhere, and then if you can just talk about on a year-over-year basis what labor hours per store look like in the third quarter and what you're modeling for the fourth quarter.

Well, we were able to offset some of the accelerated reinvestment due to some actions that we took here at the store support center.

But as we mentioned, in the third quarter we de-leveraged expenses in total in the retail segment by 69 basis points.

From an hours perspective, our labor staffing model is richer in the third quarter than it was last year, and than we planned.

And as we look to the fourth quarter, so labor standards -- staffing model will also be richer than last year and what we planned.

It's important to note, however, that we don't have a flat staffing model.

We have a highly engineered staffing model that allots hours based on tasking and selling activities inside a store.

And I will tell you this is highly engineered.

So the hours that are being allotted to each store today is based on the activities that are happening inside the stores today.

And there is variability.

But when I look at it it in total, the staffing model and the staffing standard is richer in the fourth quarter.

Okay.

And then just final quick question for Craig.

This is a first quarter we saw average ticket decline, and I think something close to four years.

How should we think about the positive drivers of that?

Mix up on merchandise?

Growth of appliances faster than the overall business?

Success with installed sales and broadening of your capabilities there against what was obviously a period of extraordinarily strong major project selling.

So how do we think about the cyclical versus the structural drivers of average ticket?

I think when we look at the business we saw, you know, strength in repair/remodel categories, which certainly allow us to drive some projects selling, but when you look at the weakness in flooring, for example, which is a big ticket project, and kitchens, as we mentioned, those were certainly categories that were a de tractor to our average ticket.

When we look at the expansion of things like our holiday assortment, you know, as we look at that through the fourth quarter, that would actually be a driver that could potentially bring average ticket down compared to the total, with the price points that are offered to that product category.

let me just give you some data for the third quarter this might be helpful.

Average ticket was down $0.59.

If you back out the benefit of appliances, the average ticket was down $0.94.

So, in other words, appliances contributed $0.35 of growth year-over-year.

So if you look at the average ticket down excluding appliances, as Craig pointed out it's really big-ticket related.

It's lumber price deflation, so hopefully that helps you understand the composition of average ticket and where it might go.

Okay.

Craig, it sounds like you just need to attach a 42-inch plasma to every ticket and you'll be set.

We didn't buy that many.

No, we didn't.

Okay.

Phil, we have time for one more question.

And that question comes from Danielle Fox, Merrill Lynch.

Thanks.

Good morning.

Hi, Danielle.

I'm looking for higher thinking about your long-term growth targets that you laid out earlier in the year.

Bob, are you expecting lower lows and higher highs based on what you're seeing, or have you changed your view of the earnings potential of the business?

Well, I think two things, Danielle.

Obviously given the re-profile we just did for the third quarter, fourth quarter, and therefore the full year, we're going to take a really hard look at '07, and then we'll take a look at, you know, as Budd and some of the folks asked me about the recovery, we're going to really take a hard look at that, then we're going to be in a position, I think we've got a meeting coming up beginning of the year, where we'll want to sit with all of you as we do annually at the investors conference, and we will be in a position then to talk a little bit more about certainly '07, '08, '09, and then the impact on the '10 guidance.

So I think you would agree that given the environment, certainly what we're experiencing here today, we'd have to change the profile of that, certainly the starting point where we're exiting '06, the impact on '07, and then the slope or the curve for 2010.

So what I'd like to do if it's okay, is ask you to give us a chance to digest this, take a look at it, review it internally, then we'll be in a much better position to give you a thoughtful, informed decision on that guidance.

Sounds fair.

Thank you very much.

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

Thank you.

That does conclude today's conference call.

We do thank you for your participation.

You may disconnect at this time.