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Operator
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, Senior Vice President of Investor Relations.
Please go ahead.
- SVP IR
Thank you, Audra, and good morning to everyone.
Welcome to the Home Depot third quarter earnings conference call.
Joining us on our call today are Frank Blake, Chairman and CEO of the Home Depot, Craig Menear, Executive Vice President of Merchandising, Paul Raines, Executive Vice President of U.S.
Stores and Carol Tome, Chief Financial Officer and Executive Vice President, Corporate Services.
Following our prepared remarks, the call will be open for analyst questions.
Questions will be limited to analysts and investors, and as a reminder, we would appreciate if participants would limit themselves to one question with one follow up, please.
This conference 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 also be available on our site.
If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.
Before I turn the call over to Frank, 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 Frank Blake.
- Chairman, CEO
Thank you, Diane and good morning everyone.
Our market continues to face into significant headwinds.
We started the year with a fairly pessimistic view of the housing and home improvement markets.
It turns out we weren't pessimistic enough.
We had expected some market improvement by the third quarter.
That didn't occur.
And our results reflect the difficult market.
Sales for the third quarter were $19 billion, down 3.5%.
Comp sales were negative 6.2%.
And diluted earnings per share from our retail business were down 9% at $0.59.
We expect continued difficult conditions for the remainder of 2007 and into 2008.
We have consistently used as a guide post to market conditions the ratio of residential construction spend to GDP.
The 60-year average is 4.8%.
At the height of our market in 2005, the ratio was 6.25%.
The market is now corrected to 4.5%.
When you consider the GDP is approximately $14 trillion, this represents a market contraction of over $240 billion.
While we're now close to the average, we don't expect the market to decline to the average and then pivot back up.
We expect that the soft market will continue as reflected in the current overhang of housing inventory and the difficulties in the subprime mortgage.
As painful as the correction has been, and will probably continue to be, we are now on the underside of this 60-year average.
The value of a time-tested average is that it gives you confidence in the market potential ahead.
For the Home Depot, it reinforces the importance of investing in our business and fixing our core operations.
What most distinguishes the Home Depot is the culture of our associates, their passion for the company and customer service.
As difficult as the market is, it is great to see that passion reignited.
We are achieving progress from our investments in each of our five key priorities, associate engagement, store environment, product availability, product excitement and Own the Pro.
I'll provide a quick summary on each.
But before doing that, let's look at overall market performance.
We recognized that Home Depot's issues are not only market-related.
We have also lost share through our own performance.
One of our key objectives has been to reverse that market share loss.
The latest data shows us losing about 385 basis points to the market on a rolling 12-month basis.
That is a significant improvement over last year's number of 760 basis points.
Also, as Paul will detail, in the markets where the housing and home improvement markets have been more stable, we are seeing positive comp performance.
On associate engagement, Paul will take you through what we've done on our Success Sharing program, Master Trade Specialists and other initiatives.
A good sign that we are seeing results here is that voluntary hourly attrition is down 24%.
We will continue to invest in our associates because they are at the heart of our customer experience.
On our shopping environment, we are rolling out new store standards for cleanliness and appearance and we've already seen significant improvement in our voice of customer, VOC, scores.
On product availability, with Mark Holifield and team, we have improved our in-stock position in our stores and this is also reflected in our VOC results, which show an improved store in our find and buy metric.
We also have a distribution pilot well under way.
We took an existing facility in Georgia, introduced new processes and technology, and are seeing shortened lead times and better in-stock positions in the service stores.
Building out our new supply chain will be one of our most important initiatives through the remainder of 2007, and 2008.
On product excitement, Craig will discuss the areas where we have made significant share gains.
We are also putting additional resources into our regional merchandising efforts and adding talent to our merchandising organization.
On our Own the Pro initiative, we are using the analytics from Dunnhumby to gain better insights into the 2% of our customers who drive nearly 30% of our sales.
Through these analytics, we are gaining a better understanding of who these customers are and what their unique buying patterns are.
The analysis is being used to drive targeted direct mail pieces to optimize our job lock quantity SKU lists and to generate customer contact lists for our pro-desk sales associates.
I would also like to make a brief comment on core retail.
We've launched a program to transform our merchandising systems and processes and we are of on track to deliver the first phase in Canada next year.
Our international business remains strong.
Mexico posted double-digit comps in the quarter.
Canada had positive comps.
And China is making good progress.
Our international stores now contribute 9% of sales and 11% of operating profit, an impressive record of performance for these businesses.
Finally, let me make a few comments about our sale of HD Supply and our recapitalization plan.
We closed the sale on August 30th.
And we are now focused exclusively on our retail business.
We used the proceeds from the Supply sale to fund the bulk of our $10.7 billion tender offer which we completed in early September.
That completes about 50% of our recapitalization.
Given the market environment now, both in the housing and home improvement market and the credit market, we don't think it's prudent to rush to execute the remainder of the recapitalization.
So this is not something that will happen in the remainder of 2007.
The basic principles behind the recapitalization -- that we will be disciplined in our capital allocation and benchmark our use of capital against returning dollars to our shareholders, remain in place as does our overall goal.
We will provide a more complete view of our perspective on this in 2008 in February.
In a meeting last week, one of our vendors made a great comment.
A downturn is a terrible opportunity to waste.
This market downturn is an opportunity for the Home Depot to focus our resources and attention on the things that matter and to bring greater customer focus to the business.
That is what we're doing.
Now let me turn the call over to Craig.
- SVP - Merchandising
Thank you, Frank and good morning, everyone.
In the third quarter, we experienced negative sales growth in all of our departments except kitchens, which was driven by appliances.
The departments that outperformed the company average comp were plumbing, kitchen and bath, garden, paint, and hardware.
The departments that underperformed the company average comp were lumber, millwork, lighting and building materials, and flooring performed at the company average.
First let's talk about what negatively impacted us during the quarter including regional differences in performance and later, we'll highlight some of the wins that we had had in the quarter.
A large driver of our weak sales performance in the quarter was due to the softness in our building materials and related businesses.
Lower demand as well as commodity deflation in building material categories such as dimensional lumber and drywall, impacted average ticket which was down 1.5% from last year, to $57.48.
As you would expect, we're seeing double-digit declines in markets like South Florida, California and portions of the northeast.
However, a few regions showed positive comps in these commodity-related businesses, such as the Southwest and Ohio Valley.
The category where we lost share in the quarter was lighting.
This is a product category that we have opportunity to enhance our merchandise offering and simplify the selection process for our customers.
Here we have promoted our top EXPO merchant, Lisa McClellan, to merchandising Vice President to lead this category going forward.
She is leveraging the learnings from EXPO in fashion and design as the assortment is retooled for the spring of 2008.
Our kitchen category also remains challenged.
In markets facing significant home price depreciation such as Phoenix, Sacramento and Tampa, we are experiencing double-digit negative comps.
Despite the headwinds that we face in this big ticket category, we remain focused on improving our share loss.
We completed the roll-out of our assembled kitchen cabinet program that we mentioned last quarter and we're pleased with the early results.
As we move into the fourth quarter, we're taking learnings from our success in the flooring department to our kitchen department and we will simplify the purchase process and increase the value proposition for our customers.
We are upgrading the shopping experience by resetting showrooms and enhancing the capability of our associates through additional training and technology upgrades.
Now, let's talk about some tear was where we've seen share gains in the quarter, paint, appliances and power tools.
Despite increasing competitive dynamics in the paint business, our market share of paint grew again this quarter.
We have a great partner in mass co with Behr Paint, which has been consistently rated number one in independent product testing for the past five years.
Sales were particularly strong in our exterior paint and stain categories and customers are responding to the market-leading innovation and products such as our exclusive Nano Guard paint which requires no priming.
In a shrinking appliance market, we continued to gain share this quarter, building on the gains that we've seen for the past few years.
We saw significant strength in this category throughout the country.
Our success has been driven by our ability to stay relevant to our customers, by providing them with the latest features and benefits at great values.
Customers continue to be pleased with the innovations, style and design we are offering in appliances in products like the GE cafe and the LG Kitchen Series, both high end suites of kitchen appliances.
Another area that is beginning to show positive share results is our hardware department.
Power tools and accessories, we gained share in a shrinking market and extended our leadership in this category.
We saw strong performance across the country including markets such as Los Angeles, Washington, D.C., Chicago, San Francisco and Denver.
We drove these share gains by staying relevant to both the pro and the Do-It-Yourself customer and providing them with tools that have the latest functionality at great value.
An example of this was our October launch of the new Ryobi One Plus Lithium products which offers professional features at affordable prices.
A final comment on areas that we were pleased with in the third quarter would be our merchandising resets.
Where we have completed our resets and implemented change from our product line review process, collectively, these categories are outperforming the store's sales performance, in line with our expectations.
There's no question that we're operating in challenging times.
And as we look forward, we remain focused on our merchandising fundamentals, enhancing our processes and strengthening our team.
I've talked to you in the past about our focused bay approach.
The company transactions were down 1.8% for the quarter, however, where we have applied our strategy against our specific category roles, we are beginning to see positive results.
For example, in tool sets, whose intent is to drive traffic, we have seen this category turn from a negative to a positive comp performance in the quarter.
We are also partnering with our suppliers to bring value to our customers.
Two weeks ago we met with all of our top suppliers.
We spent a lot of time developing actions to more collaboratively solve customer problems and drive sales for both of our companies.
As we look forward to the fourth quarter, we're pleased with early sales of our holiday program and gift-oriented products.
This year we expanded and refined our assortment and expect to be the number four retailer in U.S.
holiday decor sales with double-digit year-over-year growth.
We are also focused on managing our seasonal categories such as heating, snow removal, and organization.
Before I turn it over to Paul, I want to mention some exciting changes in our merchandising organization.
During the past quarter, we are invested to add talent within merchandising team at our senior level.
Bruce Marino, a 23 year veteran of the Home Depot has come back to merchandising after spending eight years as the Western Division President.
Bruce is leading our field merchandising teams, merchandise service organization, store environment and new concepts.
We also have three Senior Vice Presidents that are responsible for our merchandising categories.
Another former Division President and merchant, Eric Peterson, is our SVP, running our building materials businesses.
Giles Bowman, who has held various merchandising positions throughout the organization, is our SVP for hard lines.
Lastly, we are pleased that [Gordie Erickson] has joined us as our SVP of decor.
He brings a strong background of merchandising with 32 years of experience in home center, mass and specialty retailing.
And now I would like to turn the call over to Paul.
- EVP - US Stores
Thank you, Craig.
As Frank mentioned, we have seen significant differences in regional performance driven by macroeconomic trends and housing indicators.
In those markets with favorable housing trends and strong disposable income, we are seeing positive comp performance.
For example, in the Southwest, our Dallas, Austin and San Antonio markets had positive comps for the quarter.
In those areas that have been the hardest hit by housing turnover and new home sales, we continue to feel significant pressure.
It is no surprise that Sacramento, Las Vegas and Fort Myers/Naples, fall in this category.
With Fort Myers/Naples posting negative comps in excess of 20%.
Our business displayed significant variation across geographies and that underscores the importance of having a local focus.
For example, within our Ohio Valley region, we have relatively stable housing markets as well as markets with deteriorating housing indicators, both posting positive comps for the third quarter.
We believe that our performance in these markets is being driven by share gains as well as our focus on our five priorities.
Now let's talk about some of our progress on those priorities.
This year, we have made a lot of progress on our associate engagement priority and despite the difficult business environment, we are driving positive changes around our associate reward and recognition programs.
You know that the motivation and engagement of our more than 300,000 associates make a huge impact on customer satisfaction and on sales.
In our second quarter earnings call, we spoke a lot about compensation enhancements.
The changes in our Success Sharing program and incentive program for our hourly associates driven by individual store performance allowed us to increase our associates' participation in Success Sharing by almost 40 points year-over-year for the first half.
The largest check an hourly associate received was $1,855, the average check was around $200.
The issuance of restricted stock grants have more closely aligned Assistant Store Managers with the company's goals.
We have also seen positive results from the reinstitution of our Homer Badge program.
Where associates get rewarded with merit badges for outstanding Customer Service, which they can submit for cash compensation.
To date, over 78,000 Homer Badges have been awarded, including 7 gold-level badges and 2 platinum-level badges.
We have also seen a big impact from our Master Trade Specialist Program.
As of last week, we had over 2,000 Master Trade Specialists in our stores, all being either licensed plumbers or electricians.
We are extremely pleased with this program.
These specialists are better able to help customers with their plumbing and electrical projects, help train associates and help us better assort stores to comply with local building codes and requirements.
Our merchant team is also leveraging these specialists by having regular conference calls to ensure that we are adopting and changing our offering in stores to reflect the regional needs of the business.
While we view this as an investment in the short term, we are confident that longer term, we will see a return on this investment.
We are seeing the impact of our focus on associate engagement through reduced turnover and our Employer of Choice Survey.
As Frank mentioned, voluntary hourly turnover in our stores is down 24% from last year.
EOC results indicate that our initiatives in associate engagement are making a meaningful difference.
Earlier this year, we surveyed almost 300,000 of our associates at both the stores and the store support centers.
Our highest scores were in those areas that are the most difficult to change, meaningful and challenging work, inclusive culture, and work environment.
We definitely have room for improvement, particularly in areas like communication and work schedule.
We are pleased with the results and feel we can make progress in the areas that need our attention most.
In terms of shopping environment, we are very pleased with our progress.
As most of you know, the average age of our stores is around seven years old, a time when you really need to refurbish the stores to continue to drive sales.
Therefore, this year, we increased our maintenance budget by 2.5 times our 2005 spend, geared at making the stores clean and uncluttered and inviting to our customers.
We have integrated our field and store support center teams to better align ourselves around the needs of the business.
As well as adopted a programmatic approach to maintenance.
To date we have polished or spiffed 473 floors, striped 1,038 parking lots, remodeled 172 restrooms and now have T5 lighting in 1,765 stores.
In addition to programmatic maintenance, our integrated field and support center teams have rolled out store standards to all stores.
Through a cross-functional approach, we developed and piloted our basic expectations for stores and our goal is to drive a foundational level of store appearance that is agreed upon by our merchants, operators and support teams.
To do this, we have set common guidelines on appearance and shoppability and have created discipline around our how the store support center directly impacts a store's environment.
The standards provide guidance on things such as front apron merchandising, wing stack usage, signage presentation, fixturing and off-shelf product.
This initiative helps reduce the amount of time our store managers spend on navigating some of these issues, removes unnecessary clutter from the aisles, and implements a basic, consistent approach in terms of store appearance.
Finally, on our Own the Pro initiative, you have heard from Frank that 2% of our customers drive almost 30% of our sales.
Through Dunnhumby and our credit card programs, we have good information about what this super premium customer spends in our stores.
Over the last quarter, this customer, who typically spends twice to three times as much as a regular customer, has continued to shop with us.
We are now taking the next steps, building better relationships with them, communicating our value proposition, and staying relevant to them through our bid room and job lot quantities programs.
To continue to connect with them and gain a greater share of their wallet going forward.
We know these initiatives are making a difference because our customers are telling us.
Through our Voice of Customer survey, where we hear from over 200,000 customers a week, we see improvements in likelihood to recommend, find and buy and our clean and uncluttered metrics.
Clean and uncluttered, which measures the shopping environment, is improving faster than all other metrics.
Although we see good progress on our associate engagement, shopping environment and Own the Pro initiatives, we know that we continue to face market headwinds and challenges.
Our success will be defined by our ability to remain focused on the fundamentals of the business during this difficult environment.
I want to make a brief comment on the store's organization.
Although Craig was able to lure veteran Western Division President Bruce Marino away to merchandising, we could not be happier for Bruce and look forward to working with him closely going forward.
We have replaced Bruce with Joe McFarland, who is our new President for the Western division.
Joe is a 16 year veteran with the Home Depot who has held various operating positions including Regional Vice President, district manager and store manager.
I am very excited about having Joe in this leadership position.
One last comment before I turn it over to Carol.
It is unfortunate when we face natural disasters.
But it is during times like these that our associates and customers need us the most.
Taking care of the community and each other in a disaster is one of the things Home Depot does best.
During the recent wildfires in California, we saw thousands of customers and associates evacuated from their homes and many lost their homes or sustained significant damage to them.
In order to assist our associates and customers in need, the Home Depot kept stores open longer than any other retailer in the area and donated pallets of water, flash lights and batteries, air purifiers, gloves and more.
Beyond providing the necessary products during this disaster relief effort, our associates also donated their time to help in any way needed.
At evacuation centers, building sifters, providing shelter for animals, and hosting kids' workshops.
You can always count oven Home Depot to stand tall in times of need for our customers and associates.
I want to thank each and every one of our associates for your commitment and sacrifice.
You make us proud to wear the orange apron.
Now I would like to turn the call over to Carol.
- CFO, EVP - Corporate Services
Thank you, Paul and hello, everyone.
Before I discuss the results of the quarter, let me remind you that our third quarter results include one month of HD Supply as a discontinued operation.
As you review our financial statements, please note that the operating results and earnings impact of the sale of HD Supply are found in a one line item on our income statement entitled earnings from Discontinued Operations.
In the third quarter, sales were $18.96 billion, a 3.5% decrease from last year, reflecting negative same store sales of 6.2%, offset in part by sales from new and non-comp stores.
Consolidated same store sales were negative 5% in August, negative 7.3% in September, and negative 6.3% in October.
In the third quarter, our gross margin was 33.4%, a decrease of 18 basis points from the same period last year.
Contributing to the year-over-year decrease in our gross margin rate were the following factors.
As expected, our gross margin benefited from lower interest costs associated with our private label credit card financing program.
In the third quarter, we realized 36 basis points of margin expansion due to lower interest costs.
We gave up roughly 54 basis points of margin, due to a higher penetration of lower margin products like appliances, as well as markdowns taken to clear through some seasonal items like outdoor power equipment and grills and allow us to transition into new products like assembled cabinets and kitchen accessories.
As a percent of sales, total expenses grew by 183 basis points, to 24.1%.
Our expense deleverage reflects the impact of negative sales, where for every point of negative comp, we expect to deleverage expenses by about 20 basis points.
So with a negative comp of roughly 6%, we would expect to report expense deleverage of 120 basis points.
In the third quarter, we experienced an additional roughly 60 basis points of expense deleverage due to two main factors.
First, during the quarter, we announced our plans to close our 11 landscape supply locations.
We recognized $25 million of expense, associated with the store closings during the quarter.
Second, we share in the profitability of our private label credit card portfolio through a gain share program.
Private label credit sales make up about 30% of our total sales.
The portfolio remains very profitable, but losses within the portfolio are higher than they were one year ago.
As a result, our gain share was approximately $82 million less than last year.
Our expenses reflect investments we are making in support of our five key priorities.
We continue to view payroll as an investment.
As a percent of sales, total payroll increased by 51 basis points over last year, which includes investments in our Master Trade Specialist Program, as well as expense associated with employee bonus programs like Success Sharing.
Currently, 57% of our stores are eligible for Success Sharing, compared to 22% last year.
As a result of the factors I just mentioned, our operating margin declined from last year.
Our operating margin for the third quarter was 9.3%, as compared to 11.3% last year.
Net interest expense was $125 million in the third quarter, up $33 million from last year, reflecting higher levels of outstanding indebtedness.
In the third quarter, our income tax provision rate for continuing operations was 34.7%, compared to 37.4% last year.
In the third quarter, we reached agreement with tax authorities on several state and federal tax audits.
As a result, we recognized a $35 million tax benefit in the quarter, as well as some related interest expense benefits.
Earnings from Continuing Operations were $1.1 billion, as compared to $1.3 billion last year, and continuing earnings per diluted share were $0.59, down 9.2% from last year.
Diluted shares for the third quarter were 1.815 billion shares, compared to 2.05 billion shares last year.
The reduction in outstanding shares is due to the share repurchase program we began in 2002, including the 289 million shares we repurchased in our recent tender offer.
Through the end of the third quarter, we had repurchased a total of 743 million shares.
Earnings for our discontinued operation, HD Supply, were $20 million.
Included in this quarter's results are the net after-tax financial results for the month of August, as well as the impact of the sale of HD Supply.
After expenses and taxes, we recognized a $4 million loss on the sale of the business.
Moving to our operational metrics, during the third quarter, we opened 25 new stores, including one relocated store for an ending store count of 2,224.
Today, 236 stores, representing approximately 11% of our store base, operate in Canada, Mexico and China.
At the end of the third quarter, selling square footage was $233 million, a 5.4% increase from last year.
The average square footage per store was 105,000 square feet, the same as last year.
Reflecting the sales environment, total sales per square foot were approximately $323 for the quarter, down 7.8% from last year.
While the year-over-year trends for our new stores were also negative, sales per square foot for our new stores had their best year-over-year performance since the fourth quarter of 2006.
At the end of the quarter, retail inventory was $12.6 billion, an increase of 3.7% from last year.
On a per store basis, inventory was down 1.9% from last year.
Inventory turns were 4.4 times, slightly lower than last year.
Computed on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital for our retail business was 15%, reflecting a 130 basis point improvement from the second quarter of 2007.
We ended the quarter with $45.5 billion in assets, including $550 million in cash and short term investments.
This is a decrease of approximately $64 million in cash from the end of fiscal 2006, reflecting cash generated by the business of approximately $5.8 billion, net proceeds from the sale of HD Supply of $8.3 billion, along with commercial paper issuances of $748 million, offset by $2.5 billion of capital expenditures, $325 million paid for a minority interest in HD Supply, $1.3 billion of dividends paid and $10.8 billion paid for share repurchases.
For the year, we now estimate our total capital spending will be approximately $3.9 billion.
Given our performance to date and the softness we continue to project for the rest of 2007, we think our comps for the year will be negative 6 to 7%.
And earnings per share from Continuing Operations on a 52 week basis will be down as much as 11% from last year.
Finally, I want to give you our latest thinking on the completion of our $22.5 billion recapitalization plan.
As Frank mentioned, since we announced the plan in June, we have completed about 50% of our recap.
As you know, both the credit market and the housing market have become more difficult since June.
We believe it is prudent to take a a cautious stance with regard to the completion of the recap.
We will move forward when we see improvement in both the home improvement and credit markets, which we believe will not occur until sometime in 2008.
We will keep you apprised of our plans.
And during our fourth quarter conference call, we will provide you with sales, earnings and capital spending guidance for fiscal 2008.
So thank you for your participation in today's call, and Audra, we are now ready for your questions.
Operator
Thank you.
(OPERATOR INSTRUCTIONS).
We'll go first to Chris Horvers at Bear Stearns.
- Analyst
Thank you.
Good morning, everybody.
- CFO, EVP - Corporate Services
Good morning.
- Analyst
First question, on the recap program, I think when we're out here speaking with investors and we understand being pushed back because of the credit market aspect.
But pushing it back because of the home improvement market, what do you say to people who turn and say well, if they're not interested in buying our stock today, why should I?
- Chairman, CEO
Well, I think, again, as we said, it is looking at both markets and saying what is the prudent thing for us to do for our shareholders.
If you said all other things being equal, we were planning to go forward at the end of this year and then take another step in the spring.
But all things really aren't equal, both in terms of the credit market and we do think it makes sense to look at the housing market and see what's happening in the housing market before making another major commitment.
- Analyst
Could you just expand on that last part.
Why would you be looking at the housing market?
- Chairman, CEO
Well I think, again, for us, we look at both what our projection was for the year, where it turned out, and we want to get a better sense of 2008 and we're frankly just in the middle of the planning process around 2008.
- CFO, EVP - Corporate Services
And Chris, you'll recall that from a capital strategy perspective, we have targeted an adjusted debt to EBITDAR leverage ratio of 2.5 times.
So clearly, the housing market will impact our adjusted EBITDAR and so we're just working through our plans for 2008 and looking at that relative to our financing plan.
- Analyst
Got you.
One follow-up question, Carol.
As we think about 2008, understanding you haven't given guidance yet, we know sales, it's going to be a tough environment and we had the second downturn in the housing.
As we thing about the deleverage that might occur in '08, does the accelerated maintenance and the additional store investment this year make the potential deleverage less next year for every 100 basis points of comp?
- CFO, EVP - Corporate Services
Well, it's a great question.
We had some catch-up spending in 2007 as we've talked to you about.
Again, we are not giving guidance today for 2008 because we're just building our plans.
But as we look at our business model, we believe that we will still, for every negative point of comp sales, deleverage expenses by 20 basis points.
Then there will be some other goes ins and goes outs that we'll talk to you about.
- Analyst
Thank you very much.
Operator
Next we'll move to Deborah Weinswig at Citi.
- Analyst
I believe Carol had highlighted the fact that 57% of stores this year are eligible for success sharing, versus 22% a year ago.
I would assume that's very important for employee morale.
Can you talk about if you've changed the targets, or how you've gotten to a higher number year over year and what it means for the employees.
- Chairman, CEO
Yes, Deborah, we did change the targets.
So previously we tended to have a stretch target in order to get into Success Sharing and then you had to hit 100% of the target.
So for this year, we changed that approach and made it a percent of target and at the time, we were thinking the target we set out was a very reasonable target.
Again, the basic principle being we wanted our associates to feel the benefit of Success Sharing and then earn their way up into additional dollars, rather than feeling demotivated in the start.
- Analyst
Last question.
In terms of helping the associates in a tough environment, are there any additional tools that you're providing them with in store to help serve customers or help them upsell?
- EVP - US Stores
Yeah, I'll take that one, Deborah.
This is Paul.
There's a series of activities in the stores around learning that are very important.
We have spent a lot of time refocusing in the first half of this year around in the aisle earning and emphasizing project and product knowledge versus the heavily e-learning focus that we've had previously.
That's one of the tools that we've given them.
At the same time, we're doing a tremendous amount of focus on our VOC activities and giving them a lot of feedback in metrics around what customers are saying about the business.
We feel that we're giving our associates a lot more tools around the customer and around product knowledge and helping customers do projects in their homes through this first half.
- Analyst
Great.
Thank you very much.
Operator
Next we'll move to Steve Chick with JPMorgan.
- Analyst
This is actually Jeff Wimmer on behalf of Steve Chick.
I have a question about your guidance, if you could delve in a little bit more about that.
Looks like sales remain relatively the same, in that high mid single digit range.
Could you talk about the split between growth in SG&A deleverage?
Are you still looking for upgrowth margins year-over-year.
- CFO, EVP - Corporate Services
Year-over-year, we are projecting slight margin expansion on the expense side.
The expense deleverage that we saw in the third quarter will continue into the fourth quarter.
- Analyst
Okay.
And then I might have missed this because I got on the call a little late.
But did you give intraquarter sales yet?
- CFO, EVP - Corporate Services
From a comp perspective?
- Analyst
From a comp perspective.
Negative five in August, negative 7.3 in September, negative 6.3 in October.
Also, just thinking about going forward, you have this $600 million reinvestment plan.
Is this going to be something reoccurring next year?
Will there be additional incremental investment as we look into '08?
- CFO, EVP - Corporate Services
At the beginning of the year we said that we were investing $2.2 billion in support of our five key priorities, $1.6 billion for capital, $600 million of expense.
- Analyst
Right.
- CFO, EVP - Corporate Services
Some of that expense was catch-up spending.
We will continue to invest in the key priorities in 2008.
Just to update the capital a bit, we are going to spend this year, we project about 1.3 against the original 1.6 target but that's really because of the sale of HD Supply.
- Analyst
Okay.
Thank you.
- CFO, EVP - Corporate Services
You're welcome.
Operator
Next we'll move to Budd Bugatch at Raymond James.
- Analyst
My first question goes to appliances.
Can you kind of update us where you are on share on appliances and I noticed in some stores, maybe some additional square footage through the use of mezzanines.
Is that prevalent in a number of stores?
- Chairman, CEO
Yeah, bud, that's a very limited pilot that we were running and I would not expect to see a lot more of those.
But let me turn over to Craig for general comments on appliances.
- SVP - Merchandising
For appliances overall, again, we were pleased with the performance there.
We achieved a 12.4% penetration in terms of market share versus 10, 7, a year ago, up again from Q2 which was at 11, 7.
So the customer really continues to respond to the offering that the team has put together.
- Analyst
Craig, those are unit shares?
- SVP - Merchandising
Yes.
- Analyst
Okay.
And if you could, also, my last question is to talk a little bit about maybe any additional talent or what you see in the Merchandising Organization with Gordie's coming on-board.
Can you talk about maybe what other needs you might have?
- Chairman, CEO
Well, again, you know, very excited to not only have Gordie on-board but also to have Bruce join us, coming in from the field to help us really coordinate and connect with our regional team as we continue to try to drive the regional assortment variation that we need across our business and get that executed for the stores.
With Gordie joining us, again, great retail talent, I think well-respected in terms of his knowledge both in mass discount and specialty retailing and it's a super addition to our team.
We feel very good about the overall team that we have in place right now and looking forward to driving the business.
- Analyst
Okay.
And just could you give us maybe what the tax rate is going forward?
Any more tax issues?
- CFO, EVP - Corporate Services
We project the provision rate for the year will be 36.5%.
- Analyst
Okay.
That helps.
- CFO, EVP - Corporate Services
Okay.
Good.
Operator
We'll go next to Matthew Fassler at Goldman Sachs.
- Analyst
Thanks a lot.
Just a couple quick questions here.
First of all, the average ticket decline seemed to moderate a bit.
If you could give us any color on why you think that happened, be it mix or other factors.
Just by way of follow-up, Carol, on the recap, would you continue to expect to deploy free cash against buybacks or would you hold off from that as well?
- Chairman, CEO
Okay.
Craig, first, why don't you comment on the average ticket.
- SVP - Merchandising
Yeah.
On average ticket overall, again, what we saw there was some shift in mix, that is impacting that business.
When you look at what happened to the lumber and building materials categories as that relates to a larger repair, remodel project overall, that certainly had an impact on the category.
We did see some shifting and we're seeing within categories, for example, in a little more discretionary spend categories like outdoor power equipment, we saw shift down in the line which impacted the ticket in that category as well.
- CFO, EVP - Corporate Services
Another comment on the ticket, if you look at the sequential performance, Q3 to Q2, in Q3 we picked up $0.22 of average ticket growth because of an increased appliance penetration.
We didn't have that same benefit in the second quarter.
So that's part of what you're seeing.
- Analyst
Okay.
- CFO, EVP - Corporate Services
And on the recap question, as Frank said in his comments, we remain committed to our capital allocation strategy, where we will always compare the use of excess cash returning that to our shareholders, versus something else.
And so yeah, we'll remain committed to that.
- Analyst
Just to clarify, I mean, to the extent that you're talking about holding off in the recap, you're talking about holding off borrowing more money to buy back stock, not the repurchase of stock in and of itself?
- CFO, EVP - Corporate Services
Right.
Now, remember we have $748 million of out standing commercial papers.
We don't have excess cash as we're sitting today.
- Analyst
Thank you.
Operator
Next we'll go to Danielle Fox at Merrill Lynch.
- Analyst
Good morning.
I guess just looking back historically, the retail business has had an operating margin as high as.
Where you're tracking this year.
I'm wondering what needs to happen to get back up to those levels.
Presumably you need to return to positive comps.
But do some of these supply chain enhancements that you're beginning also need to work out in order to return to the 11.8%?
- Chairman, CEO
Yeah, Danielle, I think first, clearly positive comps because that levers positively versus the negative, the deleverage that we see now.
And then second, you're exactly right in terms of improving.
What we see is the substantial investment that we're going to make in our Supply Chain will help us improve our operating margins, as will the merchandising transformation that's really at the heart of core retail.
- Analyst
You don't see anything as having changed in the underlying cost structure that would prevent you from returning to those levels, given that you did need to sort of step up the P&L investing beginning if the second after of '06?
- Chairman, CEO
No, I mean, I would say 11.8 is a long ways away.
But I mean, we think that there's significant improvement from where we are.
- Analyst
Okay.
Thank you.
Operator
Next we'll go to Gregory Melich at Morgan Stanley.
- Analyst
Thanks.
I've got two questions.
Frank, could we start on the Canadian roll-out of the merchandising system.
- Chairman, CEO
Yes.
- Analyst
That was mentioned as something that will happen next year.
Is that a pilot or is that across all the stores or just fill us in on the timing there.
- Chairman, CEO
Yeah, the timing is around the end of March, the pilots will -- I mean the way the actual roll-out works is it starts with a set of pilot stores and you pilot that for several weeks and then fix any bumps that occur during the pilot process and then we expect to have it rolled out to every store in Canada by the end of 2008.
- Analyst
And if I remember correctly, there was a plan to maybe accelerate the U.S.
following of that, is that still the case or that will be an '09 business?
- Chairman, CEO
The way we're setting this up, and I think the tremendous advantage that we have with Canada as sort of our laboratory, in effect, is that we're going to look very closely at what the results are from Canada, both pilot and roll-out, and that's going to determine the pace that we take on the U.S.
side.
- Analyst
Okay.
So stay tuned?
- Chairman, CEO
Yeah.
- Analyst
Basically.
And the second question, Carol, is a follow-up on the earnings share of the credit business, I think you said it was $83 million.
Did I get that number right?
- CFO, EVP - Corporate Services
$82 million year over year.
- Analyst
So is that -- but it was still profitable in the quarter.
- CFO, EVP - Corporate Services
Yes, it certainly is very profitable.
- Analyst
Was that swing, would you call that sort of an ongoing.
- CFO, EVP - Corporate Services
Yes --
- Analyst
A provision that you unwound effectively.
- CFO, EVP - Corporate Services
It's a good question.
It's the lost piece of the portfolio, the portfolio is really a good portfolio.
The losses had been running in the 5, 4.5% range.
They've popped up.
We're now projecting they'll be in the 6% range.
Which relative to other credit card portfolios is not bad.
But it's higher so it means the profitability isn't as large as it was so we didn't get as much of a share gain in the quarter and that pressure will continue into the fourth quarter.
- Analyst
Okay.
So we think that 6% is now a good ongoing number that we should use.
- CFO, EVP - Corporate Services
We're going to be watching it very, very carefully.
Some other stats, for your information.
65% of the portfolio has FICO scores greater than 650 so that's very high quality.
But 17% of the portfolio has FICO scores of less than 600.
So we're going to be watching this very carefully.
I mean, the credit market is interesting in today's environment.
- Analyst
That's for sure.
Are you -- on the down side there, is there like a stop loss so-to-speak that you share the profits but is there a cap on that or no?
- CFO, EVP - Corporate Services
The profits that are shared is over a threshold.
We've got a long way to go before that would happen.
- Analyst
Okay.
Great.
Thanks.
Operator
Our next question comes from Eric Bosshard at Cleveland Research.
- Analyst
Good morning.
Two questions.
First of all, on the recap, is the adjust -- or the waiting to see what you're going to do next year, is that based on much as uncertainty about the EBITDA of the business next year?
Is that the primary driver to how you're rethinking the pace of what you're going to move on that?
- Chairman, CEO
As both Carol and I said in our comments, it is both things, both the credit markets and the underlying housing market.
As Carol indicated, obviously the underlying housing market impacts our performance which impacts our EBITDA, which impacts our coverage.
And from where we are now, I mean I think it's worth pausing and realizing look, the window's being closed to on us so we couldn't have been buying even if we had had wanted to.
The window is now open and you would say -- we'd say looking at our business and looking at the credit market that this is a time to pause and make sure we've got a pretty firm idea going forward before making that second and third steps in the recapitalization plan, which again as I said in the initial comments, we remain committed to.
It's really just a question of figuring out the right timing.
- CFO, EVP - Corporate Services
We certainly have debt capacity.
If you look at our adjusted debt to EBITDA ratio for the trailing 12 months it's 1.9 times.
So we've got debt capacity.
- Analyst
Secondly, understanding the uncertainty that you've made the decision to move slower on the repurchase, I understand that, but in terms of the capital and the sales investment that you're going to make in the business for next year, how are you thinking differently about that?
That is a wait and see how sales are until you determine what you're going to invest in the business?
Or are you going to continue to make investment regardless of the sales environment?
- Chairman, CEO
We're continuing to make the investment in the business, to make the customer experience the best possible customer experience.
I'd say where there's an impact, and where you have already seen an impact this year, is in our new store opening and taking down our new store opening both for 2007, as Carol indicated, that reduced our CapEx for 2007 and into 2008.
- CFO, EVP - Corporate Services
Recall, Eric, that at the beginning of the year, we said we'd spend $4.5 billion in capital.
We're going to spend $3.9 billion, that includes 200 million at supply.
In the retail business, about 3.7 and a delta from the beginning of the year is really new store capital.
- Analyst
Okay.
Thank you.
Operator
We'll go next to Gary Balter at Credit Suisse.
- Analyst
This is Shannon for Gary.
How much of the lower guidance is due to the reinvestment in the stores or minimum labor standards that you've put in place versus the worsening housing markets?
- CFO, EVP - Corporate Services
For the fourth quarter and full year, Shannon?
- Analyst
Yeah.
- CFO, EVP - Corporate Services
If we're looking at now comps of negative 6 to 7%, earnings from Continuing Operations EPS down 11%, right in that is expense deleverage along the lines of what you saw in the third quarter and gross margin expansion.
And the expense deleverage is just a factor of the negative comps that we're projecting, the investment and some continued pressure on credit.
- Analyst
Okay.
Thanks.
Operator
Next we'll take a question from Colin McGranahan at Bernstein.
- Analyst
Good morning.
Wanted to focus first on the expense line a little bit.
As I look at the expense dollars, year-over-year the growth rate of those dollars is about 4.1%, which is looks like a deceleration of about 100 basis points from roughly 5% growth rate in the first half of the year.
Given success sharing dollars, looked like they were pretty consistent.
You had this $82 million negative year-over-year delta in the credit portfolio.
Square footage growth is pretty much the same at 5.4%.
What was it that caused the expense dollars to decelerate and where did you realize some expense savings in the business?
- CFO, EVP - Corporate Services
We didn't call it out in our prepared remarks.
But just like the second quarter, we were actually under our expense plan in the third quarter.
Every day, we wake up and look at sales.
We look at cash and we look at where we can control expenses that doesn't impact the customer experience.
And we had good expense control in areas like advertising.
You might want to talk about payroll.
It's our biggest expense.
On the payroll side, wages are up year-over-year, that's reflecting the investments that we're making.
We've got an activity based labor model and the hours and the stores are lower than they were a year ago, because we had less activity in the stores.
On the G&A side, we've got unbelievable expense control.
We're investing where we need to invest.
But where we can cut costs, we are.
- Analyst
So were labor dollars, then, growing at a slower rate in the third quarter than they were in the first half of the year?
- CFO, EVP - Corporate Services
They were.
- Chairman, CEO
Right.
- Analyst
Okay.
So dollars of savings and advertising as a savings and just tightening the nuts on the G&A.
- CFO, EVP - Corporate Services
Yeah.
There's lots of other small goes in and goes outs.
But yeah those are the big buckets.
- Analyst
Is that 4% a reasonable pace going forward?
Looks like that 82 million credit Delta is probably recurring and given probably some stress levels some of your larger pros that are sitting on those credit cards, that may actually be getting worse, not better?
- CFO, EVP - Corporate Services
I think we've given you pretty good guidance for the year, so you can do the math.
- Analyst
Okay.
My second question, just on traffic, obviously ticket improved sequentially a little bit.
Looked like it was a pretty significant deceleration in traffic.
Would you peg any of that to kind of seasonal variances and the drought conditions and things like that or was it just general housing market?
- Chairman, CEO
As we looked at the traffic, just let me address the drought question, you know, we saw some impact in categories like live goods, pressure washers and power equipment in the Southeast area of the country.
It wasn't material overall in the quarter.
We did take the opportunity to move some power equipment into the Southwest region of the country, which was performing extremely strong and to make sure that we continued to leverage the opportunity in that business.
But overall, I wouldn't say that weather was the impact to the average ticket.
- Analyst
Traffic?
- Chairman, CEO
Traffic, I'm sorry, yes.
- Analyst
Okay.
Great, good luck, guys.
Thanks.
- SVP IR
Audra, we have time for one more question.
Operator
We'll go to Brian Nagle at UBS.
- Analyst
Hi, good morning.
- Chairman, CEO
Good morning.
- Analyst
Question on as we see the weakness in the U.S.
dollar here, you've presumably sourcing more products oversea, what impact has that or could that have upon your business or specific gross margins in the coming quarters.
- SVP - Merchandising
When we look at -- this is Craig -- what's going on with the dollar right now, certainly there is some pressure out there, but we're working hard with our suppliers to really work through that pressure with them, to find other ways that we can work together to take a mutual costs that we have out of our business and really not let that impact the retail environment whatsoever.
So we're not seeing a significant change overall.
- Analyst
One very quick question.
I noticed in the guidance, it seems like the benefit of that extra week from an EPS perspective changed this time in your guidance.
What explains that?
- CFO, EVP - Corporate Services
We tightened up our forecast.
We had carried over some cost into that extra week that we didn't need to.
We just have a better forecast.
- Analyst
Okay.
Fair enough.
Thank you very much and good luck next quarter.
- Chairman, CEO
Thank you all very much.
- SVP IR
Thank you for joining us.
We look forward to the call next quarter.
Operator
That does conclude today's conference.
Again, thank you for your participation.