家得寶 (HD) 2010 Q1 法說會逐字稿

Good day, everyone, and welcome to today's Home Depot first quarter 2010 earnings conference call.

Today's conference is being recorded.

I would like to let you know that we will be having a question and answer session today.

(Operator Instructions) Beginning today's discussion is Ms.

Diane Dayhoff, Vice President, Investor Relations.

Please go ahead.

Thank you, Cindy, and good morning to everyone.

Joining us on our call today are Frank Blake, Chairman and CEO of the Home Depot, Craig Menear, Executive Vice President Merchandising, and Carol Tome, Chief Financial Officer and Executive Vice President Corporate Services.

Following our prepared remarks, the call will be open for analyst's questions.

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

This conference call is being broadcast realtime on the Internet at earnings.homedepot.com.

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.

Now, 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 & Exchange Commission.

Today's presentations also include certain non-GAAP measurements.

Reconciliation of these measurements is provided in the financial statements included with our earnings release.

Now, let me turn the call over to Frank Blake.

Thank you, Diane, and good morning, everyone.

Sales for the first quarter were $16.9 billion, up 4.3% from last year.

Comp sales were positive 4.8%, and our diluted earnings per share were $0.43.

Our US stores had a positive comp of 3.3%.

This represents the first quarter of positive comps for the US since the fourth quarter of 2005.

From a geographic perspective, all but three of our top 40 US markets positively comped in the first quarter and all of our regions positively comped, except the Gulf region which is still impacted by hurricane-related comparisons.

We also had a return to positive comps in Florida and California.

Overall sales were better than we planned for the quarter.

And we continue to focus on improving our underlying business performance.

As Craig and Carol will describe in more detail, for the quarter we levered our operating expenses in line with our targets, improved our gross margin rate through better assortment management and improved inventory turns.

We also made significant progress on our key infrastructure initiatives.

We opened our 13th Rapid Deployment Center or RDC in Columbia, South Carolina.

RDCs now serve 70% of our US stores and we're on track to reach our goal of serving 100% by the end of the year.

It's important that our supply chain team is on track on the network buildout.

It's even more important that they maintain that schedule as they also improve the performance of the existing facilities.

This spring season has seen some unusually erratic weather from record snow in the Mid-Atlantic to unseasonably warm temperatures in April in New England.

The flexibility and responsiveness of the supply chain were critical in meeting these changing needs.

We improved our inventory turns in the quarter and improved our targeted in-stock levels during a challenging season.

Craig and the merchandising team continued to integrate new merchandising tools as part of the overall merchandising transformation.

For example, over the last three years we have steadily increased the portion of SKUs that are on centralized automated replenishment.

This year we began the process of upgrading the tools used for the centralized forecasting system.

These tools significantly improve the accuracy of the forecasting for seasonal products during the first quarter.

Based on this success, we'll be migrating centrally automated SKUs to the new forecasting tools by the end of the second quarter.

Marvin and the store operations team worked to continue to improve the customer service levels in our stores.

Last year as we described, we retrained every associate in the Company on our customer service expectations, what we call our Customer First program.

This year, we repeated and refreshed that training to emphasize that this isn't a temporary program, but part of our ongoing commitment.

We've seen consistent improvement in our net promoter score since we initiated Customer First, and it was particularly significant that we again saw an improvement in the first quarter, 600 basis points over last year, even as our transactions increased 4.2%.

On the international front, our Canadian business delivered a positive comp and significantly improved its overall business performance.

Last year's first quarter was negatively impacted by the major ERP implementation we undertook in Canada that is now behind us.

Our Mexican business also had another solid quarter with single-digit positive comps, and our team in Mexico is helping on a number of US Hispanic-focused efforts.

For example, our head of marketing in Mexico helped lead our review of Hispanic marketing in the US.

In China, our business performed to plan as we continued to refine our business model for that country.

So, there were a number of positives for us in the quarter, but there were also signs of caution.

Over the last several years, we've looked at private fix residential investment, PFRI, as a percent of GDP as a useful benchmark.

The most recent PFRI data showed a decline, reversing its pattern of improvement over the prior two quarters.

The good news is that -- that obviously our results didn't track with PFRI results.

This may be an indicator that the PFRI data will have less correlation to results as the home improvement market recovers.

But we're also mindful that a significant part of our growth in the first quarter came from seasonal consumer spending.

Our data analytics did not show positive comp growth from our Pro customers.

The rate of decline was low single-digit so there was improvement, but this core part of our business has still not returned to positive growth.

To date, this is consistent with our expectation that average ticket will lag the growth in transactions.

As Carol will describe in more detail, we have increased our earnings per share in sales guidance for the year based on our out performance to plan in the first quarter.

I want to thank our associates for all their hard work in the first quarter.

Based on this quarter's results, over 95% of our stores would be eligible for success sharing, our profit sharing program for hourly associates.

With that, let me turn the call over to Craig.

Thanks, Frank, and good morning, everyone.

We had a strong quarter compared to our expectations, and we saw encouraging signs.

First, a solid broad-based transaction performance across the store.

Second, the seasonal businesses performed well, leveraging the supply chain capabilities and merchandising tools developed over the last few years and, third, our core repair and maintenance business remained strong.

As anticipated, the challenge in the first quarter continued to be big ticket, which remains under pressure from both the Pro and discretionary spend.

On a departmental basis, every department posted positive comps for the quarter.

Garden, lumber, paint, electrical and lighting outperformed the Company's average comp for the quarter.

Plumbing, building materials, hardware, flooring, kitchen and bath and millwork, while positive, were under the Company average comp for the quarter.

From a commodity standpoint, we did experience inflation in lumber and copper in the quarter, which positively impacted US comp sales by approximately 100 basis points.

As you may be aware, structural panel and framing lumber prices are up substantially from a year ago due to supply constraints.

Overall, total customer transactions were 323 million, up 4.2% compared to last year.

This is our largest year-over-year increase since the fourth quarter of 2005.

Our total comp transactions increased by 4.4%.

The seasonal business was a key driver to this performance and with the exception of kitchens, we saw transaction growth in all our businesses.

Transactions for tickets over $50, roughly 20% of the business in the US, were up 4.7% in first quarter.

As we have seen for several quarters, the simple decor and general repair businesses have remained resilient and been contributors to transaction growth.

General repair continues to perform well with categories like caulk, safety and security, roofing, pipe and fittings all exceeding the Company average comp performance.

Simple decor projects like paint, faucets and ceramic tile all had positive comps and are examples of the continued strength that we see in these small project categories.

As I mentioned earlier, our seasonal businesses also performed well and our enhanced supply chain and merchandising tools allowed us to meet the demand throughout the quarter.

Landscape, live goods, fertilizer and chemicals all performed positively as customers were excited to get outdoors and take on simple DIY projects to spruce up their yards.

Grills, portable power, walk-behind mowers, patios, all posted double-digit positive comps in the quarter.

Our spring selling period represents a highly variable portion of our business and our tools enabled us to have the right products in the right place at the right time.

For the last three years, Mark Holyfield and his team have been working to optimize our supply chain and replenishment capabilities, resulting in shorter lead times and improved in-stock rates.

As Frank mentioned, we implemented an enhanced replenishment forecasting tool for all our seasonal categories.

The next step is to drive space planning integration.

This effort will link our assortment maintenance, forecasting and planogramming tools to our replenishment system.

While we're pleased with our first quarter results, we have yet to see a clear recovery in our Pro business or big ticket discretionary categories, such as special order kitchens.

These factors continue to pressure our comp average ticket during the quarter, which was down 1.3% to $52.01 in the US retail.

Our total Company average ticket was flat to last year, and on a comp basis was up 0.4%.

In the US, transactions for tickets $900 and above, which represent approximately 20% of sales, were down 1.4%.

While still negative, our Pro business is showing signs of improvement.

In fact, we saw positive growth in some highly penetrated Pro categories such as fasteners, hand tools, power tool accessories, wire and wiring devices.

Recently, we began to see unit improvements in categories like plywood and concrete, yet still negative for the total quarter.

We know the efforts we've taken to improve our customer service, assortment and store environment have been resonating with our customers.

Through March, our US market share is up 83 basis points on a rolling twelve month basis.

And to give you two examples of where share growth is coming from based on independent third-party tracking of consumer activity, we saw 140 basis points of market share gain in paint and 150 basis points of market share gain in electrical.

As Frank mentioned at the beginning of this year, our expectation for 2010 is that this will be a transitional year.

We expect to see greater improvement in transactions prior to ticket recovery.

We started the year off well and feel that we are well-positioned to deliver on our commitment.

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

Thank you, Craig, and hello, everyone.

In the first quarter, sales were $16.9 billion, a 4.3% increase from last year.

Excluding the $221 million of sales related to the closing of our Expo businesses during the first quarter of 2009, sales increased 5.7%.

Comp or same-store sales were positive 4.8% for the quarter with positive comps of 0.2% in February, positive 5.7% in March, and positive 7% in April.

Comps for US stores were positive 3.3% for the quarter, with US comps of negative 1.2% in February, positive 3.9% in March and positive 5.5% in April.

In the first quarter, our gross margin was 34.4%, an increase of 67 basis points from last year.

Our gross margin expansion was due to the following factors.

First, our US business reported 41 basis points of margin expansion in the quarter, of which 12 basis points was driven by lower markdowns than last year, as we saw benefits from better assortment management and fewer promotions.

We also lapped markdowns taken last year as part of the closing of our Expo businesses, which negatively affected gross margin by 29 basis points in the first quarter of 2009.

Second, we realized 26 basis points of margin expansion from our international businesses, principally Canada, as we lapped the disruption we experienced last year when we implemented score for SAP.

On a reported basis, operating expenses as a percent of sales decreased by 102 basis points to 26.6%, but the comparison is distorted due to strategic charges taken in the first quarter of 2009.

Excluding the strategic charges from last year's results, operating expenses as a percent of sales decreased by 48 basis points.

Our operating leverage was primarily the result of positive same-store sales.

Total expenses increased by a factor of 67% of our sales growth rate, slightly higher than our rule of thumb.

But we planned for this as we pull forward from spring staffing and marketing expenditures.

We also experienced higher bank card interchange fees due to a higher penetration of bank cards, our most expensive form of credit.

We expect expense growth, as a factor of sales growth, to moderate throughout the balance of the year.

Interest and other expense for the first quarter totaled $189 million.

This includes a $51 million pretax charge related to the revaluation of our HD Supply guarantee.

In connection with the sale of HD Supply in 2007, we guaranteed a $1 billion senior secured amortizing term loan.

In March, we agreed to an 18 month extension of our guarantee, extending it to April 2014.

Accordingly, we revalued our guarantee and increased the fair value liability by $51 million, which had a negative impact to first quarter earnings per share of $0.02.

Our income tax provision rate was 35% in the first quarter, reflecting certain favorable state tax settlements.

For the year, we expect our effective tax rate to be approximately 36.5%.

Earnings per share for the first quarter were $0.43, up 43.3% from last year.

Excluding the $51 million charge taken in the first quarter of 2010 and the strategic charges taken in the first quarter of 2009, earnings per share increased 28.6% to $0.45, compared to last year's adjusted earnings per share of $0.35.

Now moving to our operational metrics, during the first quarter, we opened one new store and closed one store for an ending store count of 2,244.

At the end of the first quarter, selling square footage was 235 million.

Reflecting the sales environment, total sales per square foot for the first quarter were $288, up roughly 5.4% year-over-year.

Now, turning to the balance sheet, inventory remains a good news story.

At the end of the quarter, retail inventory was $11.5 billion, up $51 million from a year ago.

On a per store basis, inventory was flat to last year.

Inventory turns were 4.1 times up from 3.9 times a year ago.

We ended the quarter with $43.6 billion in assets, including $2.4 billion in cash and short-term investments.

This is an increase of approximately $1 billion in cash and short-term investments from the end of fiscal 2009, reflecting cash generated by the business of approximately $2.1 billion, offset by $508 million used for share repurchases, $399 million used for dividends and $167 million of capital expenditures.

We have approximately $9.7 billion of outstanding debt, of which $1 billion comes due in August of 2010.

At this point, it is our intent to refinance this debt maturity.

Computed on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital was 11.5%, 150 basis points higher than the first quarter of fiscal 2009.

As Frank mentioned, we performed well against our internal expectations for the first quarter.

Based on our results, we are raising our guidance for fiscal 2010.

Remember that we guide off of GAAP.

We are calling for fiscal 2010 sales to increase approximately 3.5% with earnings per share from continuing operations increasing approximately 21% to $1.88.

Within this guidance, we now expect our operating margin to reach approximately 8.25% for the year.

Finally, we are not including the impact of any additional share repurchases outside of those executed in the first quarter in our earnings per share guidance.

But it is our intent to continue to use excess cash to repurchase shares throughout the remainder of fiscal 2010.

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

And Cindy, we are now ready for questions.

Thank you.

(Operator Instructions) We'll take our first question from Chris Horvers at JPMorgan.

Thanks and good morning.

Good morning.

Carol, can you talk about your operating expense outlook, what's the forms of foundation of why the ratio to sales should go down over the year?

And do you think by the time you get to the fourth quarter that you'll be below that 60% rule of thumb?

We do.

As we started the year, we said that our sales would grow about 2.5% and that our expenses would grow at 60% of our sales growth.

With our performance in the first quarter, we now think that expenses for the year will grow about 50% of our sales growth, and it's just a function of the sales environment.

Okay.

And as one follow-up, on the Pro side, can you talk about maybe some of the millwork and the roofing categories and what you're seeing there?

And really, as you get to the back half, what would Pro have to perform at to see accelerating comps in the back half?

Thank you.

Chris, this is Craig.

When we look at categories like roofing and windows, those categories have performed well in the quarter, and we would need to continue to see the overall Pro business continue to gain momentum as Frank mentioned.

We've seen improvement in the Pro business into a low single-digit negative environment as we look at the Pro attributes.

But we are seeing improvement in categories that are heavily Pro penetrated.

That would really need to continue through the back half for us to continue to show the kind of performance improvement we're looking for.

And so you would need a low single-digit positive in that business?

Roughly.

One-way to think about it is if you just look at the trajectory of if you go through 2009, we went from double-digit negative to high single-digit negative to where we're now kind of low single-digit negative, so our expectation is that turns positive.

Yes.

We continue to gain ground with our DIY customers which still represents 70% of our business, so --

Thank you.

Thanks.

We'll take our next question from Eric Bosshard at Cleveland Research Company.

Good morning.

Hey, Eric.

A little more color on the increased margin outlook for the year now based on the numbers that you gave Carol.

Can you talk a little bit about, within gross margin and SG&A, what is driving the more optimistic outlook?

Sure.

A couple of things.

At the beginning of the year, we said we would have modest gross margin expansion.

We're going to do a little bit better than that, based on the outperformance we experienced in the first quarter.

And then on the expense side, at the beginning of the year, we thought expenses would grow at a factor of 60% of sales.

Based on our performance in the first quarter, we now think it will be closer to 50% of our sales growth.

And to put that into a different perspective to give more color, when we built our plan, we actually thought the first quarter expense growth would be higher than the 67% that we recognized.

So, hopefully that's helpful in understanding how we're viewing the year.

Can you just go a level deeper in both of those?

Why the gross margin is better and why the expense leverage is better?

Well, on the gross margin side, as Craig has talked about, we've gotten new tools and we continue to get benefit from these new tools which allow us to have better assortment management, fewer markdowns.

And Craig, if you want to give more color on that.

Yes.

Sure.

Eric, when you look at the seasonal business, first and foremost, we had a very solid performance in seasonal.

The tools allow us to do a better job of getting the right assortment in the right places which then obviously saves us in terms of markdowns.

At the same time, as we've worked to bring every day great value to our customer, we continue to take promotional activity out of our business which also helps on the markdown side of the business.

And then, third, as we work our product line review and our assortment structure through that process, we're seeing benefit in terms of overall improvement in line structure and the gross margin dollars that that delivers when we get those category improvements.

And on the SG&A side, Eric, I think you remember that last year we did a nice job of controlling our expenses.

We haven't stopped that work.

We've got cost out teams, and we continue to have a laser approach on managing expenses, and with the positive sales environment that allows us to drive more leverage.

And then just one follow-up if I could.

The sales performance in the quarter benefited from seasonal, and I'm assuming you got a little bit of benefit from the appliance stimulus.

Can you talk about how, as we transition into 2Q, those categories perform and what influence that might have on how 2Q sales look relative to 1Q?

Sure.

This is Craig.

We did have a strong business in our seasonal business.

We do expect that to continue through the second quarter.

As a matter of fact, our outdoor business penetration in the second quarter is actually higher than the first quarter, so we're looking forward to that continuing.

We did have a solid performance in our appliance business overall with mid-single digit growth there.

We think that some of the new products that we have coming in the quarter will continue to help us drive sales in that area that in the first quarter was benefit from the stimulus package that was out there.

We do believe that roughly 80% of that business, as it relates to the rebates, are probably done as most of the big states have completed their programs.

But we're very confident that in our assortment going forward and the new products we're bringing, that we think we can continue to drive that business.

I would like to give just a little bit more color on how to think about Q1 versus Q2.

Because of the very nice weather that we had in the first quarter, we pulled forward some of our spring sales.

So, at the beginning of the year, we said that we anticipated a sequential improvement in comps every quarter until the fourth quarter where comps would be positive.

But we were lapping double-digit positive comps in Canada, so it may not show a sequential improvement.

As we look at what we believe we pull forward into the first quarter, we wouldn't necessarily expect the second quarter to be a higher comping quarter than the first quarter, still positive, but we did pull forward some sales.

Great.

Thank you.

We'll take our next question from Deborah Weinswig at Citigroup.

Good morning.

Craig, to go a step further, in your seasonal business it sounds like improved localization year-over-year driven by the assortment management tools did have a significant impact.

Should we think about the impact being greater on sales or fewer markdowns, and can you provide a specific example?

Well, I think it's a combination.

We had a very strong seasonal business overall with double-digit growth, whether that was categories like power equipment, portable power equipment running strong double-digits, patio very strong.

Our live good business in the high single digits, our barbecue grill business is double-digit positive comps, so certainly having the right assortments in the right place, making adjustments continually year after year using our assortment tool, we believe has allowed us to help deliver that performance.

And then likewise, we're also seeing a benefit in that from a gross margin dollar productivity standpoint.

And so, those sales are delivering gross margin improvement.

We have less markdowns in these categories.

As we track sell through in them on a week to week basis, we're taking less markdowns as you move through the season to really drive the inventory productivity.

And so, it's really a benefit on both sides, Deb.

Okay.

And then, Carol, not to hammer this again, but on the SG&A front, you stated that total expenses increased by a factor of 67% of sales growth.

Can you walk through though, what expenses were levered in the quarter?

And then I'm assuming you leveraged payroll in the quarter, but by how much was that levered?

Sure.

Well, payroll's is our largest expense so let's start with that.

We leveraged payroll by 23 basis points in the quarter.

That's good.

It could have been better.

We pull forward some staffing deliberately because we were having such great sales.

If you look at all the other expenses, we're pretty much in line what we expected in terms of leverage.

Here's where we didn't lever.

We pulled forward marketing dollars in terms of advertising.

We had costs associated with our Martha Stewart rollout and some other marketing expenses if you will, about $31 million of expense, more expense year-over-year, so we didn't lever that.

Another area that was a cost pressure for us in the first quarter, was higher interchange fees associated with bank cards.

We had a really interesting phenomena happen in the first quarter where the penetration of our private label card dropped by 400 basis points from 26% to 22%, and the penetration of bank cards increased by 300 basis points from 35% to 38%.

Bank cards are our highest form of tender, so that cost us about $14 million in the quarter.

But generally, if I go back to all the other expenses, they performed as we expected.

Okay.

And then actually, on the marketing front, we actually noticed significant innovation in your marketing in the quarter with some of your Black Friday and Cyber Monday advertising.

Can you talk about the drivers behind the innovation?

That was very impressive to us, especially year-over-year?

That actually our spring marketing as it relates to spring Black Friday was kind of a repeat of what we did last year.

We've worked with our suppliers to go out and develop special buys, bring them to the market to kick off the season for the last couple of years now.

And then we have tried to work hard to integrate our online business to our store business.

That's one of our initiatives that is under works, and that did perform very well for us during the quarter.

I think that's what you saw because we really have stepped it up a lot.

Yes.

We're excited about what that online marketing opportunity presents for us.

Great.

Well, thanks so much and best of luck.

Thank you.

We'll take our next question from Budd Bugatch at Raymond James.

Good morning.

My question, the first question goes to the trajectory of sales improvement over the quarter, which is certainly heartening.

Can you kind of drill down on that and talk a little bit about the trajectory as it goes to discretionary, and the normal repair and maintenance kind of transactions?

Budd, I'd say one of the things definitely you see in the spring, is obviously you have part of the trajectory is just weather, so pardon me a little bit, I've got a frog in my throat.

But February, we had some, obviously some tough weather, as you had parts of the Mid-Atlantic under snow for the first time in ages, that degree of snow, and then in April you saw some very unseasonably warm weather in parts of the northern parts of the United States.

I think that that really is responsible for a lot of the variation month over month.

So, it wasn't a major difference in ticket size or --

No.

No.

And, just my follow-up goes to -- can you talk a little bit about inventory?

Because the inventory performance is certainly also very heartening in terms of average inventory per store, and the flatness of inventory overall.

Are you running into any out of stock issues or how should we think about that and how would we model inventories now going forward?

I'd say our in-stock performance is actually improved, so we're very pleased with that.

And, look, as I said in opening comments, really pleased, not only is our supply chain team building out a new whole new supply chain mode, but at the same time, just the performance of the existing supply chain facilities, whole replenishment process is improving.

Budd, we never look at inventory productivity without connecting that to in-stock.

You just can't separate those two, so we measure ourselves based on the productivity of inventory against our in-stock improvement.

And for this year, we built a plan that shows inventory turnover improvement much along what we experienced in the first quarter which was 0.2 year-over-year.

Thank you, Carol.

Thank you, Frank.

Thank you, Craig.

Yes.

We'll take our next question from Jaison Blair at Rochdale.

Good morning, and thank you for taking my call.

Good morning.

I was wondering if you could just give us your thoughts how much cash you need on the balance sheet and how you judge your options for capital allocation?

And whether it's boosting the dividend or the return from share repurchase in the quarter?

You were building inventories, yet you still generate $1 billion of cash flow from operations, yet you only purchased 500 million of common stock.

We've got a great model, don't we?

We generate a lot of cash.

You sure do.

We sure do.

And so, the capital allocation is one of the three legs of our strategy still, how we best use this cash, and we've got a disciplined approach, investing cash back in the business.

This year we'll spend about $1.25 billion on capital and then returning it to our shareholders in the form of dividends and share repurchases.

As you will note, in the first quarter, well, at the end of last year I should say, we increased our dividend by 5%, the first time since 2006.

And Frank said that it is his intent to raise the dividend every year, so dividends are an important part of our capital distribution.

Based on the guidance that we gave this morning, our payout is about 50% of our earnings.

We will then use excess cash to return it to to the shareholders through share repurchases.

We started our share repurchase program in the first quarter back in the market.

It was just a doability factor, so we bought back 500 million, we weren't signaling anything, that's how much we got done.

We do have a lot of cash and it's our intent to use that cash appropriately by repurchasing shares.

We'll always measure the return on the share repurchase against any alternate investment of the cash, and right now we see returning it makes a lot of sense.

Okay.

And so you are conscious of the valuation at which you're repurchasing shares?

We are, yes, of course.

And just as a follow-up, I don't believe you mentioned the appliance business.

Your competitor mentioned yesterday that other retailers had a hard time keeping up with demand.

Could you just give us some thoughts on appliance demand and your ability to keep up with that demand?

We're the third largest player.

I'll start and then Craig can jump in.

We're the third largest player in appliances.

We're very happy with where we play.

Appliance sales had a negligible impact to our performance in the quarter year-on-year.

I believe the industry reported north of 8% shipments during the quarter, which is obviously a substantial improvement from where they anticipated it to be during the initial forecast that they had for 2010.

So, I don't think there is any question that some manufacturers scrambled to get product out.

They added shifts or added people to their plants to try to meet the demand that existed out there.

But overall, we were very pleased with our appliance business in the quarter.

Okay.

Great.

Thanks for taking my call and congratulations.

Thank you.

Thank you.

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

Good morning.

Good morning.

Kind of a big picture question for you, Frank.

Maybe hoping you could pull your crystal ball out at this point, and given your tracking of PFRI, what you've seen in terms of the underlying housing dynamics and clearly there's been some movement there around first time home buyer credit.

How you're looking at the employment situation in consumer and just talk maybe more broadly about maybe not the second quarter or even fiscal 2010, but what your current thinking is on the trajectory of improvement and demand for your sector.

Yes.

Okay.

Thanks, Colin.

As you said, on the PFRI, which we have used in the past, we were concerned that we'd actually dislocate from that metric in the other direction, which is that it would show greater growth as new home sales picked up than might necessarily flow through to us and in fact, the dislocation for the first quarter occurred in the other direction.

PFRI going down and we going in the opposite direction.

As we look out forward, basically while very strong first quarter, we're very pleased with the first quarter, but outlook is still pretty much the same as we had back in February.

You see this as a transitional year with the caveat that Carol described, sequentially getting better up to the fourth quarter where year-over-year might take us down a little, but it's kind of slow, sequential improvement over the course of the year and then through into 2011.

Okay.

That's helpful.

And then, just follow-up for Carol and maybe Craig.

Can you give us a little bit more detail on the gross margin expansion here in the first quarter?

I think on a non-GAAP basis apples-to-apples we calculate about 38 basis points.

What was the impact to mix, lower markdowns, any other specific drivers, shrink, et cetera, in terms of the improvement?

You bet.

So, in the United States, we had 41 basis points of margin expansion, of which 29 basis points was the Expo markdown, so back that out.

The US business grew by 12 basis points.

It always goes in as it goes out.

We didn't have much impact by mix interestingly.

So the drivers of that 12 basis points were lower markdowns, 7 basis points, and then lower deferred interest.

Because we had fewer credit promotion days in the first quarter, so we had lower deferred interest and that gave 5 basis points of margin expansion in the quarter.

Okay.

Great.

Very helpful.

Thank you.

Yes.

Thanks.

We'll take our next question from Scott Ciccarelli at RBC Capital Markets.

Good morning, guys.

How are you?

Hi, Scott.

Good morning.

Can you talk about product inflation?

I know that lumber and copper and some other items are experiencing pretty significant price increases.

And I guess my questions are twofold.

Number one, how quickly are you changing price at the retail level?

And secondly, why wouldn't we have even an even greater impact than what we did?

The back of the envelope says just from lumber alone, if lumber was up about 50% during the quarter and all form, shape and size, and your business is, let's be conservative and say 5% to 6% of your business is lumber, I would have expected the impact to be greater than it was.

So, Scott, this is Craig.

The inflation overall as it relates to let's say lumber and copper, was about 100 basis points during the quarter, of which about 70 basis points came from lumber.

When you look at lumber overall, you're right, it moved dramatically in the quarter.

Framing was up year-over-year almost 62%, and panel was up almost, over 45% year-over-year in the quarter.

When the market runs at that rate, you have to move with it, and we moved pretty quickly with it.

Then when you look at the fact that it's really not demand driven, so you're not seeing positive growth in units, that's really the element that's driving the total impact versus what you might expect.

If we were getting significant unit growth, then you'd be absolutely correct that you would expect to see more, but it's still not positive in terms of units.

But, just mathematically, let's call it 5% or 6% of our business at call it up 50%, have much more than 70 basis points impact?

It should be --

Here is another way to think -- I am sorry for jumping in.

No, please go ahead.

Another way to think about it is just the weighting of sales.

You got it right, lumber is about 7% of our sales, garden is 20% of our sales, and I'm just talking about our garden category.

And garden had a double-digit positive comp, so it is really the weighting.

Yes.

Okay.

Great.

Thanks, guys.

We'll take our next question from Matthew Fassler with Goldman Sachs.

Thanks a lot.

A couple of follow-ups to some of your earlier comments.

First of all, on the revenue front, Carol, just to get clarity, you had previously expected sequential improvement through the year.

It sounds like you think there's going to be -- there was pull forward from Q1 -- from Q2 and into Q1.

Would you expect -- I guess two follow-ups to that.

Would you expect the third quarter to pick up from the second quarter?

And to what degree are your comments on the second quarter outlook based on what you've seen in the month of May to date?

May to date, of course we're a seasonal business and we've had some good days and some bad days.

But May to date we're tracking towards plan, so that's good news.

We do think, to answer the first part of your question, we think the third quarter comps will be higher than the second quarter comps.

Got it.

And then my second question, you talked about the fact that the ticket recovery has been quite gradual, that the Pro recovery has been slow to come.

What kind of leading indicators of actual ticket increase and Pro sales increase can you typically find in your business?

Whether it's in some of the bigger ticket purchases, traffic in different segments to the store to the extent that you can measure it and if you have some read through to those, what are they telling you today?

Matt, when we look at kind of heavily penetrated pro categories is what we're watching, and when you look at it still negative in the quarter.

I guess the encouraging piece of it was if you look year-over-year in categories like plywood or concrete, substantial improvement in terms of year-over-year.

So, if you were double-digit declines last year at this time, we're running low to mid-single digit declines.

So, we would continue to watch those type of categories, and then look at the baskets overall to determine are we beginning to see some of the project businesses that would look like room additions and basement remodels.

That's the kind of things we're watching for.

What about big kitchen and bath projects?

Obviously, looking at those as well, those continue to remain under pressure for us overall during the first quarter, and we'll continue to monitor those categories and work to drive market share in them.

Now, Craig, you would agree that if we start to see movement in special order kitchens and baths, that would be a good sign for our program.

It'd be a very good sign.

Good sign both ways.

Yes.

Yes.

Got it.

Thanks so much.

Yes.

We'll take our next question from Todd Duvick at Bank of America Merrill Lynch.

Good morning.

Good morning.

Wanted to ask a quick question about --

Could you speak up a bit?

Okay.

Is this better?

Yep, that's great.

Thank you.

All right.

Thanks.

Wanted to ask about, not only the cash on the balance sheet, but debt that is maturing.

Your leverage metrics are in very good shape, below your 2.5 times leverage target, and you've got about $1 billion maturing in August and another $1 billion maturing in March.

Can you tell us what your plans are for those and if you would use that opportunity to refinance a debt as potentially time to upsize and increase your leverage at this point?

Our intent right now is to refinance the August and the March maturities as they come due, and you're right, we are under our targeted debt ratio, but I must say that that is a cap on how much debt we want to maintain.

Running under it is fine with us for right now.

We will take it one day at a time, and if we decide to do something opportunistically we'll let you all know.

The point to remember, this is the first quarter of positive comps in the US, so it's the first quarter of positive comps.

That's a great point, since 2005.

Right.

So --

No.

That helps.

Thank you for your response.

Thank you.

We'll take our next question from Alan Rifkin at Bank of America Merrill Lynch.

Thank you very much.

Question for Frank.

Frank, we've heard you speak numerous times about the importance of PFRI, and encouragingly in the quarter your business showed solid improvements despite declines.

If you continue to see declines in the PFRI for the next quarter or two, to what extent will you proactively put the brakes on spending, anticipating that possibly 2011 may be a little bit more difficult based on that statistic?

To be honest, Alan, we wouldn't do that.

I think PFRI has been a useful benchmark for us and has tracked pretty closely to our performance, but if -- and I'm just assuming your hypothetical is PFRI we continue to have more quarters like this where PFRI declines and we improve.

We're going to follow what's actually happening in our business.

Okay.

There's just a lot of goes ins and goes outs with any kind of analysis like PFRI.

It is weighted more to the new home construction, so you'd be able to think through lots of rationales of why, as the market recovers, you could still see a decline in PFRI and our performance continue to do well.

Okay.

One more question if I may, Frank.

Sure.

With the expiration of the first-time homebuyer tax credit at the end of April, in hindsight be it Q1 or even since the implementation of that program last year, what do you think has been the net benefit to your business as a result of that?

Alan, it's a great question, and unfortunately we've asked that internally, and we don't have a great answer to it.

I think we just need to recognize that as the program ended in April, house closings can go until June.

Our business will frequently lag another 60 to 90 days.

The kind of pickup around home improvement spending in a new home, newly purchased home, so, in truth we're not going to be able to have a really clear picture of the impact on that for us for quite a while.

Okay.

Thank you very much.

Yes.

We'll take our next question from [Stephan Gick] at FBR Capital Markets.

Hi.

Thanks.

Good quarter here.

Had a couple of questions, Frank, in the past you've talked about market share versus the government reported numbers of the NAICS 444.

Yes.

In this quarter, for last five quarters or so, the same-store sales of the two national companies have been exceeding that, and it looked like it was for the two combined below it this quarter, maybe even driven by April.

Have you guys looked closely at that at all and have a sense --

Yes, there are a couple of things on that, Steve.

The first is just for the April NAICS data, the government changed the way it does the data set, so we're not fully sure what all the pushes and pulls of that are.

The second thing I'd say, is that they have the latest two months are two months under revision, and they then go back and true those up, and so we tend not to reference those until after the true up.

And if you look historically, there are often some pretty significant swings that happen on those month to month true ups.

Okay.

All right.

Yes.

That's helpful.

And then second, if I could, with the comp store sales of the total company versus the US based stores, I think the GAAP is or reflects international contribution of about 150 basis points.

Did I -- Carol, did you say what the foreign currency piece of that was versus what the underlying the core international business contributed?

I didn't but I'm happy to.

Of the 1.5% contribution from international, currency actually was 1.6%, and then we lost 0.1 because of the weighting of the international businesses versus the US businesses.

For the first time since 2005, both US and international were positive.

But international wasn't as positive as the US, so it actually hurt the comps slightly if that makes any sense.

Okay.

No, that helps out a lot.

Okay.

And last, if I could, what is your -- your interest or net interest expense assumption within your guidance today?

I don't know if have you that handy.

I will get back to you on that, Steve.

I am so sorry.

I don't have it in front of me.

I will get back to you.

Okay.

Thank you.

Yes.

That would help out.

Okay.

Great.

Thanks.

Okay.

We'll take our next question from William Truelove at UBS.

Yes.

Hi.

I have two operational questions if I may.

First, through our tour of the stores looks like have you a lot more orange outfits walking around the store, so has there been a change in the customer service metrics year-over-year that you could share with us?

This is Marvin.

We talked last year about a couple of service initiatives.

One was power hours, where we basically have a period of time of the day where we stop tasking and we spent all time focused on service.

So, it's more about visibility, customer engagement and making sure we help customers solve project questions, so that provided visibility.

So, you don't necessarily add associates, associates just become more available and more visible.

We also talked about an initiative where we're shifting labor from task to service.

Last year we shifted the equivalent of almost four full time associates from jobs that customers didn't see in the back room to on the sales floor driving service.

So, you actually saw a net gain of service associates without a net gain in total associates.

We also added, in the first quarter, approximately one part time associate to the floor with that shift from task to service.

Carol talked about how we pull forward in the season additional staff because sales picked up, we had seasonal hirings.

So, I think you also saw that as an impact as well from the visibility of associates.

Okay.

But did you have any kind of service metrics from the customers in terms of the response to that?

Well, Frank talked about net promo score.

We increased roughly 600 basis points over last year, so we're real pleased with that.

We have an internal voice of customer survey, we get roughly 100,000 customer surveys per week that we look at.

That's an internal measurement we stay very close to, looking at front end, likelihood to recommend and some key metrics.

Other than that, we're just driving the same service-related focus with our customers and trying to make sure we have incremental improvement week over week and month over month.

My follow-up question would be about China.

You say that you continue to get the business model correct over in China.

What timeframe should we be thinking about in China getting the business model sorted out and profitable and growing?

Well, so the first answer to that is it's certainly longer than I expected.

So, we're now into our third year and it's, to be honest, it's still a work in progress.

We think it is an important opportunity, and so worth the time, but it is very distinctly different.

And I haven't put, and we don't have a here's the deadline.

Obviously, at some point, you might go, hey, it's long enough, you haven't figured it out by now, move on.

But it is obviously a very large potential opportunity.

It's very complicated.

It's very different.

We're making progress, so we're pleased that the first quarter kind of played out as we expected.

But at the same time that we're making progress, or maybe it's a sign of our making progress, we keep identifying new issues and new opportunities to improve.

The one thing I want to make sure that we don't do, and we're all committed to not doing, is rolling out trying to get to scale on a business model that we're not really comfortable with for our shareholders.

Wonderful.

Thank you so much.

Yes.

We'll take our next question from Dennis McGill at Zelman & Associates.

Hello.

Good morning, guys, thank you.

Good morning.

The first question just had to do with some of the metrics you stated on the consumer credit side.

How would you interpret the shift to bank credit versus private label credit?

Can we read into that that consumers are a little more willing to part with cash as opposed to using credit to do some of these purchases?

Well, we spent a lot of time trying to analyze this.

I think it's important to note that 72% of all new account applications on our private label card are being approved, and the line is around $5,000, and for the existing cardholders the line is about $6,000, and it is only 26% utilized.

So, there's credit availability with our private label card.

I think that's important to point out.

What we are seeing is that many consumers are consolidating the number of cards that they have in their wallet.

I know I have.

And moving to card that offer rewards.

Now, as you may know with the card act that was enacted earlier this year, the value proposition associated with our private label card changed.

It used to be if you spent $299, it was no interest, no payments for six months every day.

With the card act, it's still no interest, but it is minimum payment.

So, the value proposition has changed, and for our consumer they may say, this is one value proposition I can use my XYZ card and get mileage or points, et cetera, so we think there's just been a change there.

Now, we like our private label card, as you know, because it is the lowest cost of tender from a credit card perspective in our stores.

So, we've got a number of ideas under way to create new value propositions to get the consumer to use our card.

And we'll be talking to you about those over the next few quarters.

Okay.

Thank you.

And then, just one follow-up as it relates to product inflation and some of the other categories, more core categories like paint, flooring, faucets, we're hearing a lot of chatter for price increases in the channel from the manufacturers.

Can you talk about what you guys experienced in the first quarter and what your expectations would be moving forward in some of the non-commodity products?

Again, there is always things happening inside the cost structure of product categories, and we're really taking these one off at a time working individually with our suppliers.

Many times there are announcements of increases, that doesn't necessarily mean they all flow through or certainly don't flow through at the rates that are announced.

So, there are movements within certain areas, but in general, not a lot of movement in the first quarter, a little more talk in the second quarter, but all those are single one-off negotiations.

Okay.

Great.

We work hard to offset.

Thank you very much, guys.

Cindy, we have time for one more question.

Our last question today will come from Gary Balter at Credit Suisse.

Hi.

Congratulations on a great quarter.

Thank you, Gary.

Just two questions.

One, you talk a lot about the Pro and when you think Pro, could you break down what you're thinking in terms of remodel versus tied in with new construction or how should we be thinking about it from our side so we can get a handle on it?

So, Gary, I think we tend to -- our Pro is really more the remodel pro.

New home builds, I mean maybe there's some activity that we get from that again on the smaller Pro side or the fill-in side, but our core Pro customers just as Craig was talking about earlier, someone's doing an addition, it's the kitchen remodel, it's really that kind of activity.

Okay.

And then could you talk about where you are in the distribution centers, how much is that costing you at this point?

Where are you and when do you think we'll start to see the benefits from a margin perspective?

So, as we talked about, Gary, we're in the rollout phase, and so we don't anticipate any benefit until we complete that rollout phase, which will be 2011.

The good news is that the distribution centers are running quite well.

And so, as you might imagine, we did have some fuel pressure in the first quarter, and we were able to offset that fuel pressure because of how well the DC's are operating, so it's a good news story.

And Gary, this is Marvin.

We're also seeing improvements in-stock.

We talked earlier about how well we're performing even though we're managing inventory while we're seeing out of stock (inaudible) I think we're estimating roughly 20%, 25% at year-over-year and that is the existing supply chain and the improvements with the RDC working realtime.

So, we expect that to continue as the rollout continues, but even right now we're seeing those changes in stores.

Just one follow-up on that, Marvin.

First of all, your [homer fund] trophy fell off your hands on our bobble head, so I apologize for that.

I'm sure it is very important.

But, second is --

We'll send you a new one.

No, it's okay.

We glued it.

But, the second is, just on the distribution costs, this effort is costing you money now and so it's in the expenses and that will turn into essentially a benefit next year.

Is that the way we should be thinking about it?

Yes.

Okay.

That's the way to think about it.

Thank you.

It's very disappointing that you received a defective bobble head.

We'll take care of that.

Thank you, everyone, for joining us today.

We look forward to talking to you next quarter.

That does conclude today's conference.

Again, thank you for your participation.