家得寶 (HD) 2010 Q2 法說會逐字稿

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

Today's conference is being recorded.

(Operator Instructions).

Beginning today's discussion is Ms.

Diane Dayhoff, Vice President of Investor Relations.

Please go ahead.

Thanks, Yvonne, and thank you to everyone and good morning.

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 of Corporate Services.

Following our prepared remarks, the call will be opened for analyst questions.

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

This conference call is being broadcast real time on the Internet at 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.

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.

Today's presentation also includes certain non-GAAP measurements.

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

Now let me turn the call over to Frank Blake.

Thank you, Diane, and good morning everyone.

Sales for the second quarter were $19.4 billion, up 1.8% from last year.

Comp sales were positive 1.7% and our diluted earnings per share were $0.72.

Our US stores had a positive comp of 1%.

From a geographic perspective, 70% of our top 40 US markets positively comped in the second quarter.

Florida and California continued their positive growth paths with performance in line with the Company average.

We saw a retreat from some of the very strong numbers in the first quarter, particularly in the Pacific Northwest, where key markets like Portland and Seattle turned to negative comps.

But on a year-over-year comparison for the second quarter, every market except the hurricane impacted market of Houston improved.

As Craig will detail, one of the clear patterns of the first and second quarters was the shift in the timing of outdoor garden spend.

We had something of a bathtub effect in the first half in garden.

Strength in the first quarter was counter balanced by weakness in the second quarter.

But overall in garden the first half came out about where we expected.

It's a similar picture for the Company as a whole.

We anticipated that second quarter comps would decline from the first quarter.

They did.

But for the half we came in ahead of where we had planned.

This gives us some confidence as we look into the back half.

We have two quarters in a row of positive comps in the US.

We have a continuing pattern of positive comp transactions in our stores.

We're gaining share in key categories and basic execution across the business is sound.

We are also continuing to invest in our core initiatives.

We opened our 14th and 15th Rapid Deployment Centers or RDCs during the quarter in Scranton, Pennsylvania and Phoenix, Arizona and we just opened our 16th RDC in Finley, Ohio yesterday.

RDCs now serve over 80% of our US stores and we remain on track to reach our goal of serving 100% by the end of the year.

This has been a huge undertaking that has involved the entire organization.

And we think it's a very positive sign that in the midst of this buildout the Company is also improving its inventory turns.

For the third quarter in a row, our inventory turns have improved.

This is something we hadn't achieved in almost a decade.

Craig and the merchandising team continued to develop and use new merchandising tools.

The benefits of this are most clearly seen in our reduced markdowns for seasonal categories like patio and barbecue grills, where better visibility into and planning for seasonal inventory have significantly reduced the markdowns necessary to effectively exit those categories.

Marvin and the store operations team are also continuing on the path of improving Customer Service.

We previously discussed our Customer First program.

Marvin has now launched a version of that for our Pro customers and a special version focused on our checkout process and we continue to see improvement in our net promoter scores.

On the international front, our Canadian business had flat comps for the quarter as it experienced some of the same impacts in the Western regions of Canada as the US experienced in the Pacific Northwest.

And our Mexican business had another quarter of positive comps, making it 27 quarters in a row of positive comp growth.

There are, however, reasons to be cautious across our business.

We still see weakness in our Pro segment.

We had anticipated that we would start to see growth in our Pro customers as we moved into the second quarter, and based on that we thought we would see gradual improvement in our average ticket.

We're now forecasting modest to flat improvement on the Pro side, which puts pressure on average ticket.

We also are anticipating softer housing related activity than we originally thought.

Clearly, there was some pull-forward of activity from the home buyer tax credits and foreclosures remain high.

And of course, on a broader economic level, unemployment remains stubbornly high and wage growth weak.

All of these factors counsel caution as we enter the back half of the year.

As Carol will discuss in more detail, we are maintaining our earnings guidance for the year, but revising our sales guidance to reflect these concerns.

Instead of significant sequential improvement from the first half to the back half, we now think that the two halves will be similar after adjusting for commodity price inflation.

Our market has been through four extremely difficult years.

Private fixed residential investment as a percent of GDP remains at historically low levels.

But as uncertain as the economic climate is, we are seeing our business return to sales growth and the hardest hit parts of the country start to stabilize, so we will continue to invest and position our business for recovery.

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

We are very proud of the fact that 97% of our stores will be eligible for success sharing, our profit sharing program for our hourly associates.

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

Thanks, Frank, and good morning, everyone.

As expected, second quarter comps showed some deceleration following a strong first quarter and seasonal pull-forward.

But we're pleased with our overall performance.

The departments that outperformed the Company average comp were lumber, electrical lighting and plumbing.

Kitchens and flooring performed at the Company average comp.

Hardware and paint showed positive comps, while comps in millwork, seasonal and building materials were slightly negative for the quarter.

Based on census data through June, our US market share is up 28 basis points on a 12 month rolling basis.

We continue to see strength in transactions, but have not yet turned the corner on average ticket.

Comp transactions were up 1.7% in the quarter, but overall comp average ticket remained flat at $52.30.

Reflecting the economic environment, we continue to see negative growth in big ticket.

Transactions for tickets of $900 above, approximately 20% of US sales, were down 4.9% in the second quarter.

This was driven by continued pressure on big ticket discretionary spend projects as well as lower appliance sales which negatively impacted the Company's comp by 30 basis points in the quarter.

Transactions for tickets under $50, also roughly 20% of the business in the US, were up 2.4% year-over-year.

The primary drivers of this were the continued strength in repair and maintenance projects and simple decor.

In the second quarter, categories such as cleaning, plumbing repair, roofing, chemicals and safety and security led the way.

Let me share with you some specifics around our seasonal business in the quarter.

We saw a positive comp growth across several seasonal product categories such as barbecue grills, portable power equipment and landscape lighting.

This summer's record heat across much of the US drove double-digit comps in products like air conditioners and fans.

In contrast, the excessive heat kept many DIY gardeners indoors and we saw softer comp performance in live goods and landscape than anticipated.

As an example, live goods went from high single digit positive comps in the first quarter to negative comps in the second quarter.

To put all of this in perspective, of the deceleration in US comps that we saw from the first quarter to the second, approximately 200 basis points are directly related to outdoor categories, offset by 40 basis points of growth in air cooling.

Overall, we're very pleased with our performance year-to-date in our seasonal business, and we feel good about our inventory position in seasonal categories as we enter the third quarter.

We continue to execute our portfolio strategy and drive results from our investments in merchandise category resets, new product introductions, and the implementation of our everyday great value.

Let me share a few examples of this.

First, program resets in place for more than 13 weeks are exceeding our expectations.

Enhanced discipline around planning and impact modeling have led to more productive resets and less disruption for our stores.

Second, we have added new products to strengthen portions of a category's line structure.

In carpet, we launched the new Martha Stewart and Platinum Plus programs which provide customers with lifetime stain warranties.

Last week these programs provided over 100% lift in sales versus a year ago from the products that they replaced.

Third, we've been working to provide everyday great values across all levels of price points.

In hand tools we improved our offerings in both the opening and the upper price point segments.

In tool storage, we updated our Husky product in the upper price point segments.

And we introduced Ryobi's Lithium One Plus technology into cordless outdoor power equipment.

With these introductions, each of these categories delivered positive comp performance in the second quarter.

Lastly, we continued to drive excellent execution in inventory through better process, new forecasting tools and leveraging our new supply chain capabilities.

Let me offer some details.

Around process, we combined our import and domestic DCs which have begun to yield benefits through a more simplified approach to product flow.

We also completed the roll-out of our Teradata DCM forecasting tool for centrally replenished items.

This enables us to make better inventory decisions and react more quickly to trends in the business at a store SKU level.

And of course you know about our RDCs which, among many other things, shorten effective lead time, eliminate vendor minimums, and improve productivity in our ordering process.

The benefits of these actions can be seen in our inventory turnover improvements and the fact that our in-stocks are at record high levels.

As we move towards the fall, we're excited about several new product launches in our holiday offering that will be set at the end of the third quarter.

We also have several outstanding special buys planned, starting with our current Vanity and Sanity bath event going on now.

Customers are responding very well to this event and you should come into our stores and check it out.

And with that, I'd like to turn the call over to Carol.

Thank you, Craig, and hello everyone.

In the second quarter sales were $19.4 billion, a 1.8% increase from last year.

Comps or same store sales were positive 1.7% for the quarter, with positive comps of 0.6% in May, positive 3.9% in June, and positive 1% in July.

Comps for US stores were positive 1% for the quarter, with US comps a negative 0.9% in May, positive 3.7% in June, and positive 0.4% in July.

Please note that in 2010, Memorial Day weekend fell in our June rather than our May reporting period.

Our gross margin was 33.9% for the quarter, an increase of 41 basis points from last year.

Our US business contributed 36 basis points of margin expansion in the quarter, driven primarily by the following factors.

First, stronger sales in certain categories drove us to higher purchasing tiers and allowed us to earn more co-op and rebate dollars than last year.

Second, we experienced lower markdowns than last year, due to better management of our seasonal categories, as well as fewer promotions.

Finally, our international businesses contributed five basis points of gross margin expansion due primarily to higher rebates and lower shrink than last year.

Operating expenses as a percent of sales decreased by 53 basis points to 23.4%.

Adjusting for the strategic charges taken in the second quarter of 2009, operating expenses as a percent of sales decreased by 43 basis points from last year.

Our operating leverage reflects positive same store sales, as well as lower expenses in the following areas.

First, we saw 14 basis points of payroll leverage arising from the nature of our spring hiring.

You will recall that we pulled forward spring hiring into the first quarter.

And this, coupled with a higher mix of seasonal and part-time workers, contributed to the payroll leverage in the second quarter.

Second, we realized 13 basis points of leverage from lower depreciation expense, reflecting our smaller fixed asset base.

Finally, we saw 14 basis points of leverage in our general and administrative expenses, due primarily to the rationalization of our management structure and a resulting decrease in incentive compensation.

For 2010, we expected our expenses to increase by a factor of 50% of our sales growth rate.

For the first six months of the year, we were on our expense rule of thumb as adjusted expenses increased by 1.8%, compared to adjusted sales growth of 3.6%.

We expect to see some expense relief in the back half of the year, so we now believe that our expenses for the year will grow at a factor of less than 50% of sales growth.

Interest and other expense for the second quarter totaled $148 million, down $13 million from last year, reflecting lower levels of outstanding indebtedness.

Our income tax provision rate was 37.3% in the second quarter, reflecting the timing of state tax settlements.

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

Earnings per share for the second quarter were $0.72, up 9.1% from last year, and reflect $0.02 of benefit arising from our share repurchase program.

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

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

Reflecting the sales environment, total sales per square foot for the second quarter was $328, up roughly 2% year-over-year.

Now, turning to the balance sheet.

We continue to effectively manage our inventory.

At the end of the quarter, retail inventory was $10.8 billion, down $38 million from a year ago.

On a per store basis, inventory decreased by 0.5%.

Inventory turns were 4.4 times, up from 4.3 times a year ago.

We ended the quarter with $42.5 billion in assets, including $2.4 billion in cash.

This is an increase of approximately $974 million in cash from the end of fiscal 2009, reflecting cash generated by the business of approximately $3.4 billion, offset by $1.2 billion used for share repurchases, $793 million used for dividends, and $407 million of capital expenditures.

Now, on the capital structure front, a few items of note.

First, in the second quarter we repurchased $700 million or 21.4 million shares of outstanding stock.

Second, during the quarter, we replaced our $3.25 billion commercial paper program with a new $2 billion commercial paper program, that is 100% back-stopped by committed long-term bank line of credit.

As of the end of the second quarter, we had no outstanding commercial paper.

Third, 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%, 220 basis points higher than the second quarter of fiscal 2009.

And finally, subsequent to the end of the quarter, we repaid $1 billion of senior notes that came due on August 15th and expect to refinance them later this quarter.

As Frank mentioned, we executed well during the first half of the year, but economic recovery is progressing at a slower pace than we originally expected as illustrated by the Fed's recent change to its GDP outlook for 2010.

You will recall that our plan assumed we would see ticket growth in the back half of the year.

We now think that ticket growth will not materialize and that our sales growth will come from transaction growth.

We believe the back half of the year will resemble the first half of the year, which, when backing out the commodity price inflation we experienced in the first half, suggests back half sales growth in the 2% area.

Based on our year-to-date results and our current expectations for the back half of the year, we are updating our guidance for fiscal 2010.

Remember that we guide off of GAAP.

We are calling for fiscal 2010 sales to increase by approximately 2.6%, with earnings per share from continuing operations increasing by approximately 22.6% to $1.90.

Within this guidance, we now expect our operating margin to be approximately 8.3% for the year.

This guidance includes the benefit of our year-to-date share repurchases, but doesn't include the impact of any additional share repurchases.

It is our intent, however, to use excess cash to repurchase shares throughout the remainder of fiscal 2010.

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

And, Yvonne, we are now ready to take questions.

Thank you.

(Operator Instructions).

And we'll take our first question from Deborah Weinswig with Citi.

Thanks so much.

And thanks for all the color on the call.

In terms of your gross margin performance, which was extremely impressive, how should we think about the impact of the merchandising tools on the performance in the quarter?

Well, let me break down the gross margin expansion for you in the US, and then Craig, you can talk about the tools.

But if you look at the 36 basis points of expansion that we had in the quarter, 16 basis points came from higher co-op and rebate dollars as we entered in new purchasing tiers.

12 basis points came from lower markdowns, given our better management of seasonal.

And then 8 basis points came from fewer promotions, and those were primarily credit promotions.

So you can see, we got a good deal of benefit from markdowns.

And Craig, you might want to talk about the tools.

Yes, Deb, we continue to work to enhance our assortment planning, utilizing our merchandising tools to try to get the right product in the right place.

Obviously, the advantage when we do that is not only a sales advantage by having the right product there, but also it allows us to effectively move in and out of the inventory, which saves on the markdowns.

And really, helps us drive the overall gross margin productivity in a particular product category.

And as Carol mentioned, you can see the benefit in the markdown line.

Okay.

Thanks.

And then, Frank, you talked a lot about your Customer First program, and how that's really improving your customer service in the stores.

Can you talk about some of the metrics behind that, and what you've noticed over time as that program has continued to develop?

Okay.

Thanks, Deb.

Marvin Ellison is here, so I'll ask Marvin to address that.

Marvin?

Hi, Deb, this is Marvin.

What we've seen is a continued increase in our internal customer satisfaction scores.

We are benefited by having about 500,000 customer surveys per month that we get in where customers log on and tell us what they think.

And we're in a great position because our customers are very passionate, so they tell us what they like and what they don't like.

As with a lot of that, we've had our Net Promoter Score increase over 500 basis points in Q2, and that's on top of 1,000 basis point increase in Q2 of last year.

We're also seeing things like, likelihood to recommend, which is our version of, intent to return.

It is at record highs for the Company, the highest it's ever been in the eight years that I've been here.

So we feel really good about it.

As Frank mentioned, what we're going to do in the second half is put an increased emphasis on checkout.

We still noted that's one of our Achilles's heels from a service standpoint.

We want to speed up our checkout process, and make it more inviting for the customers.

And we're also going to put a specific emphasis on pro and service, because we know that when we provide quicker in and out service for our contractors then we have a chance to grow market share.

And last question, and then I'll turn it back over.

In an environment where obviously traffic trends have been difficult, but you're obviously significantly outperforming, there's obviously a lot of initiatives on your plate, but would you say that this is one of the keys to driving strong traffic in your stores?

Absolutely.

Craig and I talk a lot about a real simple equation.

And that is having compelling value from the merchants to create footsteps, and then the engagement of the associate to the customer turns those footsteps into transactions.

And we think that as we've increased our product knowledge, we've increased our training on engagement, we've seen the trajectory in transactions start to go up, and continue to stay positive.

But it's a combination of compelling value from the merchandising team that invites the customers in, but when we engage those customers, we turn those footsteps into transactions, and we're going to continue to focus on that in the second half.

If I could just jump in, it really is a team effort because looking at our in-stocks, our in-stocks are at record high levels.

So when you have great value, great service, and the product is in stock, that certainly drives transactions.

Keep up the great work, and best of luck.

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

Thanks a lot, and good morning to you.

I guess two questions.

The first, how are you thinking about forecasting sales as it relates to the macro backdrop of the volatility that we've seen in housing activity?

All of us share the sales outlook that you put out there, but the drivers are a lot less obvious given the housing stimulus within existing home sales moving up and down with unprecedented volatility.

So what's the basis for your assumption that sales growth stays level over the course of the year, other than it has essentially held at this level for the past several months?

Thanks, Matt, and it's a great question, and we obviously spend a lot of time working through how do we forecast the back half.

And if you take into account what Craig was saying in terms of the shift first quarter and second quarter in garden, you go, okay, overall you start with first half came in ahead of where we expected.

Second half, but the geography of the half was not what we expected, and that was driven overwhelmingly by the shift in garden, a pull forward in the first quarter and a bit of a draining in the second quarter.

And then you go, okay, we've seen continuing strength in transactions across the business, which is a good sign across the business, and say that we think that projects forward into the back half.

And then, as Carol was saying, we're lightening our assumptions on ticket growth, in large part because the pros are a little slower to come back than we thought, and that gets the equation of around the 2% sales growth.

And that's the thought process.

I can tell you behind that, we do a lot of things, as you can imagine.

We keep talking about private fixed residential investment, and that's had a great correlation up until recently with our sales.

The difficulty with that, and you hit on it, is a lot of the broader macro numbers actually change pretty quickly.

So if you just looked at quarter over quarter over quarter, what our projections on PFRI were, or what the expert projections on PFRI were, they have changed quite dramatically over the course of the last year.

So that does make forecasting in this environment a little challenging.

But I think you gain confidence based on how you're performing, and while it's early, if we look at our sales in August, we are on our plan, and August sales are better than July.

That's helpful color.

One follow-up, if I may.

And that relates to the appliance category.

What's your sense of how your share transpired in major appliances in Q2 versus Q1?

I know that the stimulus programs were still alive, albeit at a much diminished rate in the second quarter.

Any color you could give on trends in that business would be helpful.

Yes, Matt, this is Craig.

When you look at Q2 as reported by an independent third party, we actually stepped backwards about 60 basis points in Q2.

On a rolling 12 month basis points, we're up 80 basis points in the appliance business from that same (inaudible).

Any sense as to whether that relates to promotional stance, inventory, marketing, anything that you could put your finger on?

As you know, we've talked about the fact that our appliance business, we're very comfortable with our appliance business as to how it's positioned inside of our portfolio strategy.

We're the third player in this business.

We're comfortable being the third player in this business.

During the quarter, we very purposefully elected not to chase some deep discounts that happened in the market.

Got it, that's helpful.

Thank you so much, guys.

And we'll take our next question from Dennis McGill with Zelman & Associates.

Good morning, and thank you.

First question, just some clarity on some of the comp numbers you gave.

Do you have an estimate for what the shift in Memorial Day might have meant for the May versus June comp?

And then, secondly, can you just clarify the 200 basis point swing?

Is that essentially the delta between first quarter and second quarter that you saw from seasonal?

Yes, to answer your first question, there was a 70 basis point impact in both May and June.

So in other words -- and I'm talking the US, obviously -- May would have been 70 basis points less negative, and June would have been 70 basis points less positive.

Then in terms of the seasonal shift, I think that was Craig's comment?

Yes.

It was 200 basis points for all of our outdoor categories, that actually was impacted in the quarter comparatively to the first.

So if you just want to work the math, you start with a 3.3% positive comp in the first quarter, and then deduct from that 200 basis points, add to that 40 basis points from air cooling.

Which gets you back to the comp.

Exactly.

Okay.

So same adjustment both quarters.

And then secondly, I'm not sure if I interpreted your comments correctly but the paint category sounded like it was still positive, but maybe below average.

And I would have thought with some of your repair and remodel comments, that that would have still been a strong category for you.

So can you just elaborate on what you guys are seeing in that category?

Sure, the paint category was, in fact, still positive, although not quite as strong as it was in the first quarter, as we comped over the introduction of our Behr Ultra from a year ago.

So still feel very solid about our paint business, an area that we remain focused on overall.

Okay.

That's helpful.

Thank you very much.

And we'll take our next question from Chris Horvers with JPMorgan.

Thanks, and good morning.

First a follow-up question on the top line, and then one on the gross margin.

As you think about the pro, you're saying now it's kind of flat to slightly up, I think, in the back half.

How are you thinking about that?

Is that basically saying, hey, look, if I just look at roughly a three year or maybe even a four year trend in saying if we just keep comping those negative compares, does that imply getting towards a flat level?

Or is there some sort of embedded acceleration, as you think about it?

Yes, Chris, first off, it's more the former than the latter.

So if you think about the commentary that we've had on the pro over the last several calls, we changed the way we measure it.

We think we have a more accurate measurement of who our pro customers are.

As we improve the accuracy of the measurement, one of the things we found was a double-digit decline in the pro business as you exited the back half of 2008 and through 2009, gradually improving to where we're now in the low negative single digit on pro sales in our stores.

We had anticipated in the back half a more significant recovery, in large part for exactly the reason you said.

You just looked at your stack comparisons.

And now, just based on the performance in the second quarter, we see that as more gradually getting to flat and then slightly positive.

Okay.

So no acceleration, just basically -- .

Not really.

It's largely, just on the comparisons and grinding through some bad numbers and getting to better.

Okay.

And then actually on the SG&A side, Carol, you talked about less than 50% ratio to sales growth for the year.

Can you talk about maybe more granularly what that means for the back half, and what the levers are there that get you to those levels?

Are you taking cost out?

Is it incentive comp comparisons?

How you're forecasting labor and so forth.

Sure, well, if you look at our expenses on an adjusted basis, dollar expenses were actually down in the first half, and as we look at the back half we expect dollar expenses to be down again.

Why?

Well, the biggest driver of that is incentive compensation, and it's all based on relative performance.

We're paid off of plan.

Last year we smashed our plan.

This year, we're expecting to be on our plan, and so the dollars are down year on year.

The other driver for the back half of the year has to do with vacation, sick and holiday.

And given the nature of our staffing in our stores, we have less vacations, sick and holiday expense forecasted for the back half of the year than we did last year.

And that's the part-time, full-time mix?

It is.

Okay.

Thank you very much.

We'll take our next question from Michael Lasser with Barclays Capital.

Good morning.

Thanks a lot for taking my question.

We've heard from several retailers that consumer spending seems to be more event-driven right now, particularly for discretionary items.

And in the second quarter you had Memorial Day, Father's Day and the Fourth of July.

What sort of trends did you see around those events, and then in between the periods?

And how does that impact how you think about the third quarter when there will be fewer events in that period?

Michael, this is Craig.

Certainly a lot of focus and effort goes into the holiday periods because those are big sales weeks for retailers, and we were very pleased with the results that we saw around those events.

But when we look at the fundamentals of the business, and what customers are doing right now, customers are remained focused on maintaining their homes.

So repair and maintenance categories are pretty stable across the business.

We have been keenly focused on making sure that we are providing the right offerings for our customers in those day-to-day activities, as well as simple decor updates.

So categories like faucets and paint and simple flooring projects are where we're focused.

And that is the foundation, as I mentioned in my comments, to our transactions, and really keeping customers coming into The Home Depot.

As we look to the back half, we think that customers will remain there.

They'll remain focused not only in their yards.

I think there's certainly some stress that the yards have been through in the second quarter, so there's an opportunity there.

But we also think that they'll continue to focus on the maintenance and repair, and simple updates around their home.

So we feel like we're well-positioned for the back half against what we believe customers will actually be doing.

So just to clarify, it wasn't as though you saw a big spike in your comp around the holidays, and then things drop off in between?

No.

Again, we performed well on the holidays, and the holiday periods would be above a typical week.

Again, put more marketing, more effort behind it, but it's not like a dramatic -- .

I think, Michael, in answer to your question, it didn't seem any more spikey this year than it has in prior years.

Okay.

And then as a quick follow-up, were there any other categories that you found to be excessively promotional during the period that you chose not to participate, might have impacted the relative performance of those categories?

No, I wouldn't say that there was a ton of activity, outside of the appliances that I mentioned.

Okay.

Sounds good.

Thanks a lot.

We'll take our next question from Stephen Chick with FBR.

Hi.

Thanks.

You mentioned that the second half sales assumptions were similar to the first half, I think, if you normalize for inflation.

And I think you had said that the first quarter inflation in the comps was about 100 basis points.

What was the second quarter?

The commodity inflation was 100 basis points for the quarter and for the half.

Okay.

So it was 100 basis points again in this quarter?

Yes.

Okay.

And sorry, Craig, the 200 basis points math and the shift that you went through, I'm sorry to make you guys go through that again but I didn't quite grasp--.

If you could reconcile that again for us, that would be helpful.

So if you look at US comps at 3.3% in the first quarter.

You take the seasonal businesses, which fell 200 basis points, gets you down to 1.3%.

Add in 40 basis points of air cooling product, which was a plus, gets you back to the 1.7% comp.

But the 1.7% comp is the total Company?

The US was 1% for the quarter, right?

The US comp was 1% for the quarter.

So Craig is just tying you out to the 1.7%.

There's another 70 basis points of shift in the business, if you will, to get you to the reported 1% for the US.

Correct.

Okay.

So as we work into the second half, more importantly, I'm assuming you've thought about the fourth quarter.

If we keep the 2% transaction count comp, let's say we assume you get back to, or you're 2% for each quarter, the fourth quarter is a pretty tough compare.

Canada had a pretty tough comparison a year ago, I think both in terms of FX as well as the strength of the business.

So are you thinking about maybe the third quarter being higher than the fourth, or should we think about it being pretty even at 2% apiece?

Steve, I'd say we're thinking about it as kind of even over the two quarters, without a doubt.

As you said, there's a bigger hill in the fourth quarter, because you saw stronger numbers from us in the fourth quarter of 2009.

I would say on the other hand, all of these things are comparisons, so you have to look fourth quarter previously.

And so, we see them as balancing out, and we have taken into account, obviously Canada, we saw significant improvement in the fourth quarter, particularly the last month in Canada, last year.

And does the mix of small versus large transaction change much, Craig, the 20% and 20%?

Can we think about that being a similar mix in the second half?

Yes, it's pretty flat.

That number doesn't change dramatically quarter to quarter.

Okay.

All right, thank you.

We'll take our next question from David Schick with Stifel Nicolaus.

Good morning.

First question, I think is for Craig.

You talked about the pro business remaining sluggish, and limiting the ticket.

Is there any evidence, as you look at it, that the DIY customer is rethinking the good, better, best spectrum within a category as they're purchasing?

No, actually, again, it varies by product category but we're seeing a typical buying pattern throughout the line structure in categories.

As I mentioned in my comments, we actually improved our offerings in, for example, our tool storage at the upper end.

That was very well-received by the customers.

If you look at the Ryobi Lithium and cordless, which is actually at the top end of our cordless offering in our outdoor power equipment for a cordless category, that has performed extremely well.

Likewise, we've also made sure -- the customer's focused on value across all of the line segments, so we're trying to strengthen each of the areas, as we did, for example, in hand tools.

We actually went at both ends of the business, and saw good results.

Okay.

Thanks.

And this question's maybe a little bit circular, given your comments at the end, Carol.

But the buyback, you've always talked about a more -- maybe I'm adding the word regular, but a regular and substantial buyback when you saw a stabilization in the business, and you stepped it up in the quarter.

You talked about it, you'll do it with excess cash flows, but is this the sort of pace we should expect going forward on average or absolutely, or will there be a lot of volatility?

Or am I thinking about that wrong?

At the beginning of the year, we said based on our forecast of cash, that we could see us buying about $3 billion worth of shares in 2010.

We bought a $1.2 billion to date, so that's about 40% of the program.

As I mentioned on the call, we needed to save some cash in our bank account to repay the bonds.

This is just a timing thing.

We're going to refinance those senior notes later this quarter, so you should expect us to go back into the market, we will, start repurchasing shares, and as much as $3 billion this year in a thoughtful, planful way.

Great.

Thank you.

We'll take our next question from Scot Ciccarelli with RBC Capital Markets.

Hi, guys.

Scot Ciccarelli.

I guess I had a follow-up comment or a question regarding the cadence for the second half sales.

The question is essentially, why do you expect comps will accelerate in the fourth quarter?

Because it looks to me like you would need a fairly meaningful improvement, even on a three year run rate basis.

I'm just trying to figure out, what is it about the business that's going to get quite a bit better in the fourth quarter?

Okay.

Scot, it's not an enormous step forward.

I think what you say is, the business, you have to start with the fundamental that you think the business is turning.

You go, okay, you're going to maintain your comp transactions growth.

We think we have some plans in place across our business that will continue to drive growth into the fourth quarter.

For every turn, as the business turns, you're going to hit a point where you go, gee, I'm lapping where it started to turn last year, can I sustain it?

And so our task is to sustain that turn.

But if you said, yes, the numbers mathematically, it's harder in the fourth quarter than the third quarter, the comment is not arguable.

Many retailers are talking about holiday sales as perhaps challenging this year.

Holiday's not big for us, but we think we're going to have a good holiday season.

Okay.

That's helpful.

And then just a quick follow-up.

Given that it's in hindsight now, do you guys have any color on what the impact of the housing tax credit may have been on your business?

When you saw that expire, was there a change either in terms of quantification or what people were buying?

Scot, on the quantification side, we really don't have that, and I'd say it's going to take another couple of quarters for us to figure it out.

We're now going into a period where, for the first time, we're going to be having a few quarters without federal tax credits that applied to the housing-related activity.

We feel qualitatively that there was a pull forward.

Hard to know what it was, whether there was some incremental sales, pull forward, what's the division between them.

I'd say we're really going to have to wait until the end of the year to have a clearer picture on quantitatively what that was.

Okay.

Fair enough.

Thanks a lot, guys.

We'll take our next question from David Strasser with Janney Montgomery Scott.

Thank you very much.

Two questions.

First of all, Canada, and the reason I ask this is because Walmart said something very similar this morning.

It seemed like Canada has slowed down, particularly the west coast of Canada.

I'm just trying to think about, as you --which has been such a strong part of your business for a while.

As you think about it into the back half of the year, and think about inventory replenishment, particularly in the western part of it, do you sense a trend there?

Do you think it's a somewhat short-lived issue there?

David, as I mentioned, it is interesting because we see both what was happening in the northwest part of the US, as well as what was happening in the western part of Canada, and an awful lot of it was just straight -- you hate to say the weather word, but an awful lot of it in the second quarter was just a straight weather impact.

Okay.

Because just hearing it from Walmart as well, it just jumped out a little bit.

I'm sure there are probably other retailers that experienced the same thing.

But we had strength in the eastern part of Canada, which would, again, suggest if you normalize for weather, the country as a whole was okay.

All right.

It was also the first time I had heard it.

That is logical.

Second question, Carol, you said that August got a little bit better from July.

Anything in particular that seemed to accelerate?

Was it weather related, you think, August getting better?

Any other ways to think about, that helped that trend?

It's early days.

It has cooled off a little bit in parts of the country.

And as Craig mentioned we have Vanity and Sanity inside our stores, so you should go check it out.

All right, good, I appreciate it.

Thank you.

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

Good morning, everyone.

I'd like to just focus a little bit on gross margin.

Carol, I think you said that you had 16 basis points from rebates in this quarter, and 12 basis points from lower markdowns, and 8 basis points from fewer promotions.

How should we think about that going forward?

Do the rebates continue and the fewer promotions continue?

Or what do you think about gross margin for the second half?

Well, at the beginning of the year we told you to expect modest gross margin expansion for the full year.

We're up 40 basis points for the first half on an adjusted basis.

I would say 40 basis points is a little bit more than modest.

So look for gross margin expansion in the back half, but not at the same level that we experienced in the first half.

Okay.

All right.

Thank you very much.

We'll take our next question from Daniel Binder with Jefferies.

Hi, good morning.

It's Dan Binder.

I was just curious, with the guidelines on the credit cards and your profit sharing arrangement, if there was any benefit or detriment as a result of those new guidelines on your credit income?

Well, gosh, lots of things have happened, haven't they, as it relates to credit cards and our country?

Our cost of credit is capped at no more than 1.5% of credit sales.

And currently we're running slightly under that.

But we are seeing something interesting in terms of the behavior of the card holders.

And that really relates to the change that happened earlier this year with the Card Act, where the everyday value proposition that we used to offer, which was if you spent $299 on the card, it was no interest, no payments for six months.

That's now changed to no interest, minimum payment for six months.

And what we've seen is a decline in the penetration of usage of our private label card.

Actually, in the second quarter, it declined almost 400 basis points to now just 21% of our sales.

So as we think about this, private label's a great value proposition.

It's the cheapest form of credit for us.

We want more customers to use our card, so we do have a program inside our stores called Everyday Saving, which on certain everyday items like light bulbs and trash bags and air filters, if you use our card, it's everyday 10% off.

So, we're doing a number of things to drive up penetration.

But in terms of our cost, we don't anticipate any change.

Now, I could comment, if you'd like, on the Durbin Amendment to the financial reform bill.

The Durbin Amendment speaks to interchange fees on debit cards.

Debit is about 18% of total penetration for our business.

And there's PIN debit and signature debit.

PIN debit is cheap.

Signature debit was expensive.

It costs more than clearing a check.

With the Durbin Amendment, the Federal Reserve has been given the right to determine what the fee should be on a reasonable and proportionate basis.

We think that when those fees come out, there could be a benefit to our Company next year beginning in July, and that benefit could be in the $30 million area, which we could then turn around and reduce retail prices or make investments in other areas.

Great color.

I was just curious with that 400 basis point reduction in penetration of the private label card, has your overall credit penetration come down?

Overall credit penetration has dropped 100 basis points.

So bank cards picked up 300 basis points of the 400 basis points decline, but penetration is down.

Great.

Thank you.

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

Thank you.

Just a follow-up question on expenses.

I think consecutively you've not only done well in the quarters, but continued to find ways to reduce the growth rate of your expenses below the growth rate of sales.

We're obviously in a pretty uncertain environment here.

If things do tend to trend down, how much more juice is there in that stone?

What are remaining areas that you could still go after to take more expenses out of the business after all the success you've had?

Colin, I would say that there are always opportunities.

The challenge in our business is how we use things like technology to help us approach things more efficiently and effectively.

Embedded in the numbers that Carol was going through was a number of examples like that, where we think we've been able to reduce structure, use technology and provide a better outcome.

There are things that we're working on even as we speak that would do the same thing.

And to be clear, we'd work on those if the conditions were great or harsh because they're the right thing to do for the business, and we think they actually improve the business.

So there's still, I could tell you, we have a lot of projects that are going on that we think help take expense out of the business long-term.

Okay, fair enough.

And then a follow-up question for Carol.

It looks like on a gross basis, so gross debt to EBITDA is now down to just a touch over two times, and net debt to EBITDAR by our models, about 1.75 times.

I think a bit below where your target leverage ratios are.

Obviously it's a period of uncertainty, but at the same time it's a period of relatively cheap debt financing.

So how are you thinking about the right leverage in the business, and when you might get closer to a target leverage ratio, and what that might mean for the stock buyback going forward?

First of all, we agree with your calculation.

Secondly, it's important just to reiterate that we will maintain our strong investment grade rating of BBB plus.

And that our target adjusted debt to EBITDAR ratio of 2.5 we believe allows us to maintain that rating.

So we are under it.

We could lever up right now about $3 billion, and still stay under that target.

But to your point, Colin, it is a time of uncertainty.

So we don't feel compelled to go to market, even though interest rates are very low, because with the Fed's announcement last week that they're going to keep the size of their balance sheet for the foreseeable future, it doesn't appear to us that rates will be moving in the near term.

Fair enough.

Thank you.

Yvonne, we have time for one more question.

We'll take our next question from Gregory Melich with ISI.

Thanks.

Two questions.

One is, getting back to the point on pro, and the expected improvement in the pro.

What percentage of those larger tickets, the $500 tickets, are pros at this point under that new definition?

And then I have a follow-up to that.

Okay.

Greg, don't know.

I'd like to be able to give you the answer to that with that granularity, but we don't know.

So maybe looking at it a different way, if you look at the cadence you expect in the pro, which at least is less negative, turning slightly positive, we assume the pro is higher tickets.

Yes.

Exactly right.

So that is still getting better on a year-over-year basis.

And I guess what I'm wondering is, are we then implicitly assuming if ticket is going to remain weak, that non-pro ticket is actually going to deteriorate?

No, no, no.

I think the right way to think about it is really, our planning assumption is the ticket remains under pressure, and it remains under pressure because the recovery of the pro is slower than we thought, and so exactly when the time is that the pro turns to positive, I can't tell you.

But what I can tell you from our planning is that where we had been thinking we'd see some improvement on ticket.

If you go back to our call in February, we were talking about the back half more of a blend between ticket and transaction in terms of what would drive the comp.

And what we're saying now is no, that's really going to be transaction and not ticket.

And the big difference there is pro.

So, don't be thinking there's some significant lift we're anticipating from pro that's going to be offset by some significant decrease in the consumer.

The bigger thing to take away is that pro is slower.

And Greg, this is Marvin.

We're going to be aggressive and opportunistic with the pro customers.

We're going to focus on staffing and service levels, and getting them in and out really quick, which is a mandate that they've given us.

We have a field team that is out there, building relationships, understanding the needs of the pro.

We're working with Craig's team to make sure we're merchandised the right way, we're priced the right way.

So we're going to fight as hard as we can to take care of the customers.

But again, as Frank said, we just don't anticipate robust growth in the second half.

Great, and then a follow-up on the gross margin side.

Carol, you talked a bit about -- and thanks for the exact numbers on mix and markdown -- but it does sound like those things will start to fade.

Could you answer what was in the quarter in terms of supply chain benefits to gross margin, even if they didn't show up?

Was there a benefit that we just didn't see that we'll see more into next year?

When does that start to be a net positive?

We're going to see the supply chain benefit next year.

We didn't talk much about supply chain, although they're doing a great job of driving the business.

We had some cost pressure, as you can appreciate, with some cost coming out of international carriage.

I think many retailers were faced with a similar challenge.

But through our excellent productivity and our distribution centers, we were able to offset a lot of that cost.

So no material impact to the quarter.

And you should see the benefits next year.

Great.

Thanks for that.

Thank you to everyone for joining us today, and we look forward to speaking with you on our next quarterly earnings conference call.

That concludes today's conference.

Thank you for your participation.