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November 13, 2007 | about: HD

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The Home Depot, Inc. (HD)

F3Q07 Earnings Call

November 13, 2007 9:00 am ET

Executives

Diane Dayhoff - Senior - Vice President of Investor Relations

Frank Blake - Chairman, Chief Executive Officer

Craig Menear - Senior Vice President, Merchandising

Paul Raines - Executive Vice President of U.S. Stores

Carol B. Tome - Chief Financial Officer, Executive Vice President Corporate Services

Analysts

Chris Horvers - Bear Stearns

Deborah Weinswig - Citigroup

Jeff Wimmer - J.P. Morgan

Budd Bugatch - Raymond James

Matthew Fassler - Goldman Sachs

Danielle Fox - Merrill Lynch

Gregory Melich - Morgan Stanley

Eric Bosshard - Cleveland Research

Shannon Coyne - Credit Suisse

Colin McGranahan - Sanford Bernstein

Brian Nagel - UBS

Presentation

Operator

Good day, everyone and welcome to today’s Home Depot third quarter earnings conference call. As a reminder, today’s call is being recorded. Beginning today’s discussion is Ms. Diane Dayhoff, Senior Vice President of Investor Relations. Please go ahead.

Diane Dayhoff

Thank you and good morning to everyone. Welcome to the Home Depot third quarter earnings conference call. Joining us on our call today are Frank Blake, Chairman and CEO of The Home Depot; Craig Menear, Executive Vice President of Merchandising; Paul Raines, Executive Vice President of U.S. Stores; and Carol Tome, Chief Financial Officer and Executive Vice President Corporate Services.

Following our prepared remarks, the call will be open for analyst questions. Questions will be limited to analysts and investors and as a reminder, we would appreciate it if participants would limit themselves to one question with one follow-up, please.

This conference call is being broadcast real-time on the Internet at homedepot.com with links on both our homepage and the investor relations section. The replay will also be available on our site. If we are unable to get to your question during the call, please call our investor relations department at 770-384-2387.

Before I turn the call over to Frank, let me remind you that today’s press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the Securities and Exchange Commission.

Now let me turn the call over to Frank Blake.

Frank Blake

Thank you, Diane and good morning, everyone. Our market continues to face into significant headwinds. We started the year with a fairly pessimistic view of the housing and home improvement markets. It turns out we weren’t pessimistic enough. We had expected some market improvement by the third quarter. That didn’t occur and our results reflect the difficult market.

Sales for the third quarter were $19 billion, down 3.5%. Comp sales were negative 6.2% and diluted earnings per share from our retail business were down 9% at $0.59.

We expect continued difficult conditions for the remainder of 2007 and into 2008. We have consistently used as a guidepost to market conditions the ratio of residential construction spend to GDP. The 60-year average is 4.8%. At the height of our market in 2005, the ratio was 6.25%. The market is now corrected to 4.5%. When you consider the GDP is approximately $14 trillion, this represents a market contraction of over $240 billion.

While we are now close to the average, we don’t expect the market do decline to the average and then pivot back up. We expect that the soft market will continue, as reflected in the current overhang of housing inventory and the difficulties in the sub-prime mortgage [market].

As painful as the correction has been and will probably continue to be, we are now on the underside of this 60-year average. The value of a time tested average is that it gives you confidence in the market potential ahead. For the Home Depot, it reinforces the importance of investing in our business and fixing our core operations.

What most distinguishes the Home Depot is the culture of our associates, their passion for the company and customer service. As difficult as the market is, it is great to see that passion reignited. We are achieving progress from our investments in each of our five key priorities -- associate engagement, store environment, product availability, product excitement, and Own the Pro. I’ll provide a quick summary on each, but before doing that, let’s look at overall market performance.

We recognize that Home Depot's issues are not only market related. We have also lost share through our own performance. One of our key objectives has been to reverse that market share loss. The latest data shows us losing about 385 basis points to the market on a rolling 12-month basis. That is a significant improvement over last year’s number of 760 basis points.

Also, as Paul will detail, in the markets where the housing and home improvement markets have been more stable, we are seeing positive comp performance. On associate engagement, Paul will take you through what we’ve done on our success sharing program, master trade specialists, and other initiatives. A good sign that we are seeing results here is that voluntary hourly attrition is down 24%. We will continue to invest in our associates because they are at the heart of our customer experience.

On our shopping environment, we are rolling out new store standards for cleanliness and appearance and we’ve already seen significant improvement in our voice of customer VOC scores.

On product availability, with Mark Hollifield and team we have improved our in-stock position in our stores and this is also reflected in our VOC results, which show an improved score in our find-and-buy metric.

We also have a distribution pilot well underway. We took an existing facility in Georgia, introduced new processes in technology and are seeing shortened lead times and better in-stock positions in the service stores. Building out our new supply chain will be one of our most important initiatives through the remainder of 2007 and 2008.

On product excitement, Craig will discuss the areas where we’ve made significant share gains. We are also putting additional resources into our regional merchandising efforts and adding talent to our merchandising organization.

On our Own the Pro initiative, we are using the analytics from Dunnhumby to gain better insights into the 2% of our customers who drive nearly 30% of our sales. Through these analytics, we are gaining a better understanding of who these customers are and what their unique buying patterns area. The analysis is being used to drive targeted direct mail pieces to optimize our job lock quantity SKU lists, and to generate customer contact lists for our pro desk sales associates.

I would also like to make a brief comment on core retail. We’ve launched a program to transform our merchandising systems and processes and we are on track to deliver the first phase in Canada next year.

Our international business remains strong. Mexico posted double-digit comps in the quarter, Canada had positive comps, and China is making good progress. Our international stores now contribute 9% of sales and 11% of operating profit, an impressive record of performance for these businesses.

Finally, let me make a few comments about our sale of HD Supply and our recapitalization plan. We closed the sale on August 30th and we are now focused exclusively on our retail business. We used the proceeds from the supply sale to fund the bulk of our $10.7 billion tender offer, which we completed in early September. That completes about 50% of our recapitalization.

Given the market environment now, both in the housing and home improvement market and the credit market, we don’t think it’s prudent to rush to execute the remainder of the recapitalization, so this is not something that will happen in the remainder of 2007.

The basic principals behind the recapitalization that we will be disciplined in our capital allocation and benchmark our use of capital against returning dollars to our shareholders remain in place, as does our overall goal. We will provide a more complete view of our perspective on this in 2008 in February.

In a meeting last week, one of our vendors made a great comment -- a downturn is a terrible opportunity to waste. This market downturn is an opportunity for the Home Depot to focus our resources and attention on the things that matter and to bring greater customer focus to the business. That is what we are doing.

Now let me turn the call over to Craig.

Craig Menear

Thank you, Frank and good morning, everyone. In the third quarter, we experienced negative sales growth in all of our departments except kitchens, which was driven by appliances. The departments that outperformed the company average comps were plumbing, kitchen and bath, garden, paint, and hardware. The departments that underperformed the company average comp were lumber, millwork, lighting, and building materials, and flooring performed at the company average.

First let’s talk about what negatively impacted us during the quarter, including regional differences in performance and later, we’ll highlight some of the wins that we had in the quarter.

A large driver of our weak sales performance in the quarter was due to the softness in our building materials and related businesses. Lower demand, as well as commodity deflation in building material categories, such as dimensional lumber and drywall, impacted average ticket, which was down 1.5% from last year to $57.48.

As you would expect, we are seeing double-digit declines in markets like South Florida, California, and portions of the Northeast. However, a few regions showed positive comps in these commodity related businesses, such as the Southwest and Ohio Valley.

The category where we lost share in the quarter was lighting. This is a product category that we have opportunity to enhance our merchandise offering and simplify the selection process for our customers. Here we have promoted our top expo merchant, Lisa McLelland, to Merchandising Vice President to lead this category going forward. She is leveraging the learnings from expo in fashion and design as the assortment is retooled for the spring of 2008.

Our kitchen category also remains challenged. In markets facing significant home price depreciation, such as Phoenix, Sacramento, and Tampa, we are experiencing double-digit negative comps. Despite the headwinds that we face in this big ticket category, we remain focused on improving our share loss. We completed the rollout of our assembled kitchen cabinet program that we mentioned last quarter and we are pleased with the early results.

As we move into the fourth quarter, we are taking the learnings from our success in the flooring department to our kitchen department and we will simplify the purchase process and increase the value proposition for our customers.

We are upgrading the shopping experience by resetting show rooms and enhancing the capability of our associates through additional training and technology upgrades.

Now let’s talk about some of the areas where we’ve seen share gains in the quarter -- paint, appliances, and power tools.

Despite increasing competitive dynamics in the paint business, our market share of paint grew again this quarter. We have a great partner in Masco with Behr Paint, which has been consistently rated number one in independent product testing for the past five years.

Sales were particularly strong in our exterior paint and stain categories and customers are responding to the market-leading innovation and products such as our exclusive nano-guard exterior paint that requires no priming.

In a shrinking appliance market, we continued to gain share this quarter, building on the gains that we’ve seen for the past few years. We saw significant strength in this category throughout the country. Our success has been driven by our ability to stay relevant to our customers by providing them with the latest features and benefits at great values.

Customers continue to be pleased with the innovation, style, and design we are offering in appliances in products like the GE café and the LG kitchen series, both high-end suites of kitchen appliances.

Another area that is beginning to show positive share results is our hardware department. In power tools and accessories, we gained share in a shrinking market and extended our leadership in this category. We saw a strong performance across the country, including markets such as Los Angeles, Washington D.C., Chicago, San Francisco and Denver.

We drove these share gains by staying relevant to both the pro and the do-it-yourself customer, providing them with tools that have the latest functionality at great value. An example of this was our October launch of the new Ryobi One Plus lithium products, which offers professional features at affordable prices.

A final comment on areas that we were pleased with in the third quarter would be our merchandising resets. Where we have completed our resets and implemented change from our product line review process, collectively these categories are outperforming the store sales performance in line with our expectations.

There is no question that we are operating in challenging times, and as we look forward, we remain focused on our merchandising fundamentals, enhancing our processes and strengthening our team. I have talked to you in the past about our focused bay approach. The company transactions were down 1.8% for the quarter. However, where we have applied our strategy against our specific category roles, we are beginning to see positive results. For example, in toolsets, whose intent is to drive traffic, we have seen this category turn from a negative to a positive comp performance in the quarter.

We are also partnering with our suppliers to bring value to our customers. Two weeks ago, we met with all of our top suppliers. We spent a lot of time developing actions to more collaboratively solve customer problems and drive sales for both of our companies.

As we look forward to the fourth quarter, we are pleased with the early sales of our holiday program and gift oriented products. This year, we expanded and refined our assortment and expect to be the number four retailer in U.S. holiday décor sales, with double-digit year-over-year growth.

We are also focused on managing our seasonal categories, such as heating, snow removal, and organization.

Before I turn it over to Paul, I want to mention some exciting changes in our merchandising organization. During the past quarter, we have invested to add talent within the merchandising team at our senior level. Bruce Marino, a 23-year veteran of the Home Depot has come back to merchandising after spending eight years as the Western Division President. Bruce is leading our field merchandising teams, merchandise service organization, store environment, and new concepts.

We also have three Senior Vice Presidents that are responsible for our merchandising categories. Another former division President and merchant, Eric Pederson, is our SVP running our building materials businesses. Giles Bowman, who has held various merchandising positions throughout the organization, is our SVP for hard lines.

And lastly, we are pleased that Gordie Erickson has joined us as our SVP of Décor. He brings a strong background of merchandising with 32 years of experience in home center mass and specialty retailing.

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

Paul Raines

Thank you, Craig. As Frank mentioned, we have seen significant differences in regional performance, driven by macroeconomic trends and housing indicators. In those markets with favorable housing trends and strong disposable income, we are seeing positive comp performance. For example, in the Southwest, our Dallas, Austin, and San Antonio markets had positive comps for the quarter.

In those areas that have been the hardest hit by housing turnover and new home sales, we continue to feel significant pressure. It is no surprise that Sacramento, Las Vegas, and Fort Myers, Naples fall in this category, with Fort Myers Naples posting negative comps in excess of 20%.

Our business displays significant variation across geographies and that underscores the importance of having a local focus. For example, within our Ohio Valley region, we have relatively stable housing markets as well as markets with deteriorating housing indicators, both posting positive comps for the third quarter.

We believe that our performance in these markets is being driven by share gains, as well as our focus on our five priorities.

Now let’s talk about some of our progress on those priorities. This year, we have made a lot of progress on our associate engagement priority and despite the difficult business environment, we are driving positive changes around our associate reward and recognition programs. We know that the motivation and engagement of our more than 300,000 associates make a huge impact on customer satisfaction and on sales.

In our second quarter earnings call, we spoke a lot about compensation enhancements. The changes in our success sharing program, an incentive program for hourly associates driven by individual store performance, allowed us to increase our associates participation in success sharing by almost 40 points year over year for the first half. The largest check an hourly associated received was $1,855 and the average check was around $200.

The issuance of restricted stock grants have more closely aligned assistant store managers with the company’s goals. We have also seen positive results from the reinstitution of our Homer Badge program, where associates get rewarded with merit badges for outstanding customer service, which they can submit for cash compensation.

To date, over 78,000 Homer Badges have been awarded, including seven gold level badges and two platinum level badges.

We have also seen a big impact from our master trade specialist program. As of last week, we had over 2,000 master trade specialists in our stores, all being either licensed plumbers or electricians. We are extremely pleased with this program. These specialists are better able to help customers with their plumbing and electrical projects, help train associates, and help us better assort stores to comply with local building codes and requirements.

Our merchant team is also leveraging these specialists by having regular conference calls to ensure we are adopting and changing our offering in stores to reflect the regional needs of the business.

While we view this as an investment in the short-term, we are confident that longer term, we will see a return on this investment.

We are seeing the impact of our focus on associate engagement through reduced turnover and our employer of choice survey. As Frank mentioned, voluntary hourly turnover in our stores is down 24% from last year. EOC results indicate that our initiatives in associate engagement are making a meaningful difference.

Earlier this year, we surveyed almost 300,000 of our associates at both the stores and the store support centers. Our highest scores were in those areas that are the most difficult to change -- meaningful and challenging work, inclusive culture, and work environment.

We definitely have room for improvement, particularly in areas like communication and work schedule. We are pleased with the results and feel we can make progress in the areas that need our attention the most.

In terms of shopping environment, we are very pleased with our progress. As most of you know, the average age of our stores is around seven years old, a time when you really need to refurbish the stores to continue to drive sales. Therefore this year, we increased our maintenance budget by 2.5 times our 2005 spend, geared at making the stores clean and uncluttered and inviting to our customers.

We have integrated our field and store support center teams to better align ourselves around the needs of the business, as well as adopted a programmatic approach to maintenance.

To date, we have polished or spiffed 473 floors, striped 1,038 parking lots, remodeled 172 restrooms and now have T5 lighting in 1,765 stores.

In addition to programmatic maintenance, our integrated field and support center teams have rolled out store standards to all stores. Through a cross-functional approach, we developed and piloted our basic expectations for stores and our goal is to drive a foundational level of store appearance that is agreed upon by our merchants, operators and support teams.

To do this, we’ve set common guidelines on appearance and shopability and have created discipline around how the store support center directly impacts a store’s environment.

The standards provide guidance on things such as front apron merchandising, wing stack usage, signage presentation, fixturing, and off-shelf product. This initiative helps reduce the amount of time our store manages spend on navigating some of these issues, removes unnecessary clutter from the aisles and implements a basic, consistent approach in terms of store appearance.

Finally, on our Own the Pro initiative, you’ve heard from Frank that 2% of our customers drive almost 30% of our sales. Through Dunnhumby and our credit card programs, we have good information about what this super premium customer spends in our stores. Over the last quarter, this customer who typically spends twice to three times as much as a regular customer, has continued to shop with us. We are now taking the next steps, building better relationships with them, communicating our value proposition, and staying relevant to them through our bid room and job lot quantities programs, to continue to connect with them and gain a greater share of their wallet going forward.

We know these initiatives are making a difference because our customers are telling us. Through our voice of customer survey, where we hear from over 200,000 customers a week, we see improvements in likelihood to recommend, find and buy, and our clean and uncluttered metrics. Clean and uncluttered, which measures the shopping environment, is improving faster than all other metrics.

Although we see good progress on our associate engagement, shopping environment, and Own the Pro initiatives, we know that continue to face market headwinds and challenges. Our success will be defined by our ability to remain focused on the fundamentals of the business during this difficult environment.

I want to make a brief comment on the stores organization. Although Craig was able to lure veteran Western Division President Bruce Marino away to merchandising, we could not be happier for Bruce and look forward to working with him closely going forward.

We have replaced Bruce with Joe McFarland, who is our new President for the Western Division. Joe is a 16-year veteran with the Home Depot, who has held various operating positions, including regional vice president, district manager, and store manager. I am very excited about having Joe in this leadership position.

One last comment before I turn it over to Carol; it is unfortunate when we face natural disasters but it is during times like these that our associates and customers need us the most. Taking care of the community and each other in a disaster is one of the things Home Depot does best.

During the recent wildfires in California, we saw thousands of customers and associates evacuated from their homes and many lost their homes or sustained significant damage to them. In order to assist our associates and customers in need, the Home Depot kept stores open longer than any other retailer in the area and donated palettes of water, flashlights and batteries, air purifiers, gloves, and more. Beyond providing the necessary products during this disaster relief effort, our associates also donated their time to help in any way needed -- at evacuation centers, building sifters, providing shelter for animals and hosting kids workshops.

You can always count on Home Depot to stand tall in times of need for our customers and associates. I want to thank each and every one of our associates for your commitment and sacrifice. You make us proud to wear the orange apron.

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

Carol B. Tome

Thank you, Paul and hello, everyone. Before I discuss the results of the quarter, let me remind you that our third quarter results include one month of HD Supply as a discontinued operation. As you review our financial statements, please note that the operating results and earnings impact of the sale of HD Supply are found in a one-line item on our income statement entitled earnings from discontinued operations.

In the third quarter, sales were $18.96 billion, a 3.5% decrease from last year, reflecting negative same-store sales of 6.2%, offset in part by sales from new and non-comp stores. Consolidated same-store sales were negative 5% in August, negative 7.3% in September, and negative 6.3% in October.

In the third quarter, our gross margin was 33.4%, a decrease of 18 basis points from the same period last year. Contributing to the year-over-year decrease in our gross margin rate were the following factors.

As expected, our gross margin benefited from lower interest costs associated with our private label credit card financing program. In the third quarter, we realized 36 basis points of margin expansion due to lower interest costs. We gave up roughly 54 basis points of margin due to a higher penetration of lower margin products like appliances, as well as markdowns taken to clear through some seasonal items like outdoor power equipment and grills, and allow us to transition into new products, like assembled cabinets and kitchen accessories.

As a percent of sales, total expenses grew by 183 basis points to 24.1%. Our expense deleverage reflects the impact of negative sales, where for every point of negative comp, we expect to deleverage expenses by about 20 basis points.

So with a negative comp of roughly 6%, we would expect to report expense deleverage of 120 basis points. In the third quarter, we experienced an additional roughly 60 basis points of expense deleverage due to two main factors.

First, during the quarter, we announced our plans to close our 11 landscape supply locations. We recognized $25 million of expense associated with the store closings during the quarter.

Second, we share in the profitability of our private label credit card portfolio through a gain share program. Private label credit sales make up about 30% of our total sales. The portfolio remains very profitable but losses within the portfolio are higher than they were one year ago. As a result, our gain share was approximately $82 million less than last year.

Our expenses reflect investments we are making in support of our five key priorities. We continue to view payroll as an investment. As a percent of sales, total payroll increased by 51 basis points over last year, which includes investments in our master trade specialist program, as well as expense associated with employee bonus programs like success sharing. Currently, 57% of our stores are eligible for success sharing compared to 22% last year.

As a result of the factors I just mentioned, our operating margin declined from last year. Our operating margin for the third quarter was 9.3% as compared to 11.3% last year. Net interest expense was $125 million in the third quarter, up $33 million from last year, reflecting higher levels of outstanding indebtedness.

In the third quarter, our income tax provision rate for continuing operations was 34.7% compared to 37.4% last year. In the third quarter, we reached agreement with tax authorities on several state and federal tax audits. As a result, we recognized a $35 million tax benefit in the quarter, as well as some related interest expense benefits.

Earnings from continuing operations were $1.1 billion, as compared to $1.3 billion last year, and continuing earnings per diluted share were $0.59, down 9.2% from last year. Diluted shares for the third quarter were 1.815 billion shares compared to 2.05 billion shares last year.

The reduction in outstanding shares is due to the share repurchase program we began in 2002, including the 289 million shares we repurchased in our recent tender offer. Through the end of the third quarter, we had repurchased a total of 743 million shares.

Earnings for our discontinued operation, HD Supply, were $20 million. Included in this quarter’s results are the net after tax financial results for the month of August, as well as the impact of the sale of HD Supply. After expenses and taxes, we recognized a $4 million loss on the sale of the business.

Moving to our operational metrics, during the third quarter we opened 25 new stores, including one relocated store, for an ending store count of 2,224. Today, 236 stores representing approximately 11% of our store base, operate in Canada, Mexico, and China.

At the end of the third quarter, selling square footage was 233 million, a 5.4% increase from last year. The average square footage per store was 105,000 square feet, the same as last year.

Reflecting the sales environment, total sales per square foot were approximately $323 for the quarter, down 7.8% from last year. While the year-over-year trends for our new stores were also negative, sales per square foot for our new stores had their best year-over-year performance since the fourth quarter of 2006.

At the end of the quarter, retail inventory was $12.6 billion, an increase of 3.7% from last year. On a per store basis, inventory was down 1.9% from last year. Inventory turns were 4.4 times, slightly lower than last year.

Computed on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital for our retail business was 15%, reflecting a 130 basis point improvement from the second quarter of 2007.

We ended the quarter with $45.5 billion in assets, including $550 million in cash and short-term investments. This is a decrease of approximately $64 million in cash from the end of fiscal 2006, reflecting cash generated by the business of approximately $5.8 billion, net proceeds from the sale of HD Supply of $8.3 billion, along with commercial paper issuances of $748 million, offset by $2.5 billion of capital expenditures, $325 million paid for a minority interest in HD Supply, $1.3 billion of dividends paid, and $10.8 billion paid for share repurchases.

For the year, we now estimate our total capital spending will be approximately $3.9 billion.

Given our performance to date and the softness we continue to project for the rest of 2007, we think our comps for the year will be negative 6% to 7%, and earnings per share from continuing operations on a 52-week basis will be down as much as 11% from last year.

Finally, I want to give you our latest thinking on the completion of our $22.5 billion recapitalization plan. As Frank mentioned, since we announced the plan in June, we have completed about 50% of our recap. As you know, both the credit market and the housing market have become more difficult since June. We believe it is prudent to take a cautious stance with regard to the completion of the recap. We will move forward when we see improvement in both the home improvement and credit market, which we believe will not occur until some time in 2008.

We will keep you appraised of our plans and during our fourth quarter conference call, we will provide you with sales, earnings, and capital spending guidance for fiscal 2008.

Thank you for your participation in today’s call and we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Chris Horvers at Bear Stearns.

Chris Horvers - Bear Stearns

Thank you and good morning, everybody. First question on the recap program, I think when we are out here speaking with investors and we understand being pushed back because of the credit market aspect but pushing it back because of the home improvement market, what do you say to people who turn and say well, if they are not interested in buying our stock, why should I?

Frank Blake

I think again, as we’ve said, it is looking at both markets and saying what is the prudent thing for us to do for our shareholders. If you said all other things being equal, we were planning to go forward at the end of this year and then take another step in the spring, but all things really aren’t equal, both in terms of the credit market and we do think it makes sense to look at the housing market and see what’s happening in the housing market before making another major commitment.

Chris Horvers - Bear Stearns

Could you just expand on that last part? Why would you be looking at the housing market?

Frank Blake

I think again for us, we look at both what our projection was for the year, where it turned out, and we want to get a better sense of 2008 and we are frankly just in the middle of the planning process around 2008.

Carol B. Tome

Chris, you’ll recall that from a capital strategy perspective, we have targeted an adjusted debt to EBITDAR leverage ratio of 2.5 times, and so clearly the housing market will impact our adjusted EBITDAR, and so we are just working through our plans for 2008 and looking at that relative to our financing plans.

Chris Horvers - Bear Stearns

One follow-up question, Carol; as we think about 2008, and understand you haven’t given guidance yet, we know sales -- it’s going to be a tough environment and we had the second downturn in the housing. As we think about the deleverage that might occur in ’08, does the accelerated maintenance and the additional store investment this year make the potential deleverage less next year for every 100 basis points of comp?

Carol B. Tome

Well, it’s a great question. We had some catch-up spending in 2007, as we’ve talked to you about. Again, we are not giving guidance today for 2008 because we are just building our plans. But as we look at our business model, we believe that we will still, for every negative point of comp sales, deleverage expenses by 20 basis points. Then there will be some other goes-ins and goes-outs that we’ll talk to you about.

Chris Horvers - Bear Stearns

Thank you very much.

Operator

Next we’ll move to Deborah Weinswig at Citigroup.

Deborah Weinswig - Citigroup

Good morning. Frank, I believe Carol had highlighted the fact that 57% of stores this year are eligible for success sharing versus 22% a year ago. I would assume that that’s very important for employee morale. Can you talk about if you’ve changed the target or how you’ve gotten to a higher number year over year, and just what it means for the employees?

Frank Blake

Yes, we did change the targets, so previously we tended to have a stretched target in order to get into success sharing, and then you had to hit 100% of the target. So for this year, we changed that approach and made it a percent of target and at the time, we were thinking the target we set out was a very reasonable target, with again, the basic principal being we wanted our associates to feel the benefit of success sharing and then earn their way up into additional dollars, rather than feeling demotivated from the start at a tough plan that they didn’t think they could achieve.

Deborah Weinswig - Citigroup

Okay, and then last question, in terms of helping the associates in a tough environment, are there any additional tools that you are providing them with in store to help serve customers or help them upsell?

Paul Raines

I’ll take that one. There is a series of activities in the stores around learning that are very important. We’ve spent a lot of time refocusing in the first half of this year around in-the-aisle learning and emphasizing project and product knowledge versus the heavily e-learning focus that we’ve had previously. So that’s one of the tools we’ve given them.

At the same time, we are doing a tremendous amount of focus on our VOC activities and giving them a lot of feedback and metrics around what customers are saying about the business. So we feel that we are giving our associates a lot more tools around the customer and around product knowledge and helping customers do projects in their homes through this first half.

Deborah Weinswig - Citigroup

Great. Thank you very much.

Operator

And next we’ll move to Stephen Chick with J.P. Morgan.

Jeff Wimmer - J.P. Morgan

This is actually Jeff Wimmer on behalf of Stephen Chick. I have a question about your guidance, if you could delve in a little bit more about that. It looks like sales remain relatively the same, in that high, mid-single digit range, but could you talk about the split between growth and SG&A deleverage? Are you still looking for up gross margins year over year?

Carol B. Tome

Yes, year over year we are projecting slight margin expansion. On the expense side, the expense deleverage that we saw in the third quarter will continue into the fourth quarter.

Jeff Wimmer - J.P. Morgan

Okay, and then I might have missed this because I got on the call a little late, but did you give intra-quarter sales yet?

Carol B. Tome

From a comp perspective?

Jeff Wimmer - J.P. Morgan

From a comp perspective, yes.

Carol B. Tome

We sure did, and let me just tell you negative 5 in August, negative 7.3 in September, negative 6.3 in October.

Jeff Wimmer - J.P. Morgan

Okay, and then also, just thinking about going forward, you have the $600 million reinvestment plan. Is this going to be something reoccurring next year? Will there be additional incremental investment as we look into ’08?

Carol B. Tome

At the beginning of the year, we said that we were investing $2.2 billion in support of our five key priorities, $1.6 billion for capital, $600 million of expense. Some of that expense was catch-up spending. We will continue to invest in the key priorities in 2008.

Just to update the capital bit, we are going to spend this year we project about 1.3 against the original 1.6 target, but that’s really because of the sale of HD Supply.

Jeff Wimmer - J.P. Morgan

Okay. Thank you.

Operator

Next we’ll move to Budd Bugatch at Raymond James.

Budd Bugatch - Raymond James

Good morning. Let me ask you a question -- my first question really goes to appliances. Can you update us where you are on share on appliances? I noticed in some stores maybe some additional square footage through the use of mezzanines. Is that prevalent in a number of stores?

Frank Blake

Budd, that’s a very limited pilot that we were running and I would not expect to see a lot more of those, but let me turn it over to Craig for general comments on appliances.

Craig Menear

For appliances overall, again we were pleased with the performance there. We’ve achieved a 12.4% penetration in terms of market share versus 10.7 a year ago, up again from Q2, which was at 11.7, so the customer really continues to respond to the offering that the team has put together.

Budd Bugatch - Raymond James

And Craig, those are unit shares?

Craig Menear

Yes.

Budd Bugatch - Raymond James

Okay, and if we could also, my last question is to talk a little bit about any additional talent or what you see in the merchandising organization with Gordie’s coming on board, or can you talk about maybe what other needs you might have?

Craig Menear

Well again, very excited to not only have Gordie on board but also to have Bruce join us, coming in from the field to help us really coordinate and connect with our regional team as we continue to try to drive the regional assortment variations that we need across our business and get that executed for the stores.

And with Gordie joining us, again great retail talent. I think well respected in terms of his knowledge, both in mass discount and specialty retailing and it’s a super addition to our team.

We feel very good about the overall team that we have in place right now and looking forward to driving the business.

Budd Bugatch - Raymond James

Okay, and Carol, could you just give us what the tax rate is going forward? Any more tax issues?

Carol B. Tome

We project that the provision rate for the year will be 36.5%.

Budd Bugatch - Raymond James

Okay, that helps.

Operator

We’ll go next to Matthew Fassler at Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot. Just a couple of quick questions here. First of all, the average ticket decline seemed to moderate a bit. If you could give us any color on why you think that happened, be it mix or other factors.

And then just by way of follow-up, Carol, on the recap, would you continue to expect to deploy free cash against buy-backs or would you hold off on that as well?

Frank Blake

Craig, why don’t you comment on the average ticket.

Craig Menear

On average ticket overall, again what we saw there was some shift in mix that is impacting that business. When you look at what happened to the lumber and building materials categories, as that relates to a larger repair/remodel project overall, that certainly had an impact on the category.

We did see some shifting and we are seeing within categories, for example, in a little more discretionary spend categories like outdoor power equipment, we saw some shift down in the line, which impacted the ticket in that category as well.

Carol B. Tome

Just another comment on the ticket, if you look at just the sequential performance, Q3 to Q2, in Q3 we picked up $0.22 of average ticket growth because of an increased appliance penetration. We didn’t have that same benefit in the second quarter, so that’s part of what you are seeing.

And on the recap question, as Frank said in his comments, we remain committed to our capital allocation strategy where we will always compare the use of excess cash, returning that to our shareholders versus something else, and so yes, we’ll remain committed to that.

Matthew Fassler - Goldman Sachs

But just to clarify, to the extent that you are talking about holding off on the recap, you’re talking about holding off borrowing more money to buy back stock, not the repurchase of stock in and of itself?

Carol B. Tome

Right. Now remember, we have $748 million of outstanding commercial paper, so we don’t have excess cash as we are sitting today.

Matthew Fassler - Goldman Sachs

Fair enough. Okay, thank you.

Operator

Next we’ll go to Danielle Fox at Merrill Lynch.

Danielle Fox - Merrill Lynch

Thanks. Good morning. I guess just looking back historically, the retail business has had an operating margin as high as 11.8%, which is about 200 basis points above where you are tracking this year. I’m wondering what needs to happen to get back up to those levels. Presumably you need to return to positive comps, but do some of these supply chain enhancements that you are beginning also need to work out in order to return to the 11.8%?

Frank Blake

I think first, clearly positive comps, because that levers positively versus the negative, the deleverage that we see now. And then second, you are exactly right in terms of improving. What we see is the substantial investment that we are going to make in our supply chain will help us improve our operating margins, as will the merchandising transformation that’s really at the heart of core retail.

Danielle Fox - Merrill Lynch

You don’t see anything as having changed in the underlying cost structure that would prevent you from returning to those levels, given that you did need to step up the P&L investing beginning in the second half of ’06?

Frank Blake

No, I would say 11.8 is a long ways away, but we think there is significant improvement from where we are.

Danielle Fox - Merrill Lynch

Okay. Thank you.

Operator

Next we’ll go to Gregory Melich at Morgan Stanley.