Home Depot Inc (HD) — Q1 2016 Earnings Call Transcript

Thank you, and good morning to everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, EVP of Merchandising; and Carol Tomé, 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 the participants would limit themselves to one question with one follow-up, please. If we are unable to get to your question during the call, please call the Investor Relations department at 770-384-2387. Now before I turn the call over to Craig, 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 that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today’s presentations may also include certain non-GAAP measurements. Reconciliation of these measurements is provided on our website. Now, let me turn the call to Craig.

Thank you, Diane, and good morning everyone. Sales for the first quarter were 22.8 billion, up 9% from last year. Comp sales were up 6.5% from last year, and our US Stores had a positive comp of 7.4%. Diluted earnings per share were $1.44 in the first quarter. We are pleased with the start of the year. In the US, all three of our divisions posted positive comps in the first quarter, led by our southern division. And all 19 US regions and top 40 markets saw single to low double-digit comps in the quarter. Internationally, our Mexican and Canadian businesses had another quarter of solid performance. Mexico reported positive double-digit comps in local currency, making it the 50th consecutive quarter of positive comp growth. Our Canadian business also posted mid-single digit comps in local currency for a total of 18 consecutive quarters of positive comp growth. While weather had somewhat of a positive impact on our business and certainly drove variability in demand, the first quarter was not an early spring story; it was an execution in the core of the store story. We continue to see broad-based growth across our stores, as both ticket and transactions grew in the quarter. All of our merchandising departments posted positive comps, and we saw a healthy balance of growth among both our Pro and DIY categories, with Pro outpacing our DIY business in the US. As Ted will detail, our customers continue to respond positively to our deep assortment of trusted brands, as we are the product authority for both our Pro and DIY customers. The Interline integration is progressing nicely. We continue to move forward on a number of exciting sales-driven initiatives, and we have outlined a path to truly realize the value of the Interline acquisition and the total Pro opportunity over the next 18 to 24 months. We also continue to believe that blending the physical and digital channels into a seamless customer experience, which we call interconnected retail, provides a unique opportunity for us to expose the power of the Home Depot. This has been and will continue to be one of the central tenets of our company strategy, and we will remain committed to investments in our interconnected capabilities. For the quarter, online traffic growth was double-digits, and our online sales grew 21.5%. Investing in interconnected capabilities goes beyond our dotcom business, as we are also continuing to further invest to more effectively meet customers’ demands for increased fulfillment options. The rollout of COM, our new customer order management system, is on track to be fully deployed in our US stores before year-end. Following behind the COM rollout is the implementation of BODFS or Buy Online Deliver From Store. In certain markets where BODFS has been introduced, the demand has been much stronger than we anticipated. This is a good problem to have, but it is challenging delivery capacity, which we’re working to address. We still expect BODFS to be fully rolled out by the end of the fiscal year. For the spring season, we are focused on further connecting our in-store and online experiences. We offered a more expanded assortment of spring seasonal products online. We also leveraged our digital assets to more effectively target customers with personalized messages pertaining to relevant products and special buys. Additionally, we used digital media to highlight local in-store assortments to drive foot traffic to our stores. To ensure our stores were properly staffed for the busy spring selling season, we hired over 80,000 associates to meet the demand of these increased footsteps. We continue to see great productivity from our supply chain. The flexibility and nimbleness of our supply chain was especially evident in the quarter as we navigated spikes in demand without sacrificing in-stock levels. We continue to see dividends from investments made in our supply chain in our in-stocks, inventory productivity, logistics cost, and service to our stores and customers. Our BOSS via RDC capability, which enables us to fulfill Buy Online, Ship to Store orders through our RDC network, leverages both our inventory and our fulfillment channels. The cost savings of this initiative have been above our expectations and both our ship times and customer satisfaction scores continue to improve. We’ve made great strides with our supply chain over the past several years, and we continue to optimize our network with initiatives like supply chain Sync. While Sync is in its early days of a multi-year rollout, we are pleased with our initial results. Though it is early in the year, our view of the macro environment remains consistent. We believe that housing data indicates continued tailwinds for our business. As Carol will detail, because of our outperformance in the first quarter versus our plan, we are increasing our sales and earnings per share guidance for the year. We now expect fiscal 2016 sales growth of approximately 6.3% and diluted earnings per share of $6.27. Today we have over 400,000 associates, and I want to close by thanking them for their hard work and dedication to our customers. In addition to serving our customers in our stores through Team Depot, our associate-led volunteer force, our associates donated their personal time to complete more than a thousand projects and serve our local communities over the past 12 months. And with that, let me turn the call over to Ted.

Thanks, Craig, and good morning everyone. We had a strong first quarter, driven by continued strength across the store, particularly with our Pro customers, and an unseasonably warm February was followed by a more normal but wetter March and April. While weather positively impacted our sales performance in the first quarter, spring has not yet arrived in many of our markets. In the first quarter, total comp transactions grew by 4%, while comp average ticket increased by 2.5%. Our average ticket increase was somewhat impacted by commodity price deflation, mainly from lumber and copper. The total impact to ticket growth from commodity price deflation was approximately 15 basis points. Transactions for tickets under $50, representing approximately 20% of our US sales, were up 2.7% in the first quarter. Transactions for tickets over $900, also representing approximately 20% of our US sales, were up 9.5% in the first quarter. The drivers behind the increase in big ticket purchases were appliances, roofing, sheds, and windows, all of which had double-digit comps. The departments that outperformed the company’s average comp included appliances, tools, building materials, lumber, lighting, hardware, millwork, and décor. Electrical, paint, flooring, indoor garden, kitchen and bath, plumbing, and outdoor garden had positive comps but were below the company average. Pro-heavy categories continue to show great strength, as we saw double-digit comps in fencing, pressure-treated decking, boards, fasteners, doors, and conduit. In addition, the core of the store continues to perform well, and we saw strength in maintenance and repair categories across the country. Tool storage, commercial and industrial lighting, portable power, power tool accessories, hand tools, and wiring devices had double-digit comps in the quarter. Our store associates did a great job executing our 8th Annual Spring Black Friday event and creating excitement in our stores. In particular, special buys around appliances, outdoor power, and hardscapes were well received by our customers, resulting in double-digit comps in those categories. As Craig mentioned, the Home Depot is the product authority for both our professional and DIY customers. We have the deepest assortment of the leading programs in the marketplace. Many of these brands represent billion-dollar categories for us. Our pros recognize our brand advantage, and Pro sales outpaced the company average in the first quarter. We continue to use detailed analytics to help us balance the art and science of retail. In marketing, we maintain our best-in-class creative and we are also optimizing our ad effectiveness with targeted digital marketing. We remain focused on leveraging customer data to build the right message at the right time for the right customer. As we’ve made strategic moves away from print and mass marketing to more targeted digital marketing, we have seen great results. Since 2010, our return on advertising spend has nearly doubled. Now let me turn our attention to the second quarter. We continue to be the leader in the marketplace for innovation and value that saves our customers both time and money. To maintain the momentum in our double-digit comp in the pneumatics category, we are introducing the new Milwaukee Pneumatic Framing Nailer, which is the latest addition to the M18 FUEL lineup. This high-powered nailer is much faster than competing battery-powered nailers, saving our Pros time on the job site. And new from Duval is the 20 volt Max Brushless Finish Nailer. This compact and lightweight finish nailer has innovative features including depth adjustments and multi-functional LED lights to illuminate workpieces. These are great examples of innovative and exclusive products from trusted, best-in-class Pro brands. For our DIY customers, we are excited about the new exclusive launch of Pergo Outlast Plus Laminate Flooring. This easy-to-install laminate is water-resistant and uses SpillProtect24 technology, a proprietary coating that prevents water from seeping into the floor. Outlast Plus Flooring allows customers to install laminate flooring in high-traffic and water-prone areas such as kitchens, bathrooms, and mudrooms. In addition to all the great new products, we are excited about our upcoming events. Our Thrill of the Grill, Memorial Day, Father's Day, and 4th of July events are right around the corner, and we have an incredible line of great values and special buys that help our customers enjoy this outdoor season.

Thank you, Ted, and good morning everyone. In the first quarter, sales were $22.8 billion, a 9% increase from last year, driven primarily by positive comp sales as well as the impact of Interline Brands. Versus last year, a stronger US dollar negatively impacted total sales growth by approximately $196 million or 0.9%. Our total company comps, or same-store sales, were positive 6.5% for the quarter, with positive comps of 10.2% in February, 6.7% in March, and 4.3% in April. Comps for US stores were positive 7.4% for the quarter, with positive comps of 11.8% in February, 7.7% in March, and 4.6% in April. We estimate that weather-driven demand positively impacted our US sales growth by approximately $250 million. The variability in our comp sales performance during the quarter was due in large part to weather and to the timing of Easter this year versus last year. Our total company gross margin was 34.2% for the quarter, a decrease of 13 basis points from last year. The change in our gross margin is explained largely by the following factors; first, as expected, we had 25 basis points of gross margin contraction due to the impact of Interline. Second, we had 12 basis points of gross margin expansion in our supply chain, driven by lower fuel costs and increased productivity. For fiscal 2016, we continue to expect our gross margin rate to be about the same as what we reported in fiscal 2015. In the first quarter, operating expense as a percent of sales decreased by 122 basis points to 20.7%. Our expense leverage reflects the impact of positive comp sales growth along with great expense control. For the year, we now expect our expenses to grow at approximately 35% of our sales growth rate. Our operating margin for the quarter was 13.5%, an increase of 109 basis points from last year. Interest and other expenses for the first quarter were $237 million, up $44 million from last year, due primarily to higher long-term debt balances. In the first quarter, our effective tax rate was 36.5% compared to 34.3% in the first quarter of fiscal 2015. Recall that the effective tax rate in the first quarter of last year was favorably impacted by the settlement of a tax audit. For fiscal 2016, we expect our income tax provision rate to be approximately 37%. Our diluted earnings per share for the first quarter were $1.44, an increase of 19% from last year. Now moving to some additional highlights; during the first quarter, we opened one new store in Mexico and we ended the quarter with a store count of 2275, and selling square footage of 237 million. Total sales per square foot for the first quarter was $377, up 6.5% from last year. Now turning to the balance sheet, at the end of the quarter, inventory was $13.2 billion, up $913 million from last year, reflecting both the impact of Interline and the seasonality of our business. Inventory turns were 4.8 times, up one-tenth from the first quarter of last year. In the first quarter, we repurchased $1.25 billion or approximately 9.45 million shares of outstanding stock. For the remainder of the fiscal year, we intend to repurchase approximately $3.75 billion of outstanding stock using excess cash, bringing total anticipated 2016 share repurchases to $5 billion. Computing on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital was 29.2%, 300 basis points higher than the first quarter of fiscal 2015. Now turning our attention to the full year, while US GDP forecasts have pulled back slightly since we built our 2016 sales plan, we continue to see strength in the housing market, with home price appreciation, housing turnover, and household formation trending where we thought they would. Sales in the first quarter exceeded our expectations, not just because of favorable weather, but because of higher demand for many of our core product categories. While we ordinarily don’t raise our sales growth guidance so early in the year, we are going to roll forward some of our first quarter outperformance, given the underlying strength of the business. Further, the US dollar has weakened such that the current spot rate of exchange is now in line with the foreign exchange rates we used to build our plan. Because of this, we are going to a single-point estimate instead of a range for our 2016 guidance. From the high end of the guidance range we provided in February, today we are raising our sales and earnings per share growth guidance. We now expect our 2016 sales to grow by approximately 6.3% with comps of approximately 4.9%. For earnings per share, remember that we guide out of GAAP. We now expect fiscal 2016 diluted earnings per share to grow approximately 14.8% to $6.27. We thank you for your participation in today’s call. And Derek, we are now ready for questions.

In aggregate, it seems like weather did help the quarter, and you talked about $250 million or so; can you elaborate on where you saw that benefit, and if that means you actually pulled some sales forward, or do you think that’s just incremental?

So obviously, with a warm February, we had a great start to the year, and we saw outdoor project business in the north very strong. The $250 million that we’ve estimated, that is - it’s kind of hard to understand exactly how much of that is pull forward, but that’s - what we’re estimating is the demand that we saw from the weather benefit. We think there is about $40 million or so in seasonal products pulled forward.

And the rest of the outperformance was in building material categories like concrete and pressure-treated lumber, and so on and so forth. That really is weather-driven demand.

And just a follow-up there, does that $250 million consider that spring weather hasn’t arrived in some markets as you alluded to, and would that be factored into that number?

That’s right. We think we pulled forward two spring-related categories - about $40 million to $50 million. And as you know, I don't know what you’re saying, Seth, but as you know, in certain parts of the country spring has not yet arrived, so we’re still anticipating a bang-up spring quarter.

And just one follow-up on the Pro initiatives here, the extension of credit earlier in the quarter. Can you just talk about how that’s going and how incremental to the number this quarter that may have been?

Yes, we’re very pleased with the new value proposition that we are offering on our private label card for our Pros. You’ll recall that we are now offering 60 days to pay, 365-day return, and discounts at the fuel pump. What we’re seeing with our Pros is great receptivity; new accounts are ahead of our sales plan, which is great news. But Seth, remember that we just rolled this out to all stores in January, so there was no measurable impact to the topline because of this, but we anticipate that to come.

Just want to clarify something, when we used the word pull forward, and if we take the $40 million out, that was seasonal. Just thinking about the other part that was pulled forward, maybe other projects getting done a little earlier; do we know statistically one to three months pull forward? These are projects that presumably could get done in other parts of the year. And where I’m going is trying to think about how that could impact the second quarter versus others later in the year.

Well here’s how we’ve looked at this: we think there was about $250 million of weather-driven demand. It’s not all seasonal pull forward; this is just activity because of great weather earlier in the quarter, and we’re not rolling that forward because we anticipated that these were projects that would be completed later in the year and just got done earlier in the year. So we’re not rolling that forward. It will bleed into Q2, Q3, maybe even Q4.

To your point, if somebody was doing a concrete project, but maybe they had planned for the summer and they said, hey, look, the ground's not frozen in the north, I can do it now, and they do it. It’s hard to tell which quarters it’s come from, but it’s certainly probably the next couple of quarters.

As we think about the shape of the year, and this might help for modeling, we now think that the first quarter will be the highest comping quarter, as a result the first half will be slightly higher than the back half of the year, and if you look at the comps that we are projecting for Q2, Q3, and Q4, we expect them to be in a similar range, not a lot of difference in those comp numbers.

That’s helpful. My follow-up on the online business, I think you mentioned growth of about 21.5%; anything different about the pickup in store percentage that changed, and then your comments on the delivery strain maybe from delivering from store; is that because Home Depot is offering the customer the option of where they want the product from, or is that your system that’s choosing to deliver from store?

First of all, a comment: the percentage of pickup is around 40%, where the customer is choosing the option to pick up their items from HomeDepot.com in our stores. And as it relates to the delivery, we have piloted the delivery program for a while. We saw mid-single digit growth in deliveries with the pilot; when we went into additional markets, markets like Atlanta for example, we saw a pretty substantial increase in the customer option to choose that delivery, and we’re seeing double-digit growth in deliveries.

Carol, as you mentioned, it’s not typical for the company to raise its guidance after the first quarter, and you have seen strong first quarters in the past. So what’s different about what you’re witnessing in the business right now that inspires so much confidence for you to move estimates higher?

It’s really the strength across the store, and as you know when we build our sales plan, we use our directionally correct but imperfect sales forecasting model, which is an economic driven model. We do not build market share gains into our forecast. As we look at the performance in the first quarter, clearly there were some share shifts. Look at appliances; Ted called it out, appliances contributed 50 basis points of our comp growth in the first quarter. So we are confident with what we saw in the first quarter and what we’re seeing early in May to roll forward the outperformance of the first quarter.

So you mentioned GDP forecasts are a little lower; housing is about where you thought it was. So what’s changed is you’re gaining a little bit more market share than you originally thought?

We don’t plan market share, as you know, so we believe there were share shifts and that was confirmed by NAICS data that came out that shows that from a census perspective anyway we did grow share. The other thing that we must look at is housing, and just from all sorts of things that are happening within the housing market that we haven’t built into our plan but we find to be of interest. Here’s the statistic; we’ve seen home equity values increase 94% since 2011. How is that possible? Because home prices are up 25% and people have continued to pay down their mortgages. So there’s a wealth effect that’s occurring with homeowners. And this wealth effect, as we’ve talked at length, if you feel like your home is an investment and not an expense, you spend differently in your home, and you can see the impact in our big ticket categories.

And then my follow-up question is on the expense outlook. You’re now expecting expenses to grow at 35% of the sales growth. Is that all due to what happened in the first quarter, or do you expect there to be some expense improvements in the remainder of the year?

Well despite the outperforming plan considerably in the first quarter, our total expenses were actually $13 million under our plan. That was driven by lower utilities, as you would expect because of warmer weather in February, but also we’re not seeing the kind of pressure on medical costs as we had anticipated. So now for the full year, we anticipate that our expenses will be lower than our original plan, which is helping to tick our expense growth faster down from what we have said at 40% to now 35%.

I wanted to follow up on the other question that was just asked. Just given some of the earnings that we’ve seen so far for Q1, the health of the US consumer I think is being called into question somewhat. So I wondered if you could, beyond what you’ve already mentioned, just talk about the DIY business and if there’s any read through there to the overall take of the consumer, and just how much of the outperformance of Pro versus DIY is driven versus maybe the housing statistics versus your initiatives?

I would say that when you look at the strength of the business, it really comes across the board. We’re really pleased with the mix of both transactions and ticket growth that we had; it’s something we look for in terms of balancing the business. We see the consumer continuing to engage in big ticket sales with transactions above $900, growing at 9.5% in the quarter. So while our Pro business was strong, and we’re pleased to see that, we’re also very pleased to see the growth in our DIY business. So the balance is really what we’re striving to achieve and we’re seeing that balance across the store.

And again I go back to the housing data; the housing data suggests that homeowners still perceive they have more value than they did before. Look at negative equity; homes with negative equity have dropped from 22% at the beginning of 2012 to now 8.5%.

It pretty much is almost everything we sell, whether it’s online or in-store, that will be eligible for delivery, and we’ll leverage the supply chain network that we’ve built out to do that in the most cost-effective way using our RDCs as flow-through points for products that will come from our distribution points that a customer chooses to have delivered, so definitely a broad approach to the assortment that we carry.

I just wanted to go back to the Buy Online and Deliver From Store economics, trying to understand it a little bit more. Our research has suggested, particularly the pro-customers, really want to do that. They don’t really necessarily want to pick up in-store. I was just wondering, looking at the uptake exceeding expectations, what are the margins attached to that business?

First, I would say that in our business, we have a lot of project business. We have a lot of things that are big and bulky, and so that’s why in many ways we’re seeing a significant portion of our customers choose to pick up their products in-store and then potentially have it delivered from the store. We also have Pros who are interested in having the product delivered from store to their job sites. It saves them time; it saves the runners from having to come into the stores overall. And then candidly, we’ve been doing delivery from store for quite some time, for years, and that’s just part of the overall operating cost of doing the business, and so we approach that on a day-in, day-out basis as part of operating the business and our value proposition for the customer across products takes on a new account.

So refresh my memory, do you guys charge for that or is that not charged for?

Yes, we do. We charge for it, and there are options for tighter windows where a premium is paid.

Sure. Our private label credit card is underwritten by a third party, and I’ll do some averages and talk to you about outliers. So for our commercial customers, these would be our Pros, the average line of credit is $6,600, which seems to adequately meet their needs, but we do have some higher spend Pros. So the third-party underwriter will extend larger lines, and we have six established lines for many of our customers who ask for those lines. Furthermore, if there is a situation where the credit lines tighten up a bit, we have a second look program with another third-party provider that will take a second look at the request and raise the line of credit. So we have a number of tools in our toolkit to adequately provide the financing requirements of our Pros. The biggest tool is moving to 60 days because if you think about it, we’re providing working capital support for them. They are going to get paid by their customers before they have to pay us back.

And I think you said there are some six-figure amounts out there. With the mix of the business, are you anticipating that $6,600 that you referenced going up meaningfully, and would you guys ever think of taking some of this on your own balance sheet or no?

We’ll let the customers take us where they take us. We want to grow the Pro, and if they need more credit, we’re happy to support them in that effort. In terms of taking it on our balance sheet, we love the arrangement that we have with our third-party underwriter today.

Wanted to just, at the risk of beating a dead horse so to speak, follow up on California and the oil markets. We’ve seen someone like Costco see some variability in California, and they sell a lot of food, so it was a bit surprising to us. Are you seeing anything different in those markets that alerts you or causes any concern?

No, overall we’re really not, and the area that we watch most closely is Texas. We have 178 stores in Texas. Texas absolutely outperformed the company average in the quarter. I think all major markets in Texas outperformed well. Texas clearly has diversified their economy more so over the past few years, which I think is a benefit. Clearly, in western Canada, we saw some pressure, as you might imagine; not quite as diversified environment there. So we haven’t really seen any major shift.

Actually in California, Governor Brown just released some water restructuring, so we think that would be a good mark for our growing business. So our California business is doing quite well. We did have a pop-up store in North Dakota; we popped it up during the height of the fracking days. Chris, we’re popping that store down.

It’s a big pop-up.

That’s about the impact really.

Understood, and can you talk about any research that you’ve done around millennials and household formation? Are they coming to form households now? Do you think they will act like Gen X did before them, and how do you think it impacts the long-term outlook of the box and the online business?

We actually have done a fair amount of research here, and it was part of our strategic planning last summer, where we had several groups of millennials work on what Home Depot looks like 8 to 10 years out as well. What our research tells us is that basically this is a delayed cycle, that the millennial generation has many of the same desires that generations prior to them have. We’ve seen household formation go up; roughly a third or so of those formations are happening with millennials at the tail end of that age group. It appears there’s about a six-year delayed cycle here. But our research indicates that in many ways they’ll act the same as previous generations.

Yeah, the average age of new home buyers last year was 33 years old; that’s the edge of the millennials. So that’s another proof of age that at some point they want to own a home.

Just one or two, maybe even three follow-ups. One, just to clarify on the guidance: are you raising the full year guidance because of currency being less burdensome and what you saw in the first quarter? Are you also changing and raising the second, third, or fourth-quarter guidance, or is all the increase just because of what we saw in the first quarter and currency?

Mike, the increase is solely related to the outperformance in the United States. The reason that we are no longer providing a range is that the exchange rate that we use for our plans is now about the same as the current spot rate. So no need to provide a range, but we’re just rolling forward our performance except for weather-driven demand. We are rolling over the rest of the outperformance.

So no real change in how you would have thought about the second, third, and fourth quarters?

That’s right.

Two others; one, Easter: so if I understand it, so Easter hurt March, helped April; that’s because people don’t really shop on Easter. But I would’ve thought that would have been outweighed by people shopping before Easter to do some outdoor projects, but that’s not the case. Easter hurts March and it helped April to shift; did I understand that correctly?

Easter is not a big selling day for the Home Depot.

But again, the sales around Easter don’t offset that, I suppose?

No, they don’t.

Well, thank you for joining us on our call today, and we look forward to discussing quarter earnings results in August.