The Home Depot, Inc. (HD) Q2 2016 Earnings Report, Transcript and Summary

Good day everyone and welcome to The Home Depot Q2 '16 Earnings Call. Today’s conference is being recorded. [Operator Instructions]. At this time, I'd like to turn the conference over to Ms. Diane Dayhoff, Vice President, Investor Relations. Please go ahead.

Thank you, Shirlone, 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'd 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 our 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 measures. Reconciliation of these measures is provided on our Web site. Now, let me turn the call over to Craig.

Thank you, Diane, and good morning everyone. We had a solid quarter achieving a milestone of the highest quarterly sales and earnings results in Company history. Sales for the second quarter were $26.5 billion, up 6.6% from last year. Comp sales were up 4.7% from last year and our U.S stores had a positive comp of 5.4%. Diluted earnings per share were $1.97 in the second quarter, up 13.9% versus last year. In the U.S., all three of our divisions posted positive comps in the second quarter led by our Western division. In all 19 U.S regions and top 40 markets saw single to 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 51 consecutive quarters of positive comp growth. Our Canadian business also posted positive comps in local currency for a total of 19 consecutive quarters of positive comp growth. We continue to see broad-based growth across our stores both ticket and transactions grew. 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 sales outpacing our DIY business in the U.S. The Interline integration is progressing as we continue to deliver on the acquisitions of value drivers. We’ve been piloting our first business use case offering Interline's catalog of products to Pros shopping Home Depot stores. We are pleased with the traction that we've seen in this pilot although it is still early days. We continue to work towards leveraging Interline's capabilities to expand our share of wallet with our current customers, as well as gain new customers. Our online business had sales growth of approximately 19% versus last year and represented 5.6% of total sales. As Ted will detail, we continue to leverage our merchandising tools to refine product offerings across channels based on customer preferences. Our goal is to provide our customers with the convenient and fulfillment options they desire. We continue to build our capabilities to improve the overall customer experience. For example, in recent months we began implementing our dynamic ETA feature for online purchases. Dynamic ETA provides a delivery date based on the customer's location. In the past, we issued a generic delivery window estimate, which allowed for extra time or cushion for the delivery commitment to customers. As we’ve begun to implement the dynamic ETA, our promised delivery date to customers is earlier and more accurately estimated. As a result, we're seeing an increased conversion in customer satisfaction. We continue to see great productivity from our supply chain as the dividends from investments made over the past several years yield a positive impact on our inventory productivity, logistics costs, and service to our stores and customers. As you know, we see our supply chain transformation as an ongoing work in progress and continue to optimize our network with initiatives like supply-chain Sync. Sync is in the early stages of a multiyear rollout. We're investing to more effectively meet our customer's demands. The rollout of COMS, our new Customer Order Management System, is now fully deployed in all U.S stores. The next phase of COM is to optimize and fine-tune this new system. Following behind COM is the rollout of BODFS or Buy Online Deliver From Store, which we expect to be completed by the end of the fiscal year. While we had a strong quarter, as you've heard we're instituting a high degree of change across many areas of the business. With this amount of change there will be learnings and opportunities to refine the process along the way. In the quarter, we identified several opportunities for improvement, particularly, around inventory management and freight handling, which we're working to address. Turning to the macro environment, we continue to see positive signs in the housing data, which we believe serve as a tailwind for our business. As Carol will detail, we are reaffirming our sales guidance and increasing our earnings per share guidance for the year to reflect our outperformance this quarter and our outlook for the remainder of the year. A successful spring season depends on the hard work and dedication of the 400,000 plus associates we have serving our customers today. I want to close by thanking them. Based on the first half results, almost 100% of our stores qualified for success, sharing, our profit-sharing program for our hourly associates. We are very proud of their efforts. And with that, let me turn the call over to Ted.

Thanks, Craig, and good morning everyone. We were pleased with our results in the second quarter. Core maintenance and repair categories, as well as many Pro heavy categories continue to have solid performance in the quarter. Our growth in the quarter was balanced. Total comp transactions grew by 2.2% for the quarter, while comp average ticket increased 2.5%. Ticket growth was driven by an increase in items per basket as project business continued to show strength. Our average ticket was also positively impacted from slight commodity price inflation, mainly from building materials and lumber. The total impact to ticket growth from commodity price inflation was approximately 18 basis points. In addition, the stronger U.S dollar had a negative impact to our average ticket growth with approximately 69 basis points. Focusing on big ticket sales in the second quarter, transactions for tickets over $900 representing approximately 20% of our U.S sales were up 8.1%. The drivers behind the increasing big ticket purchases for HVAC, appliances, and roofing. All merchandising departments posted positive comps led by appliances, which had double-digit comps in the quarter. Tools, lumber, plumbing, décor, indoor garden, building materials, and lighting were above the Company's average comp. Hardware, outdoor garden, kitchen, bath, millwork, electrical, paint and flooring were positive, but below the Company average. As Craig mentioned, we continue to see notable strength with our Pro customers. Pro sales grew faster than the Company comp, led by our high spend Pro customers. This continued strength led to comps above the Company average in commercial, industrial lighting, fencing, power tools, power tool accessories, wiring devices and interior doors. We saw continued strength in the core of the store, as our customers undertook various projects. For example, landscape lighting, laminate, and vinyl flooring, garage organizations and cleaning had strong comps for the quarter. Widespread and record setting heat in the quarter drove strong performance in HVAC, air conditioning, fans, and air circulation. Sales were also strong in categories like irrigation and watering still over double-digit comps. Our store associates did an exceptional job executing our summer events and creating excitement in our stores. Our Memorial Day, Father's Day, and Fourth of July events provided excellent value and we saw strong demand from our customers. These events help drive robust comps in appliances, tool storage, outdoor power, and grills. In our ongoing effort to update and refresh our assortments, we continually leverage our merchandising tools to fine tune our online and in store assortments. One specific example of this is with our Patio offering. We found that many customers want to come into our stores to purchase and pick up their Patio Sets. We altered our assortment and put certain Patio Sets back into the store. This strategic move was well-received by our customers, leading to record sales and sell-through in our stores. Our online business had strong growth in the quarter with double-digit traffic growth and improvement in conversion. Our interconnected retail initiatives continue to evolve to meet the changing demands of our customers. Mobile and tablet are over 50% of our traffic and are important tools that our customers use to engage with our products, our stores and our associates. We are enhancing the functionality in mobile with features like larger and clear product images, live mobile chat, and a simplified checkout experience. As evidence of the success of our interconnected strategy, approximately 42% of our online orders are now leveraging our store footprint for fulfillment and nearly 90% of our online product returns are processed through the convenience of our stores. Now let's turn our attention to the third quarter. Our focus on innovation is a key part of our strategy. For our Pro customers we will be introducing the DEWALT FLEXVOLT system in our stores this fall. This DEWALT system uses the innovative FLEXVOLT battery, which identifies various types of DEWALT tools and adjust voltage to provide the appropriate level of power needed. These products provide corded performance without the code and the innovative brushless motors increase tool runtime and durability, saving our Pros time and money on their job sites. Among big box retailers, the DEWALT FLEXVOLT system can only be found at the Home Depot. As smart devices continue to resonate with customers, we're excited about expanding smart technology with the new Ryobi garage door opener. This innovative system connects with any smart device and allows our customers to operate the garage door remotely, talk on the phone or play music through an embedded Bluetooth speaker or park with ease using the laser park assist attachment. The new exclusive Ryobi garage door opener can only be found at the Home Depot. The fall season and cooler temperatures are just around the corner and we have an incredible line up of great values and special buys for our customers during our Labor Day, fall cleanup and Halloween harvest events. With the Halloween harvest season we’ve a tremendous amount of new seasonal products like the exclusive animated window projector kit, which allows our customers to easily decorate their windows with animated digital holiday clips. This is the first digital decoration in the marketplace and it is exclusive to the Home Depot. Our exciting third quarter events along with outstanding execution in stores will position us for success in the third quarter. With that, I’d like to turn the call over to Carol.

Thank you, Ted, and hello, everyone. Before I review our results, I’d like to remind you that our net earnings for the second quarter of 2015 included a pre-tax net expense of $92 million related to our 2014 data breach and a $144 million pre-tax gain on sale of HD supply common stock. When added together these two items contributed $0.02 of diluted earnings per share last year that did not repeat this year. So with that, let’s get started. In the second quarter, sales were $26.5 billion, a 6.6% increase from last year driven primarily by positive comp sales, as well as the impact of Interline brand versus last year a stronger U.S dollar negatively impacted total sales growth by approximately $181 million or 0.7%. Our total Company comp store same-store sales were positive 4.7% for the quarter with positive comps of 2.3% in May, 7.5% in June and 4.5% in July. Comps for U.S stores were positive 5.4% for the quarter with positive comps of 3% in May, 8.4% in June and 5% in July. Our monthly comp sales were a bit distorted by the timing of Memorial Day. Last year Memorial Day sales were included in our May results and this year they were included in our June results. Adjusting for this timing shift, our U.S comps would have been 4.3% in May, 7% in June, and 5% in July. Our total Company gross margin was 33.7% for the quarter, an increase of 3 basis points from last year. The change in our gross margin is explained largely by the following factors. First, as expected, we had 22 basis points of gross margin contraction due to the impact of Interline. Second, we had 13 basis points of gross margin expansion in our supply chain driven primarily by increased productivity and by lower fuel costs. And finally, we had 12 basis points of gross margin expansion due primarily to reaching higher co-op and rebate tiers in certain category classes, which lowered our costs. 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 second quarter, operating expense as a percent of sales decreased by 78 basis points to 18.2%. As I mentioned, our expenses in 2015 included $92 million of net data breach related expenses that did not repeat in 2016. In the quarter, we were pleased with our expense performance, as total expenses were under our plan. Due to our continued focus on expense control, we now believe that our fiscal 2016 expenses will grow at approximately 32% of our fiscal 2016 sales growth rates. Our operating margin for the quarter was 15.5%, an increase of 81 basis points from last year. Interest and other expense for the second quarter was $228 million, up $144 million from last year reflecting last year's pre-tax gain on sale of HD supply common stock that did not repeat this year. In the second quarter, our effective tax rate was 37% compared to 37.3% in the second quarter of fiscal 2015. For fiscal 2016, we expect our income tax provision rate to be approximately 37%. Our diluted earnings per share for the second quarter were $1.97, an increase of 13.9% from last year. Now turning to the balance sheet. At the end of the quarter, inventory was $12.3 billion, up $464 million from last year due primarily to the impact of Interline. Inventory turns were 5.2x, up 1/10 from the second quarter of last year. Year-over-year accounts payable increased by $778 million to $8.3 billion reflecting the timing of purchases and the impact of Interline. In the second quarter, we repurchased $1.25 billion or approximately 9.46 million shares of outstanding stock. For the remainder of the fiscal year, we intend to repurchase approximately $2.5 billion of outstanding stock using excess cash bringing total anticipated 2016 share repurchases to $5 billion. Computed on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital was 29%, 400 basis points higher than the second quarter of fiscal 2015. Now turning our attention to the full-year. Recent GDP growth estimate suggests a slowdown in the U.S economy from what we expected. But we are encouraged by the strength of our core business as the U.S housing market continues to recover. Based on our first half performance and our outlook for the balance of the year, we are reaffirming the sales growth guidance we laid out at the end of our first quarter. For fiscal 2016, we expect sales to grow by approximately 6.3% with comps of approximately 4.9%. Implied with this guidance is the comp for the second half of fiscal 2016 of approximately 4.3%. This is not a reflection of the sequential slowdown in sales, but rather a reflection of year-over-year performance. On a two-year stack basis, we expect our comps in the back half of the year to be about the same as what we reported for the first half of the year. While we are reaffirming our sales growth guidance, we are lifting our earnings per share growth guidance for the year principally because of better expense control and therefore more operating leverage than we anticipated at the end of the first quarter. For earnings per share, remember that we guide off of GAAP. We now expect fiscal 2016 diluted earnings per share to grow by approximately 15.6% to $6.31. So we thank you for your participation in today's call. And Shirlone, we are now ready for questions.

[Operator Instructions] We will have our first question from Simeon Gutman with Morgan Stanley.

Thanks. Good morning. There was a lot of noise it sounds like in the early part of the quarter with weather and some Memorial Day shift. Do you -- was there any, I don’t know if it's possible to measure this, but do you think there was some degree of demand destruction that you didn’t pick up, granted June, July improved. But I’m trying to get a sense if you think underlying demand could actually be stronger than it looks?

I think, there is no doubt to your point that May result was a tough start. When you look at variability in the quarter month-to-month compared to a year-ago, we had higher variability and part of that was clearly driven by weather. An example would be in Washington DC alone there were 20 days of rain in the month of May. So it's hard to tell, but clearly we know there was an impact.

Okay. And then, my follow-up, I mean there is a lot of noise in retail across many segments. You mentioned that the housing or housing outlook is fine. I know this seems obvious, but can you maybe just talk about what gives you confidence in it? Is it the Pro growth, is it the type of projects, I’m sure it's all the above, but I would love to hear just some color on that topic?

So clearly when we look at housing, things that we focus on our own value appreciation which continues to grow, we look at housing turnover which is kind of running that norms, a little north of 4% of the housing stock is projected to turn in fiscal 2016. And then we look at new household formations and all of those are drivers in our business and all those continue to recover.

But I'd say what gives us confidence is strengthen the big ticket as Ted called out another outstanding quarter in our big ticket categories. As Ted also called out, the growth in the quarter was balanced between ticket and transactions and part of the ticket growth was item in the basket growth. And that tells us that the project business is alive and well. And then finally we look at the strength in Pro and our Pro business outpaced our DIY business. So when you couple just the trends that we see in our existing business coupled with what we see in housing, it gives us confidence for the back half of the year.

Okay. Thanks.

We will go next to Kate McShane, Citi Research.

Hi. Thank you for taking my question. This might sound a little nitpicky, so I apologize, but I just had noticed in your prepared comments that you had mentioned that kitchen specifically was below the Company average comp. And I was just trying to reconcile the strength that you saw in Pro during the quarter versus some of this merchandise commentary and what you are seeing more specifically in terms of what is driving that Pro business in Q2?

Well, our overall kitchen business did comp positively. The special order kitchens are not as much of a Pro category. The take with kitchens, our in stock kitchen business is more the Pro business and that in fact was a stronger comp than the special order.

You’d expect to see some seasonality in our kitchen business. People are on vacation during the summer time, putting a new kitchen into your home isn't really top of your mind. We expect the kitchen business to come back in the fall time, because it typically does.

Thank you.

We will go next to John Baugh, Stifel.

Thank you. Congratulations on a strong quarter. I was just curious on payables which were quite strong. You mentioned timing. If you could just talk about the sustainability of that number in the second half and whether your free cash flow assumptions have changed at all for the year? Thank you.

Hey, John. The payables performance at the end of the third quarter was a reflection of increased purchases. Craig commented in his remarks that we had some learnings during the quarter and one of those learnings was actually we had an error in our order logic that we use for inventory purchases. And so we corrected that error and have corrected it and actually sent purchases to our suppliers, so that is just the timing matter. It will normalize itself by the end of the year. So this isn't a consistent trend.

Great. Thank you.

Yes.

Yes.

We will go next to Christopher Horvers with JPMorgan.

Thanks. Good morning.

Good morning.

I wanted to talk about inventories a little bit. We’ve heard a number of vendors talk about inventory destocking at retail, orders down in the second quarter. Is that process largely behind The Home Depot? Does it in any way reflect a less robust outlook for the market? And I know, Craig, you mentioned learnings and process improvement around inventory management and freight handling. Did that have any impact in terms of what we heard from the vendor community?

Hey Chris, as Carol just mentioned, one of the learnings this quarter was in fact that we did have an error in an update logic that we put into our replenishment. We identified that, corrected it, and that clearly did have an impact on the order flow that happened during the quarter that has been corrected moving forward.

Okay. And just thinking about the weather and thinking about the first half in the upcoming fourth quarter, in retrospect now that you are further along, could you reassess the amount of pull forward and the bathtub effect between the first quarter and the second quarter? And as you think about lapping this upcoming fourth quarter, I think a lot of investors are talking about, hey, you know, The Home Depot really benefited from a warm winter. What’s your thoughts on that and do you think the fourth quarter in effect pulled forward demand from the first half of this year?

Yes. It's really, really hard to gauge that. Clearly as we called out in the first quarter, we felt that there was some pull forward. It's really hard to know exactly how much that happens. Who knows what they -- whether in the upcoming fourth quarter will be, but we’ll try to stay focused on driving the business.

And we know we had a large comp in the fourth quarter of last year that we have to comp on top of and we plan for that. We’ll have a great holiday that, that we’ll talk to you about next quarter.

Okay. Thanks very much.

Next Scott Mushkin, Wolfe Research.

Hi, guys. Thanks for taking my questions. I’ve got three kind of quick ones.

Sure.

I think the first one is, the 60 day terms, I think that you guys brought forward I think was in the last year beginning of this year for the Pro sales. Any quantification on what you think that's doing to your Pro sales, as you look at, I know you’ve talked about strength there.

Right. So as we look at sales on our private label card particularly our commercial private label card, we’re really pleased with the results. Sales are up year-on-year, ahead of our expectations. Our new accounts are up double digit ahead of our expectations. So it's still early days, we’re only six months into the program. But we’re very pleased with what we’re seeing. Now if I could zoom out a little bit and talk about our private label program in total, we actually saw a decline in penetration year-on-year of about 30 basis points, taking our penetration down to just under 23%. The decline was attributed to a decline in the consumer card. And when we peal back the layers of the onion to say, well what’s happening with the consumer card? We see a few things. Last year we had key promotional events that we did not repeat this year. So that impacted the penetration. And then we see increasing competition coming from bank cards. In fact I received one just at my home this week from Visa that's offering deferred financing. So there’s increased competition out there. And then finally and interestingly, we’re seeing a robust penetration increase in PIN-debit. PIN-debit up over a 100 basis points year-on-year is now the third largest form of tender inside of our Company. So the first largest is the bank card, the second largest is the private label card and the third largest is PIN-debit.

Interesting. Thank you. That's good information. Did you -- have you guys looked at when we through election cycles, kind of what -- we’re obviously going to heat up the election cycle, and we’ve heard that at the high-end, some high-end consumers are postponing certain purchases because of the election cycle. Have you guys looked at your numbers, and how does that flow through the Home Depot as we go through the fall?

To be totally honest with you, we’re focused on our customer. We don’t really pay a lot of attention to it. It's all about how do we take care of our customers every single day and make sure we’re driving volume for them every day.

All right. Then my last, and this one is definitely a random question, but it's our second year of Prime Day. Do you guys feel Prime Day as Amazon does it? And then I'll yield. Thanks.

Interestingly on Prime Day there is so much activity in the market place. It draws a lot of shoppers online and our customers respond, and we have a good day dropping off Prime Day.

All right. Perfect. Thank you, guys.

We’ll go next to Budd Bugatch, Raymond James.

Good morning and congratulations on a solid quarter. I guess, my first question has to do with the Interline integration. Maybe talk a little bit more or give us a drilldown and give us some color, of A; what’s your doing, and B; maybe the impact on the economics of the company during the quarter?

So, Budd, we’re again still working through the integration. We’re kind of ahead of the value drivers. We’ll likely see, but I’ll let, Bill comment on that. He’s here.

Budd, we talked a little bit last call, but our customer intercepts and research that we’re doing in the prioritization of our used cases where it's based on really the customer feedback plus if you look at the market opportunity, and we have in pilot our first used case which is the ability to enable customers to shop Interlined assortments inside the Home Depot stores. We have a pilot of 20 stores. It's really early days, but our results are exceeding expectations or really three times expectation. So it's encouraging. It says that all of the assumptions there have the ability to increase Share of Wallet with the Pro, remain intact, and so look at -- and continue to focus on that. But again it is very, very early days.

And in terms of the impact on the quarter, as we talked about our top-line growth exceeded our comp sales growth because of the impact on Interline. We called out the impact on our gross margin. It did have a dilutive impact on our gross margin, which we more than made up for with productivity and supply chain, and vendor co-op and rebate. And then it does add more variability and expenses. So, if you look at our expense growth factor for the quarter, backing out Interline it was a little higher than 60%, as we expected. As we now anniversary the Interline acquisition moving into the third quarter, our expense growth factor is going to come more in-line with what we expected. And in fact, our expenses are under such good control, we were under our expense plan for the second quarter. We’re taking our expense growth factor down from the year. At the beginning of the year we said it would be about 40% of our sales growth. We now think it's about 32% of our sales growth.

Okay. And my follow-up really has to do with appliances, a double-digit comp if I heard you correctly. Ted, how is that -- how sustainable is that? What’s causing that? Do you see that advance in the market itself?

Well, there’s clearly some share opportunity in the marketplace that we purposely positioned our self for, so we continue to invest in expanding our appliance showrooms with the larger showrooms, we can put more display pieces on the floor. It allowed us to get a much broader showing of Whirlpool’s offering as well as high-end brands like, KitchenAid. So we’re just a lot more relevant in this space with a better offering.

And a double-digit comp in appliances meant 50 basis points of total comp growth for our Company.

Okay. And just quickly, just one follow-up, is Pro penetration, can you give us any comment on that as a percentage of sales?

It's hovering where it's always hovered around 40% of sales.

Right.

Thank you very much. Congratulations.

Thank you.

We’ll go next to Michael Lasser, UBS.

Good morning. Thanks a lot for taking my question. Craig, how long do you think that home improvement demand can remain decoupled from other elements of the economy, other elements of retail? I think, Carol, in her prepared remarks noted that some economic prognostications have been ratcheted down, but you’re keeping your forecast for same store sales in place. So, how long do you think that this can be kind of an oasis within the broader economy?

Well, I think when you look at a few factors. First of all there’s about 4.6 months of supply, average historical is about six months. So that certainly means there’s opportunity as you go forward, that's also helping to keep home value appreciation going. And there is projections in the market out there from various sources that would say home value appreciation continues for the next couple of years for sure. And so, I think this is a tailwind that we see for the foreseeable future in the guidance window that we’ve given.

And if you look at some of the housing market that has gotten really hot, San Francisco, Miami. Are you seeing similar trends there or any sign that demand is starting to ebb out?

We don’t really see any change.

We haven’t seen any change. The fundamentals which, Craig, pointed out for housing and then the impact to home improvement are really, really good, and you go back to household formation. If the number of people in households were they drop to the 2000 plus, it would create 4.3 million new households. Now will they all go into single family owned households? No. But we serve both. We served owned households and we served rental households. So there’s just a tremendous amount of talent that continues to support our business, and our business outlook through 2016 into 2017 for sure. If not ’18, ’19.

And my follow-up question is on the implementation of comp along with change in your ordering algorithm that you implemented in the quarter. Did that have any impact on sales? Did it drag down sales at all? Did it have any impact on in-stock?

I mean, it's really hard to know. We really don’t know. And the reason that we don’t is, there is so many items candidly in the store that can be substituted. So, if we cause ourselves hurt in one item, it's very possible that a customer picked up another item. So it's pretty difficult to tell.

Understood. Good luck with the second half of the year.

Thank you.

We’ll go next to Seth Sigman, Credit Suisse.

Thanks. Good morning. Great quarter, guys. I just want to follow-up one the last questions. So you exited the quarter with a pretty healthy trend. It sounds like the tone is positive on the demand outlook. Is there anything we should be thinking about in terms of the cadence of comp growth in the back half of the year, Q3 versus Q4?

Yes. The way that we built our plan and our forecast, is that the comps for Q3, and Q4 will be more or less the same, shouldn’t see a lot of variability there. Now where you will see variability is on the expense growth factor. The expense growth factor will be higher in the third quarter than it is in the fourth quarter principally because of year-over-year comparison. For the full-year, the expense growth factor should be about 32% of our sales growth.

Okay. That's helpful. And then, maybe just to dig in a little bit further. I mean, have you seen any major change in trends or the demand -- demand outlook exiting the quarter, like early in the third quarter here?

No, we’re very pleased with our August results. Parts of the country obviously are flooded. We have a store closed in Louisiana, and we -- our heart goes out to the people who are impacted by that. But if you ignore that kind of activities, we’re very pleased.

Okay, got it. And then, one of the things that you guys talked about is the growth in units per transaction. I’m just wondering, is there a change in trend there, and if so, like you think that's the result of some of the initiatives or is the comp position of the projects that are getting done right now maybe a little bit different like, how do you think about that trend?

I think that the units per transaction, this is about the third quarter now that, when you think of all the positive comps we’ve had over the past several years, the units per transaction really didn’t move that much. But for the last few quarters, we’ve seen a healthy growth in units per transaction and it's really units in the larger ticket items. When you start to get into larger ticket items, you’re looking at 40, 50, 60 even 70 items in a basket. So this is clearly a project, while appliance sale for example would help the average ticket, you’re only looking at one or two items, the appliance and maybe some connecting hoses. But our project business remains very healthy, and the growth of that unit per transaction and units in things like lumber and building materials are very healthy for the business. So it speaks to Pro, and it speaks to project.

Okay. That's great color. Thanks very much.

We’ll go next to Peter Benedict, Robert Baird.

Hi, guys. Just following up on that, is there any historical perspective you guys can provide us with around this, units per transaction trend that you’re seeing? How does the current metrics compare to any period in the past? And when you started to see an uptick historically, how long does that go on for? Is there any perspective around that you could help us with? Thank you.

The granularity in items per basket, our history is not so good. Our record keeping is not so extensive, but we can’t really go back to prior periods. But what we can currently and this is, I think a really good new story in terms of the health of the Pro, is that while, the high spend Pros drove the outperformance, the gap between high spend Pros and low spend Pros is narrowing. And as that gap narrows, as we would expect that's a sign of health in this -- in the Pro space. So we would expect this trend in items per basket to continue.

Okay, Carol thanks. That's helpful. And then just my one follow-up would be, just curious if you guys are seeing anything around mix shifts within categories, building products in particular? Any evidence of any trade-up going on or anything like that? Thank you.

Well, we’ve continued to see trade-up, we talked about this the last several calls where we’re looking at all our price points and again we had another quarter where our comp progression improves as we go up the line structure from good, better, best. And specific to Pro pricing, I’d say the only callout would be lumber prices are on the move when you’re starting to get some trade-off between plywood and OSV. Just as those prices get back elevated the more premium product in plywood there isn’t as much of a gap in that product class.

Clearly innovation is a driver to the customer stepping up in the line structure. When you provide new innovative products, people step in.

Okay. Makes, sense. Thanks very much.

We’ll go next to Dan Binder, Jefferies.

Thank you. I just want to go back to the comment you made earlier about the replenishment era. I was just curious if it was significant enough that it created any in-stock or in-stock issues or loss sales impact?

I mean, we definitely saw an impact in our in-stock position for about six weeks during the quarter, but clearly have recovered from that at this point.

And let’s put that in perspective for you. We strived to have in-stocks of 99% or greater. As Craig pointed, we were six weeks under that goal, but the largest gap was 13 basis points. So it wasn’t a major disruption, but because of our standards to be 99% or better, we felt it.

Yes. We missed our own expectations.

Okay. Great. And then, you mentioned earlier that there was certain promotions you didn’t repeat, causing the private label penetration on credit to come down a bit. I was just curious on that, if you could talk a little bit about your promotional posture, how you’re thinking about promotions relative to the market both from big box online, anything you can share with us on that front that will be great.

I would say that we have really redoubled our efforts to focus on every day value for the customer. So we are increasingly focused on providing the best product with the best brands at the best prices everyday for all of our customers regardless how they pay.

Okay. Last one for you if you could. Last year there was a willingness to take on some more debt for share buyback thus far you stuck to the $5 billion share buyback, is there a scenario where you could see the leverage increase a bit? I think you’re still under that two times adjusted that EBITDA at this point.

We are around 1.8 times which gives us about $3 billion of borrowing capacity relative to our target. It's not our intent to let that borrowing capacity continue to grow. And as we have in the past, we’ve opportunistically taken advantage of interest rates and availability to raise incremental shares and increase our share repurchases. So you should think about our past practice. It's something that we should continue in the future. But we like to guide based on what we know today. And what we know today is excess cash to buy back shares. And if we like to issue some incremental debt and buy back some additional shares, we’ll let you know.

Great. Thank you very much.

Brian Nagel, Oppenheimer.

Hi. Good morning. Congrats on a nice quarter.

Thank you.

My first question, I apologize it may be somewhat repetitive to some of the prior questions. But just to be clear and I think someone else mentioned, there’s been a lot of noise out there with -- in retail sales lately from what other companies are talking about, and clearly we talk about weather. But as you look at the data, even more granular than what we discussed today. Is there anything -- are you seeing anything to suggest or anything to hint at a more cautious consumer environment, particularly in a bigger ticket type projects?

As we’ve said, we are fortunate that we are in a space where the customer is willing to spend. That's clearly driven by the dynamics that exist in the housing market overall. And as Ted, called out, we had a strong performance in tickets above $900 growing 8.1% in the quarter, and driven not only by big ticket categories like HVAC and appliances but by the units per basket around the project business. So, it's very encouraging what we’re seeing in that.

Thanks. And then a follow-up Carol, on the expense leverage side. For a while now it seems that Home Depot continues to beat the expectations with regard to expense leverage. You mentioned that again today with, now the higher EPS guidance for the year. So maybe more color on exactly where this latest bit of beat is coming from? And as you look out, is there anything to suggest that at some point Home Depot could really have a more difficult time leveraging expenses or are there continued opportunities?

Well, we view productivity as a virtuous cycle in our business. And we are constantly looking out ways to drive productivity while ensuring that the customer experience is the best it possibly could be. Most recently, our HR team did a great job of renegotiating some contracts in support of our medical benefit programs for our associates. And that reduction has caused actually a cost out and with that cost out, our people cost are going to be as high this as we anticipated. That benefit will flow through into 2017, which is a good news story. And there are other examples of that, I won't bore you with all those examples, but there are other examples of where our team continues to go after large purchasing contracts to drive productivity and make sure that the experience is one that we want to deliver.

Thank you and congrats again.

Thank you.

Thank you.

Scot Ciccarelli, RBC Capital Markets.

Good morning, guys. Scot Ciccarelli. I know you are guys are focused on everyday value, I know you already commented on that. But there was some noise in the quarter regarding maybe heightened promotional cadence around some of the competitors in your space. Is there anything to note from your vantage point regarding changes in the promotional environment?

I mean from time-to-time we see increases in promotional activity. We saw it certainly during the quarter, but we're focused on driving everyday value for our customers.

Okay. So nothing of note. And then Carol, I know one of the things you’ve talked about increasingly over the last couple of quarters is the aging housing stock in the U.S. I’m curious if you’ve started to come to any conclusions regarding how big of a driver or impact that could be on your business over time? Thanks.

We are doing more research in this regard, because we've never been in this place in our country, so we don’t have any history to rely on. So we’ve got more research to do. It actually makes us comfortable about our growth forecast as we go into '17, because when things start to break, you got to fix it. And we think it’s a tailwind, but Scot, I don’t -- I can't quantify it yet. Maybe we look at that research done and by the end of next quarter we can give you some more thoughts.

That would be great. Thanks, guys.

Thank you.

Jessica Mace, Nomura Securities.

Hi. Good morning.

Good morning.

My question is a follow-up on the supply chain. You talked about it being a work in progress. And you mentioned that COM system and some other factors, but I was wondering if you could just give us a little bit more detail on the next milestones that we should be expecting and what that impact could be on the P&L? Thank you.

Sure. So we do view the supply chain as a an ongoing continue opportunity to optimize, the next big initiative in that is supply chain Sync and Mark Holifield is here. I will let Mark comment.

Yes, we're pleased -- as we’ve mentioned, it is a work in progress. We continue to see opportunity to improve our in-stock, our inventory productivity, our logistics costs. Sync is the biggest initiative we’ve going in that. Sync is currently in two thirds of our RDCs, 12 of our 18 RDCs, and we're handling about 60% of the cost of goods sold, the dollar volume that goes through there on the Sync initiative. From that we're seeing mainly improved transportation costs and smoother demand flow and we are working with our suppliers to continue to improve those benefits for all in the supply chain. So we will continue along that path until -- but we're not in a hurry. It's still early days and it's a multiyear initiative that we're pursuing there.

To put it in perspective between 2011 and 2015, on a cumulative basis, our supply chain has driven 68 basis points of gross margin expansion. So it's been very productive for us. We call that the productivity that we experienced in the second quarter and year-to-date we've had about 12 or 13 basis points of productivity. So, we continue to anticipate benefits coming on the gross margin line through the productivity in our supply chain and also there will be longer-term inventory turn benefits. We never want to go out of stock, but there will be longer term inventory turn opportunities.

And that really comes from shortening lead times.

Great. Thank you for taking the question.

Sure.

We will go next to Greg Melich, Evercore ISI.

Hi. Thanks. I would love to dig a little deeper into the digital online business. I think up 19%, still quite strong, but it is decelerating. Is that just the law of large numbers? Was there something given all the initiatives you’ve whether it be Sync or supply chain changes or getting ready for BOFDS that’s impacted that?

We don’t look at it as a deceleration on a nominal dollar basis. We've now grown over $200 million for …

14 quarters.

… 14 quarters. One change was the patio line structure I spoke about, we put more value product into the store that really sold incredibly well. And that took about 2, 3 points of comp of our online number. So we’ve been running at that 20-ish, 20 plus for several quarters now growing the business $200 million a quarter.

Got you. And if you -- and just to make sure I got the numbers right, I think you mentioned 42% of online now is done through the stores and I want to make sure I got that right. And two, as you go to this Deliver From Store, how do you think about that in terms of how it could change the online business?

Yes, that’s right. So, 42% of online orders are picked up in the store and 90% of returns are processed in the store and then one of the big benefits following the rollout of comp is we are now following with what we call BOFDS, which is Buy Online Deliver from Store. We’ve always delivered from our stores. The difference now is you can execute the transaction online and pick much shorter delivery window for your delivery. We are in about 700 plus stores now with buy online deliver from store very early days. We will be finished with that rollout by the end of this year and we're seeing really nice pickup from our customers and reuse, particularly our Pros, who have used buy online deliver from store coming back and using it a second and third time. So we think that fulfillment number which is the 42% will grow when we include BOFDS deliveries in that number. It's just -- it's very early right now.

That’s great. Thanks a lot. Good luck.

Thank you.

Shirlone, we have time for one more question.

That will come from Laura Champine with Roe Equity Research.

Good morning. I wanted to dig a little deeper into what’s going on with the Pro. Do you think that you’re benefiting from the growth in the market, or are you actually taking market share with Pros? And then assuming you’re taking share with Pros, do you see more strength with smaller Pros, larger Pros, what categories are you dominating that’s driving that share gain?

I definitely think that the market in total at least when you talk to Pros, they’re busier than they were a year-ago. So the market growth is certainly there. And when we look at the strength in our Pro categories, we believe based on all the data that we have or what we’re taking share in those categories as well.

And if you think about it Laura, based on the census data, which is an [indiscernible] we grew share year-on-year. And since Pro outpaced DIY growth it had to be share coming from -- in the Pro space. So clearly the market is growing, but we’re taking share at the same time.

Got it. And any comments on the strength of the smaller Pro versus the larger Pro?

Yes. What --- as I mentioned earlier, what we’ve seen is a narrowing between the large spend Pro and the high spend Pro in terms of the rate of growth and that is a very healthy sign.

Got it. Thank you.

You bet.

Well, thank you for joining us today. We look forward to having you join us on our next quarterly earnings call in November.

That does conclude today's conference call. You may disconnect at this time. We do appreciate your participation.