Home Depot Inc. (HD) Q2 2020 Earnings Call Transcript

Home Depot Inc. (NYSE: HD) Q2 2020 Earnings Conference Call Aug. 18, 2020



Greetings and welcome to The Home Depot Second Quarter 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Isabel Janci. Please go ahead.

Isabel Janci — Vice President, Investor Relations and Treasurer

Thank you, Christine, and good morning everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Richard McPhail, Executive Vice President and Chief Financial Officer.

Following our prepared remarks, the call will be opened for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. 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 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 will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Craig.

Craig Menear — Chairman, Chief Executive Officer and President

Thank you, Isabel, and thanks to all of you for joining our call this morning. We hope that you and your loved ones are safe and healthy and our thoughts and prayers continue to be with all of those that have been directly impacted by COVID-19. The COVID-19 pandemic and its impact have forced us to change the way we live, work and interact with each other.

Though these tough times have been unquestionably challenging, as we mentioned in the first quarter, we have navigated this crisis by aligning our decisions and actions to some of our most important values – do the right thing and take care of our people. Our focus has been and continues to be on two key priorities: the safety and well-being of our associates and customers, and providing our customers with the products and services they need at this time.

In the first quarter, we had to adjust our stores to an environment that promoted social and physical distancing, and we did this by implementing a change to store hours, limiting the number of customers in store and eliminating traffic driving instruments, as well as operational changes like floor marking, signage and plexiglass shields.

In the second quarter, we continue to adapt based on our learnings in ever-changing environment. Our team continues to work to promote a safe shopping environment. We made several adjustments in the quarter to our operating approach. First, we expanded our operating hours from 6:00 PM to 8:00 PM. This action was taken to relieve the end-of-day bottlenecks we observed in some stores while we were operating under more restrictive hours. Second, we modified the national approach that we had in the first quarter to limit the number of customers in stores and now are taking a more localized approach by relying on our store managers and field teams to closely monitor safety and implement customer limits as needed. Third, we announced that mask or facial coverings are required for all associates and customers in our U.S. stores and other facilities.

Given the ongoing demands and complexity of the current environment, we have continued to focus on taking care of our people by extending weekly bonuses for hourly associates in our stores and distribution centers. Through the second quarter, we have spent approximately $1.3 billion on enhanced associate pay and benefits in response to COVID-19. Additionally, the company’s first half performance resulted in a record payout for Success Sharing, our profit-sharing program for our hourly associates. I’m incredibly proud of our associates for the many ways that they have lived our values by serving our customers, communities and each other during this unprecedented time.

Our team has demonstrated ongoing flexibility to effectively operate in this dynamic environment, while also executing to deliver record breaking sales. Sales for the second quarter were $38.1 billion, up 23.4% from last year. Comp sales were up 23.4% from last year with U.S. comps of positive 25%. Diluted earnings per share were $4.02 in the second quarter. These record results were driven by broad-based strength across our stores and geographies.

As Ted will detail, both ticket and transactions were up double-digit in the quarter and we saw healthy growth from both our Pro and DIY customers. During the quarter, we saw customers take on projects throughout their homes. From deck building to painting projects, landscape work and home repairs due to increased wear and tear. Clearly, our customers engaged with home improvement in a meaningful way.

That being said, as we discussed in the first quarter, we are cautious to extrapolate trends from the first half of the year into a forecast for the remaining of the year, particularly given the tremendous amount of uncertainty we face with regards to the duration and continued impacts of the virus. So, while we can’t predict the sales trajectory for the back half of the year, we do know that for many of our customers, The Home has never been more important.

Our recent customer survey work tells us that customers have a continued willingness to take on both indoor and outdoor projects in the near term. Customers are consolidating the number of retailers they visit and are blending the physical and digital elements of the shopping experience more than ever before. As a result, the distinct competitive advantages and overarching benefits of an interconnected One Home Depot strategy has never been more relevant.

Our interconnected retail strategy and underlying technology infrastructures have supported record web traffic on a consistent basis for the past several month. Sales leveraging our digital platforms increased approximately 100% in the quarter, and more than 60% of the time our customers opted to pick up their order at a store. The accelerated growth of our interconnected and digital offerings has given us the opportunity to showcase, in a very condensed timeframe, new capabilities and different ways to engage with The Home Depot that customers may not have been fully aware of. The rate at which customers are authenticating with us is also accelerated, which provides us with the unique opportunity to know our customers even better. This is critical as we continue on our journey to offer a deeper level of personalization and further enhance the interconnected shopping experience.

That being said, the step change in demand across our digital platforms is not without its challenges, particularly from a delivery and fulfillment standpoint. We have been able to leverage investments we have made in the scale and flexibility of our supply chain network to relieve some of the pressure. This is exactly what we did during the quarter when we temporarily transitioned one of our recently opened Market Delivery Centers or MDC’s to a Direct Fulfillment Center or DFC, which primarily fulfills online orders. The investments that we have made in the underlying infrastructure and system supporting the MDC, coupled with a strong cross-functional alignment across the organization, enabled us to make this conversion in just a few short weeks. The net result for our customers was the reduction in lead times for orders flowing from our direct fulfillment network.

We are focused on continuing the momentum of our strategic investments to enhance the interconnected shopping experience and position ourselves for continued share capture over the long term. At the same time, we know that we must remain agile and flexible to execute against the demand Of the current environment. Through it all, we will continue to lead with our values and I could not be more proud of the resilience and strength that the team has demonstrated as we navigate these extraordinary circumstances together. I want to thank our incredible associates and supplier partners for their hard work and dedication to serve our customers and communities. And with that, I’d like to turn the call over to Ted.

Ted Decker — Executive Vice President, Merchandising

Thanks, Craig, and good morning everyone. I too want to thank all our associates and supplier partners for their relentless focus on serving our customers. During the second quarter, we saw unprecedented levels of engagement from both our DIY and Pro customers. Our teams satisfied the strong demand by working together in a flexible and agile manner, while also prioritizing safety. As an example, we decided to cancel our annual Memorial Day event and adjust other spring events as we didn’t want to drive even more traffic into already crowded areas of our store, like garden and paint. We also removed most of our off-shelf merchandising displays in order to support social distancing. Our teams were incredibly flexible and worked in a cross-functional manner to coordinate changes. We altered marketing plans, social media, product flow, product selection and space allocation. Our merchants, suppliers, marketers, supply chain, merchandising execution, in-store teams remained agile throughout the quarter and focused on our customers.

We are fortunate to have the best supplier partners in the business. Leveraging our tools and analytics, we worked together to make real-time adjustments to our assortments. In many instances, we introduced alternative products and reduced assortments to the highest demand SKUs that our partners could supply most effectively. As an example, to support in-stock levels for high demand items such as cleaning products, we worked with suppliers to streamline production on key product, sizes and fragrances. And as you heard from Craig, the investments we’ve made in our supply chain over the last decade allowed us to be more flexible than ever in flowing product to the right geographies.

During the second quarter, 13 of our 14 merchandizing departments posted double-digit comps in the quarter, led by our lumber department. Our kitchen and bath department posted high-single-digit comps. During the quarter, comp average ticket increased 10.1% and comp transactions increased 12.3%. The growth in our comp average ticket was driven by both an increase in basket size, as well as customers trading up to new and innovative items. In addition, inflation in core commodity categories like lumber positively impacted our average ticket growth by approximately 61 basis points. The strength of our comp transaction growth was driven by consistently strong in-store and online transactions.

During the second quarter, big ticket comp transactions or those over $1,000 were up approximately 16%. We saw very strong performance across a number of big-ticket categories like appliances, riding lawn mowers and patio furniture. However, this strength was partially offset by softer performance in certain indoor installation heavy categories like special order kitchens and countertops. We saw strong sales growth with both our Pro and DIY customers, with DIY sales growing faster than Pro sales. Sales to our Pro customers accelerated meaningfully compared to the first quarter and grew double-digits compared to the second quarter of last year.

Looking deeper into our Pro sales, we saw notable strength with our smaller Pro customer. As markets continue to reopen, we see increasing demand from all our Pro customer cohorts. We continue to lean into our strategic investments to create a Pro ecosystem that encompasses professional-grade product, exclusive brands, enhanced delivery, credit, digital capabilities, field sales support, HD rental and more. We believe our differentiated ecosystem will continue to drive deeper engagement with our Pro customers.

Turning to our DIY customers. Our DIY customers are reengaging with their home and with The Home Depot in a meaningful way and they are engaging across the store. While we have seen strong demand with exterior projects like building decks, sheds, fences and gardens, we’ve also seen strong growth with interior projects like hard surface flooring, interior lighting and painting, to name a few. We firmly believe that our One Home Depot strategy is creating a best-in-class interconnected shopping experience. We are building unique capabilities that let our customers engage across our digital platforms, our updated physical stores and our enhanced delivery experience. And our confidence in these new capabilities led us to change our tagline in marketing efforts to How Doers Get More Done.

During the second quarter, new and existing customers set record levels of engagement across our new capabilities. The rate at which our existing customers are adopting new channels to engage with The Home Depot more than doubled year-to-date. And we also saw a third of recently acquired customers re-engage with The Home Depot for another purchase in a different department.

During the second quarter, our mobile app saw a record number of downloads and we saw significant growth in conversion rates across all digital platforms. These results confirm our belief that we have been making investments in the right areas of our business and that those investments are resonating with our customers.

Let me give you an example to help illustrate our enhanced capabilities and options for customers. Over the last couple of years, we have enabled multiple fulfillment options including: buy-online-pickup-in-store with convenient pickup lockers; buy-online-deliver-from-store with our express car and van delivery; and most recently our curbside pickup option. As customers accelerate their adoption of an interconnected shopping experience, we have seen increased usage of these different fulfillment options. During the second quarter, we saw triple-digit growth across all these platforms.

Another example is our HD Home business. As part of our strategic investments over the last three years, we have been leaning into several home decor categories. As consumers shop fewer and fewer retailers, our research show that our customers are increasingly looking to homedepot.com to help with project completers like room decor and textiles. We are investing to create a better, frictionless online shopping experience for decor. We are showcasing our collections, enabling shop-by-room and highlighting our capabilities and product offerings with HD Home. With record levels of traffic on homedepot.com, we have seen significant outsized sales growth with our HD Home assortment. All the investments across the business make us more flexible as we continue to navigate this fluid and dynamic situation.

As we look to the back half of the year, we will be working with our supplier partners, as well as our cross-functional teams to satisfy our customers’ evolving home improvement needs. With that, I’d like to turn the call over to Richard.

Richard McPhail — Executive Vice President and Chief Financial Officer

Thank you, Ted, and good morning everyone. We appreciate everyone joining the call today and we hope you and your loved ones are safe and healthy.

In the second quarter, total sales were $38.1 billion, a 23.4% increase from last year. Foreign exchange rates negatively impacted total sales growth by approximately $200 million. Our total company comps were positive 23.4% for the quarter with positive comps of 24.6% in May, 25.7% in June and 20.4% in July. Comps in the U.S. were positive 25% for the quarter with positive comps of 27.3% in May, 27.3% in June and 21% in July.

As you heard from Craig and Ted, the strong demand we saw was broad-based with a high degree of performance uniformity among our three U.S. divisions in Canada. All 19 of our U.S. regions posted double-digit positive comps and our Canadian business reported record sales. Mexico’s performance was impacted by a lag in COVID-19 cases relative to the U.S. and Canada. And as a result, Mexico’s performance was negative in the beginning of the quarter before turning to positive growth at the end of the quarter.

In the second quarter, our gross margin was 34%, an increase of approximately 20 basis points from last year. The change in our gross margin was driven by several factors, including a benefit from a reduction of annual events during the quarter. This benefit was partially offset by the mix of products sold and pressure from shrink.

During the second quarter, operating expense as a percent of sales of approximately 18.1% increased approximately 10 basis points compared to last year. Let me take a moment to comment on a few of our expense items. First, during the quarter, we continued to support our associates with enhanced benefits, which totaled approximately $480 million in the second quarter, resulting in 125 basis points of expense deleverage. Second, we incurred approximately $110 million of operational COVID-related expenses, including personal protective equipment for our associates and customers and enhanced cleaning of our stores, resulting in approximately 30 basis points of operating expense deleverage. Third, we recorded expenses related to our strategic investment plan of approximately $280 million, an increase of approximately $40 million compared to last year. We are committed to completing our strategic investments. However, given the priority around safety and the complexities of the operating environment we find ourselves in, we are deferring certain in-store investments and now expect some of the projects we initially earmarked for fiscal 2020 to be completed in fiscal 2021. And finally, during the second quarter, we showed strong expense control in all areas of the business and drove approximately 145 basis points of expense leverage. Included in this 145 basis points of leverage is approximately 90 basis points of pressure driven by accrued bonus expense related to our significant outperformance for our biannual store Success Sharing program in store and field-based management bonuses for the first half. Our operating margin for the second quarter was approximately 15.9%, an increase of approximately 10 basis points from last year. Interest and other expense for the second quarter grew by $54 million to $337 million due primarily to higher long term debt levels than one year ago. In the second quarter, our effective tax rate was 24.4% compared to 24.6% in the second quarter of fiscal 2019. Our diluted earnings per share for the second quarter were $4.02, an increase of 26.8% compared to the second quarter of 2019. At the end of the quarter, merchandise inventories declined $1.2 billion to $13.5 billion, driven by the significant and steady demand we saw during the quarter. Inventory turns were 6.1 times, up from 5.1 times last year. Moving on to capital allocation. While our long term principle of returning excess capital to shareholders remains intact, we believe that in this unprecedented environment, it is appropriate for us to maintain a strong liquidity position. During the quarter, we invested approximately $445 million back into our business in the form of capital expenditures and we repaid approximately $1.75 billion of long term debt. We also paid $1.6 billion in dividends to our shareholders. Computed on the average, beginning and ending long term debt and equity for the trailing 12-months, return on invested capital was approximately 41.1%, down from 43.7% in the second quarter of fiscal 2019. This decrease primarily reflects our decision to temporarily enhance our liquidity position, including the suspension of our share repurchase program back in March. Looking ahead, through the first two weeks of August, comparable sales growth remains at levels similar to total company’s second quarter comp sales. Our customers tell us that they plan to continue to invest in a wide variety of projects to maintain and enhance their homes. However, given the degree of uncertainty in our external environment, we cannot extrapolate current observations to predict future performance. As a result, we are focused on operating with discipline and flexibility in order to grow market share, regardless of what demand patterns emerge. And despite the significant uncertainty in the current environment, we do believe in the resilience of home Improvement demand over the long term. The home typically represents our customers’ largest asset. The housing stock is aging and we believe the capabilities we are investing in across our interconnected platform will position us well to continue capturing market share in any environment. Thank you for your participation in today’s call and we are now ready for questions.

Questions and Answers:


Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Simeon Gutman — Morgan Stanley — Analyst

Thanks, everyone. Good morning. My first question is a little medium to longer term. It’s on the margin potential of the business. The environment now is pretty fluid and I’m sure you describe it as still competitive. When you laid out the One HD plan, most of the plan was recouping some of the margin that you would be invest — making to make investments, but you never really baked in sales upside and, by default, you never really promised or committed to more margin. Can you talk about — does that change? And it’s not about those margin go up over time, but does that — does it create the potential for margins to trickle up over time or you’re going to be steadfast on reinvesting and maintaining a certain margin level going forward?

Craig Menear — Chairman, Chief Executive Officer and President

Simeon, as we shared last December, everything we’re doing in terms of the investments that we’re putting into the business is to be able to position us to outgrow the market for the long term. And the whole objective behind that is to be able to drive incremental margin dollar and bottom-line growth. That’s really the focus that we have. We’re not — we’re really not worried about how the basis points of rate falls. This is all about incremental op margin dollar growth.

Simeon Gutman — Morgan Stanley — Analyst

Okay, thanks for that. And then maybe sticking with you, Craig, you mentioned in the article, I think it was this week, right, correlations don’t work right now and they don’t apply, which makes sense. Can you talk to just two components of that? How could — how does the surge in home improvement could it transition from spring-summer into fall? And do you expect these condition — these surge conditions to persist until there is a vaccine?

Craig Menear — Chairman, Chief Executive Officer and President

I mean, it’s really so uncertain. We don’t know the answer to that, which is why we can’t really extrapolate current performance to future performance. What we do know is, again, the home has never been more important to the customer. We’re all spending lots of time there, we’re seeing things that need to be done, or things that you want to be done. There is additional wear and tear and we’re clearly seeing the customer engaged in a very strong way right now. The most important thing for us, as we think about the future going forward, is we operate in key areas on a pretty short cycle, so think labor planning, think inventory planning. Those are short cycle activities for us and that’s what we’re really focused on. How do we remain flexible and adjust? Simeon, the Interesting thing is we had really unbelievable demand for multiple quarters or multiple months in a row, as Richard shared the quarterly monthly comps. And the team was able to react to that. And that’s really what we’re focused on being able to do.

Simeon Gutman — Morgan Stanley — Analyst

Okay, thanks. Good luck.

Craig Menear — Chairman, Chief Executive Officer and President

Thank you.


Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question.

Michael Lasser — UBS — Analyst

Good morning. Thanks a lot for taking my question. And I guess you practiced what you teach [Phonetic] with doers getting it done. My question is on the Pro business, which you mentioned it was up double-digit. Can you quantify the spread between what you think your Pro business did, and what you think your DIY business did? And with that being said, is there an argument and you subscribe to it that the Pro business is being held back by consumers not wanting outsiders in their home and don’t want to be dislocated from their homes in this current time, so there is a pretty visible path to future growth as the Pro business takes over for the strength In the DIY business right now?

Craig Menear — Chairman, Chief Executive Officer and President

Michael, we’re obviously not going to split out the numbers on cohorts for obvious reasons, but we were super pleased that we saw double-digit growth with the Pro as well as incredible strength with the DIY customers. They’re clearly engaged with projects as well. I’ll let Bill jump in with a little bit more color as to what we’re seeing in terms of major markets [Technical Issues] where there is still a little pressure as it relates to permitting [Technical Issues].

Bill Lennie — Executive Vice President, Outside Sales and Service

Yeah. Hey, Michael, Bill Lennie.

Michael Lasser — UBS — Analyst

Hey, Bill.

Bill Lennie — Executive Vice President, Outside Sales and Service

We did see good Pro sales growth across our cohorts towards all end markets and all geographies. There was notable strength with the low spend Pro. They were less impacted with the downturn in Q1, but continued to rebound and accelerate in Q2. The high spend Pro also continued to rebound. And I would see that as being an outcome of permitting and job inspections coming back online. Yeah, there are areas where homeowners are becoming more comfortable with having Pro’s and service providers in their homes. There are some end markets that haven’t totally recovered. I’ll give you one example and that would be multifamily property managers. Obviously, there is slower turns on the units, they have less access to the properties and they still remain in more of a break-fix mode, holding back on major rehabs and capital projects. But with that said, even in multifamily Pro customers, we’ve seen upturn and a rebound in sales to those cohorts.

Michael Lasser — UBS — Analyst

Thank you very much. My follow-up question is on the gross margin. Richard, you give us a little bit of detail on some of the moving pieces. Noting that mix and shrink was still drag in the quarter, so how should we think about and how should we be calibrating our models for when shrink is going to get better? And at what point do you think the promotional environment will move from being supportive to more normal?

Richard McPhail — Executive Vice President and Chief Financial Officer

Michael, thanks for the question. So, for the quarter, the most significant influence were really the cancellations of annual events during the quarter. If you look at the pressures again, as we stated, there was some pressure from mix and from shrink, but really those pressures were consistent with what we expected at the beginning of the year and what we saw in Q1. As you know, shrink is an item that we have pushed a few initiative towards last year and this year. Those efforts are ongoing. We will see benefits from that over time. It takes a while for that to work our way through the system. But again shrink and mix, those components really worked out where we expected they would have even at the beginning of the year.

Ted Decker — Executive Vice President, Merchandising

And as far as promotions, though we’ll continue to have promotions and events, but they will continue to be modified. So when you think at the beginning of the year, our spring Black Friday event and Memorial event, we essentially canceled those. We had a modified more modest 4th of July event where there was some promotion, not as deep. And there was some in-store activation in our event spaces. I would see going forward, we’d continue to have modest modified events, but at net benefit with promotions.

Michael Lasser — UBS — Analyst

That’s very helpful, thank you very much.


Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question.

Steve Forbes — Guggenheim — Analyst

Good morning. Maybe just to focus on the additional workforce benefits that you’ve noted here. I don’t know, Richard, if you can go into a little more detail about the $480 million. Is it simply just tied to the weekly bonuses? And then just revisit sort of what the current thinking is around the continuation of these bonuses, what it’d be committed to and sort of how do you sort of think about balancing the cultural impacts rate of it with obviously the commitment you have towards safety, etc.

Richard McPhail — Executive Vice President and Chief Financial Officer

Thanks for the question, Steven. So if you take a look at the approximately $480 million that we invested in enhanced benefits in the quarter, you’d take a look at that and say, about $360 million of it would represent spend on benefits that continue into the third quarter with the vast majority of that $360 million being in the form of weekly bonuses to associates. The remainder of that — the remaining $120 million that we expensed in Q2 represented benefits like enhanced overtime pay that have not continued into the third quarter. So again, of that second quarter, about $360 million continues in the third quarter.

It’s worth pointing out that in a 23% comp environment, there are more hours, there are more associates eligible for those weekly bonuses. We certainly were not planning, at the beginning of the quarter, for a 25% — 23% comp environment. So that number is going to naturally be a little bit higher in Q2 because of that. So that’s the breakdown of our associate expense and it’s something that we review on a continuous basis. We think that, that expense was prudent and appropriate in the second quarter and we’ll continue to review it as circumstances develop.

Steve Forbes — Guggenheim — Analyst

Thank you. And then just a quick follow-up, right, as we look at lumber inflation here and think about the puts and takes on the model, I don’t know if you can sort of just give us your current thinking about the potential implications as we look out to the third quarter here, given that you called out mix. I mean, how do we sort of contextualize the P&L impacts?

We are still processing the Q&A portion of the conference call. We will be updating it as soon as we analyze and process the con call. Stay tuned here for more updates.


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