18 August 2010

HD: Income Statement Analysis for the July 2010 Quarter

The Home Depot, Inc. (NYSE: HD) earned $0.72 per diluted share on a GAAP basis in fiscal 2010's second quarter, which ended on 1 August 2010.  Earnings per share increased 8.6 percent when compared to the $0.66 Home Depot made in the same quarter of 2009.

On a non-GAAP "adjusted" basis, earnings increased from $0.67 to $0.72 per share.  The non-GAAP numbers exclude unusual items, but the most recent quarter had no such gains or losses.

This post examines Home Depot's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.01 better than the $0.71 per share we had forecast.  The extra penny of EPS was due to the number of shares outstanding being lower than we anticipated.

The principal sources for this income statement analysis were the earnings announcement and the ensuing conference call (transcript available from Seeking Alpha).

In a second article, we will report Home Depot's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

The Home Depot, Inc. (NYSE: HD) is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.  The company operated 2,244 retail stores at last count, of which 1,976 (88 percent) were in U.S. states or territories.  Home Depot competes with Lowe's (NYSE: LOW), cooperatives such as Ace and True Value, and a multitude of smaller hardware stores.  Additional background information about Home Depot and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue in the July quarter increased 1.8 percent, from $19.1 billion last year to $19.4 billion in the most recent three months.  Revenue was 1.5 percent weaker than our $19.7 billion estimate, which was derived from the company's sales guidance for the fiscal year and from seasonal patterns.

Comparable (akin to same-store) sales in the second quarter grew 1.7 percent overall, but only 1.0 percent in the U.S.  The Pacific Northwest was an area in which comparable sales declined.

Very warm temperatures in much of the U.S. boosted the sales of seasonal products in the affected areas.   However, the sales rise was offset to some extent by reduced sales to gardeners.

Sales to professional customers, presumably contractors and tradespeople, were weaker than expected.  This resulted in an average sale per transaction ("ticket") of $52.30, which didn't rise as the company had hoped.  The number of tickets over $900 were down a disappointing 4.9 percent.

The Cost of Goods Sold increased to $12.8 billion (66.1 percent of Revenue) from $12.7 billion in the year-earlier quarter.  The latest amount translates into a Gross Margin of 33.9 percent, about 36 basis points more profitable than the 33.5-percent margin in last year's second quarter.  Home Depot attributed the margin expansion to the mix of merchandise sold, fewer markdowns and promotions, and improvements outside the U.S.

Although the Gross Margin increased when compared to June 2009, we had expected it to get up to 34.2 percent of Revenue.  Home Depot fell short of this target by 30 basis points.

Depreciation and Amortization charges of $406 million were 6.5 percent lower than last year.  This reduction was the result of the company having a smaller base of fixed assets. The Depreciation expense was 3.3 percent less than our $420 million target for the quarter.

At $4.13 billion in the latest quarter, Sales, General, and Administrative expenses were almost the same as last year's $4.12 billion.  As a percentage of Revenue, these expenses inched down from 21.6 percent to 21.3 percent.

SG&A expenses were 2.6 percent less than our $4.24 billion target for the quarter. 

Subtracting the various operating expenses discussed above from Revenue yields Operating Income of $2.05 billion, up 11.8 percent from $1.83 billion in the year-earlier quarter.  The increase can be credited to Revenue growth, the more lucrative Gross Margin, and good control of other operating expenses.

Operating Income was only 1.6 percent less than our $2.08 billion estimate.  Although revenue was lower than we anticipated, less-than-expected charges for Depreciation and SG&A nearly made up the difference.

The $148 million Non-Operating expense was less than in recent quarters.  It was also $22 million less than we anticipated. 

Pretax income was $1.9 billion, almost reaching our $1.91 billion target.

The effective Income Tax Rate was 37.3 percent, a rate slightly more burdensome than the 37-percent rate we had assumed.  The rate was inflated modestly by the timing of state tax payments.

This brought after-tax Net Income to $1.19 billion, which was 6.8 percent better than the $1.12 billion earned in last year's second quarter.  Our estimate was $1.20 billion.

On a per-share basis, earnings increased from $0.66 to $0.72.  Our estimate was $0.71.  We over-estimated the number of diluted shares outstanding by 1.3 percent.  Home Depot repurchased $700 million of its shares, more than we expected, in the quarter.

Full disclosure: Long HD at time of writing.

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