q3 2007 home depot inc earnings conference call on nov. 13 ... · 11/13/2007 · overview...

E D I T E D B R I E F

HD - Q3 2007 Home Depot Inc Earnings Conference CallEvent Date/Time: Nov. 13. 2007 / 9:00AM ET

OVERVIEW

Management discussed 3Q07 results, reporting earnings from continuing operations of $1.1b or $0.59per diluted share on sales of $18.96b, which were down 3.5% from 2006. Guidance was for 200752-week EPS from continuing operations down as much as 11% vs. 2006.

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CORPORATE PARTICIPANTSDiane DayhoffHome Depot Inc - SVP IR

Frank BlakeHome Depot Inc - Chairman, CEO

Craig MenearHome Depot Inc - SVP - Merchandising

Paul RainesHome Depot Inc - EVP - US Stores

Carol TomeHome Depot Inc - CFO, EVP - Corporate Services

CONFERENCE CALL PARTICIPANTSChris HorversBear Stearns - Analyst

Deborah WeinswigCitigroup - Analyst

Jeff WimmerJPMorgan - Analyst

Budd BugatchRaymond James - Analyst

Matthew FasslerGoldman Sachs - Analyst

Danielle FoxMerrill Lynch - Analyst

Gregory MelichMorgan Stanley - Analyst

Eric BosshardCleveland Research - Analyst

Shannon MikusCredit Suisse - Analyst

Colin McGranahanSanford Bernstein - Analyst

Brian NagleUBS - Analyst

OVERVIEWManagement discussed 3Q07 results, reporting earnings from continuing operations of $1.1b or $0.59 per diluted

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E D I T E D B R I E FNov. 13. 2007 / 9:00AM, HD - Q3 2007 Home Depot Inc Earnings Conference Call


share on sales of $18.96b, which were down 3.5% from 2006. Guidance was for 2007 52-week EPS from continuingoperations down as much as 11% vs. 2006.

FINANCIAL DATAA. 3Q07 sales = $18.96b.

B. 3Q07 earnings from continuing operations = $1.1b.

C. 3Q07 continuing EPS = $0.59 (diluted).

D. 3Q07 sales decline = 3.5% from 2006.

E. 3Q07 GM = 33.4%.

F. 3Q07 total expenses = 24.1% of sales.

G. 3Q07 capex = $2.5b.

H. 3Q07 retail inventory = $12.6b at quarter-end.

I. 3Q07 assets = $45.5b at quarter-end.

J. 3Q07 cash and short-term investments = $550m at quarter-end.

K. YTD 2007 shares repurchased = 743m.

L. 2007 52-week EPS from continuing operations guidance = down as much as 11% vs. 2006.

PRESENTATION SUMMARY

I. 3Q07 PERFORMANCE (F.B.)

A. Overview:1. Market still facing significant headwinds.

a. Started year with pessimistic view of housing and home improvement markets, but not pessimisticenough.

i. Expected market improvement by 3Q, which did not occur.b. Results reflect difficult market.

B. 3Q07 Highlights:1. Sales were $19b, down 3.5%.2. Comp sales were negative 6.2%.3. Diluted EPS from retail business were down 9% at $0.59.

C. Outlook:1. Difficult conditions for 2007 and into 2008.2. Ratio of residential construction spend to GDP 60-year average is 4.8%.

a. At height of market in 2005, ratio was 6.25%, but is now 4.5%.i. Considering GDP approx. $14t, this represents market contraction over $240b.

3. Soft market will continue.a. Overhang of housing inventory.b. Difficulties in subprime mortgage.

4. Now on underside of 60-year average.a. Reinforces importance of investing in business and fixing core operations.





5. Great to see associates' passion reignited.6. Progress from investments in five key priorities.

D. Priorities:1. Co. has also lost share through its performance.

a. Key objective has been to reverse market share loss.b. Latest data shows co. losing about 385 bp to market on rolling 12-month basis, vs. last year's 760 bp.

2. In markets where housing and home improvement markets have been more stable, seeing positive compperformance.

3. Associate engagement, voluntary hourly attrition down 24%.a. Will continue investing in associates.

4. Shopping environment, rolling out new store standards.a. Seen significant improvement in voice of customer (VOC) scores.

5. Product availability, improved in-stock position in stores.a. Reflected in VOC results.

i. Improved score in 'find and buy' metric.6. Co. has distribution pilot underway.

a. Took existing facility in Georgia, introduced new processes and technology.b. Seeing shortened lead times and better in-stock positions in service stores.c. Building out new supply chain will be one of most important initiatives through 2007, and 2008.

7. Product excitement, significant share gains.a. Putting additional resources into regional merchandising efforts.b. Adding talent to merchandising organization.

8. 'Own the Pro' initiative, using analytics to gain better insights into the 2% of customers who drive nearly30% of sales.

a. Analysis being used to optimize job lock quantity SKU lists and generate customer contact lists.9. Core retail, launched program to transform merchandising systems and processes.

a. On track to deliver first phase in Canada next year.

E. International Business:1. Remains strong.2. Mexico posted double-digit comps in quarter.3. Canada had positive comps.4. China making good progress.5. International stores now contribute 9% of sales and 11% of operating profit.

F. Sale of HD Supply:1. Closed sale August 30.

a. Now focusing on retail business.2. Used proceeds from sale to fund bulk of $10.7b tender offer, completed in early September.

a. Completes about 50% of recapitalization.3. Not prudent to rush to execute remainder of recapitalization.

a. Will not happen in 2007.4. Basic principles behind recapitalization remain in place as does overall goal.

a. Will provide more complete view in February 2008.

G. Comment:1. In meeting last week, one of co.'s vendors said a downturn is a terrible opportunity to waste.2. This market downturn is an opportunity for HD.

II. DEPARTMENTS (C.M.)





A. 3Q07 Departments:1. Negative sales growth in all departments except kitchens, which was driven by appliances.2. Departments that outperformed co. average comp were plumbing, kitchen and bath, garden, paint and

hardware.3. Departments that underperformed co. average comp were lumber, millwork, lighting and building materials.4. Flooring performed at company average.

B. Negatively Impacting 3Q07:1. Large driver of weak sales performance was softness in building materials and related businesses.2. Lower demand and commodity deflation in building material categories impacted average ticket, which

was down 1.5% from last year to $57.48.a. Seeing double-digit declines in markets like South Florida, California and portions of northeast.b. A few regions showed positive comps in these commodity related businesses.

3. Lighting, lost share.a. Co. has opportunity to enhance merchandise offering and simplify selection process for customers.b. Promoted top expo merchant, Lisa McClellan, to Merchandising Vice President to lead this category

going forward.i. Leveraging lessons from expo in fashion and design as assortment retooled for spring of 2008.

4. Kitchen category remains challenged.5. In markets facing significant home price depreciation, experiencing double-digit negative comps.6. Despite headwinds, focused on improving share loss.7. Completed roll-out of assembled kitchen cabinet program mentioned last quarter.

a. Pleased with early results.8. Into 4Q, taking lessons from success in flooring department to kitchen department.

a. Will simplify purchase process and increase value proposition for customers.9. Upgrading shopping experience and enhancing capability of associates.

C. Areas of Share Gains:1. Paint, appliances and power tools.

D. Paint:1. Despite increasing competitive dynamics in paint business, market share grew again this quarter.2. Sales strong in exterior paint and stain categories.3. Customers responding to innovation.

E. Appliances:1. Shrinking market.2. Continued gaining share this quarter, building on gains for past few years.3. Significant strength in this category throughout country.4. Success driven by staying relevant to customers, providing latest features and benefits.5. Customers pleased with innovations, style and design.

F. Hardware:1. Showing positive results.

G. Power Tools:1. Power tools and accessories, gained share in shrinking market and extended leadership in category.2. Strong performance across country.3. Drove share gains by staying relevant to customers.

H. Merchandizing Resets:1. Pleased with in 3Q.





2. Where co. has completed resets and implemented change from product line review process, collectively,these categories are outperforming store's sales performance, in line with expectations.

I. Outlook:1. Operating in challenging times.2. Focused on merchandising fundamentals, enhancing processes and strengthening team.

J. Focused Bay Approach:1. Co. transactions were down 1.8% for quarter.

a. Where co. applied strategy against specific category rolls, seeing positive results.

K. Tool Sets:1. Intent is to drive traffic.2. Seen category turn from a negative to positive comp performance in quarter.

L. Partnerships:1. Partnering with suppliers.2. Two weeks ago, met with all top suppliers.3. Developing actions to solve customer problems and drive sales.

M. 4Q07 Outlook:1. Looking to 4Q, pleased with early sales of holiday program and gift-oriented products.2. This year, expanded and refined assortment.

a. Expects to be Number 4 retailer in US holiday decor sales, with double-digit YoverY growth.3. Also focusing on seasonal categories.

N. Merchandizing:1. During past quarter, invested to add talent within team at senior level.

a. Bruce Marino came back to merchandising after eight years as Western Division President.i. Leading field merchandising teams, merchandise service organization, store environment and new

concepts.2. Also has three SVPs responsible for merchandising categories.

III. MARKETS, PROGRESS ON PRIORITIES (P.R.)

A. Trends:1. In markets with favorable housing trends and strong disposable income, seeing positive comp performance.

a. Dallas, Austin and sand Antonio markets had positive comps for quarter.2. In areas hardest hit by housing turnover and new home sales, still significant pressure.

a. Sacramento, Las Vegas and Fort Myers, Naples.i. Fort Myers, Naples posted negative comps in excess of 20%.

3. Business displayed significant variation across geographies.a. Underscores importance of having local focus.

4. Within Ohio Valley region, has relatively stable housing markets and markets with deteriorating housingindicators, both posting positive comps for 3Q.

a. Performance in these markets is being driven by share gains and five priorities.

B. Associate Engagement:1. Much progress this year.2. Despite business environment, driving positive changes around associate reward and recognition programs.

a. Motivation and engagement of over 300,000 associates impacts customer satisfaction and sales.

C. Compensation Enhancements:





1. Spoke about on 2Q earnings.2. Changes in Success Sharing program and incentive program for hourly associates allowed co. to increase

associate's participation in Success Sharing by almost 40 points YoverY for 1H.a. Largest check an hourly associate received was $1,855, and average check was around $200.

3. Issuance of restricted stock grants have more closely aligned assistant store managers with company'sgoals.

D. Homer Badge:1. Positive results from reinstitution of program.2. To date, over 78,000 badges have been awarded.

a. Seven gold-level and two platinum-level badges.

E. Master Trade Specialist Program.1. Big impact from program.2. As of last week, had over 2,000 master trade specialists in stores, all either licensed plumbers or electricians.3. Pleased with program.4. Merchant team leveraging specialists.

a. Adopting and changing offering in stores to reflect regional needs of business.b. Co. confident that longer-term, will see a return on this investment.

F. Turnover:1. Voluntary hourly turnover in stores is down 24% from last year.

a. EOC results indicate that initiatives in associate engagement making difference.2. Earlier this year, surveyed almost 300,000 of associates.

a. Highest scores were in those areas that are the most difficult to change.b. Room for improvement.c. Pleased with results.

i. Can make progress in areas that need attention most.

G. Shopping Environment:1. Pleased with progress.2. Average age of co.'s stores is around seven years, when store refurbishment needed to continue driving

sales.3. This year, increased maintenance budget 2.5 times of 2005 spend.4. Integrated field and support center teams to better align around needs of business.5. Adopted programmatic approach to maintenance.

a. To date, polished 473 floors, striped 1,038 parking lots, remodeled 172 restrooms and now has T5 lightingin 1,765 stores.

6. Integrated field and support center teams have rolled out store standards to all stores.a. Developed and piloted basic expectations.b. Goal is to drive a foundational level of store appearance.

H. Own the Pro:1. Co. has good information about what the super premium customer spends in stores.2. Over last quarter, this customer who typically spends 2-3 times as much as a regular customer, has continued

to shop with HD.3. Now building better relationships with them.

I. Feedback:1. Customers saying initiatives making a difference.2. Through VOC survey, where co. hears from over 200,000 customers a week, see improvements in 'likelihood

to recommend', 'find and buy' and 'clean and uncluttered' metrics.a. 'Clean and uncluttered' improving faster than all metrics.





J. Outlook:1. Continue facing market headwinds and challenges.2. Success will be defined by ability to remain focused on fundamentals of business during difficult

environment.

K. Organization:1. Has replaced Bruce Marino with Joe McFarland, the new President for Western division.

a. A 16-year veteran with HD, who has held various operating positions.b. Excited about him in this leadership position.

L. Natural Disasters:1. During these times, associates and customers need HD the most.2. During recent wildfires in California, thousands of customers and associates evacuated from their homes.

a. Many lost their homes or sustained significant damage to them.3. HD kept stores open longer and any other retailer in area and donated pallets of water, flashlights and

batteries, gloves and more.4. Associates donated their time to help.5. Thanks associates for commitment and sacrifice.

IV. 3Q07 FINANCIAL DETAILS, GUIDANCE (C.T.)

A. Note:1. 3Q results include one month of HD Supply as discontinued operation.2. Operating results and earnings impact of sale of HD Supply are found in line item on income statement

entitled 'Earnings from Discontinued Operations'.

B. 3Q07 Results:1. Sales were $18.96b, down 3.5% from last year.2. Negative same store sales were 6.2%, partially offset by sales from new and non-comp stores.3. Consolidated same store sales were negative 5% in August, negative 7.3% in September, and negative

6.3% in October.4. GM was 33.4%, down 18 bp from same period last year.

a. Benefited from lower interest costs associated with private label credit card financing program.i. Realized 36 bp of margin expansion due to lower interest costs.

b. Gave up roughly 54 bp of margin due to a higher penetration of lower margin products and markdownstaken to clear through seasonal items and transition into new products.

C. 3Q07 Expenses:1. Total expenses grew 183 bp, to 24.1% of sales.2. Expense deleverage reflects impact of negative sales, where for every point of negative comp, co. expects

to deleverage expenses about 20 bp.a. With negative comp of roughly 6%, expects to report expense deleverage of 120 bp.

3. Experienced an additional roughly 60 bp of expense deleverage.a. During quarter, announced plans to close 11 landscape supply locations, recognizing $25m of expense

associated with store closings during quarter.4. Private label credit sales make up about 30% of total sales.

a. Portfolio remains profitable, but losses higher than one year ago.i. Gain share was approx. $82m less than last year.

5. Expenses reflect investments in support of five key priorities.6. Co. views payroll as an investment.

a. As a percent of sales, total payroll increased 51 bp over last year.





i. Includes investments in Master Trade Specialist Program and expense associated with employee bonusprograms like Success Sharing.

b. Currently, 57% of stores are eligible for Success Sharing, vs. 22% last year.7. Due to factors just mentioned, operating margin declined from last year to 9.3%, vs. 11.3%.8. Net interest expense was $125m, up $33m from last year.

a. Higher outstanding indebtedness.9. Income tax provision rate for continuing operations was 34.7%, vs. 37.4% last year.

a. 3Q, reached agreement with tax authorities on several state and federal tax audits.b. Recognized a $35m tax benefit in quarter, and related interest expense benefits.

D. Earnings:1. Earnings from continuing operations were $1.1b, vs. $1.3b last year.2. Continuing EPS (diluted) were $0.59, down 9.2% from last year.3. Diluted shares were 1.815b shares, vs. 2.05b shares last year.

a. Reduction in outstanding shares is due to repurchase program begun 2002, including the 289m sharesrepurchased in recent tender offer.

b. Through end-3Q, repurchased 743m shares.

E. HD Supply:1. Earnings for HD Supply were $20m.2. Included in quarter's results are net after-tax financial results for month of August, and impact of sale of

HD Supply.3. After expenses and taxes, recognized a $4m loss on sale of business.

F. 3Q07 Operational Metrics:1. Opened 25 new stores, including one relocated store, for ending store count of 2,224.

a. Today, 236 stores, representing approx. 11% of store base, operate in Canada, Mexico and China.2. At quarter-end, selling square footage was 233m, up 5.4% from last year.

a. Average square footage per store 105,000, the same as last year.3. Total sales per square foot were approx. $323, down 7.8% from last year.4. YoverY trends for new stores were also negative.

a. Sales per square foot for new stores had best YoverY performance since 4Q06.5. At quarter-end, retail inventory was $12.6b, up 3.7% from last year.

a. On per-store basis, inventory was down 1.9% from last year.6. Inventory turns were 4.4 times, slightly lower than last year.7. Computed on average of beginning and ending long-term debt and equity for trailing four quarters, ROIC

for retail business was 15%, up 130 bp from 2Q07.8. Ended quarter with $45.5b in assets, including $550m in cash and short term investments.

a. This is down approx. $64m in cash from end-FY06.i. Reflects cash generated by business of approx. $5.8b, net proceeds from sale of HD Supply of $8.3b,

commercial paper issuances of $748m, offset by $2.5b of capex, $325m paid for minority interest inHD Supply, $1.3b of dividends paid and $10.8b paid for share repurchases.

G. Guidance:1. For year, estimate total capital spending will be $3.9b.2. Comps for year will be negative 6-7%.3. EPS from continuing operations on 52-week basis will be down as much as 11% from last year.

H. Recapitalization Plan:1. Regarding completion of $22.5b plan, since announcing plan in June, completed about 50% of recap.2. Credit and housing markets have become more difficult since June.3. Co. believes it prudent to take cautious stance regarding completion of recap.





4. Will move forward when co. sees improvement in home improvement and credit markets.a. Co. believes this will not occur until 2008.b. Will provide information on plans.

5. During 4Q conference call, will provide sales, earnings and capital spending guidance for FY08.

QUESTIONS AND ANSWERSOperator

Thank you. (OPERATOR INSTRUCTIONS). We'll go first to Chris Horvers at Bear Stearns.

Chris Horvers - Bear Stearns - Analyst

Thank you. Good morning, everybody.

Carol Tome - Home Depot Inc - CFO, EVP - Corporate Services

Good morning.


First question, on the recap program, I think when we're out here speaking with investors and we understand beingpushed back because of the credit market aspect. But pushing it back because of the home improvement market,what do you say to people who turn and say well, if they're not interested in buying our stock today, why shouldI?

Frank Blake - Home Depot Inc - Chairman, CEO

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


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


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






And Chris, you'll recall that from a capital strategy perspective, we have targeted an adjusted debt to EBITDARleverage ratio of 2.5 times. So clearly, the housing market will impact our adjusted EBITDAR and so we're justworking through our plans for 2008 and looking at that relative to our financing plan.


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


Well, it's a great question. We had some catch-up spending in 2007 as we've talked to you about. Again, we arenot giving guidance today for 2008 because we're just building our plans. But as we look at our business model,we believe that we will still, for every negative point of comp sales, deleverage expenses by 20 basis points. Thenthere will be some other goes ins and goes outs that we'll talk to you about.


Thank you very much.

Operator

Next we'll move to Deborah Weinswig at Citi.

Deborah Weinswig - Citigroup - Analyst

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


Yes, Deborah, we did change the targets. So previously we tended to have a stretch target in order to get intoSuccess Sharing and then you had to hit 100% of the target. So for this year, we changed that approach and madeit a percent of target and at the time, we were thinking the target we set out was a very reasonable target. Again,the basic principle being we wanted our associates to feel the benefit of Success Sharing and then earn their wayup into additional dollars, rather than feeling demotivated in the start.


Last question. In terms of helping the associates in a tough environment, are there any additional tools that you'reproviding them with in store to help serve customers or help them upsell?





Paul Raines - Home Depot Inc - EVP - US Stores

Yeah, I'll take that one, Deborah. This is Paul. There's a series of activities in the stores around learning that are veryimportant. We have spent a lot of time refocusing in the first half of this year around in the aisle earning andemphasizing project and product knowledge versus the heavily e-learning focus that we've had previously. That'sone of the tools that we've given them. At the same time, we're doing a tremendous amount of focus on our VOCactivities and giving them a lot of feedback in metrics around what customers are saying about the business. Wefeel that we're giving our associates a lot more tools around the customer and around product knowledge andhelping customers do projects in their homes through this first half.


Great. Thank you very much.

Operator

Next we'll move to Steve Chick with JPMorgan.

Jeff Wimmer - JPMorgan - Analyst

This is actually Jeff Wimmer on behalf of Steve Chick. I have a question about your guidance, if you could delve ina little bit more about that. Looks like sales remain relatively the same, in that high mid single digit range. Couldyou talk about the split between growth in SG&A deleverage? Are you still looking for upgrowth marginsyear-over-year.


Year-over-year, we are projecting slight margin expansion on the expense side. The expense deleverage that wesaw in the third quarter will continue into the fourth quarter.


Okay. And then I might have missed this because I got on the call a little late. But did you give intraquarter salesyet?


From a comp perspective?


From a comp perspective. Negative five in August, negative 7.3 in September, negative 6.3 in October. Also, justthinking about going forward, you have this $600 million reinvestment plan. Is this going to be something reoccurringnext year? Will there be additional incremental investment as we look into '08?






At the beginning of the year we said that we were investing $2.2 billion in support of our five key priorities, $1.6billion for capital, $600 million of expense.


Right.


Some of that expense was catch-up spending. We will continue to invest in the key priorities in 2008. Just to updatethe capital a bit, we are going to spend this year, we project about 1.3 against the original 1.6 target but that's reallybecause of the sale of HD Supply.


Okay. Thank you.


You're welcome.

Operator

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

Budd Bugatch - Raymond James - Analyst

My first question goes to appliances. Can you kind of update us where you are on share on appliances and I noticedin some stores, maybe some additional square footage through the use of mezzanines. Is that prevalent in a numberof stores?


Yeah, bud, that's a very limited pilot that we were running and I would not expect to see a lot more of those. Butlet me turn over to Craig for general comments on appliances.

Craig Menear - Home Depot Inc - SVP - Merchandising

For appliances overall, again, we were pleased with the performance there. We achieved a 12.4% penetration interms of market share versus 10, 7, a year ago, up again from Q2 which was at 11, 7. So the customer really continuesto respond to the offering that the team has put together.






Craig, those are unit shares?


Yes.


Okay. And if you could, also, my last question is to talk a little bit about maybe any additional talent or what yousee in the Merchandising Organization with Gordie's coming on-board. Can you talk about maybe what otherneeds you might have?


Well, again, you know, very excited to not only have Gordie on-board but also to have Bruce join us, coming infrom the field to help us really coordinate and connect with our regional team as we continue to try to drive theregional assortment variation that we need across our business and get that executed for the stores. With Gordiejoining us, again, great retail talent, I think well-respected in terms of his knowledge both in mass discount andspecialty retailing and it's a super addition to our team. We feel very good about the overall team that we have inplace right now and looking forward to driving the business.


Okay. And just could you give us maybe what the tax rate is going forward? Any more tax issues?


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


Okay. That helps.


Okay. Good.

Operator

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





Matthew Fassler - Goldman Sachs - Analyst

Thanks a lot. Just a couple quick questions here. First of all, the average ticket decline seemed to moderate a bit.If you could give us any color on why you think that happened, be it mix or other factors. Just by way of follow-up,Carol, on the recap, would you continue to expect to deploy free cash against buybacks or would you hold off fromthat as well?


Okay. Craig, first, why don't you comment on the average ticket.


Yeah. On average ticket overall, again, what we saw there was some shift in mix, that is impacting that business.When you look at what happened to the lumber and building materials categories as that relates to a larger repair,remodel project overall, that certainly had an impact on the category. We did see some shifting and we're seeingwithin categories, for example, in a little more discretionary spend categories like outdoor power equipment, wesaw shift down in the line which impacted the ticket in that category as well.


Another comment on the ticket, if you look at the sequential performance, Q3 to Q2, in Q3 we picked up $0.22 ofaverage ticket growth because of an increased appliance penetration. We didn't have that same benefit in thesecond quarter. So that's part of what you're seeing.


Okay.


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


Just to clarify, I mean, to the extent that you're talking about holding off in the recap, you're talking about holdingoff borrowing more money to buy back stock, not the repurchase of stock in and of itself?


Right. Now, remember we have $748 million of out standing commercial papers. We don't have excess cash aswe're sitting today.






Thank you.

Operator

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

Danielle Fox - Merrill Lynch - Analyst

Good morning. I guess just looking back historically, the retail business has had an operating margin as high as.Where you're tracking this year. I'm wondering what needs to happen to get back up to those levels. Presumablyyou need to return to positive comps. But do some of these supply chain enhancements that you're beginningalso need to work out in order to return to the 11.8%?


Yeah, Danielle, I think first, clearly positive comps because that levers positively versus the negative, the deleveragethat we see now. And then second, you're exactly right in terms of improving. What we see is the substantialinvestment that we're going to make in our Supply Chain will help us improve our operating margins, as will themerchandising transformation that's really at the heart of core retail.


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


No, I mean, I would say 11.8 is a long ways away. But I mean, we think that there's significant improvement fromwhere we are.


Okay. Thank you.

Operator

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

Gregory Melich - Morgan Stanley - Analyst

Thanks. I've got two questions. Frank, could we start on the Canadian roll-out of the merchandising system.






Yes.


That was mentioned as something that will happen next year. Is that a pilot or is that across all the stores or justfill us in on the timing there.


Yeah, the timing is around the end of March, the pilots will -- I mean the way the actual roll-out works is it startswith a set of pilot stores and you pilot that for several weeks and then fix any bumps that occur during the pilotprocess and then we expect to have it rolled out to every store in Canada by the end of 2008.


And if I remember correctly, there was a plan to maybe accelerate the U.S. following of that, is that still the case orthat will be an '09 business?


The way we're setting this up, and I think the tremendous advantage that we have with Canada as sort of ourlaboratory, in effect, is that we're going to look very closely at what the results are from Canada, both pilot androll-out, and that's going to determine the pace that we take on the U.S. side.


Okay. So stay tuned?


Yeah.


Basically. And the second question, Carol, is a follow-up on the earnings share of the credit business, I think yousaid it was $83 million. Did I get that number right?


$82 million year over year.






So is that -- but it was still profitable in the quarter.


Yes, it certainly is very profitable.


Was that swing, would you call that sort of an ongoing.


Yes --


A provision that you unwound effectively.


It's a good question. It's the lost piece of the portfolio, the portfolio is really a good portfolio. The losses had beenrunning in the 5, 4.5% range. They've popped up. We're now projecting they'll be in the 6% range. Which relativeto other credit card portfolios is not bad. But it's higher so it means the profitability isn't as large as it was so wedidn't get as much of a share gain in the quarter and that pressure will continue into the fourth quarter.


Okay. So we think that 6% is now a good ongoing number that we should use.


We're going to be watching it very, very carefully. Some other stats, for your information. 65% of the portfolio hasFICO scores greater than 650 so that's very high quality. But 17% of the portfolio has FICO scores of less than 600.So we're going to be watching this very carefully. I mean, the credit market is interesting in today's environment.


That's for sure. Are you -- on the down side there, is there like a stop loss so-to-speak that you share the profits butis there a cap on that or no?


The profits that are shared is over a threshold. We've got a long way to go before that would happen.






Okay. Great. Thanks.

Operator

Our next question comes from Eric Bosshard at Cleveland Research.

Eric Bosshard - Cleveland Research - Analyst

Good morning. Two questions. First of all, on the recap, is the adjust -- or the waiting to see what you're going todo next year, is that based on much as uncertainty about the EBITDA of the business next year? Is that the primarydriver to how you're rethinking the pace of what you're going to move on that?


As both Carol and I said in our comments, it is both things, both the credit markets and the underlying housingmarket. As Carol indicated, obviously the underlying housing market impacts our performance which impacts ourEBITDA, which impacts our coverage. And from where we are now, I mean I think it's worth pausing and realizinglook, the window's being closed to on us so we couldn't have been buying even if we had had wanted to. Thewindow is now open and you would say -- we'd say looking at our business and looking at the credit market thatthis is a time to pause and make sure we've got a pretty firm idea going forward before making that second andthird steps in the recapitalization plan, which again as I said in the initial comments, we remain committed to. It'sreally just a question of figuring out the right timing.


We certainly have debt capacity. If you look at our adjusted debt to EBITDA ratio for the trailing 12 months it's 1.9times. So we've got debt capacity.


Secondly, understanding the uncertainty that you've made the decision to move slower on the repurchase, Iunderstand that, but in terms of the capital and the sales investment that you're going to make in the business fornext year, how are you thinking differently about that? That is a wait and see how sales are until you determinewhat you're going to invest in the business? Or are you going to continue to make investment regardless of thesales environment?


We're continuing to make the investment in the business, to make the customer experience the best possiblecustomer experience. I'd say where there's an impact, and where you have already seen an impact this year, is inour new store opening and taking down our new store opening both for 2007, as Carol indicated, that reducedour CapEx for 2007 and into 2008.






Recall, Eric, that at the beginning of the year, we said we'd spend $4.5 billion in capital. We're going to spend $3.9billion, that includes 200 million at supply. In the retail business, about 3.7 and a delta from the beginning of theyear is really new store capital.


Okay. Thank you.

Operator

We'll go next to Gary Balter at Credit Suisse.

Shannon Mikus - Credit Suisse - Analyst

This is Shannon for Gary. How much of the lower guidance is due to the reinvestment in the stores or minimumlabor standards that you've put in place versus the worsening housing markets?


For the fourth quarter and full year, Shannon?


Yeah.


If we're looking at now comps of negative 6 to 7%, earnings from Continuing Operations EPS down 11%, right inthat is expense deleverage along the lines of what you saw in the third quarter and gross margin expansion. Andthe expense deleverage is just a factor of the negative comps that we're projecting, the investment and somecontinued pressure on credit.


Okay. Thanks.

Operator

Next we'll take a question from Colin McGranahan at Bernstein.





Colin McGranahan - Sanford Bernstein - Analyst

Good morning. Wanted to focus first on the expense line a little bit. As I look at the expense dollars, year-over-yearthe growth rate of those dollars is about 4.1%, which is looks like a deceleration of about 100 basis points fromroughly 5% growth rate in the first half of the year. Given success sharing dollars, looked like they were prettyconsistent. You had this $82 million negative year-over-year delta in the credit portfolio. Square footage growthis pretty much the same at 5.4%. What was it that caused the expense dollars to decelerate and where did yourealize some expense savings in the business?


We didn't call it out in our prepared remarks. But just like the second quarter, we were actually under our expenseplan in the third quarter. Every day, we wake up and look at sales. We look at cash and we look at where we cancontrol expenses that doesn't impact the customer experience. And we had good expense control in areas likeadvertising. You might want to talk about payroll. It's our biggest expense. On the payroll side, wages are upyear-over-year, that's reflecting the investments that we're making. We've got an activity based labor model andthe hours and the stores are lower than they were a year ago, because we had less activity in the stores. On theG&A side, we've got unbelievable expense control. We're investing where we need to invest. But where we can cutcosts, we are.


So were labor dollars, then, growing at a slower rate in the third quarter than they were in the first half of the year?


They were.


Right.


Okay. So dollars of savings and advertising as a savings and just tightening the nuts on the G&A.


Yeah. There's lots of other small goes in and goes outs. But yeah those are the big buckets.


Is that 4% a reasonable pace going forward? Looks like that 82 million credit Delta is probably recurring and givenprobably some stress levels some of your larger pros that are sitting on those credit cards, that may actually begetting worse, not better?






I think we've given you pretty good guidance for the year, so you can do the math.


Okay. My second question, just on traffic, obviously ticket improved sequentially a little bit. Looked like it was apretty significant deceleration in traffic. Would you peg any of that to kind of seasonal variances and the droughtconditions and things like that or was it just general housing market?


As we looked at the traffic, just let me address the drought question, you know, we saw some impact in categorieslike live goods, pressure washers and power equipment in the Southeast area of the country. It wasn't materialoverall in the quarter. We did take the opportunity to move some power equipment into the Southwest region ofthe country, which was performing extremely strong and to make sure that we continued to leverage the opportunityin that business. But overall, I wouldn't say that weather was the impact to the average ticket.


Traffic?


Traffic, I'm sorry, yes.


Okay. Great, good luck, guys. Thanks.

Diane Dayhoff - Home Depot Inc - SVP IR

Audra, we have time for one more question.

Operator

We'll go to Brian Nagle at UBS.

Brian Nagle - UBS - Analyst

Hi, good morning.






Good morning.


Question on as we see the weakness in the U.S. dollar here, you've presumably sourcing more products oversea,what impact has that or could that have upon your business or specific gross margins in the coming quarters.


When we look at -- this is Craig -- what's going on with the dollar right now, certainly there is some pressure outthere, but we're working hard with our suppliers to really work through that pressure with them, to find other waysthat we can work together to take a mutual costs that we have out of our business and really not let that impactthe retail environment whatsoever. So we're not seeing a significant change overall.


One very quick question. I noticed in the guidance, it seems like the benefit of that extra week from an EPS perspectivechanged this time in your guidance. What explains that?


We tightened up our forecast. We had carried over some cost into that extra week that we didn't need to. We justhave a better forecast.


Okay. Fair enough. Thank you very much and good luck next quarter.


Thank you all very much.

Diane Dayhoff - Home Depot Inc - SVP IR

Thank you for joining us. We look forward to the call next quarter.

Operator

That does conclude today's conference. Again, thank you for your participation.





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Cover PageCorporate ParticipantsConference Call ParticipantsOverviewFinancial DataPresentation Summary3Q07 Performance (F.B.)Departments (C.M.)Markets, Progress on Priorities (P.R.)3Q07 Financial Details, Guidance (C.T.)

Questions and Answers1. Operator2. Chris Horvers3. Carol Tome4. Chris Horvers5. Frank Blake6. Chris Horvers7. Frank Blake8. Carol Tome9. Chris Horvers10. Carol Tome11. Chris Horvers12. Operator13. Deborah Weinswig14. Frank Blake15. Deborah Weinswig16. Paul Raines17. Deborah Weinswig18. Operator19. Jeff Wimmer20. Carol Tome21. Jeff Wimmer22. Carol Tome23. Jeff Wimmer24. Carol Tome25. Jeff Wimmer26. Carol Tome27. Jeff Wimmer28. Carol Tome29. Operator30. Budd Bugatch31. Frank Blake32. Craig Menear33. Budd Bugatch34. Craig Menear35. Budd Bugatch36. Frank Blake37. Budd Bugatch38. Carol Tome39. Budd Bugatch40. Carol Tome41. Operator42. Matthew Fassler43. Frank Blake44. Craig Menear45. Carol Tome46. Matthew Fassler47. Carol Tome48. Matthew Fassler49. Carol Tome50. Matthew Fassler51. Operator52. Danielle Fox53. Frank Blake54. Danielle Fox55. Frank Blake56. Danielle Fox57. Operator58. Gregory Melich59. Frank Blake60. Gregory Melich61. Frank Blake62. Gregory Melich63. Frank Blake64. Gregory Melich65. Frank Blake66. Gregory Melich67. Carol Tome68. Gregory Melich69. Carol Tome70. Gregory Melich71. Carol Tome72. Gregory Melich73. Carol Tome74. Gregory Melich75. Carol Tome76. Gregory Melich77. Carol Tome78. Gregory Melich79. Operator80. Eric Bosshard81. Frank Blake82. Carol Tome83. Eric Bosshard84. Frank Blake85. Carol Tome86. Eric Bosshard87. Operator88. Shannon Mikus89. Carol Tome90. Shannon Mikus91. Carol Tome92. Shannon Mikus93. Operator94. Colin McGranahan95. Carol Tome96. Colin McGranahan97. Carol Tome98. Frank Blake99. Colin McGranahan100. Carol Tome101. Colin McGranahan102. Carol Tome103. Colin McGranahan104. Frank Blake105. Colin McGranahan106. Frank Blake107. Colin McGranahan108. Diane Dayhoff109. Operator110. Brian Nagle111. Frank Blake112. Brian Nagle113. Craig Menear114. Brian Nagle115. Carol Tome116. Brian Nagle117. Frank Blake118. Diane Dayhoff119. Operator

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q3 2007 home depot inc earnings conference call on nov. 13 ... · 11/13/2007 · overview...

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