Home Depot Q2 2006 Earnings Conference Call Transcript (HD)

The Home Depot, Inc. (NYSE:HD)
Q2 2006 Earnings Conference Call
August 15, 2006 9:00 am ET

Executives

Robert L. Nardelli - Chairman, President, Chief Executive Officer
Carol B. Tome - Chief Financial Officer, Executive Vice President
Thomas V. Taylor - Executive Vice President of Merchandising and Marketing
Diane Dayhoff - Vice President of Investor Relations
Carl C. Liebert III - Executive Vice President, Home Depot Stores
Joe DeAngelo - Executive Vice President, Home Depot Supply

Analysts

Eric Bosshard - Cleveland Research Company
Deborah Weinswig - Citigroup
Matthew Fassler - Goldman Sachs
Danielle Fox - Merrill Lynch
Gary Balter - Credit Suisse
Michael Baker - Deutsche Bank
David Strasser - Banc of America Securities
Joe Feldman - Telsi Advisory Group

Operator

Good day, everyone, and welcome to today’s Home Depot second quarter earnings conference call. As a reminder, today’s conference is being recorded. Beginning today’s discussion is Ms. Diane Dayhoff, Vice President of Investor Relations. Please go ahead.

Diane Dayhoff

Thank you, and good morning, everyone. Welcome to the Home Depot second quarter earnings conference call. Joining us on our call today are Bob Nardelli, Chairman, President, and CEO of the Home Depot; Carol Tome, Executive Vice President and Chief Financial Officer; and Tom Taylor, Executive Vice President of Merchandising and Marketing.

Today’s discussion will begin with a review of our business by Bob. Tom will provide insight into our merchandising efforts, and Carol will complete our prepared statements with a discussion of our financial results. Following this brief discussion by management, the call will be open for analysts’ questions. Questions will be limited to analysts and investors, and as a reminder, we would appreciate it if the participants would limit themselves to one question with one follow-up please. This conference call is being broadcast real-time on the Internet at homedepot.com, with links on both our home page and the investor relations section. The replay will also be available on our site. 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 Bob, let me remind you that today’s press release and the presentations made by executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. These risks and uncertainties include but are not limited to those factors identified in the release and in our filings with the Securities and Exchange Commission.

Now, let me turn the call over to Bob Nardelli.

Robert L. Nardelli

Thanks, Diane. In the second quarter, we delivered sales of $26 billion, up almost 17% from last year. Our net earnings were $1.9 billion, and excluding a one-time tax assessment, diluted earnings per share were $0.93, an increase of over 13%.

During the quarter, we continued our focus on returning value to our shareholders. In May, as you recall, the board approved the repurchase of $2 billion, or approximately $53 million shares, through an accelerated share repurchase program. Since the inception of our buyback program in late 2002, we have repurchased almost 350 million, or approximately 17% of our outstanding shares.

In addition, since 2000, we have more than doubled our annual dividend, increasing it from $0.16 to now $0.60 a year.

Over the past five years, we have returned 65% of cumulative earnings to our shareholders in the form of dividends and share repurchase. Carol will take you through our financial results in more detail later.

Our retail segment grew by 5%, with an operating margin of close to 13%. In the second quarter, we continued introducing new and innovative merchandise and gained market share in key categories, including appliances, grills, patio furniture, and outdoor power.

Our services revenue, which is included in the retail segment, grew by almost 10% in the quarter to $1 billion. Our Home Depot Direct business, representing e-commerce and catalogues, experienced solid growth and is on track to deliver $1 billion in annual sales.

In the second quarter, sales in our Home Depot Supply segment grew by 325% and the operating margin in that business was 7.5%, up from the 7.2% last year. Our integration of Hughes Supply is exceeding our expectations.

Over the last few months, Home Depot Supply acquired four additional companies, and we would like to welcome Western Fasteners, Texas Contractors Supply, Rice Planter Carpets, and Forest Product Supply into the Home Depot family.

Let me now shift to the macro-economic environment. As you know, we use an econometric model for planning purposes, and the economic indicators that drive growth in our industry are mixed. Some indicators like unemployment and wages remain healthy. Also, the installed base for homes has grown over the last three years, and housing continues to age, which benefits home repair and maintenance spending. In fact, we believe discretionary dollars will become repair and maintenance dollars.

On the other hand, the consumers feeling the pressure of higher oil and gas prices, rising interest rates, possible rate mortgage resets, and this pressure on the consumer impacts our transaction count. Therefore, we see a challenging second half and we are planning conservatively overall, but not in the retail business. We are accelerating investments to aggressively focus on our valued customers and attempt to gain share in a down market.

First, in May, we told you that we were going to reset 100 bays in each of our top 500 volume stores by year-end. Today, we are excited to announce that we have added the 40 stores here in our hometown of Atlanta. I have walked the first reset stores and really liked what I have seen.

This aggressive refreshening will become part of our ongoing retail model to the balance of this year and beyond. Further, as you will hear from Tom Taylor, the financial results of the resets have been positive. Tom will also talk to you about our merchandising initiatives later in the call.

Second, we are accelerating capital expenditures on our store modernization program. This includes the completion of self-check-out in all stores, customer service call boxes to selected stores, and just simply spending more on store appearance to improve the overall shopping experience.

Third, typically we adjust our staffing levels to match sales -- up in the spring, down in the fall. For the back-half of the year, we are going to keep the staffing level in place and will be adding more. In total, the U.S. stores will have 5.5 million more hours in our stores to serve our customers. You will see more associates in the store than prior fall seasons.

Finally, in floors, we are continuing with our technology and the logistics initiatives, SOSI, special order service initiative, should be in the flooring department in all of our U.S. stores by the first quarter of next year. Our core retail initiative is moving forward in Canada before we bring it to the U.S.

Additionally, I am delighted to have Mark Holifield on staff as our new Senior Vice President of Logistics. Mark brings 29 years of logistics experience to the Home Depot. In just a few weeks with us, he has already brought some great ideas.

Finally, last quarter we launched a new associate initiative program, raising the awareness and rewarding good customer services. We call that Orange Juiced. Orange Juiced will pay out $30 million to our store associates on top of our success sharing program, so I want to thank our associates for their hard work and focus on taking care of our customers. We are clearly seeing the results on our current voice of customer data.

In total, we are spending about $350 million more in capital expenses than we had planned. In order to do this, we have reprioritized some non-customer facing initiatives. We are confident of our competitive position, both in the retail business and in Home Depot Supply, and in a challenging environment like this, we believe it is all about investing to win.

In the back half of the year, we are investing in our customers, our associates, and our stores, and I am confident in our team’s ability to execute.

So now, I would like to turn the call over to Tom to give you an update.

Thomas V. Taylor

Thanks, Bob, and good morning, everyone. We entered the second quarter with momentum. From a merchandising perspective, we saw solid average ticket growth. Our average ticket reached $59.98, a 4.2% increase compared to the same period last year. The growth in average ticket was driven by continued strength in our repair/remodel businesses, as well as market share gains in key categories.

While we had great merchandise momentum, our transaction softened up in the last part of the quarter, and we think it was a function in part of the economy. Let me get back to merchandising.

We saw strength in our repair/remodel business, particularly in building materials, hand tools and power tool accessories, and electrical products, such as wire, conduit and fittings. These categories all reported positive comps, driven by whole project selling, as well as increases in commodity prices.

We also gained market share in key categories, including electrical, hand tools, hardware, outdoor power equipment, grills, patio furniture, and appliances.

In electrical, we gained share due to our ability to maintain a strong, in-stock position compared to other regional competitors. In outdoor power equipment, we gained share in a shrinking market as a result of our comprehensive line-up of mowers and tractors. According to an independent third-party, on a rolling 12-month basis, our core lawn power equipment market share increased 60 basis points to 24.4%. Our results were driven by a stronger merchandising assortment and the power equipment specialists on the floor of our stores.

We have become the destination for grills and patio furniture. Two years ago, we had a limited assortment of grills and a 14.4% market share. Today, we have an expansive assortment of grills and have increased our market share by over 300 basis points to 17.5%.

Patio furniture had another great quarter, as we continue to increase our assortment, enhance the quality and provide great values through our proprietary Hampton Bay brand.

The momentum in appliances continued as we grew market share and hit our highest close rate ever. According to an independent third party, on a rolling 12-month basis, our core market share increased 130 basis points to 10.1%. Our results were driven by a merchandising assortment and our knowledgeable sales associates.

Our customers continued to respond to our new and innovative products. During the second quarter, we rolled up the midnight blue LG steam sense laundry with LCD display. We also introduced an LG French door bottom out refrigerator with ice, crushed ice, and a water dispenser. In small appliances, we added a new and exclusive vacuum line by Maytag.

Given the heat across the country, we saw strength in our air movement categories. We had strong sell-through in air condition units, portable fans, air filters, and evaporative coolers, and saw customers trade up in this category to optimize product efficiency and reduce energy costs.

During the second quarter, lumber prices fell to 2002 levels and had a negative impact for the category. Had lumber prices been at last year’s retail price, our retail comps would have been slightly positive.

In the first quarter, we told you we saw softness in flooring. It did not get much better in the second quarter, but we are making progress. As we begin the third quarter, we are introducing new fashion floor merchandise in every category, including hard flooring, ceramic tile, and soft flooring.

For example, we are expanding our hard flooring assortment to include Thomasville wood flooring, DuPont Real Touch Elite flooring, pre-sealed natural stone, and a Lorel vinyl flooring that has the look of real wood but the resilience of vinyl. As part of our accelerated capital investment in the stores, we will reset ceramic tile in over 500 of our stores.

In soft flooring, we are introducing our exclusive line of [Pruess] Carpet that is specifically designed to resist stains and reduce odor in your home. We are also adding five new products to he Sorona Carpet line, which offers superior stain resistance.

In addition to the merchandise, we have a number of other flooring initiatives underway, from staffing to shortening the installation cycle time to clarifying our pricing proposition -- all of which will turn this very important category around.

Bob talked about mixed signals in the economy. As we look to the back half of the year, we know from our past experiences that in times like these, our customers spend money on core repair and maintenance projects. Knowing that, we will be prepared to serve that customer.

At the beginning of this year, we had a number of merchandising resets underway. Last quarter, we mentioned that we are increasing the reset activity. In over 500 of our highest volume stores, we will reset approximately 100 bays in each of those stores by year-end. These 100 bays include key repair and remodel categories. We call this program Rapid Refresh. We have reset six pilot stores and are very pleased with their initial results. The 100 reset bays are outperforming the same 100 bays in our control stores.

In the third and fourth quarters, we have a number of new programs and products that we will roll out into the stores. We plan to help our customers reduce their energy costs inside their home. As the Energy Star retailer of the year, we have a comprehensive program, including clinics that will teach our customers how to reduce costs in their homes by using energy efficient products.

We will hold clinics in our stores throughout October promoting awareness of our Energy Star products. These products include everything from lighting and ceiling fans, windows and doors, weather stripping, caulk and installation, and appliances. In fact, we have almost 2500 approved Energy Star products in our stores.

In power, we will continue to expand our assortment through the addition of more lithium-ion power tools through Rigid. We carry the most comprehensive assortment in the home improvement industry. New to lithium-ion products from DeWalt, Rigid, and Bosch were added to complement the Milwaukee, Mikita, and Skil products that were introduced last fall.

We will also add seven new products to our exclusive Ryobi One Plus family, increasing the number of tools that can be operated through the Ryobi 18-volt platform to more than 30 tools.

In appliances, you will see us expand the LG Steam Sense laundry line and introduce the LG giant washer and dryer, and the Maytag Duet front-load washers and dryers.

In paint, building on the momentum from our top-rated Behr paint products, we are introducing new Behr kitchen and bath and exterior paints. These exterior paints utilize Behr’s exclusive nano-guard technology, providing improved durability, color retention, wash ability, and mildew resistance. These paints also eliminate the need for a primer and can be used over bare metals.

Our proprietary brand of Behr paints differentiates us as we continue to deliver value to our customers through quality, innovation, and service. I am excited about the initiatives and product introductions that we are planning to roll out from now until the end of this year. We understand the challenges ahead and from a merchandising perspective, we are prepared.

Now, I would like to turn the call over to Carol.

Carol B. Tome

Thank you, Tom, and hello, everyone. As Bob mentioned, in the second quarter, our total company sales grew by 16.7%, or $3.7 billion, to $26 billion.

Of the $3.7 billion in sales growth, $1.1 billion came from our retail segment, and $2.6 billion came from our supply segment. In the second quarter, sales in the retail segment were $22.6 billion, a 5.1% increase over the same period in 2005. This sales increase was driven by the addition of new stores.

Beginning this quarter, we are returning to our historical practice of providing a comparable store sales for the retail segment. Against a strong retail comp of 3.4% in the second quarter of 2005, comp or same-stores sales were a negative 0.2% for the second quarter of 2006. This is slightly down from our first quarter comp, which was a positive 0.2%.

The second quarter started off strong and our May comp sales were in line with our expectations. June softened up a bit, and in July, our comps fell slightly negative.

One last comment about comp sales -- as you know, we strategically cannibalize our stores to take pressure off of high-volume stores and to support market growth. In the second quarter, we cannibalized about 18% of our stores, which had a negative impact on comp sales of approximately 2.1%.

We saw strong growth within our supply segment. Sales in the supply segment were $3.5 billion, up 325% over the same period in 2005. We look at sales growth in this segment from an organic and an acquired perspective. Excluding 2006 acquired sales, total revenues at Home Depot Supply grew by 126% in the second quarter, and for the businesses we owned as of the end of the second quarter last year, the year-over-year organic growth rates was approximately 12%.

Another way we look at the performance and the underlying health of recently acquired businesses is to analyze each acquisition on a full-year basis. For example, while we did not own Hughes in 2005, year over year, Hughes had organic growth of 14%. This illustrates our success in buying quality companies with strong growth potential.

Consolidated net earnings totaled $1.9 billion for the quarter, an increase of 5.3% over the second quarter of 2005. Reflecting the impact of our share repurchase program, diluted earnings per share increased by 9.8% to $0.90 per share.

During the second quarter, Quebec passed legislation that retroactively changed the tax laws and as such, subjected us to additional tax and interest. As a result, we received an assessment from Quebec for the 2002 through 2005 taxable years of approximately $69 million. The earnings per share impact of this assessment in the second quarter was $0.03 per share. Excluding this discreet item, our diluted earnings per share was $0.93, up 13.4% from last year.

In the second quarter, consolidated gross margin was 32.2%, a decrease of 102 basis points from the same period last year. Our consolidated gross margin rate reflects our evolving business model. As you know, supply has a lower gross margin rate than retail. Given the growth in our supply segments, we are experiencing a higher penetration of lower supply gross margin rate dollars.

In the second quarter last year, 4% of our gross margin dollars came from our supply segment. In the second quarter this year, 11% of our gross margin dollars came from supply. In the second quarter, supply’s gross margin rate was approximately 26.5%.

A higher penetration of lower gross margin dollars, coupled with a slight decline in the retail gross margin, caused total gross margin compression in the quarter.

The retail gross margin rate dropped 26 basis points to 33%, reflecting a changing mix of products sold due to growth in appliances. Appliances are now our largest category class.

In the second quarter, we continued to drive expense productivity, as total operating expenses decreased 48 basis points to 20% of sales. This leverage was not at the expense of store labor.

In the second quarter, payroll, which is our biggest expense in the retail stores, increased by 6.2%. Further, our stores and store associates received $10 million in incentives in the second quarter, directly related to improvement in customer service ratings.

Our ability to leverage total company expenses in the second quarter was due to the strong sales growth in supply, as well as continued benefit arising from safety programs and other initiatives inside the retail business.

In the retail segment, our operating margin was 12.9%, about flat to last year, reflecting slight gross margin compression and expense leverage. In the supply segment, our operating margin grew by 34 basis points to 7.5%, reflecting continued progress in achieving acquisition synergies as we leveraged the power of our combined businesses.

Consolidated operating margin for the second quarter was 12.2%, down 54 basis points from the same period last year, reflecting our evolving business model.

Net interest expense was $98 million in the second quarter, up $78 million from the second quarter last year due to interest associated with $1 billion of term debt issued in August 2005, and $4 billion of term debt issued in March of this year, as well as interest related to the Quebec tax assessment.

In the second quarter, our income tax provision rate increased to 39.6% from 37.4% last year, resulting primarily from the Quebec tax assessment.

For the year, we expect our income tax provision rate to be approximately 38%.

Diluted shares for the second quarter were 2.07 billion shares, compared to 2.15 billion shares at the end of the second quarter of 2005. The reduction in outstanding shares is due to our share repurchase program.

In the second quarter, we repurchased 58 million shares, shares repurchased under our accelerated share repurchase program and cumulatively, since 2002, when the program began, we have repurchased 349 million shares and spent $12.5 billion under our $14 billion authorization.

Now, I would like to share some of our operational metrics. During the second quarter, we opened 30 new stores, including two relocations, with two new stores in Canada and one new store in Mexico. Approximately 10% of our store base is found in Canada and Mexico, and we are the market leader in those two countries.

Today, we own 87% of our retail stores.

In the supply segment, we lease most of our locations and today, we have over 900 locations in 44 states and in Canada. In Atlanta alone, when you combine our retail and our supply businesses, we have over 90 locations, and the served market has grown from $4 billion to now $16 billion.

At the end of the second quarter, selling retail square footage was $219 million, a 6.3% increase from a year ago. The average square footage per store was 105,000 square feet, the same as last year. Retail sales per square foot were approximately $411 for the quarter, down 2.3% from last year. Sales per square foot in our new stores increased. They increased by 1.3% and it was the highest it has been since the second quarter of fiscal 2003.

Now, turning to the balance sheet, at the end of the quarter, total inventory was $13.6 billion, an increase of 21% from last year, and inventory turns were 5 times, about flat to last year.

The growth in inventory is primarily due to Home Depot Supply acquisitions, as well as new stores. On a per store basis, inventory levels were $5.8 million, which is about the same as the first quarter.

Computed on beginning long-term debt and equity for the trailing four quarters, return on invested capital was 23.7%, an increase of 70 basis points from last year. We ended the quarter with $51.8 billion in assets, including $659 million in cash and short-term investments. This is a reduction of approximately $148 million in cash and short-term investments from the end of fiscal 2005, which includes cash flow generated by the business of approximately $5.8 billion, along with the net proceeds of $3.5 billion of term debt, offset by $3.8 billion paid to acquire new businesses, $2.8 billion paid for share repurchases, $1.5 billion of capital expenditures, $800 million used to repay commercial paper, and $628 million in dividends paid.

Our long-term debt-to-equity ratio at the end of the second quarter was approximately 24%.

Now, as Bob mentioned, we are upping our investment in our core business and will spend about $350 million more than we had planned. Of that, $180 million is capital, and we project that our full-year capital expenditures will be approximately $3.8 billion. $170 million of the accelerated investment is expense, and will be partially offset by reduction in certain non-customer facing initiatives.

In January, we told you that we though we would grow our 2006 sales by 14% to 17%, and grow our earnings per share by 10% to 14%. Given the current environment, we think comps could be flat to slightly negative in the back-half of the year. Based on our performance for the first-half of the year, our conservative view for the back-half of the year, and our reinvestment plans, we now believe we will grow our fiscal 2006 sales and earnings per share at the low-end of our guidance.

The Home Depot is a financial powerhouse and we are using the power of our stellar financial position to invest in our customers and our business. As Bob and Tom said, it is a challenging environment but we are taking action.

Thank you for your participation in today’s call. Gwen, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will go first to Eric Bosshard with Cleveland Research.

Eric Bosshard - Cleveland Research Company

Good morning. Could you talk a little bit about the $350 million spend, as we think not only about the second half of ’06, but about 2007 as well? Specifically, what I am interested in is the incremental investments, are those going to continue next year? What form and magnitude would those take? Ultimately, what payback do you think we would get from these?

Carol B. Tome

Eric, good morning. As we mentioned, the $350 million spend for the back-half of the year is broken into both capital and expense. $180 million is capital, and that is capital that we will spend on revitalizing the front-end of our stores, as well as the merchandising resets that Tom talked about. Of the $170 million of expense, more than 50% of that is directly related to the investment that we are making in our associates. The remaining expense are expenses associated with the various store merchandising and store revitalization programs that we have underway.

As we think about what this means for then 2007, what you should expect is a continued investment in the retail business. As Bob mentioned in his comments, in an environment like this, it is all about investing to win, and that is what we are planning to do.

Eric Bosshard - Cleveland Research Company

So does this suggest that it is a -- strategy shift is the wrong word, but is this a changed mindset about the amount of investment that you want to make in the retail business permanently, and what payback do you think that means in terms of sales growth as well as profitability?

Carol B. Tome

We have a balanced approach in terms of investing in our business, as you know, but if you look at the capital spend this year, the $3.8 billion, 95% of that capital spend is directly in support of the retail business. You should expect that to continue.

Operator

We will go next to Deborah Weinswig with Citigroup.

Deborah Weinswig - Citigroup

Good morning. In terms of the initiative with redeploying additional labor to the stores, can you give us additional specifics in terms of categories that we might see that labor, and is there any change in terms of the staffing, you know, thoughts on the store?

Carl C. Liebert III

The way we allocate our labor model in the store is based on the types of stores, whether it be volume or the format of the store. What we are doing is reinvesting in the customer experience inside our store in the various types of store. For example, you will see more aprons on the front-end to take care of our customers. You will see more aprons in the departments in order to serve customers in the transactional side, and as Bob alluded to earlier, is making sure we have enough aprons in the store to make sure that we present that we are ready to go from a store-readiness perspective each and every day. It is really based on a store-by-store decision.

Deborah Weinswig - Citigroup

Then, Carol, can you provide additional color on the gross margin performance in the quarter?

Carol B. Tome

Absolutely. If you want to just break it in its components, what we saw is a changing mix in the retail business, and the retail business saw accelerated growth, as Tom talked about, in appliances. Because appliances are a lower-margin category than the rest of the store, that puts some pressure on the gross margin. The gross margin in the retail business dropped 26 basis points to now about 33%.

On the supply side, we saw an evolving mix in the supply business because of the acquisition of Hughes. The supply margin of 26.5% in the second quarter is ahead of our plan, so we are very pleased with the synergies that Joe DeAngelo and the rest of the team are driving in that business.

Deborah Weinswig - Citigroup

Bob, I was very impressed with the accelerated retail investments for the back-half of the year. In light of those, how should we think about the comps in the back-half.

Robert L. Nardelli

Well, I think as Carol said, we certainly would expect flat to negative comps in the second half of the year.

Carol B. Tome

If I could just jump in, that is really reflecting the economic environment that we see ahead of us, and as you know, when you invest, it takes time to see a return on that investment. As Tom pointed out, in the categories that we have reset in those six pilot stores, the 100 bays are outperforming our control stores, so we feel good about that.

Deborah Weinswig - Citigroup

So should we really expect then to see the benefits of these investments in 2007? I am just trying from a model perspective -- should we be more optimistic on ’07 in light of the investments that are being made in the back-half of ’06?

Carol B. Tome

Well, there are a couple of dynamics to think about as you are building your model for 2007. We are investing in the business to win. We also have economic headwind that is coming right at us, so you have to balance those two things as you think about your model for 2007.

Deborah Weinswig - Citigroup

Okay, but in light of the economic backdrop that most of us probably already had in our models, should we then think this would give an additional lift?

Diane Dayhoff

I do not think we can talk to you specifically about your specific model, so what Carol says I think is an overarching thought process.

Deborah Weinswig - Citigroup

Great. Thank you so much.

Operator

We will go next to Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thank you. A quick question on the inventory. You talked about the sequential change from Q1 levels. Can you compare that to a year ago as well, and also just tell us how you think about your inventory in the context both of the slowing economic environment you see, but also your effort to raise customer service levels.

Carol B. Tome

Yes, absolutely. Relative to a year ago, inventory in our stores is up. Some of that is by design. Some of it also is a reflection of the sales environment that we just discussed. We feel very good about the quality of the inventory in our stores. That is the most important thing. We will sell this through in the ordinary course of business.

Matthew Fassler - Goldman Sachs

Understood, just a very quick follow-up, a clarification on your guidance. You guided to the low-end of your 10% to 14% earnings guidance. How should we think about the $0.03 tax item? Is that included in your guidance or excluded?

Carol B. Tome

It is included. We guide off of GAAP, so if you think about the first-half of the year, we earned $1.60, and if you look at the guidance towards the low-end of the earnings range, that would imply $1.40 in the back-half of the year.

Operator

We will go next to Danielle Fox with Merrill Lynch.

Danielle Fox - Merrill Lynch

Thank you, good morning. Bob, can you talk about what you are doing to develop the next generation of senior executives at Home Depot? In particular, what you are doing in terms of succession planning and how close you are to filling Tom’s merchandising spot.

Robert L. Nardelli

It has been one of the key initiatives in our company over the last five years. We are very proud of a number of initiatives as it relates to the store leadership program, our merchandising leadership program, our business leadership program. We are investing not only in the senior management but we will do over $600 million of training in our stores, in our associates this year.

We have a very robust process where we review succession planning with the board. We spend a significant amount of time, Dennis Donovan and myself, on the road. We did five days, just within the last four weeks, and we did six sessions a day across the country, meeting what we believe is top talent. We are looking very closely at positioning them in career-expanding opportunities.

The good news is Tom has agreed to stay on, which allows for a very orderly transition. I think we have rich, robust talent within this company that we are looking at from a transitional standpoint.

Danielle Fox - Merrill Lynch

Great, then just a follow-up question about your acquisition strategy in the supply business. Could you revisit, now that we have two quarters of segment reporting for Home Depot Supply, could you revisit your next steps and longer range plans for driving supply to be I think a $25 billion business -- this was your target -- by 2010. At the analyst meeting, Carol, you mentioned that you did not expect to spend more in acquisitions over the next five years than you did over the past five years. Is that still your latest thinking in terms of how acquisitions will contribute to achieving that goal?

Robert L. Nardelli

Well, we have the expert in the room, and Joe, why don’t you comment on that?

Joe DeAngelo

Certainly I think we are consistent with what we talked about in January, is that we are always looking at great acquisitions but they need to be the right acquisitions at the right time, so we are always looking for a willing seller with great talent, has a great business model, and is at the right price, and so we will continue to be right on that path. I think Frank Blake and his team, with Ted Decker, do an awesome job of just lining up the pipeline and being very discreet in terms of who we buy. We look at 10 to 15 for every one that we get.

Also, we are very much focused on just being an organic growth machine. So we buy everybody to grow. I think you have seen that in the Hughes acquisition to date and every acquisition we have had, so really, we look at it in terms of if you do not have a great, organic growth model, you do not earn the right to acquire.

We will stick on strategy and it will happen the same way it happened the last couple of years.

Danielle Fox - Merrill Lynch

Do you feel like that 12%, which was a really good number, could have been even higher in a more robust demand environment? Or you are not really seeing the macro impact at the supply business?

Joe DeAngelo

I think any time the economy goes up, you are going to get some tailwind on that. I could not be happier and prouder of what the teams have done in every one of the market segments that we participate in.

Operator

We will go next to Gary Balter with Credit Suisse.

Gary Balter - Credit Suisse

Thank you. Just a comment, then a question. I have been -- I am used to being audited from Quebec, so it feels good that it was only $0.03.

Carol B. Tome

You feel our pain.

Gary Balter - Credit Suisse

The question is for Bob, I guess. The investment back in retail effectively marks a change where what we have been seeing is we have been paying actual lower labor hours than if anything lower investments in the past. What caused the change? Is it looking at your relative performance versus lows? Is it just a sense that the retail business was not moving in the direction that you thought? Obviously this is a pretty significant change, so there has to be something behind it. Thank you.

Robert L. Nardelli

I think it is a multi-pronged response. Certainly I think in a down-market, we have to get more aggressive to hold share. That is clearly a priority for us in the second-half.

Two, as I said, seasonally we would adjust our labor models up in the spring, down in the fall, so consistent with the capital reinvestment, we all know that you can have great merchandise, great looking stores, but it is our associates that bring it to life. So it is just a logical extension of a capital investment to invest in our associates, to make sure that we have more associates on the floor when customers will be more discerning, have more choices, and we clearly are going to be aggressive and committed to holding and gaining share. We are starting to see very good results in our voice of customer, certainly supported by these initiatives, and certainly the opportunity for incentive recognition through Orange Juiced. Carl and the team were up in Minnesota last Sunday night, had a big celebration. We are going to be announcing the second quarter winners as soon as we get off this call.

So it is all about momentum. It is all about attitude. We wanted to convey a very robust, strong commitment.

I think Carol mentioned about the capital, 90% was in retail, so I do not see it as a dramatic change from where we have been, but we certainly are laser-focused in what we think will -- with the uncertainties of the second-half, we are laser-focused on retail.

Gary Balter - Credit Suisse

What does this do to the buyback?

Robert L. Nardelli

I think Carol mentioned we still have about $1.5 billion remaining on our buyback. We have I think set a pattern as a corporation, and certainly in retail, we do not just announce buybacks, but we actually do them. As evidenced in what we have done over the last few years, we have returned 65% of our earnings back to our shareholders. As we said time and again, going forward, you should use what we have done as a representative model in your planning going forward.

Obviously that is all contingent upon board approval, but I certainly would say that what we have done is certainly something you could consider for the future.

Gary Balter - Credit Suisse

Giving that you are reinvesting $350 million back in, and you are going to continue the buyback, have you changed your thoughts about the leverage that you would like in the company?

Robert L. Nardelli

No, I think again, we said time and again, we have a pretty balanced approach. I think we are certainly reinvesting through stock repurchase. We have taken the dividends from $0.16 when I got here to $0.60, while at the same time, I think you would agree with me, Gary, that the strategic reinvestment in going from zero to $12 billion in our Home Depot Supply business certainly broadens our ability, broadens our customer base.

Just here in Atlanta, we will go from a $4 billion market to a $14 billion market by a combination of stores and branches. In 12 months, we now have a $1 billion catalogue business. In three years, we have a $1 billion business in Mexico.

I think the approach is balanced. I think we are very sensitive to a broad range of constituents out there. I think we have been very responsible in our actions, and we will be going forward.

Carol B. Tome

If I could just jump in, as you know, we have added additional leverage into our capital structure, increasing our debt-to-equity ratio to now 24%, where last year it was 9%. We have a tremendous amount of cash that comes off of our business. Our stores are cash cows. On average, they generate $5 million in EBITDA. We have access to tremendous leverage outside of the business. We can do whatever we need to do.

Operator

We will go next to Michael Baker with Deutsche Bank.

Michael Baker - Deutsche Bank

Thank you, just a couple quick ones here. Just on the guidance, I think originally when you gave the guidance in January of 10% to 14% earnings growth, it did exclude any impact of share buyback, and then I think you reiterated that at least offline, in the first quarter to me. Is that still the case, this 10% to 14%? Does that exclude your assumption of share buybacks?

Carol B. Tome

What I would like you to think about is in the second quarter, we had $0.03 of accretion from our buyback program, and we lost $0.03 because of the Quebec tax assessment, so those two offset each other.

What we are guiding from is GAAP, freezing the buyback as of where we are today, and then looking forward to the back-half of the year, so the full year guidance we have given you is at the low-end of the EPS growth of 10% to 14%. Does that help?

Michael Baker - Deutsche Bank

You said, sorry, freezing the buyback where you are today?

Carol B. Tome

Just from a modeling perspective.

Michael Baker - Deutsche Bank

Right, in other words, not assuming any more buybacks.

Carol B. Tome

Correct. That is right, yes.

Michael Baker - Deutsche Bank

Now that I think, the way you said it in January, and I wanted to be clear. Then, quickly one more, on the Home Depot, so you said you are planning conservatively. Bob, you said you are planning conservatively, but then said not at retail. Does that imply that you are planning conservatively at the Home Depot Supply business? Broadly speaking, the macro slowdown, which I think we are all seeing here, is that more impactful to Home Depot Supply or your Home Depot retail business?

Robert L. Nardelli

Two comments, and then I will flip it over to Joe on the second half. My comment was specifically uncharacteristically, companies would probably pull back, given the downward pressure in the economy. My comment was specifically as it related to our retail announcement of the $350 million of accelerated expenditures, in that uncharacteristically, we were going to accelerate investments in spite of the uncertainty in the economy.

I think Carol shared with you from a guidance standpoint at the retail level with same-store sales, so again, we are planning conservatively as it would relate to that. We are being very aggressive. Our capital reinvestment was the point I was trying to make.

I think Joe, as he indicated, will stay the course, but I would ask Joe to comment.

Joe DeAngelo

I think when you look at Home Depot Supply, we have a very diverse portfolio now, which really helps through any cycle, so we are about 36% infrastructure, about 43% construction, 16% maintenance, 4% repair and remodel, about 2% international, so no matter what is happening in a cycle, our philosophy is we are going be number one in every one of those segments. When certain things go down, certain other things go up, so we plan to have strong performance through the back half.

Michael Baker - Deutsche Bank

If I could slide in one more -- actually, I will turn it over to someone else. Thank you.

Operator

We will go next to Dave Strasser with Banc of America Securities.

David Strasser - Banc of America Securities

Thank you. In listening to your vendors conference calls for the second quarter, virtually all of them talked about trying to raise prices and push pricing through as a result of commodities. They talked about in a lot of different ways. How are those negotiations going and where is that level of discussion at this point?

Robert L. Nardelli

It is interesting. Before Tom answers, having been on the other side of the fence in selling to major retailers, I am going to be interested to hear Tom’s comment.

Thomas V. Taylor

Thank you, Bob. I think we feel very good about our vendor negotiations, as we may have mentioned on a previous call, or certainly in my one-on-one sessions with the analysts. We added a vendor management team at the end of the last quarter. They are in place now, assisting our merchants when we do see price increases, and aggressively going out, going after, taking costs out of our business.

We feel good about it. I think that we are approaching our negotiations better-educated than we have ever been. I think the merchants are coming with great knowledge and an understanding, so when a vendor partner comes in with a price increase, we have a better understanding and can negotiate favourably.

I think we are doing a very good job.

David Strasser - Banc of America Securities

Philosophically, when you think about it, when you are going to accept them at some point, is it something that you would most likely plan on passing through, or would you accept increases that you did not think you could?

Robert L. Nardelli

I think in our discussions with our supplier partners, and they have been great, is we both work on the same objective -- that is, to get volume and hold customer volume traffic. At the end of the day, if in fact commodity prices, and we feel good about the productivity pass through that our suppliers are giving us, it would be our position to test the market. If they hold, then we will stay there. If they do not, then we go back and talk with our supplier about sharing the burden, but certainly not being uncompetitive in the marketplace.

A point too, I think one of the big advantages we have in addition to broadening our customer base through supply is the commonality of our suppliers. Joe and his team along with Tom have had some great harmonizing discussions with our suppliers. Again, if you look at our cost of goods sold, we certainly have a premier position in talking to the suppliers and again, keep in mind not only have we added 900 stores, but we have added 900 branches. So their ability not only to grow in the existing channels, but those precious new channels that Joe talked about in construction, industrial, and so forth, in giving them access to market is a huge opportunity for them through the same company base.

Diane Dayhoff

Gwen, we have time for one more question.

Operator

We will go next to Joe Feldman with Telsi Advisory Group.

Joe Feldman - Telsi Advisory Group

One question about the supply chain. I know Mark is pretty new there and you had suggested, Bob, in your earlier comments that he has already even had a little impact. I was just wondering, from his perspective, if he is available, what he has seen and where he thinks there might be some opportunities.

Robert L. Nardelli

Let me say this. Mark is not in the room because he is doing what all new associates do. He is working in the store, and I think even though he has close to 30 years of experience, I think it is important, and he is having a great time working in the store, working all the departments. He has also spent a significant amount of time obviously in our DDC’s, transfer centers.

I think the first thing Mark is looking at is bringing his experience and how we might optimize what we currently have. Tom and I are very pleased with certainly his fresh look. Concurrent with that, and I think Mark is going to be looking at where do we go from our current system and how do we maximize what we have to where do we want to go? Basically, we have asked Mark to come in with no preconceptions, no mandate but a clean sheet approach. Bring his wealth of experience over the years, and then come up with a recommendation.

Joe Feldman - Telsi Advisory Group

The one last thing I wanted to ask, on the new Orange Juiced program, can you describe a little more in detail how it works and what type of metrics that you actually measure and how you measure them?

Carl C. Liebert III

We actually spend an enormous amount of time looking at overall satisfaction in the store, as well as likelihood to recommend, because we know that is an important metric for our customers, as well as loyalty in our consumer base.

So what we have is monthly winners by region. As you know, we have RVP’s in the marketplace. Each RVP is allowed to award overall satisfaction metrics as well as most improved within the month. We award monetary awards at the store level. Most importantly, at the associate level. The benefits go directly back to the associates who are serving our customers.

As Bob alluded to, I was in Michigan earlier this week for our highest overall satisfaction store in the chain. We celebrated and we awarded five associates a monetary bonus that serve our customers. They were nominated by their peers as the best servers of customers in their store, and they received that award. Bob is going to pull the names out of the hat for the second quarter here shortly after this call, and then we will be traveling out to three stores, one store in each division, three stores total, to award those checks to those associates as well.

It has been a huge morale lift for our stores and a big win. We invested over $30 million and if you are a divisional associate, one of the winners, you get a check for $10,000. So five associates in these three divisional winning stores get a check for $10,000 each. It is a great, great win for the person.

Diane Dayhoff

Thanks, everybody, for being on the call with us today. We look forward to talking to you next quarter.

Operator

Thank you everyone. That does conclude today’s conference. You may now disconnect.