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The Home Depot, Inc. (NYSE:HD)

F2Q09 Earnings Call

August 18, 2009 9:00 am ET

Executives

Diane Dayhoff - Senior Vice President, Investor Relations

Frank Blake - Chairman, Chief Executive Officer

Craig Menear - Senior Vice President, Merchandising

Carol B. Tome - Chief Financial Officer, Executive Vice President Corporate Services

Matt Carey - Executive Vice President, Chief Information Officer

Marvin R. Ellison - Executive Vice President - U.S. Stores

Mark Holifield - Senior Vice President, Supply Chain

Analysts

Maggie Gilliam - Gilliam & Company

Stephen Chick - FBR

Matthew Fassler - Goldman Sachs

Scott Ciccarelli - RBC Capital Markets

Mike Baker - Deutsche Bank

Gary Balter - Credit Suisse

Dan Binder - Jefferies & Company

Budd Bugatch - Raymond James

Christopher Horvers - J.P. Morgan

Eric Bosshard - Cleveland Research Company

Gregory Melich - Morgan Stanley

Operator

Good day, everyone and welcome to today’s Home Depot second quarter earnings conference call. Today’s call is being recorded. (Operator Instructions) Beginning today’s discussion is Ms. Diane Dayhoff, Vice President of Investor Relations. Please go ahead, Madam.

Diane Dayhoff

Thank you, Augusta and good morning to everyone. Welcome to the Home Depot second quarter earnings conference call. Joining us on our call today are Frank Blake, Chairman and CEO of The Home Depot; Craig Menear, Executive Vice President, Merchandising; and Carol Tome, Chief Financial Officer and Executive Vice President, Corporate Services.

Following our prepared remarks, the call will be open for analysts’ questions. Questions will be limited to analysts and investors and as a reminder, we really 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 homepage 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 Frank, let me remind you that today’s press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. 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.

Today’s presentations also include certain non-GAAP measurements. Reconciliation of these measurements is provided in the financial statements included with our earnings release. Now let me turn the call over to Frank Blake.

Frank Blake

Thank you, Diane and good morning, everyone. Sales for the second quarter were $19.1 billion, down 9.1% from last year. Comp sales were negative 8.5% and excluding the charges related to the expo business closings, diluted earnings per share were $0.67.

Despite the negative sales environment and difficult market conditions, there were some significant positives for us in the quarter. As Craig will detail, we had positive comp transactions in the U.S. for the first time in more than five years. We also had the largest gain in total market share that we have seen in five years and we saw improved comp rates in some of our most important and most hard hit markets like Florida and California.

Craig and his team drove terrific values in innovation in core DIY projects and we achieved positive comps in paint and had a strong selling season in outside garden. We continue to make improvements in the underlying business. Since our last earnings call, we’ve opened two new RDCs, one in Houston and one in Cincinnati. As of today, we have eight RDCs serving approximately 800 stores or more than 40% of our U.S. store base. Mark Holifield and his team, by the end of this quarter, will basically be opening an RDC every month. This is an impressive, maybe unprecedented pace for a large-scale supply chain effort.

Marvin Ellison and the store operations team have brought more focus and better execution on customer service and we see that through our net promoter scores, which take the percent of our customers who rate their experience with us as a 9 or a 10 and subtract from that the percent of customers who rate their experience as a 6 or worse.

Our net promoter score has improved approximately 1,000 basis points year over year and is now at 62.7%. It’s particularly significant for us that our scores went up in the second quarter versus the first quarter since frequently there can be a deterioration of performance as foot traffic increases.

On the international front, our business in Mexico produced another solid quarter with positive single-digit comps in the face of a contracting economy. We had negative comps in both Canada and China but I should point out that the SAP implementation issues that impacted our Canadian business over the last several months have been largely resolved. The Canadian team is now focused on the business, not a system implementation.

We had good expense control across the board and managed inventory levels effectively by achieving flat inventory turns year-over-year. All in all, relative to our plan, we had a solid second quarter. As Carol will detail, based on our first half performance, we are lifting our earnings per share guidance for the year.

But the larger question for us is when will we start to see a broader market turnaround? We are now in the fourth year of a major correction in the housing and housing related markets? Private fixed residential investment as a percent of GDP is at 2.4%, the lowest it has been in over 60 years and down 30 basis points from the first quarter, which previously set a record low.

To understand the current trends across the country, we can look at the comp performance of our top 40 markets in the second quarter versus their comp performance in the first quarter. There is some encouraging news here, since nearly 75% of the markets perform better in the second quarter than the first and as indicated, we’ve seen some significant improvement in California and Florida. In California, double-digit negative comps turned to single-digit negative and in Florida, while we still have some double-digit negative comp markets, the percentage comp decline is about half what it was in the second quarter last year.

But caution is still appropriate. We have some short-term sales headwinds in the back half of the year as we anniversary hurricane activity from last year and commodity inflation in fuel-related categories. More importantly, while the performance across most of our regions is better, we are still not seeing positive comps in any areas other than the areas impacted by hurricanes last year and while there was improvement in hard-hit markets like California and Florida, we remain concerned by the high level of foreclosure activity which we believe continues to put pressure on the housing markets in those areas as reflected in lower sales of basic building material products.

With the dunnhumby tools, we are also getting a clearer look at customer behavior across different segments of our shoppers. Again, there’s a mixed picture. Some clear strength on the consumer side as basic DIY activity picks up but these tools also allow us to see some areas of stress with greater clarity.

For example, we have traditionally said that pro sales represent approximately 30% of our business. That turns out to be accurate as a statement of the past. What has happened in the downturn is that our pro business has declined more rapidly than our consumer business. As an indication of that, pro sales are now down to about 27% of our overall business versus approximately 32% at this time last year. A key element to returning to positive comps for us will be the recovery of this important segment.

Whatever the timing of a return to positive comps, our associates are doing an excellent job of laying the foundation for the future success of the business. We intend to reflect the heritage of this company by setting the standard for customer service and product authority in our market. It is a source of great pride for the company that even in these tough times, we will have record success sharing in the first half with 96% of our stores participating.

Now let me turn the call over to Craig.

Craig Menear

Thanks, Frank and good morning, everyone. As expected, our second quarter comp showed an improvement over the first quarter and we posted a positive comp in paint. The departments that outperformed the company’s average comp were paint, seasonal, building materials, flooring, and plumbing.

Millwork, hardware, kitchens, lumber and electrical under-performed the company’s average comp for the quarter.

We are very pleased with the progress we made in driving customers to our store during the quarter. Our total customer transactions were positive for the first time in two years at positive 0.3% and comp transactions were flat year over year. In the U.S., our comp transactions were up 0.4% and this is the first time since the second quarter of 2003 that we have not had a comp transaction decline in the U.S.

This increase was driven by innovative new product, enhanced customer service, and our continued commitment to drive value for our customers. We saw a marked improvement across several departments with lumber and building materials showing a material improvement in transactions, along with paint and seasonal businesses which experienced positive growth in transactions.

For average tickets of $50 and below, roughly 20% of our business in the U.S., transactions were up 3% year over year. This is the second consecutive quarter of positive transactions for tickets under $50.

The primary drivers of this were the continued strength of basic repair and maintenance categories, paint, and our seasonal garden business.

However, despite a slight improvement from the first quarter, average tickets of $900 and above, which also represent approximately 20% of U.S. sales, transactions remain double-digit negative. Here the weakness continues in high dollar discretionary spend categories.

Our overall seasonal business results were mixed in the quarter. The usual summer heat never came in parts of the U.S. with June temperatures averaging their lowest in five years and July the coolest in 18.

As a result, products like air conditioners and fans under-performed compared to last year and negatively impacted U.S. comps by approximately half a point.

On the positive side, we were very pleased with our performance in lawn and garden. During the second quarter, we saw a positive comp growth across several product categories, like live goods, fertilizers, chemicals, seed and landscape products. In outdoor power equipment, sales significantly outperformed the company average and we grew share on the strength of our exclusive product offerings with Toro, Honda, Cub Cadet, Ryobi, and Home Life.

Paint is another area contributing to our positive transactions in the quarter. Guided by our portfolio strategies, the major investments we’ve made in our paint department are clearly paying off. With the help of Matt Carey and his IT team, we completed the rollout of new paint tinning equipment across all of our U.S. stores, making the process more efficient for our associates and driving inventory efficiency by simplifying the tint base as required.

We also launched innovative product -- Behr’s Premium Plus Ultra, a paint and primer all in one; Rustoleum’s Ultra IIX Product, which delivers twice the paint in the can for about half the cost of competitive product; relaunched Glidden; and reset our applicator program, simplifying the offering for our customers.

As a result of these actions, the department showed a positive comp as we improved the total project sales and gained market share.

The downward pressure on ticket continues in construction categories and big ticket discretionary spend. In total, our average comp ticket for the second quarter was down 8.5%. In the U.S., our average comp ticket declined by $4.11, or 7.3%. Key contributors to the decline in average ticket were commodity categories, such as lumber, building materials, and electrical. Framing lumber and structural panel remains down about double-digit from a year ago; similarly, copper prices were still running on average about 40% lower than the same time last year. These impacts were partially offset by inflation in roofing.

Finally, in the second quarter big ticket discretionary projects like kitchens and millwork contributed over $1.00 reduction of the year-over-year average ticket decline.

Overall, we are continuing to make progress through the implementation of our portfolio strategy and the use of our new tools. We are committed to deliver value to our customers while managing the business in a tough environment. The team delivered a solid performance in inventory and gross margin dollar productivity, as you will hear from Carol. These efforts resulted in the company achieving total share gain during the quarter, despite having closed our expo business and significantly slowed new store growth.

Six of our 13 departments grew share in the second quarter compared to last year and additionally, several key classes saw unit share gains such as carpet, hand tools, hardware, toilets, molding, and cleaning, to name a few.

As we exit the busy spring selling season, we remain focused on providing value to our customers every day. Our organization and storage business is off to a great start. We have invested in a new merchandising set that provides an expanded offering of energy efficient CFLs and LED bulbs. We are providing online tools to educate customers on the importance of weatherization and simple projects like caulking. We are helping customers take advantage of the government sponsored tax credits on weatherization products like storm doors, and we are well-positioned to offer energy and money-saving products, along with fall project know-how.

And now I would like to turn the call over to Carol.

Carol B. Tome

Thank you, Craig and hello, everyone. In the second quarter, sales were $19.1 billion, a 9.1% decrease from last year, reflecting negative comp or same-store sales of 8.5%, plus the net impact of fewer stores due to the closing of our expo businesses. While total company comps were negative 8.5%, we experienced great variability during the quarter, principally due to weather, with negative comps of 6.8% in May, negative 10.7% in June, and negative 8.1% in July. 1.6% of our comp decline is attributable to our international businesses, principally due to a weak sales environment in Canada and a considerably stronger U.S. dollar.

Comps for U.S. stores were negative 6.9% for the quarter, with negative comps of 4.7% in May, negative 9.8% in June, and negative 6.5% in July.

Earnings per share for the second quarter were $0.66, down 7% from last year. During the quarter, we had $20 million of expenses related to the closing of our expo businesses. Excluding the expo related expenses, adjusted earnings per share were $0.67.

Our gross margin was 33.5% in the second quarter, an increase of 32 basis points from last year. Our U.S. stores reported 38 basis points of margin expansion in the quarter, driven principally by two factors -- first, we had lower markdowns than last year as we anniversaried clearance markdowns that we did not need to repeat this year and second, favorable shrink performance.

Through our focus bay portfolio approach, our U.S. merchants continued to introduce new lower prices while growing overall gross margins. The U.S. gross margin expansion was offset by 6 basis points of margin contraction arising from our non-U.S. businesses due to certain higher costs.

Now, you may recall that in the first quarter, our Canadian business experienced significant margin contraction as it worked through inventory and other adjustments related to our score or SAP conversion. I am pleased to report that our Canadian team worked diligently to resolve these issues and our Canadian gross margin rate is back on track.

Operating expenses increased by 43 basis points to 23.9% for the quarter. As a percent of sales, our expense deleverage reflects the impact of negative comp sales. We experienced another solid quarter of expense control, with expenses coming in roughly $20 million under our plan.

We are seeing some benefits from some fundamental changes we’ve implemented to improve spending efficiency in our business. For example, earlier this year we introduced an automated checkbook in our stores. This is a great tool that allows our store managers to manage their expenses on a real-time basis. Managers can see how their expenses are trending relative to their [inaudible], and make on-the-spot adjustments. Essentially, this tool gives our associates the power to control what they can control in order to run a better business.

As a general rule of thumb, we expect to deleverage expenses by about 10 basis points for every point of negative comp. Year-to-date, we are running much better than that, due to our strong expense control and the impact of a lower cost of private label credit.

As we have previously discussed, the year-over-year benefit arising from our private label credit renegotiation will be more pronounced in the first half of the year than the second half.

Additionally, the weighting of our sales distribution is higher in the first half than the back half. About 68% of our expenses are fixed, so we would expect more expense deleverage in the back half than the first half of the year.

For the year, we believe that our general rule of thumb of approximately 10 basis points of expense deleverage for every point of negative comp holds true.

Our operating margin was 9.6% in the second quarter, down 12 basis points from last year. In the second quarter, our income tax provision rate was 33.3%, down from 36.2% last year, due primarily to a favorable foreign tax settlement. This settlement reduced our tax expense by approximately $50 million for the quarter and provided approximately $0.03 of earnings per share benefit. As a result of the settlement, we now expect our effective tax rate to be approximately 35% for the year.

Now moving to our operational metric, during the second quarter we opened three new stores and closed one store in China for an ending store count of 2,240. At the end of the second quarter, selling square footage was 235 million, down eight-tenths of 1% from last year.

Reflecting the sales environment, total sales per square foot for the second quarter were $322, down roughly 8%.

Now turning to the balance sheet -- inventory remains a good news story. At the end of the quarter, inventory was $10.8 billion, down approximately $1.1 billion or 9% from last year. On a per store basis, inventory was down 8.3%.

Inventory turns were 4.3 times, flat to last year. We ended the quarter with $44 billion in assets, including $3.1 billion in cash and short-term investments. This is an increase of approximately $2.6 billion in cash and short-term investments from the end of fiscal 2008, reflecting cash generated by the business of approximately $3.7 billion, offset by $353 million of capital expenditures and $762 million of dividends paid.

As a reminder, we have a $3.25 billion A2P2 commercial paper program that is 100% back stopped by a committed long-term bank line of credit. As of the end of the second quarter, we had no outstanding commercial paper.

We have approximately $11.4 billion of outstanding debt, of which $1 billion comes due in the third quarter and $750 million comes due in the fourth quarter of 2009. At this point, it is our intent to repay the debt maturities as they come due using cash generated by the business.

Computed on the average of beginning and ending long-term debt and equity of the trailing four quarters, return on invested capital was approximately 9.3%. On an adjusted basis, excluding charges related to our 2008 store rationalization actions and the closing of our expo businesses, return on invested capital was 10.3%.

We [inaudible] control what we can control. We are focused on executing our strategic imperatives and our financial results reflect the success that we’ve had thus far. Our results for the first half of the year were better than our plans but as Frank mentioned, the external signals call for caution. We are comfortable with the sales guidance we gave at our June investor conference, as we still believe sales will be down roughly 9% for the year.

On the earnings front, based on our first half performance, we are lifting our guidance and are calling for fiscal 2009 earnings per share from continuing operations to be flat to up 7% for the year, and adjusted earnings per share from continuing operations to be down 15% to 20%.

Thank you for your participation in today’s call and we’ll be happy to take your questions. Augusta, we are now ready for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Maggie Gilliam with Gilliam & Company.

Maggie Gilliam - Gilliam & Company

I wonder if you could please talk a little bit more about Canada and the SAP initiative, whether you have learned anything from it yet regarding adopting it in the United States? And also, what kind of merchandising initiatives are you pursuing vis-à-vis Canada and the U.S., Canada being a place where you are selling more décor products?

Craig Menear

Okay, Maggie, thanks very much for the question. Actually here, Matt Carey is here and probably is in the best position to talk about some of the SAP implementation points. I will say to the latter part of your question in terms of the merchandising initiatives that one of the great things about having the Canadian business is that they do go out and do some things a little bit differently than we do in the U.S. and as you said, that some of their stores are significantly more project focused and décor project focused and the Canadian team has had great success with that.

The Canadian team actually was early on adopter of eco options, which we then took that program and as you know are running with it in the United States. So a lot of the things that they do in Canada in terms of merchandising initiatives, we’re then able to transplant here so it’s terrific to have that group working on different ideas.

SAP implementation was very much a part of that, in terms of being able to use the Canadian business to understand what an effort of that magnitude might look like for us and so with that, let me just turn it over to Matt to make a couple of comments on the SAP implementation.

Matt Carey

Good morning, Maggie. What I would tell you is that as we said in the past, we’re going to continue to kind of monitor and watch this SAP performance, the implementation of that system has kind of smoothed out from my perspective and I think from the Canadian team’s perspective. We’ve obviously learned a lot of things about how to do change in our environment and we will continue to apply those learnings as we modify systems in the chain.

We also have found a few things that we would like to bring to the U.S. around labeling and signing, as well as things in the U.S. that we would like to put in Canada around data maintenance and some of the other things, so we are going to continue to share best practices where appropriate and we will continue to look at the SAP implementation in Canada as a learning lesson that might inform us about future decisions.

Frank Blake

And I would also just make a general comment on that, Maggie, that as we think about the SAP implementation, there are really two sets of issues. There’s first, what’s the performance in Canada and what do we learn from that performance? And then also, what do we do in the U.S. and what have we learned over the last year in terms of what we are capable of doing in the U.S. without a major implementation like that? And we’ve seen a lot of progress in the last year on that side of the ledger.

Operator

We’ll go next to Stephen Chick with FBR.

Stephen Chick - FBR

Thanks. A couple of questions -- I guess on -- I appreciate the clarity that you provided on the pro commercial percentages, you know, 27% I think for this quarter, down from a year ago, 32% if I took that down right. Can you give us an idea of what the trajectory of that has been and can you confirm, is that -- do you think of that as higher profit margin business relative to the non-commercial, or is it the other way around?

Frank Blake

Okay. Thanks, Steve -- first on the trajectory, it’s interesting because -- and this is -- frankly a lot of these trends we might not have see but for a better understanding of some of our underlying data. A significant difference in how the pro business reacted post September 2008 versus the consumer business and when you think about it, it actually makes some sense that the pro business was under more pressure from September 2008 going forward. The consumer business was also under pressure -- it was just the pro business was under more pressure. So that’s the trajectory that we have seen, kind of pretty much following, if you kind of do October 2008 on.

In terms of the margin performance, what you would see with the bulk of our pros is they shop the whole store and so the margin performance around the pro is not that -- is not that dissimilar from the consumer.

Craig, do you want to add anything on that?

Craig Menear

Steve, I would tell you that from a ticket standpoint, you know, our pro average ticket, as you might imagine, is a higher average ticket and of course their frequency of shop is higher than our average customer, so those are both downward pressures against those metrics.

Stephen Chick - FBR

Okay, that’s helpful and then second, if I could, I think related to maybe Craig’s comments on ticket sales above 900, did -- I just want to make sure I kind of took it down right -- is it -- it’s a double-digit decline. Is that a lesser -- I think last quarter you had -- I thought you had said down 15%. Is it down less than that rate or is it more? And is the geographic makeup of your sales, like the improvements in California, has that helped that metric?

Craig Menear

The metric is still double-digit negative and it has improved slightly from the first quarter and in the first quarter it was down approximately 15% and it is -- it is really driven across several areas of the business. As we see it, we had transaction improvement in our lumber and building materials areas. Part of that was driven through outdoor projects, part of it was just driven through DIY projects but I wouldn’t say that it was specific to one area.

Stephen Chick - FBR

Okay, it’s just interesting because your competitor said I think the opposite but I am not sure why that is but okay, all right. Great. Thanks, Craig.

Operator

We’ll go next to Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning. Carol, if you could give us some specifics on the impact of credit to the expense line this quarter and then also offer up color on what you are seeing in terms of turn-downs and general use of the private label credit card and other credit related forms of payment, that would be great.

Carol B. Tome

Yes, I’d be happy to. First on the expense line, year-over-year we had a $42 million benefit as a result of a lower cost of private label credit and year-to-date, the benefit is about $160 million.

Relative to what we are seeing with the consumer and credit, we are seeing a shift. Total credits penetration, and that includes not only our private label card but Visa, MasterCard, et cetera -- last year total credit penetration was about 65%. This year total credit penetration, about 62%, so a 300 basis point contraction, if you will, and that’s all in our private label credit. So private label credit has dropped from 28% penetration last year to 25% this year.

Now in terms of what we are seeing with our customers, for anyone who is applying for a private label credit card, about 76% of all applications are approved. That’s down about 50 basis points from last year.

In terms of the average credit line that is being approved, it’s about $5,2000. That’s down $1,600 from last year. The through-the-door FICO scores for those who are being approved is about 712, up slightly from last year. If you look at our existing cardholders, those who are just using the card within the store, the average FICO score is 677, which is about the same as it was last year.

So hopefully that gives you some color on the consumer.

Matthew Fassler - Goldman Sachs

And how does the $5200 compare with the average outstanding line? I know that’s kind of approved capacity but where is the average line for your program?

Carol B. Tome

It’s a little north of $6,000 and the average utilization is about 25%.

Matthew Fassler - Goldman Sachs

Only 25%? So in essence the credit card companies are taking down risk but not necessarily cutting off the actual spending needs of most of your customers?

Carol B. Tome

Other than those who are defaulting, that’s correct.

Matthew Fassler - Goldman Sachs

That’s fair. Okay, thank you so much.

Operator

We’ll go next to Scott Ciccarelli with RBC Capital Markets.

Scott Ciccarelli - RBC Capital Markets

Can you guys point to the reasons why you think California has improved, especially in the face of the unemployment situation in that state? Do you think that’s simply a function of improving housing turnover or are there other factors at work?

Frank Blake

Well, first you do -- weather does play a role in our business and we had a streak of some very nice seasonable weather out in California and in our western division that helped with our outside garden sales. I would say also as we’ve talked about before, you do have a churn of some houses as they go through the foreclosure process that drives things like paint, drives things like carpet upgrades and the like. And that’s balanced against a larger drag that we think there is, as you go through accelerating foreclosures and that kind of slows down some of your basic building material business. Is that helpful?

Scott Ciccarelli - RBC Capital Markets

All right, that’s it. Thank you.

Operator

Our next question is from Mike Baker with Deutsche Bank.

Mike Baker - Deutsche Bank

Thanks, guys. So two questions -- one is you said that you gained share in six of seven categories, yet it was your biggest share gain in five years. I think previous quarters you have gained in seven categories and then the quarter before that, nine categories. So I guess the way you reconcile those is in the six categories we gained share, the share gains must have been out-sized, given where they have been, so can you discuss where that is?

Frank Blake

Mike, first and I’ll turn this to Craig to address but I would also offer this caution as we go through the share data -- our market doesn’t have a lot of really clear share markers and one of the things when we reference, when Craig was referencing the six areas where we gained share, that was largely around the consumer. And then if you remember that e have a substantial percentage of our business that’s also pro and both the pro and the consumer data is reflected in the overall market share, which is the number I referenced, you can see that you’ve got some goes ins and goes outs there that don’t always neatly fit together.

But Craig, if --

Craig Menear

Yeah, so the reference was that six of our 13 departments on the consumer side gained share in the quarter and that was around paint, hardware, plumbing, both our lawn and garden categories, both sides of that business, both in power equipment as well as nursery and landscape. As well as appliances gained share in the quarter.

And then if you look at the total that Frank was referencing and as we look at both consumer and pro and compare that, it was our largest share gain that we’ve had and we broke the 20% mark at the end of July.

Carol B. Tome

And just to give a little bit more information on the market share, when we talk about overall total company market share, we reference our performance against the NYEX 444, which is census data, and we think that’s the best representation of both the pro and the consumer market.

Mike Baker - Deutsche Bank

Right, yeah, I think that makes sense. Okay, thanks for the color -- the one last just sort of maintenance question is on the earnings guidance, so is the right pace $1.42 from last year when we are thinking about flat to up about 7%? And then does that include the $0.03 -- I think it does include but confirm, does that include the $0.03 tax benefit you got this quarter?

Carol B. Tome

Yes, our guidance includes the $0.03 tax benefit that we got this and let’s just use adjusted -- the adjusted earnings per share that we are guiding off of from last year is $1.78.

Mike Baker - Deutsche Bank

Okay. Thank you.

Carol B. Tome

You’re welcome.

Operator

Our next question is from Gary Balter with Credit Suisse.

Gary Balter - Credit Suisse

Thank you. Two questions -- one is a crystal ball question -- when you look at all the macro data, should we be starting to think that we can actually see positive comps?

Frank Blake

Gary, I would say it will be some time we’re thinking in 2010 and probably second quarter or back half of 2010.

Gary Balter - Credit Suisse

Okay. And the second is you talked about power tools in some of the private label and there’s been some discussion about how well you are doing with some of your technology innovations. Could you go into like an area like power tools in a bit of detail? And then discuss -- is that why you think you are gaining share in those categories?

Frank Blake

Well, we really believe that we have a great lineup that services both our pro and our DIY customer in power tools. We certainly focus on key brands within that product category that our pro customers want. We have focused on launching and trying to be ahead of the game on lithium technology, which delivers more power, longer run-time, better battery life for our pro customers. When you look at the innovation over the years that we’ve been able to bring with the Ryobi program on the consumer side, with the lowest replacement costs of batteries pretty much in the market. It has become a great product for both our pro and light duty -- or light duty pro and our DIY customers, so we believe that the strong focus on brands that dominate the market and positioning ourselves with advanced technology has helped us in that product category.

Gary Balter - Credit Suisse

How do you get that message out to the customers, both consumer and pro?

Frank Blake

That’s a great question. It’s something that we think we have opportunity to improve upon. But we are obviously working with our suppliers on that and we are working on our -- with our marketing team to enhance that messaging. But it’s an upside opportunity for us.

Gary Balter - Credit Suisse

Thank you.

Operator

We’ll go next to Dan Binder with Jefferies.

Dan Binder - Jefferies & Company

Good morning. I was wondering if you could give us a little bit more detail on whether or not deflation across the entire box had a meaningful impact and whether or not you were able to grab a little extra margin as prices came down to you and any lag time that may have existed with that passing through to the customer.

Frank Blake

So when you look at the big impacts, lumber was about a 39 basis point impact, wire was about 28 base points, but that was offset by building materials to a degree at plus 29. But from a margin impact, I mean, the market moves with the cost market when it comes to retail, so there’s really not much of an impact on margin at all.

Dan Binder - Jefferies & Company

Okay, and then secondly, you addressed the credit in quite a bit of detail. I’m just curious -- are you starting to see any reversal or loosening of credit with your credit partner, versus let’s say six months ago?

Frank Blake

No, we’re not.

Carol B. Tome

-- have to go back and talk to them now that he asked the question.

Dan Binder - Jefferies & Company

Okay, and then just finally, is your big ticket exposure materially higher in Q3 and Q4 versus the front half of the year?

Frank Blake

No, it really is not. It’s pretty consistent across the quarters.

Dan Binder - Jefferies & Company

Okay, great. Thanks.

Operator

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

Budd Bugatch - Raymond James

Good morning and thank you for taking my question. Frank, I was really kind of very interested in your comments about the pro versus the consumer and that 32% and 27%, if my math is correct and I applied it correctly, it looks like the pro business year over year in the quarter was down around 24% while the consumer business was down somewhere between 2.5% to 3%? Am I thinking about that right first?

Frank Blake

Your math is very good, Budd.

Budd Bugatch - Raymond James

And secondly then, can you give us some more color of what may be driving the pro business or not driving it? Is there a net promoter score that’s attached to it? Is there some color on ticket or have you lost share in pros or the number of pros that you are being able to serve?

Frank Blake

So I would say, Budd, it’s -- and again if -- let me preface this by saying if we had been looking at this with the data set that we had previously applied, we would have said the pro and consumer business were down roughly the same. We’ve taken a different cut at the data set that looks more at buying behavior than an SIC code because the fact is pros don’t come in with a little badge that says I am a pro, and that’s what I referenced in terms of the dunnhumby data -- we’re looking at buying behavior, so maybe the single-most accurate way of saying it is people who bought like pros in 2008 this time versus people who were buying like pros in 2009 is down significantly. And then when you think through why that would be, first you’ve got a lot of very basis things, which is you look at that private fixed residential investment number which has a lot of what you would call pro-related spend in and you would see if anything our decline is less dramatic than the decline in that indicator, which would also be consistent with what we see in the share data. But you’ve got high unemployment in the construction trades, you’ve got a lot of pressure obviously in home building, a lot of pressure in larger projects that we think goes into that number and I would say the other thing underneath it is we then sub-segment that into different kinds of pro like buying behavior and look at the different patterns within that and again, as you might anticipate it, the folks who are more maintenance repair, operations related pros are responding differently than a general contractor pro. So I hope that color helps.

Budd Bugatch - Raymond James

It does, and when you say responding differently, I hope they are responding better, almost more like the consumer side of it, so it’s the heavier pro that has really been more impacted, because the MRO has got to go on anyway.

Marvin R. Ellison

The pros are pretty resilient, so that MRO customer now has become a maintenance repair kind of customer because they are trying to find a way to stay busy. But again, just like the normal consumer when this market gets more difficult than they find different ways to spend, their spending patterns change but they still have to try to keep business going and we spend a lot of time in the relationships that we’ve built with pro customers, talking to them about the different projects they are working on and we try to make the necessary merchandising adjustments to give them what they need so they can in act continue to stay busy.

Budd Bugatch - Raymond James

I’ve got you, and if I can sneak in one more question for Carol, you gave us the year-over-year second quarter on credit and the year-to-date, could you remind us what your forecast was for the year on credit benefit or -- and is that still the same?

Carol B. Tome

Well, we told you that our cost of private label credit would not exceed 1.5% of credit sales and we asked you to use a number of about 30% penetration. Obviously our penetration is down so we didn’t give you a clear dollar figure for the year-over-year benefit. We might have guided around $250 million, something like that, for the year.

Budd Bugatch - Raymond James

And that’s still intact?

Carol B. Tome

Yeah.

Budd Bugatch - Raymond James

Thanks, Carol. Thank you, Frank. Thank you, Marvin.

Operator

Next we’ll go to Chris Horvers with J.P. Morgan.

Christopher Horvers - J.P. Morgan

Thanks and good morning. First of all, a question -- any comment on -- it seems like July seemed to have an early -- earlier in July was tougher and it seemed to recover towards the end of the month. Any comment on how August is shaping up, particularly with some of the better weather in the Northeast?

And second, really bigger picture as we think about the back half of the year, seasonal mix does come down, or at least the outdoor mix does come down as a percentage of sales. I mean, how do you merchandise into that and how do you -- do you think -- how does the increased DIY trend that we’ve seen in the first half kind of manifest itself in the back half of the years, whether it’s snowblowers or what have you?

Carol B. Tome

Well, I can give you color on how we are performing in August and then Craig can talk to you about what we are doing for the back half from a merchandising perspective.

As we built our plan, we told you that the comps in the first half of the year would be worse than the comps in the back half of the year and we still think that could be true. The third quarter, there’s a lot of noise in the third quarter because we are anniversarying hurricanes, et cetera, so we don’t expect the third quarter to be materially different than that of the second quarter. We exited the quarter with a total company comp of a negative 8.1% in July and that’s where we are running today, so we are running at where we thought we would for the August period to date.

We’ve got a lot of good things going in the merchandising perspective.

Craig Menear

Yeah, if you think about the seasonal business, as you were saying the trend falls off as you move into the third quarter, first step back and recognize that that happens every year so our comparisons are the same, if you will, year over year. And then we’ll really focus as we move into the third quarter on those things that become really important to the customer at that timeframe. The finishing up of outdoor projects that prepares their homes for the winter season, as customers are beginning to think more about energy and focusing their on how to prepare their homes -- you know, we’ll be focused in those areas. Fall clean-up -- those are all simple, easy projects that a customer can take on and be prepared.

And then of course, there is the -- what I’ll call simple décor updates that will take place in the fall season as well. We fully expect there to be continued pressure in the big ticket discretionary spend but the simple updates of the home are the areas that we will focus on.

Christopher Horvers - J.P. Morgan

And just as a follow-up, is it all moot if California and Florida continue to sequentially improve? I mean, does the whole seasonal outdoor question really become a moot question?

Craig Menear

I think when we look at California in the second quarter, you know, as Frank said, we certainly had some benefit from good weather and that helped drive the outdoor business but I also -- when we look at the numbers, we’re seeing a relatively solid performance in DIY projects.

Carol B. Tome

It is really because of the seasonal nature of our business. It’s important to look at our business year over year rather than sequentially -- 55% of our sales occur in the first six months of the year and that holds true in a down market as well as an up market.

Christopher Horvers - J.P. Morgan

Right, but I’m saying like assuming big ticket doesn’t really come back, right and that remains under increased pressure -- if California and Florida recover at the end of the day, that could overwhelm that aspect?

Frank Blake

Certainly the recovery of California and Florida, if I understand your question, Chris, that would be helpful. Again, understand that that’s only a percentage of our business but that would be helpful.

Christopher Horvers - J.P. Morgan

Okay. Thank you.

Operator

Our next question will come from Eric Bosshard with Cleveland Research Company.

Eric Bosshard - Cleveland Research Company

Thank you. Good morning, or basically one question -- the upside performance relative to plan on sales, and I believe on gross margin, can you identify or at least bucket what you think drove that or allowed you to accomplish that in the quarter?

Craig Menear

I think we have a continued focus first of all on driving value in the marketplace for our customers. I think Marvin and the operations team have done an outstanding job of really focusing on customer service. And then we believe that we are getting traction in terms of doing a better job through our new marketing campaign of beginning to communicate the value proposition that we have as a company.

Carol B. Tome

We didn’t plan for positive comp transactions.

Craig Menear

Right.

Marvin R. Ellison

I think, Eric, one thing to consider, Carol cited the inventory reduction year over year but we also are experiencing our best in-stock percent that we really have on record. I’ve been here seven years, we measured it the same way for seven years and we now have our best in-stock position in the stores with the degree of inventory take-out, so you couple all those things together and we feel very, very good about our progress.

Frank Blake

And then secondly, as far as the expense leverage, obviously the market share performance would suggest you are adequately investing in the business but I just would be interested in a little bit of the thought process of limiting the SG&A or the expense growth to the degree that you are, if there’s any concern that you might be under-investing in the business?

Frank Blake

No, we very consciously set out objectives we have for improving our business and have identified areas where we are and have been consistently investing. There are other areas where we have been able to trim back and we think they are largely non-customer focusing areas and we think those are appropriate and sustainable.

Carol B. Tome

Right, and on the capital side, we told you that we deliberately back-end weighted our capital spending, given the economic uncertainty so you may say well, are you a little light on capital for the first half? No, this is what we said we would do. We’ve got about $650 million remaining in our plan and we will spend it by the end of the year.

Eric Bosshard - Cleveland Research Company

Great. Thank you.

Diane Dayhoff

We have time for one more question.

Operator

All right -- our final question will come from Gregory Melich with Morgan Stanley.

Gregory Melich - Morgan Stanley

Thanks, guys. A follow-up for Craig and then Carol -- Craig, on the gross margin side, if one of the ways we are able to get inventory, that great inventory performance and keep in-stocks up, are we taking down SKU counts? Is that part of the focus bay approach? And if so, how far are we in that process? And I had a follow-up for Carol.

Craig Menear

So first of all, if you look at gross margin, we’ve been telling you that we’ve been working hard on process and the implementation of new tools, including forecasting tools and our assortment maintenance tool, which allows us to better position product in the right places. That has begun to pay off for us and as we mentioned, we have not spent the money in clearance where we did last year because we’ve gotten really inventory in the right spots.

Part of our portfolio strategy approach based on the specific roll and intent of specific categories is in fact looking at the assortment breadth and we have, where appropriate, been reducing SKUs to simplify for our customers. As a matter of fact, in the applicator reset that we just put into the stores, we had a fairly significant reduction in SKUs and that, to be honest with you, Greg, will be ongoing work and it’s category by category. Some categories may actually expand in SKU count while others will go down.

Marvin R. Ellison

There’s two other points I will make on in-stock -- if you have frequented our stores over the years, you would notice that our overheads are much emptier today than probably ever before because there’s been a concerted effort on improving the operational process in the stores but also the supply chain improvements allow us to take product from receiving to the shelf versus from receiving to the overhead as we’ve done over the course of the past few years, so operation improvements in the store, our supply improvements just allow us to have the inventory in the right place so customers can actually buy it.

Gregory Melich - Morgan Stanley

Okay, great. And then Carol, on the deleverage effect, the 10 basis points or 100 basis points a comp, as we go into the future into next year and beyond, is there something that’s changed in the supply chain or the fixed cost structure that makes you think that that won’t revert back to a 20 basis point per 100 once we cycle the credit and expo closing? Is there something that’s changed there or is that a --

Carol B. Tome

Our rule of thumb is in a negative comp environment. Once we turn positive and we heard from Frank that will happen next year, once we turn positive we would expect to see more than 10 basis points of expense leverage.

Now, we are like all companies in corporate America, are faced with rising medical costs, other costs that are coming with us, so we’ve got to work those through our model before we can give you our general rule of thumb. But where we sit today, we would expect to see more than 10 basis points.

Gregory Melich - Morgan Stanley

Great, and then Frank, is that the -- in the second quarter, is that the first month of the second quarter or is that July?

Frank Blake

Exactly -- wish I knew.

Gregory Melich - Morgan Stanley

Thanks.

Frank Blake

Okay, thanks very much.

Diane Dayhoff

Thanks to everybody for joining us today and we look forward to talking with you next quarter.

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Source: Home Depot F2Q09 (Qtr End 8/2/09) Earnings Call Transcript
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