Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Diane Dayhoff - Senior Vice President, Investor Relations

Frank Blake - Chairman, Chief Executive Officer

Craig Menear - Senior Vice President, Merchandising

Paul Raines - Executive Vice President of U.S. Stores

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

Mark Holifield - Senior Vice President, Supply Chain

Analysts

Deborah Weinswig - Citigroup

Wayne Hood - BMO Capital Markets

David Strasser - Banc of America Securities

Michael Lasseter - Lehman Brothers

Colin McGranahan - Sanford C. Bernstein

Matthew Fassler - Goldman Sachs

Budd Bugatch - Raymond James

Gregory Melich - Morgan Stanley

Michael Baker - Deutsche Bank

Daniel Binder - Jefferies

The Home Depot, Inc. (HD) F1Q08 Earnings Call May 20, 2008 9:00 AM ET

Operator

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

Diane Dayhoff

Thank you, Connie, and good morning to everyone. Welcome to the Home Depot first 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 of Merchandising; Paul Raines, Executive Vice President of U.S. Stores; and Carol Tome, Chief Financial Officer.

Following our prepared remarks, the call will be open for analyst questions. Questions will be limited to analysts and investors and as a reminder, we would really 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.

Now let me turn the call over to Frank Blake.

Frank Blake

Thank you, Diane and good morning, everyone. Sales for the first quarter were $17.9 billion, down 3.4%. Comp sales were negative 6.5%. As Carol will describe, sales and comps for the quarter reflect a benefit in seasonal timing due to the 14th week in the fourth quarter of 2007.

Diluted earnings per share were $0.21. That includes a $0.20 charge related to our decision to rationalize square footage growth in existing stores.

I would like to summarize what I see as the positives for the quarter and then talk about some concerns. First on the positive side, we showed significant improvement in the disciplines around our merchandising, as Craig will describe. We had better execution in our seasonal business and had better focus on moving away from promotional activity that confused our customers and undermined our brand.

We also took significant steps to restructure our workforce to provide more customer facing hours. Paul will go through some of these actions. We shut down call centers, we rolled out day freight receiving, we restructured our HR field team, and in each instance, we redeployed hours to customer facing activities. So a source of great pride that our 300,000 plus associates could take on so much change in such a short period of time in such difficult conditions and yet continue to drive improvements in customer service, as we are seeing in our voice of customers scores. These changes were necessary to adapt to current market conditions but they will also position us well for the future.

As we announced a few weeks ago, we took a significant step to rationalize our new store growth. The stores we are taking out of our pipeline weren’t expected to meet our targeted returns. They would have diverted investment from our existing stores and negatively impacted our overall return to shareholders. By not building them, we’ll free up approximately $1 billion in cash over the next three years to invest in maintenance, merchandising resets, and other areas within our existing stores.

We’ll continue to open new stores in the future but we’ll do so in locations that offer the best opportunity for long-term growth and profitability. We will be very disciplined in our capital allocation and very focused on the customer experience.

We continued in the first quarter to invest in our five key priorities -- associate engagement, shopping environment, product excitement, product availability, and own the pro. We have now opened three rapid deployment centers, or RDCs, and expect to roll out an additional five by year-end. We began piloting core retail in two Canadian stores at the end of March and remain on track to complete the rollout by year’s end.

Our agenda for transforming the business is aggressive but measured. We are going to take some risks. We have to but we are also going to respond quickly to any issues we see. And it’s encouraging that we continue to see positive trends on our overall market share.

We also continue to see strong performance from our international businesses. Mexico posted positive double-digit comps for the 14th straight quarter. Canada had positive comps, and we are very pleased that China posted positive double-digit comps. We feel that we have the right strategy there, start small and build up through success, and it’s encouraging to see those stores performing well.

Now on the concerned side, we are still seeing relatively weakly demand for our non-seasonal products. And housing turnover, which is down over 30% from the highs in 2005, remains a concern. There’s a significant inventory of homes to work through and the latest national association of realtors data shows home prices down 7.7%, with some areas of the country down substantially more than that. So the housing and home improvement markets remain very difficult.

At the same time, we are seeing significant pressure on the cost side as the price of basic commodities goes up and our customers are also facing pressure as they see the price of gasoline and food increase.

There isn’t a well-worn path guiding us on what all these pressures will do to our business, but we certainly see on the general market side more risk than opportunities through the remainder of the year. So we are approaching the second quarter and the second half by focusing on those things we can control. We will continue to invest to improve the customer experience and we will show the discipline necessary to stop doing those things that aren’t related to our key priorities.

One of our vendors said it well the other day -- it’s time for those who are serious about this business to get serious about the business. That’s a good description of Home Depot now. We are serious about the business and we are taking the serious actions necessary to position us for the long-term success.

Now let me turn the call over to Craig.

Craig Menear

Thanks, Frank and good morning, everyone. In the first quarter, we experienced a negative sales growth in all departments except garden. Plumbing, while negative, outperformed the company average comp. As expected, the significant weakness in the quarter came from continued softness in big ticket and construction departments. Building materials, electrical, millwork, and kitchens all had double-digit comp declines. With softness in these project businesses, among others, average ticket was down 2.8% from last year to $57.36.

Regionally in markets where home prices have declined approximately 15%, we are continuing to see double-digit negative comps. This was reflected in our results in California and in Florida. Even garden, which posted a positive comp for the company reported negative comps in those areas.

While these two regions remain weak, there are a few areas of the country, such as the Ohio Valley and the Southwest region, as well as our international businesses that are helping to offset some of those declines.

We are also seeing pressure from commodity price inflation and deflation in the market, although pricing for wood products has stabilized, including dimensional lumber and sheet goods, which are now on par with pricing from last year, we continue to see pressure from gypsum deflation.

Copper pricing is up year over year and higher than we had anticipated. Additionally, we are seeing inflationary pressure from petroleum and metals, which is leading to cost pressure.

As we shared with you last quarter, we continue to see strength in the basic repair categories, with comps less negative than the company average. We know that during difficult times, customers will continue to make essential repairs in their home. As a result, we focused our activity on improving our line structures and understanding customers’ repair needs.

A good example is assortment adjustments that we’ve made in hand tools, power tools, and plumbing fixtures, all which resulted in share gains in the quarter.

Another area of strength this quarter stemmed from our execution in our seasonal business. We are pleased with the results of our spring seasonal categories which posted positive comps for the quarter. Live goods, handheld power, chemicals, fertilizers, and landscape performed well and seed and lawn décor posted double-digit positive comps. These results were driven by continued line structure improvements and new innovative products such as Pennington’s Smart Seed, which requires 30% less water and Vigoro’s Super Green, a slow release fertilizer that will last up to five months.

Large contributors to the comp increase in live goods were the expanded offerings of the proven winners brand and growth of our eco-options products, which include vegetable and herbs in plantable, biodegradable pea pods.

While we’ve made progress, we continue to have opportunities to improve line structures and product offerings. For example, in the second quarter we will invest in several categories where we have lost share, particularly ceramic tile, bath faucets, and bath fixtures.

We will reset ceramic tile and bath faucets and we will enhance our assortment of bath fixtures.

We continue to drive merchandising transformation, and while it is still early, we are starting to see a difference in our business when we align the right people, processes, and tools. Investments made in our associates, both in the field and the store support center, are starting to pay off.

With the team in place, we made significant progress in improving, and in some cases creating crucial processes. We remain committed to implementing our focused approach to finding the role and intent of each category which drives our assortment, pricing, and marketing strategy.

In addition, we have also provided our merchants with improved tools that deliver significant benefits and time savings for the merchandising team, maximizing assortment and forecasting visibility.

These investments are beginning to show results and for the last rolling 12 months, we have experienced unit share growth in several categories, including patio, paint, hand tools, and carpet.

In patio, we provided great brands at exceptional values, as seen with our exclusive Thomasville and Hampton Bay lines, and our share gains in paint are all about new product innovation and execution at store level.

Last year we started down the long-term path to return to our merchandising roots, providing everyday compelling values to our customers. By focusing in on our merchandising fundamentals with this objective in mind, we were able to better manage our gross margin dollars. Our gross margin productivity in the first quarter was the result of better assortment planning, visibility created by our new tools, a change in promotional strategy, and improve seasonal inventory management.

As we head into the summer, we are pleased with our seasonal lineup and feel that we are well-positioned in patio, grills, mowers, and power equipment. We feel that the merchants have captured the change in customer preference in our air movement category with our new portable air conditioning units and diverse assortment of environmentally friendly products under our eco-options line.

And we continue to provide great values and innovation in emerging products, like fresh air paint, the only true odorless and VOC, or volatile organic compound free paint in the market.

Before I turn the call over to Paul, I would like to welcome Frank Bifulco, our new Chief Marketing Officer, to the merchandising team. Frank brings 30 years of marketing experience to the Home Depot and a strong consumer brand management background from his years at Hasbro, Timberland, and the Coca-Cola Company.

2008 is going to be another tough year but we have a strong merchandising team focused on our fundamentals who will continue our promise of delivering everyday value to our customer.

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

Paul Raines

Thank you, Craig. As Frank mentioned, we are focused in in-store execution and improving customer service. We executed a number of transformational changes in the first quarter. In the past, the types of changes we made this quarter would have taken years. It is a shift in philosophy that has allowed us to increase the rate of change and improve execution. I would like to take a few minutes to share this philosophy.

Our approach is to seek out best practices from those who are closest to the customer, our stores. As we identify opportunities, we assign a field leader to develop the concept and implement this in their region with support from our corporate staff. Once proven in the field, we implement across our entire chain, with field leaders taking ownership for success in their area.

We have found that our approach is highly efficient and can be implemented at a high rate of speed. In this environment, moving with velocity to transform our stores and better service customers is vital.

One of our main initiatives is aprons on the floor. This program is geared at investing in our stores by adding more selling hours to the floor through better expense allocation. Our goal in 2008 is to reallocated $180 million to add more sales hours to the stores. There are several areas where we have redeployed resources. Let me take you through a few of the more significant changes we have made.

Based on a recommendation from our field teams, in February we rolled out our day freight initiative to over 1,100 stores. The purpose of this was two-fold; to increase associate availability during our peak selling hours and provide more ownership of inventory management to our department supervisors. This initiative changed our receiving and recovery time from overnight to early morning and evening shifts to allow us to have more associates on the floor assisting customers.

This was heavy lifting but we were able to accomplish it with little noise because of the personal involvement of the field team.

Along with the change in receiving, we also empowered our department supervisors. We returned inventory management responsibilities to department supervisors who have greater visibility and knowledge about product needs.

This is the most significant change to our operating model since the SPI, or service performance initiative, in 2000.

During the past five years, the Home Depot has standardized and institutionalized our human resources function across the organization. In April, we told you that we were going to restructure our field human resources function and as of May 1st, we replaced our in-store human resources manager with district-based human resources teams.

Sometimes we need to restructure to reinvest. We are committed to prudently managing our expenses and taking action where we can to hit our $180 million goal to reinvest in associates.

We know motivation and engagement of our more than 300,000 associates make a huge impact on customer satisfaction and on sales. We continue to focus on recognizing and rewarding associates.

Despite the difficult environment, we are continuing to reward associates through our success sharing and Homer Badge programs. We have not given out over 410,000 Homer badges. We are also proud to say that we now have 3,000 master trade specialists, all licensed plumbers or electricians, in our stores.

As you know, we have taken steps in the past year to refocus our training efforts back to hands-on, in-the-aisle learning. During the quarter, we introduced a product knowledge badge. This new badge rewards associates through cash compensation for completing 100% of the product knowledge training in their departments and adjacent departments. Associates that complete this training are better able to help our customers with projects that cut across multiple product categories.

Our associates are reacting positively to the changes they are seeing. We know that taking care of our customers and each other by investing in our stores and associates is the right thing to do. Our voluntary turnover continues to decline at a double-digit rate year over year and our store associate tenure continues to increase.

In terms of shopping environment, we are pleased with our progress. As most of you know, the average age of our stores is around eight years old, a time when you really need to refurbish the stores to continue to drive sales.

We have adopted a programmatic approach to maintenance and will continue to spend significantly more in 2008 than the historical trend.

We are operating a large complex organization. In a business this size, driving changes requires simplification and consistency in our approach. As a result of our investments, we are seeing results. We continue to see improvements in our VOC survey, where we hear from more than 115,000 customers a week.

We know 2008 is going to be a difficult year. We remain committed to executing the fundamentals, our key priorities, and to investing in our associates and customers.

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

Carol B. Tome

Thank you, Paul and hello, everyone. In the first quarter, sales were $17.9 billion, a 3.4% decrease from last year, reflecting negative same-store sales of 6.5%, offset in part by sales from new stores.

We reported earnings per share of $0.21 in the quarter, which reflect a charge of $543 million, due to the recently announced closing of 15 stores and removal of 50 stores from our future growth pipeline.

For the purpose of today’s call, we are going to refer to this charge as the store rationalization charge. Excluding the store rationalization charge, earnings per share from continuing operations were $0.41, down 14.6% from last year. Our first quarter comp sales decline was slightly worse than our plan. Comps or same-store sales were negative 6.5% for the quarter, with negative comps of 6.4% in February, negative 8.7% in March, and negative 4.9% in April. Comp sales remain negative in May but are running in line with our expectation.

In 2007, we had 53 weeks in the year. This shifted our 2008 fiscal calendar. Because of this shift, and given the seasonal nature of our business, first quarter sales benefited from a seasonal timing change. The calendar shift added about $524 million to first quarter comp sales. Adjusting for this, comps would have been negative 9.2% for the quarter.

In the first quarter, our gross margin was 33.9%, an increase of 14 basis points from last year. Our gross margin expansion is due principally to lower markdowns than last year. While it isn’t material, our gross margin expansion is net of a five basis point, or $10 million impact of markdowns associated with inventory in our 15 closing stores.

The calendar shift did not impact the gross margin rate but drove gross margin dollars. For the quarter, the calendar shift resulted in approximately $0.04 of year-over-year earnings per share growth.

In the first quarter, operating expenses increased by 508 basis points to 29.8% of sales. Excluding the charge of $533 million related to our store rationalization, operating expense increased by 211 basis points to 26.9%. Our expense deleverage reflects the impact of negative sales, where for every point of negative comp we expect to deleverage expenses by about 20 basis points.

The negative comps in the first quarter resulted in expense deleverage of approximately 115 basis points. Further, as expected, in the first quarter we experienced an additional 96 basis points of expense deleverage due to a higher cost of credit associated with our private label credit card.

Operating margin was 4.1% in the first quarter, down 495 basis points from last year. Excluding the store rationalization charge, operating margin was 7.1% in the first quarter, down 192 basis points from last year and in line with our plan.

Net interest expense was $164 million in the first quarter, up $4 million from last year. In the first quarter, our income tax provision rate was 36.9%, reflecting the impact of the store rationalization charge. We expect our tax rate to be approximately 37% for the year.

Diluted shares for the first quarter were 1.68 billion shares, compared to 1.97 billion shares last year. The reduction in outstanding shares is due to our share repurchase program and includes the tender offer we completed last September.

We did not repurchase any shares during the first quarter and the completion of our recapitalization plan remains on pause as we are waiting for stability, both in our business and the credit markets.

Now moving to our operational metrics, during the first quarter we opened 26 new stores, including two relocations for an ending store count of 2,258. Today, 247 stores representing approximately 11% of our store base operate in Canada, Mexico, and China.

At the end of the first quarter, selling square footage was $237 million, a 3.9% increase from last year. Reflecting the sales environment, total sales per square foot were approximately $305 for the quarter, down 7.4% from last year.

Now turning to the balance sheet, at the end of the quarter, retail inventory was $12.6 billion, down from $12.7 billion last year. On a per store basis, inventory was down 4.6%.

As you heard from Craig, this year we instituted a new seasonal inventory planning process and as a result, our seasonal inventory levels are in good shape relative to the sales environment. But based on the sales environment, our inventory turnover was 3.9 times compared to 4.2 times last year.

Computed on the average of beginning and ending long-term debt and equity for the trailing four quarters, return on invested capital for continuing operations was approximately 12%, down 240 basis points from last year due to the decline in our operating profit and the store rationalization charge. Excluding the store rationalization charge, our return on invested capital was approximately 13%.

We ended the quarter with $45.6 billion in assets, including $779 million in cash and short-term investments. This is an increase of approximately $322 million in cash and short-term investments from the end of fiscal 2007, reflecting cash flow generated by the business of approximately $2.4 billion, offset by $530 million of capital expenditures, $379 million of dividends paid, and a $1.2 billion repayment of outstanding commercial paper.

First quarter earnings were in line with our expectations. As Frank mentioned, we do see certain headwinds ahead. While it is early in the year, today we are more comfortable with the low-end of our EPS from continuing operations guidance of down 24% from fiscal 2007. This guidance does not include the store rationalization charge.

We are holding our investor conference on June 5th and look forward to covering our business performance and prospects with you at that time.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Deborah Weinswig from Citigroup.

Deborah Weinswig - Citigroup

Good morning. Craig, you talked about providing the merchants with improved tools and how these tools helped improve visibility. Can you go into that in a little bit more detail? And also compare what they were using a year ago with what they are using now?

Craig Menear

Sure. What we’ve done is we’ve provided some new assortment planning tools to the merchants that really helps them in terms of the difficulty it was to plan below a market level, so we were able to plan really down to a store level in several of our categories, and that’s a pretty big significant enhancement for them.

At the same time, one of the other new tools we updated or upgraded a forecasting tool that our merchant and finance teams use, and that provided greater visibility to overall forecasting and actual results that allows us to act faster.

Deborah Weinswig - Citigroup

Great, and then as a follow-up, Frank, it sounds like between the hiring of Frank and also adding Brian Cornell to the board that there’s an increased focus on advertising and marketing. Can you talk about what we should expect going forward with regard to these two initiatives?

Frank Blake

Well, as Craig said, we are very happy to have Frank come on board and he just brings a lot of experience, and clearly for a company like ours, marketing, which broadly defined is a deep understanding of our customer, is absolutely critical and we are looking at that -- we are looking to be best in class in that.

And we also have some strength on the board to give us advice and counsel -- Brian Cornell, Al Carey, and Bonnie Hill and others who really have good, strong marketing backgrounds. So it is -- again, I hope this company will be characterized by the extent to which we understand our customers’ needs and fulfill them.

Deborah Weinswig - Citigroup

Thanks so much and congratulations.

Operator

We’ll take our next question from Wayne Hood from BMO Capital.

Wayne Hood - BMO Capital Markets

I’m not sure you want to talk about this, but could you discuss a little bit how you are getting your hands around the disruptions at the regional distribution centers, particularly Dallas as we come up on the Memorial Day weekend and in light of the rollout that you expect by the end of the year? And then Craig, could you talk about your market share in flooring, the changes you made a year ago and has that really resulted in an increase in share in flooring?

Frank Blake

So on the first one, we’re happy to talk about the issues. We have had some issues in a number of our initiatives as we have rolled them out, and as I tried to say in the overall comment, look, we know we are moving quick and we are asking the organization to change a lot. We know we will stub our toe occasionally but we also are committed to responding rapidly

What I would is Mark Holifield and then Paul Raines too to comment on the situation in the Dallas RDC, and then Craig, you should address the back half of Wayne’s question.

Mark Holifield

Just to refresh everybody’s memory, we are moving very quickly from about 20% central distribution penetration to about 75%, so it’s a very aggressive supply chain transformation. Our target for this year is to end up serving about 40% of our stores with about 30% of their cost of goods sold. And with any major transformation like that, you do encounter some bumps in the road. We did encounter some with [Bradenton], we encountered some with our Chicago opening, which we did January. We opened up Dallas in March. It was the most aggressive opening that we’ve done so far, with about 180 stores served, going right into our spring peak. So we did see some more disruption than we desired there but we do feel we are getting our hands around that. We are on the road to recovery there and we expect that we will have that back on track. Don’t see any major issues for the Memorial Day selling period and we do see ourselves as on track for the 40% of stores and 30% of cost of goods sold targets by the end of the year, so we are working it and expect to see that behind us soon.

Paul Raines

And Wayne, this is Paul. On the store side, we know that transforming our supply chain is vital to our success, so we’ve been preparing our stores in advance of the rollout. Specific to the RDC situation, Mark and I are in touch and working very closely on this on a day-to-day basis and there is a significant amount of support from our stores team with that RDC team really integrated on the ground, working through the issues together. As Mark says, this is a company with a high rate of velocity, so anything we do has a lot of complexity with it and I am really pleased with what our team in the Southwest has done to support the supply chain organization.

Craig Menear

On flooring, I have shared with you in the past that we were losing share. That really started in the flooring business somewhere around the mid part of 2005. We were losing as much as 300 to 400 basis points to the market. We’ve been able to turn that in Q1 and actually have a positive share growth for the category in total, and for a few quarters now, we’ve actually been able to see positive growth in carpet, ceramic tile, and laminate.

Diane Dayhoff

Connie, next question.

Operator

We’ll go next to David Strasser for Banc of America Securities.

David Strasser - Banc of America Securities

Thank you very much. So after the store closures, 15 of them, as you continue to look at that, how should we be thinking over the next say one or three years about the store base? Are there more to come as you look out?

Frank Blake

David, we did a very thorough review of our stores, and maybe Carol will describe it a bit, but we were focused on trying to get at one time all the stores that we didn’t think made economic sense for the company to be operating. So it’s not as though there are a whole series of other stores that are on the bubble, or where action is imminent. We really think throughout our 2000-plus chain, these were the 15 stores that needed to close, and that’s -- it’s not a huge percentage on that kind of a store base and we feel pretty good about that number.

Carol B. Tome

We went store by store, started by looking at our stores that are older than three years, because those are stores that are mature, but we decided to look at every store. So in fact of the 15 stores that we are closing, three of those stores are younger than three years old, so it was a very thorough analysis.

Frank Blake

Now having said that, obviously things can change but we’ve taken as good a swing as we could at the time.

David Strasser - Banc of America Securities

And I guess on a related basis, I guess one of the things that seem to be changing is there seems to be just a lot of independent store closures. I guess Lowe’s talked about that yesterday, you guys have talked about it. How does that -- do you have any sense of what percent of the market has gone away over the last 12 months? I don’t know how you would judge that, and if so, does that change how you would sort of think about opening stores even going forward?

Frank Blake

First off, no, we don’t -- I mean, we don’t have a good number on what that might be and it really doesn’t change what our view is on future store openings. I mean, the best that we get is anecdotal data, so probably the same as others get.

David Strasser - Banc of America Securities

And do you know exactly what day the housing market is going to bottom?

Carol B. Tome

Oh, please tell us.

David Strasser - Banc of America Securities

Because if you know, it would be -- that’s the question we get, so --

Frank Blake

It’s August 8th.

David Strasser - Banc of America Securities

Excellent.

Frank Blake

Of what year --

David Strasser - Banc of America Securities

Thank you very much.

Operator

We’ll take our next question from Michael Lasseter from Lehman Brothers.

Michael Lasseter - Lehman Brothers

Good morning and thanks for taking my questions, and as long as we are on the subject, perhaps you could us if we are going to win the Triple Crown or not. But two questions -- first, how are you thinking about the balance between preserving financial flexibility in this time by targeting certain leverage ratios, such as lease adjusted debt to EBITDAR and the other end of the spectrum of stewarding capital to the highest return investments? Because there could be an opportunity or a disconnect between the period when perhaps the financials haven’t caught up but yet the stock price has rallied and there is a window of opportunity to purchase the shares at an attractive level.

Frank Blake

I’ll ask Carol to answer that in more detail but obviously that’s something we focus quite a bit on and hope -- you know, in the first instance, that is, we look at our business and look at all of the underlying signals that we get between geographic signals and signals in particular kinds of classes and sub-classes of product that we can build up a confidence level on what the market is doing and do that in a timely fashion.

Carol, you may want to comment as well.

Carol B. Tome

Last year we completed a thorough analysis on the question of financial flexibility and determined that our capital structure based on the maturity of our company needed to change from one that facilitated growth to one that facilitated capital distribution. And we determined that we wanted to measure that through an adjusted debt to EBITDAR ratio of 2.5 times, and that is our target. Today we are at 2.1 times if you look at it on a trailing 12-month basis.

Part of our capital structure strategy, of course, was to recapitalize our company and we announced a $22.5 billion recapitalization plan, of which we’ve completed about 50%. The remaining recapitalization plan is on pause just because of the instability of our business and the instability of the credit markets. But obviously we are looking at this very closely every day.

Michael Lasseter - Lehman Brothers

Okay, and as a quick follow-up, can you reconcile the commentary that in the press release that many areas of the country worsened during the period and then perhaps on the call you mentioned that May was running in line with plan?

Frank Blake

Well, we have planned for some negative performance, so what we are seeing is roughly what we anticipated.

Michael Lasseter - Lehman Brothers

Okay. Is there any -- I guess is there some of the regions that had been stronger, are they starting to experience weakness due to perhaps economic factors?

Frank Blake

Yeah, I’d say -- I mean, generally, because it’s obviously something we look at very closely in terms of the different regional performance, areas that have been hit hard in the past, Florida and California come immediately to mind, continue -- I mean, it’s hard to see a lot of improvement there. We’ve got other areas that had been relatively strong that have declined a bit, and then as Craig called out, we’ve got some areas of strength, like the Southwest and some areas in the Midwest where there wasn’t -- where both there’s stronger economic activity now, like in the Southwest there’s not so much speculative activity in the past, like the Midwest.

Michael Lasseter - Lehman Brothers

Okay. Thank you for taking my questions, best of luck.

Operator

We’ll take our next question from Colin McGranahan from Bernstein.

Colin McGranahan - Sanford C. Bernstein

Good morning. I just have two brief ones today -- first, Carol, I may not have heard you right about the impact of the credit card business? I thought I heard you say 96 basis points. Is that correct?

Carol B. Tome

That’s correct.

Colin McGranahan - Sanford C. Bernstein

So that seems substantially higher than I think what your expectation was for the full year. Is there any kind of seasonality or can you talk a little bit more about how the delinquency trends are and the credit contribution is flowing relative to your prior expectations?

Carol B. Tome

There is a bit of seasonality but I will say that only as it relates to the profitability of the portfolio in that a year ago, we were enjoying excess profits from our gain sharing arrangement and we had none of those excess profits in the first quarter of this year. So the year-over-year comparisons are going to be tougher in the first half of the year than they will be in the back half of the year, so hopefully that helps you.

Colin McGranahan - Sanford C. Bernstein

Yeah, that makes sense. Obviously those profits deteriorated through the years, the delinquency rate stepped up sequentially. So was the overall delinquency or charge-off rates largely in line with your expectation to date?

Carol B. Tome

It’s running a little heavier actually, or a little higher. The good news, if there is good news in this environment, it seems to have stabilized.

Colin McGranahan - Sanford C. Bernstein

Okay, and you -- that, just so I understand that correctly, once your gain sharing is zero, it’s zero, right? You can’t actually have negative gain sharing?

Carol B. Tome

Our arrangement is a profit sharing arrangement. In excess, we share in the profits in excess of a targeted return. If the targeted return is not achieved, then we could have to pay more for the cost of the credit.

Colin McGranahan - Sanford C. Bernstein

Okay. And then just again, a brief question, seasonal impact through the year -- what should we expect in the coming quarters in terms of impact on sales 2Q, 3Q, 4Q, roughly? And operating margins?

Carol B. Tome

Well, the good news is that by the end of the year, there won’t be any impact. It will all work out but clearly if you have an extra week of spring in the first quarter, you are going to have one less week of spring in the second quarter.

Colin McGranahan - Sanford C. Bernstein

And then just a -- so the same 13-weeks, whether you started in the February week or ended in the April week, that was that roughly negative 9.2 comp?

Carol B. Tome

If you do a like-for-like comp, that’s correct.

Colin McGranahan - Sanford C. Bernstein

Okay. Great. Thank you so much.

Operator

We’ll take our next question from Matthew Fassler from Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot. Good morning, guys. A couple of questions, if I could -- on the comp store sales, if you could talk both about your U.S. only comps excluding China, Mexico, and Canada, and also if you could talk on the comp store sales side about whether the monthly numbers were distorted by either the calendar shift or by Easter.

Frank Blake

Well, I’ll let Carol give the specifics but there were -- I mean, there was an Easter impact but obviously over the course of the quarter, that eased out and there would also have been some shifting impacts on the month. I don’t know that we actually kind of broke that out for you, but we gave you the overall number.

Carol B. Tome

I’m sorry for jumping in, but Matt, the way we look at it is relative to our plan.

Matthew Fassler - Goldman Sachs

I guess the reason I ask is because your competitor was out with numbers yesterday that were more volatile month to month with April showing a much bigger improvement. I’m wondering if your business was more consistent through the quarter or whether it was actually, when you put aside the calendar shift, a little more volatile than it looks on a reported basis?

Craig Menear

Maybe I can add a little bit of light to that. As we looked at the numbers in April last year, remember we had a couple of really horrendous weeks with weather. Our numbers in those weeks were sub-double-digit negatives, so we were nowhere near as down as much as what our competitor reported yesterday in those two weeks, which we think is what really is the difference in April in our performance versus theirs.

Matthew Fassler - Goldman Sachs

Understood. And one quick follow-up -- on the expense line, as we measured it, your retail expenses per foot or per store excluding the charges were essentially flat, maybe up a little but I guess we could do the credit card work on our own and kind of back it out, but if you look at that at the store level excluding the credit card impact, is that down kind of low to mid-singles, or low singles in your view?

Carol B. Tome

It is.

Matthew Fassler - Goldman Sachs

And is that consistent with where you’ve been or perhaps a little more of a pull-back on SG&A?

Carol B. Tome

It’s a reflection of the store count, the expenses that we have associated with store count. You know, we are only opening 55 stores this year.

Matthew Fassler - Goldman Sachs

Understood. And the payroll, if you look at store payroll per se and you look at the either dollars per foot or leverage versus say last quarter, do you know what direction that moved in?

Carol B. Tome

It was flat to slightly up.

Matthew Fassler - Goldman Sachs

The dollars or the ratio?

Carol B. Tome

The ratio.

Matthew Fassler - Goldman Sachs

Great. Thanks so much, guys.

Carol B. Tome

Matt, we didn’t answer your question on U.S. only comps, and we’re happy to do that. If you look at the contribution from our businesses outside of the United States, as Frank pointed out we had positive comps everywhere outside the United States. The contribution in the first quarter was 1.9%, about the same as it was in the fourth quarter.

Matthew Fassler - Goldman Sachs

So it’s basically unchanged from where it’s been. Thank you so much.

Operator

We’ll take our next question from Budd Bugatch from Raymond James.

Budd Bugatch - Raymond James

Good morning and thank you for taking my question. As you think about the business, Frank and Carol, you are kind of describing a leaner, and a lot of the announcements that we’ve seen, a leaner and a meaner Home Depot that is more in touch with the customer at the store level. Can you talk a little bit about what expense difference that means, maybe from the store service support center? I know there have been some actions taken there and obviously you talked about the call centers as well. How should we think about the overall overhead going forward and when does that show up in the numbers?

Frank Blake

Well, the first thing, Budd, to point out is as we were going through a number of the actions that we’ve taken like the call centers, like restructuring our field HR teams, like the day freight, we actually put those savings or hours back into the store. We reallocated back to customer-facing activity. So as a leadership team, we looked at this and said we know we need to address as one of our first priorities and key priorities associate engagement and this is -- that’s one of the sets of activities we are going to be taking to address the need to improve our coverage on the floor. And that’s going to be an ongoing effort. So Paul and his team, he’s got a whole group that is focused around what we call aprons on the floor where people come up with ideas on things we can do better, cheaper, faster, whatever it is and then how we redeploy that into hours on the store.

We will always have opportunities, I suspect, in terms of our SSC here in getting our organization sized correctly to support the business. We took a very significant action a few months ago and look, all of our jobs here is to figure out how best to support the stores and how to do a better job tomorrow, which means being able to do it for faster and cheaper than we are doing today.

Budd Bugatch - Raymond James

Okay. And as you described what was going on with the field leaders, it almost sounded like a store Kaizen events, if I can put it in that term. How many field leaders are there? How many of those kinds of initiatives and events are there going on? Can you quantify a little bit of that for us?

Frank Blake

Let me ask Paul to discuss that.

Paul Raines

Sure, Budd. I think what’s going on in this aprons on the floor, and we’ll add some color to it at the investor conference but this is our own continuous improvement. Kaizen is a good term. This is our own program to generate thinking around how do we find solutions for customer service.

So our team literally is receiving hundreds of ideas on a weekly basis. We are taking action on those. The large ones you’ve heard about -- underneath those, there are several others that are smaller -- method improvements, process improvements, et cetera. But as Frank said, this is part of a multi-year framework to reallocated and reinvest in our customer service levels on the floor. So you will hear us at the investor conference talk about that multi-year game plan to continue this process.

Budd Bugatch - Raymond James

Well, you and I have talked about that in another venue and I am all for that. I think that is a great thing to do. My last question, if I could, is just piggy-backing a little bit on Colin’s question about the 96 basis points of higher credit. Carol, if you could maybe talk a little bit about that, how that played out month by month over the quarter -- I know you may not want to give us the actual granularity on it, but was the -- did that increase or decrease as the quarter unfolded?

Carol B. Tome

Well, we actually account for the profit sharing at the end of the month. We don’t do it each month.

Budd Bugatch - Raymond James

So you do it at the end of the quarter, not just at the end of the --

Carol B. Tome

Yes, at the end of each quarter, yes.

Budd Bugatch - Raymond James

Okay. All right, thank you very much.

Diane Dayhoff

Connie, we’re ready for the next question.

Operator

We’ll go next to Gregory Melich from Morgan Stanley.

Gregory Melich - Morgan Stanley

A couple of questions; one, Carol, you said it was $0.04 is what the week shift implied. Am I backing into that right, that’s it about a 20% variable margin, those sales?

Carol B. Tome

That’s right.

Gregory Melich - Morgan Stanley

Okay. And is it fair then to say that that’s what you see in the second quarter the other way, or how does that play out towards the end of the second quarter?

Carol B. Tome

We’ll explain it to you when we get done with the second quarter. We’ve got to see how the numbers come in. It really depends on the top line.

Diane Dayhoff

But yes, there is a change, yes, you are right.

Carol B. Tome

Of course, yeah.

Gregory Melich - Morgan Stanley

Okay, great. And then, not to beat credit like a dead horse, but we’ll try -- if the gain share goes away and then you don’t take losses from that, but if you start paying it say in a few, 2% or 3% as opposed to 1%, does that then show up in gross margin? Is that the way the accounting works?

Carol B. Tome

No, it’s a little bit more complicated than that, I’m sorry. There are three components of our cost of credit. There’s the deferred interest component, which is the fee we pay for our no interest, no payment programs, and our everyday value proposition is if you use the card and you spend 299, it’s no interest, no payments for six months. That deferred interest is accounted for as a cost of goods sold.

Then there are two other components. There is the gain share, which is a profit back to us and an interchange fee, which is a charge to us. And when you add it all up, the gain share and the interchange is in our selling and store operating expenses and when you add it all up, the deferred interest, the gain share, and the interchange, you get a cost of credit.

In 2007, our cost of credit as a percent of credit sales -- and remember, credit sales are about 30% of our total sales, our cost of credit in 2007 was less than 50 basis points. In 2008, our plan is that it will be 200 basis points or 2%. And we stress tested this and we don’t think it would be any higher than 4%. So hopefully that’s helpful.

Gregory Melich - Morgan Stanley

That is and at some point though, you could see some of that showing up in another line but that overall number is helpful.

Carol B. Tome

It’s going to be in the same line, deferred interest, which is in cost of goods and then selling and store operating. Deferred interest isn’t going to move. That’s a fixed fee, if that’s helpful. It’s really how profitable is the portfolio. That’s where you could see movement and it would be in our selling and operating expenses.

Gregory Melich - Morgan Stanley

Got it, perfect. And then third was rising fuel costs -- where does that show up? Is it SG&A or is it in cost of goods sold?

Carol B. Tome

It’s in both. It’s in both. Obviously it’s in our cost of goods but we also within SG&A, we have delivery expense. Delivery expense would be a factor of fuel expense, so it’s in both lines.

Gregory Melich - Morgan Stanley

Okay, great. Thanks.

Operator

We’ll go next to Michael Baker from Deutsche Bank.

Michael Baker - Deutsche Bank

Thanks. So first question on gross margin -- so it was better this quarter because of being less promotional. Any expectation on the trend going forward? I think, correct me if I’m wrong, but a year ago you were a little bit more promotional in the first quarter and then you did back off on that throughout the year, so should we expect that same kind of gross margin gain going forward or is that going to change?

Craig Menear

In terms of the promotional activity, we went in and we really took a hard look at the promotional activity itself and what we were getting from that. And when we looked at about 10% of the promotions driving about 80% of the lift, that wasn’t a great return on the other 90%. So that’s where we became much more rational in terms of what we were doing with the promotions themselves and we obviously benefited from that.

As we look at what’s going on with overall inflation, particularly as it relates to fuel, that’s where we are seeing pressure and we think that will certainly translate into some pressure overall in our margin but we are going to do our best to offset that for the customer, obviously.

Michael Baker - Deutsche Bank

Okay, thanks. And then if I could ask one more question just on May, you said it’s in line with plan. I think your previous plan at the beginning of the year was for comps to get better throughout the year. Does that include the second quarter -- but then, of course, you have the negative calendar shift, which was apparently within your plan, so that would make the second quarter plan worse than the first quarter. Just wondering if you can help us there, put that into context. Should the second quarter, plan to be better or worse than the first quarter?

Carol B. Tome

Sure. Because of the calendar shift, our second quarter should be our worst comping quarter of the year.

Michael Baker - Deutsche Bank

Okay. Thank you very much.

Diane Dayhoff

Connie, we have time for one more question.

Operator

We’ll take our final question from Daniel Binder from Jefferies.

Daniel Binder - Jefferies

Appreciating the fact that the quality of the labor is changing, I was wondering if you can maybe quantify, either on a comp basis or a total hour basis, what the increase or decrease in hours, labor hours has been year over year? And the second question was related to store-wide market share; could you give us any comments on that? And then lastly, just wondering if you are pleased with the consistency of the in-aisle training and whether or not the loss of the HR function at the store level will be disruptive in that.

Frank Blake

Let me take those in reverse order. On the consistency of the in-aisle training, and whether we will lose something from the loss of the HR imposition in our stores, the first thing I would acknowledge is we will lose something. I mean, these are trade-offs that we make in terms of some of the operational benefits in the store versus our belief that we do need to reallocate labor and do some restructuring on our workforce to provide better service for our customers.

As Paul indicated, we are very focused on training. We’ve got a new program we are rolling out in terms of product knowledge badges, rewarding associates for -- so the question is a very fair question. It’s one we focus on and as I said, every time you do these decisions there are downsides and the best we do is address the downside as well as we can.

On your second question, if I understood that, that was kind of our general market share -- was that your question?

Daniel Binder - Jefferies

Yes, just if you look at unit market share across all categories for the whole store, are you losing or gaining share.

Frank Blake

So I’d say the way we look at it, there are roughly 13 -- we look at 13 categories and we are gaining or holding our own in half of them. And we see that as improvement. We know we’ve got a hill to climb here, so we see that as improvement. Craig and his team, along with everybody else on the senior leadership team, we’ve identified areas where we think we can gain market share, turn that around and we feel good about our plans to do that over the remainder of the year.

And then your last question on sales per hour, I’m not sure.

Daniel Binder - Jefferies

Well, I was trying to just understand quantitatively, if you were to look at labor hours per store, are they going up at this point on a comp basis or are they just declining less than comps?

Frank Blake

Yeah, they -- and for sure again, and it varies, and Paul can discuss the labor model but there’s a -- or maybe will take you to a level of detail none of you wants to go, but it obviously varies store by store on what the sales are in the particular store, but it could be just exactly as you said, that what’s happening is just the hours are declining at a lower rate than the sales.

Paul Raines

In a negative comp environment, if you are in a store that’s negative comping, you know, the actual store customer traffic is decreasing. That store will have less associates in it.

But when we talk about our aprons on the floor campaign, that $180 million that I referenced is we are -- our goal is to add the equivalent of three full-time employees selling hours to each store. Some of that will be a reallocation of tasking that we have made more efficient. Some of that will be incremental spend in the store based on the cost reductions of the call centers in HR, et cetera. So it’s all a combination of efforts to put more selling hours in front of each customer than we would have had otherwise.

Daniel Binder - Jefferies

And are you making the progress you had hoped to on the master trades hires? Is that still a top priority and where do you expect that to be this year?

Frank Blake

I think it’s a very exciting program for us. As Paul indicated, we’ve got over 3,000 master trades specialists. As you would expect, and as we would expect, this is not an investment that you see an immediate return on but we are very pleased with how that program is going and we think it relates very directly to the foundation of Home Depot, that knowledge, that deep knowledge in the store, so we are pleased with the program.

Daniel Binder - Jefferies

Okay, great. Thanks.

Diane Dayhoff

Thank you, Connie, and thank you, everyone, for joining us today. We look forward to our speaking with you if you are coming to Atlanta for our conference in early June, otherwise we’ll talk to you in August. Thank you.

Operator

And this concludes today’s conference. We thank you for your participation and you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Home Depot F1Q08 (Qtr End 4/29/07) Earnings Call Transcript
This Transcript
All Transcripts