2008 Home Depot Inc. Earnings Conference

The Home Depot, Inc. Q308 Earnings November 18, 2008

MANAGEMENT DISCUSSION SECTION

MANAGEMENT DISCUSSION SECTION Operator: Good day everyone and welcome to today’s Home Depot Third Quarter Earnings Conference Call. Today’s call is being recorded. [Operator Instructions] Beginning today’s discussion is Ms. Diane Dayhoff, Senior Vice President of Investor Relations. Please go ahead, ma’am.

Diane Dayhoff, Senior Vice President, Investor Relations

Thank you, Augusta, and good morning to everyone; welcome to The Home Depot Third 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 Tomé, Chief Financial Officer and Executive Vice President, Corporate Services. 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 appreciate it if the participants would limit themselves to one question with one follow-up please. If we are unable to get to your questions 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, Chairman and Chief Executive Officer

Thank you, Diane, and good morning, everyone. Sales for third quarter were $17.8 billion, down 6.2%. Comp sales were negative 8.3%. As Carol will describe, sales for the quarter were negatively impacted by approximately $225 million because of the seasonal shift associated with 53 weeks in fiscal 2007. Adjusting for that, comp sales were negative 7.1%. Diluted earnings per share were $0.45. You all obviously know that this is a difficult environment in the housing and home improvement markets. The view we had at the start of the quarter that we might be nearing a bottom, our August was actually better than we planned, gave way to the financial crisis in September and beyond. We’ve seen the kinds of pressure you’d expect in this environment. Our big ticket sales are down significantly, as Craig will describe. Our customers are finding credit harder to come by, as Carol will discuss, and we’re generally seeing continued softness in tough markets and erosion in previously strong markets. Let me give you some specifics. Since the mid-September and forward time period is the most relevant, we look at the rolling six-week comp performance of our top 40 markets versus Q3 2007. Of those top 40 markets, only 15 are performing better now. So we are not seeing the improvement that we thought we’d see as we cycled against the soft comparisons from last year. Where we are seeing better performance, frequently there is only fractional improvement. So for example, Miami is performing better, but is still mid-teens negative comping. We’ve seen some improvement in California and New England, but again these markets remain under pressure.


At the same time, previously strong markets have eroded. Last year, the Northwest was a relatively strong area for us. Now Seattle, Portland, and Spokane have negative double-digit comps. We expect that these pressures will continue into the fourth quarter and 2009. In many respects, the difficult market is obscuring the progress that our associates are making. Our customer service levels as reflected in our voice of customer surveys continue to improve. Marvin Ellison, our Executive Vice President U.S. Stores, has implemented significant changes in our store operations, making our approach simpler, more consistent, and more customer focused. On the merchandising side, you can already see some of the improvements Craig and his team have accomplished. It’s an enormous challenge to operate a business our size in a declining market with rapidly changing commodity prices and achieve price leadership, margin stability, and inventory control. For the quarter, we launched a strong new lower price campaign, achieved significantly better markdown control, and lowered per-store inventory by 7.5%. I believe we have better execution in our business across merchandising, operations, supply chain, and our supporting functions than we have had in quite a while. At the end of October, we opened our fourth Rapid Deployment Center, or RDC, in Winchester, Virginia. RDCs now serve approximately 400 of our stores. We remain committed to enhancing our supply chain and are pleased to be back on the track of opening facilities. This year, we have one more facility that we will open in the fourth quarter. Our international businesses, particularly Canada, have started to feel some of the economic pressures that we’ve had in the U.S. Canada had mid-single-digit negative comps and saw a similar pattern of accelerated declining sales in the quarter. In addition, our Canadian team tackled a major business system implementation with SAP Core Retail, which is now live in all our Canadian stores, a substantial undertaking in the midst of very difficult market conditions. The rest of our business will now benefit from the learning’s we can gain from the Canadian effort. And I’m very excited to have Matt Carey, who has over 20 years of experience with Wal-Mart and eBay on board as our new EVP and CIO to help is in that effort. China also reported negative comps, driven in large part by the impact of the Olympics in China in August. But Mexico continued its strong performance with another quarter of double digit positive comps. Across our entire business, we are making the adjustments necessary to respond to a tough market environment. We are carefully controlling our discretionary spending, scrutinizing every dollar of capital, and most importantly intensifying our focus on our customers. The culture at Home Depot is our strength and I want to thank our associates for responding well in a tough time. Now let me turn the call over to Craig.

Craig Menear, Executive Vice President, Merchandising

Thanks, Frank, and good morning everyone. In the third quarter, we experienced negative comp sales growth in all departments except building materials, which was driven by strong sales in roofing and insulation. Both categories increased in the number of units sold, though it should be noted that some of the comp dollar gain in roofing was driven by higher prices due to increased petroleum costs. Additional departments that outperformed the company’s average comp were plumbing, hardware, and garden. The departments that underperformed the company average comp were kitchen and bath, millwork, electrical, lumber, and flooring. And paint performed at the company’s average comp.


Average ticket was down $1.62 or $2.8% from last year to $55.86. We saw a decline in two areas. First, big ticket sales continued to suffer. For example, special order kitchens were down nearly 30% versus last year. And second, we saw that approximately 40% of the decline in average ticket was due to lower average spending per basket. From a regional perspective, areas of the North, particularly the Northern Plains and Ohio Valley, performed above the company’s average comp in the third quarter. The same is true for parts of the South like Texas, Oklahoma, and Louisiana. The positive results along the Gulf are attributed primarily to hurricane related sales. Hurricanes Gustav and Ike added approximately $125 million in incremental sales in the quarter. However, we did not realize any benefit to the bottom line as those sales were low margin sales and margin dollars were offset by additional expense such as freight, store damage, and associated costs. I am proud of the cross-functional team’s efforts before, during, and after the storms to ensure our products and associates were in place to help our customers and their communities. As Frank said, in this challenging environment we need to remain focused on executing and improving those things that we can control. We have discussed for several quarters the implementation of our portfolio strategy. And while we have a long ways to go, we’re starting to see the delivery of results. One such result was reflected in our transactions. While total company transactions of 315 million were down 3.4% year over year, we saw an improving trend during the last six weeks of the quarter. One of our ongoing initiatives has been to reduce promotions and refocus our efforts on being an everyday value provider as part of our portfolio strategy. By the third quarter, we felt that we had accomplished enough in this transition to effectively communicate our progress to our customers. Our marketing campaign supporting our new lower price reinforces the everyday value message. Our new lower price program increased transactions and drove attachment sales. Another metric supporting the initial success of our portfolio strategy and overall merchandising transformation was our gross margin results. The third quarter presented the most volatile commodity market I’ve ever seen. However, we worked through it and we saw a 27 basis point improvement in gross margin over the third quarter last year. Earlier this year, we introduced new tools to our merchants to better plan, assort, and react to changes in the market by forecasting at a more granular level. The clarity that these tools provided drove gross margin and inventory productivity, particularly in our seasonal categories. In the third quarter alone, we saw a 200 basis point gross margin improvement in our U.S. Garden category due to lower markdowns. All the merchandising initiatives that I have described so far are also driving results in market share. In the U.S., 6 out of 13 departments gained unit share in the third quarter and 10 out of 13 showed share improvements from where they ended the second quarter. Based on independent third-party tracking of consumer activity, we saw strong share gains in several key merchandising classes. For example, insulation, carpet, ceramic tile, power tools, toilets, faucets, grills, and molding all gained share in the quarter, to name a few. Many of these classes received concentrated merchandising focus and investment, utilizing our portfolio strategy. For example, in molding we updated the assortments regionally. We refined the merchandising sets, improved the value proposition, and added point-of-sale information, making it easier for customers to shop and make a selection. As we look to the fourth quarter, we expect that we will continue to see relative strength in energy efficient and basic repair products. We have a compelling selection of value conscious and energy efficient products. We are positioned well in holiday products, including our expanded assortment of LED lighting. Our gift centers have strong values in hand tool sets and power tools


across varying price points, and we’re ready to serve the storage and organization needs of our customers following the holidays. In this difficult environment, we are focused on things that we can control and executing on them. We will continue to execute our portfolio strategy, make assortment and pricing adjustments, implement resets, and drive project sales by the way we position merchandise in our stores. We believe these actions improve the value proposition for our customers and simplify their shopping experience. And now, I’d like to turn the call over to Carol.

Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services

Thank you, Craig, and hello everyone. In the third quarter, sales were $17.8 billion, a 6.2% decrease from last year, reflecting negative same-store sales of 8.3%, offset in part by sales from new stores. Net earnings $756 million compared to $1.1 billion last year. Earnings per diluted share from continuing operations were $0.45 versus $0.59 last year. Comp store same-store sales were negative 8.3% for the quarter, with negative comps of 6.5% in August, negative 7.4% in September, and negative 10.5% in October. The last three weeks in October were particularly weak. In fiscal 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, third quarter sales on a like-to-like calendar basis were negatively impacted by approximately $225 million. Excluding the calendar shift, our like-for-like comp for the quarter was negative 7.1%. Roughly 10% of our sales are outside of the United States. Late in the third quarter, we saw significant strengthening of the U.S. dollar against all currencies. The impact to total sales was about $40 million. And similarly from an earnings perspective, the strengthening of the U.S. dollar did not have a material impact in the quarter. In the third quarter, our gross margin was 33.7%, an increase of 27 basis points from last year and reflects the benefits arising from our focus based portfolio approach as well as a shift in the mix of products sold. Specifically, our gross margin expansion was driven by the following factors. First, lower markdowns coupled with a smarter approach to promotions covered the cost of new lower price program and drove 23 basis points of margin expansion. Second, a decline in the penetration of our lower margin kitchen and appliance category drove 14 basis points of margin expansion. And finally, we experienced a contraction in our gross margin of 10 basis points resulting from clearance activities taken in connection with the one-time conversion of our Canadian stores to their SAP Core Retail platform. In the third quarter, operating expenses increased by 214 basis points to 26.3% of sales. Our expense deleverage reflects for the most part the impact of negative sales. Generally, we expect to deleverage expenses by about 20 basis points for every point of negative comp. In the third quarter, our expense deleverage per point of negative comp was approximately 17 basis points, for total of 144 basis points of deleverage. Further as expected, in the quarter we experienced an additional 70 basis points of expense deleverage due to a higher cost of credit associated with our private label credit card. In the third quarter, our total cost of credit as a percent of private label credit sales was approximately 2.2%. Looking forward, our new private label credit card contract with Citi begins in January of 2009; and at that time, the cost of credit will be capped at 1.5% of private label credit sales. As you know, a great deal of pressure has been placed on consumers and therefore retail sales due to tightening of consumer credit. Sales under our private label credit card made up 28% of


our total sales compared to 30% one year ago. Today, over 70% of our new account applications are granted credit lines but the average approval limit has decreased by 5% from last year. Further, in some cases existing credit lines have been reduced. So as we look out, continuing pressure on credit availability could potentially impact sales. Our operating margin was 7.4% in the third quarter, down 186 basis points from last year. Net interest expense was $151 million, an increase of $26 million from last year, reflecting a decline in interest income due to the lower interest rate environment and lower invest able cash balances. In the third quarter, our income tax provision rate was 35.5%. We expect our tax rate to be approximately 36.1% for the year. Diluted shares were 1.69 billion shares compared to 1.82 billion shares last year. The reduction in outstanding shares is due to our share repurchase program and includes the tender offer we completed in September of 2007. At the beginning of the third quarter, we repurchased 2.4 million shares for $70 million. When the financial markets shut down, we put our recapitalization program back on pause and it will remain on pause until further notice. Now moving to our operational metrics, during the third quarter we opened 11 net new stores for an ending store count of 2,268. Today 257 stores, representing approximately 11% of our store base, operate in Canada, Mexico, and China. At the end of the quarter, selling square footage was 238 million, a 2.1% increase from last year. Reflecting the sales environment, total sales per square foot were approximately $296 for the quarter, down 8.5% from last year. Sales per square foot for our new stores were up 2.1% from last year. Now turning to the balance sheet, our balance sheet and our cash position remain strong. At the end of the quarter we had $874 million in cash and no outstanding commercial paper. As a reminder, we have a $3.25 billion A2/P2 commercial paper program that is 100% backstopped by a committed long-term bank line of credit. We do not foresee the need to access the commercial paper market during the remainder of the fourth quarter. However, if we need to issue commercial paper, we believe the market is open to us at this time. We have approximately $11 billion of long-term debt, of which $1.7 billion comes due in 2009. The average duration of our long-term debt portfolio is approximately 11 years. We ended the quarter with $44.2 billion in assets. Since the end of the year, our cash position has increased by approximately $400 million, reflecting cash flow generated by the business of approximately $4.9 billion, offset by $1.4 billion of capital expenditures, $1.1 billion of dividends paid, and $2 billion used to repay outstanding commercial paper and an operating lease obligation. At the end of the quarter, retail inventory was $11.9 billion, down 5.7% from last year. On a per store basis, inventory was down 7.5%. Our operators and merchants have done an excellent job of controlling inventory in this sales environment. The quality of our inventory has never been better and clearance inventory is at a record low. Further, our in-stock level is at a record high. Reflecting the sales environment, however, inventory turnover was 4.2 times compared to 4.4 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 11.6%. Excluding the store rationalization charge earlier this year, our return on invested capital was approximately 12.7%.


As we look forward, we continue to project a challenging sales environment. We’ve been controlling what we can control, but November comps to date are about the same as October. Based on our year-to-date results, the stronger U.S. dollar, and our view that the consumer could be very challenged in the fourth quarter, we now believe that fiscal 2008 sales could be down as much as 8% for the year. We continue to project that our earnings per share from continuing operations excluding the store rationalization charge will be down approximately 24% from last year. We will share our 2009 guidance with you during our fourth quarter earnings conference call, which is scheduled for February 24. So thank you for your participation in today’s call. And Augusta, we are now ready for questions.


QUESTION AND ANSWER SECTION

Operator: [Operator Instructions] Our first question will come from Colin McGranahan with Bernstein. <Q – Colin McGranahan>: Good morning. <A – Frank Blake>: Good morning. <Q – Colin McGranahan>: You said, Craig, that 40% of the decline in ticket was due to lower spending per basket. I’m assuming the remaining 60% decline in average ticket then was due to mix, fewer large ticket purchases. Can you comment maybe how that compares over the course of the last, I don’t know, year or two and what that implies in terms of how the mix impact is working on the average ticket? <A – Craig Menear>: Yes, Colin, the balance was in fact the decline in average ticket. We’re continuing to see pressure in big ticket categories like kitchen and millwork that is impacting the overall average ticket. And I would tell you that in the third quarter as we looked at those larger transactions above 500 or $1,000, they took a step down to double digit. <A – Carol Tomé>: I’ll just jump in on the appliance side because I think this is important. If you look back in 2007 and 2006, we saw average ticket growth because of an increasing penetration of our appliances. In the third quarter, we lost $0.17 in our ticket just due to appliances. <Q – Colin McGranahan>: Okay, okay. And then second question, I don’t know if Matt Carey is actually on the call, but if he is and if he’s not, maybe somebody else can jump in. In terms of what are the initial experiences with SAP in Canada, what you have learned, and how you are thinking about those learning’s in terms of U.S. IT implementation? <A – Frank Blake>: Colin, Matt is here. Matt, why don’t you address... <A – Matt Carey>: You know, it’s early days. We are just in the very end of the rollout. The teams have been focused very hard in completing the rollout. And we’ll be assessing the performance of those stores and that business in the coming year and learning as much as we can such that we can help the U.S. business as well. So... <Q – Colin McGranahan>: Okay, thank you. <A – Frank Blake>: Yes, and Colin, the one thing I’d say is we entered this with a number of questions and one of the first questions was could we do it; could we implement this without just a dramatic impact on the business because frankly you look at other big implementations like this and there have been some significant – beyond divots, huge potholes. And I give credit to the Canadian team and to Matt’s team. The implementation as an implementation has gone pretty well. <Q – Colin McGranahan>: It seems like you converted all the stores. There were no major snafus, up and running and you’re probably already seeing some initial benefits I would imagine. <A – Frank Blake>: I can’t talk, as I outlined, Canada is seeing – if you think about Canada, they’ve got some of the same issues in terms of impact from the auto industry, oil and gas, so it’s way too early yet for us to be able to tease out what the benefits are as they wrestle with a tough market. <Q – Colin McGranahan>: I understand; thank you. <A – Frank Blake>: Yes.


Operator: Our next question will come from Peter Benedict with Wachovia. <Q – Peter Benedict>: Thanks, guys. Again on the average ticket, it has been down the last nine quarters and I think the third-quarter number puts us basically back to where we were in about the third quarter of 2004. When you look at the mix of your business in the stores today, what period would you say it’s most similar to over the last several years? Is it like 2004 or is there some other year that we can look back to that would be more representative of what you’re seeing in the stores today? <A – Craig Menear>: This is Craig. I would tell you that as we look at the current decline in the big ticket, the change in our business from 2004 to now as it relates to appliances, I don’t think you can really compare it to – I think the mix is different. So we’ve grown our appliance business significantly since 2004. And on the flip side, in this current environment the categories like kitchen cabinets are down significantly. So I’m not sure it’s a... <A – Frank Blake>: Peter, it really is tough because as both Carol and Craig said, you’ve got to look at categories. I think of things like countertops that we were barely in in 2004 versus now. <A – Carol Tomé>: Kitchens, flooring, the whole emphasis on specialty is very different and that is our business model that’s being impacted by the economic environment. <A – Frank Blake>: Correct. <Q – Peter Benedict>: Okay, great, thanks a lot. <A – Frank Blake>: Yes. Operator: Next to David Strasser with Deutsche Bank (sic) [Banc of America] <Q – David Strasser>: Hello? <A – Frank Blake>: Hi, David. <Q – David Strasser>: It’s Banc of America, but no problem. So quickly when you look at the mix of stores around the country, the Northeast now is about 17% of stores, and the order Midwest 10% of stores. It is pretty – you can make a good argument that those areas based on what’s happening in the economy are going to get worse. When you look at some of the mistakes or some of the things, positive things you were able to do in areas like Southern California, Nevada, Florida, what have you learned about that you can use to anticipate slowdowns as some of the things that are going on in those areas start to materialize? <A – Frank Blake>: David, I’d say – and this is more anticipation than direct experience at this point. I would expect that the dynamics are going to be different. So when you look at California, Florida, Nevada, you had just a lot of speculative homebuilding. You had strong employment, strong underlying GDP growth, but a housing bubble that had a direct impact on us as that bubble collapsed. I suspect we’re going to be seeing a different dynamic play out going forward where it’s less a housing bubble unwinding than it is a region dealing with basic difficulties on economic growth and employment. So just on your premise, we’re not anticipating that it will be same-same and we can have hypotheses on how that will play out in our stores, but I think we’re going to see a very different unfolding. <Q – David Strasser>: And I guess – I’m sorry. <A – Frank Blake>: No.


<Q – David Strasser>: Just as a follow-up, at the beginning of the call, you had said the Northeast – could you repeat what you had mentioned how the business had trended there? <A – Frank Blake>: Yes, the comment on New England was that it’s better than it was, which is good, but I want to be very cautious in saying better is truly a relative term and that it’s still under pressure. <Q – David Strasser>: All right; thanks a lot. I appreciate it. <A – Frank Blake>: Thanks, David. Operator: And I do apologize; from Deutsche Bank, we have Michael Baker. <Q – Michael Baker>: Hi, thanks. So you said November was about where it was in October. Is that that 10.5 that you said for October or it sounds like the end of October was worse than the total October 10.5? I just wanted to clarify where November was relative to that. <A – Carol Tomé>: It’s around the negative 10.5 area. <Q – Michael Baker>: Okay, good. My follow-up is I think the sales guidance, the full year sales guidance down 8%, seems to imply down 18 for the fourth quarter. You have one fewer week, so you adjust for that, maybe down 12 or 13. You get a percent or two from square footage, so it sounds like the guidance for the comp at least is a little bit worse than down 10 if my math is even close to right. Is that just being conservative thinking things might drop off or is my math just completely off? <A – Carol Tomé>: Your math is right. What’s included in our guidance is our view of the U.S. dollar impact to our fourth quarter sales. The U.S. dollar strengthened at the end of the third quarter, so it didn’t have a big impact to our third quarter. But we assume that the dollar will remain strong in the fourth quarter and that will have an impact to our sales outside the United States. <Q – Michael Baker>: By a percent or two or something along those lines? <A – Carol Tomé>: I’m thinking almost a couple percent. <Q – Michael Baker>: Okay. Okay, thank you. <A – Carol Tomé>: You’re welcome. Operator: Our next question will come from Scot Ciccarelli with RBC. <Q – Scot Ciccarelli>: Hi, guys, Scot Ciccarelli. What has been the big change in terms of the sales trends in October and November? I’m sure it’s just a continuation, but are we seeing incremental pressure on traffic or is it incremental pressure on ticket or is it both? <A – Frank Blake>: I think I will turn it to Craig, but as Craig was outlining, we actually feel like we are gaining some traction on the transactions, but just seeing continued pressure on ticket. <A – Craig Menear>: Yes, that is correct. We look at transactions actually in October. We actually saw a significant change or improvement in transactions. But when you look at ticket in the month of October, that fell significantly. Ticket above $500 was double digit off. <Q – Scot Ciccarelli>: Okay, that’s what I was looking for. Thanks, guys. <A – Frank Blake>: Yes.


Operator: Next to Deborah Winnowing with Citigroup. <A – Carol Tomé>: Debra? Operator: Apparently, she has left the queue. We will go next to Chris Hovers with J.P. Morgan. <Q – Chris Hovers>: Good morning everybody. I want to understand maybe how we should read the stack trend or the trend in the business as you’re entering the fourth quarter and try to get our arms around how do we: a) how do compares ease as you go from November to January; and b) how much should we read into or ascribe the shift down in comps to the fact that the seasonal and the maintenance categories just don’t do as well whenever it’s holed up in the winter with the windows shut and the heat on? <A – Carol Tomé>: Let me answer the first part of your question if I could. In terms of comparisons looking at last year, and remember it’s a calendar shift that distorts some of this. But last year, our comps were negative 6.6 in November, negative 7.2 in December, and negative 10.8 in January. From a comparison, it would appear that January is the easiest compare. <A – Frank Blake>: In terms of your comment on the product assortment and what sells, the mix, it’s going to be roughly the same year over year, that same shift away. Obviously there are a lot of things like kitchen remodels and new flooring and the like that really slow down pretty significantly once you’re past frankly this period, once you’re past the Thanksgiving Day period. <A – Craig Menear>: Yes, and when you look at seasonal impact of like the garden department, the big shift obviously comes from Q2 to Q3. It’s much less significant Q3 to Q4. <Q – Chris Hovers>: Maybe coming at it from a different angle, how much would you say because of this because of that mix shift away from outdoor and from seasonal, how much of this is just a dip down because we’re entering that time of year and how much might maybe we recover in the first half next year when you get into a better seasonal period? <A – Frank Blake>: Again on the comp perspective, you’re comparing same dip to same dip. And then obviously our business does pick up. This is – January is our lowest month. <A – Carol Tomé>: If you look at just total sales dollars, you should expect this to be a weak quarter for us just because of the seasonal nature and it picks right back up when spring comes. <Q – Chris Hovers>: Okay. <A – Carol Tomé>: Does that help? <Q – Chris Horvers>: That helps. And a follow-up question on SG&A trends, you have been basically keeping SG&A per foot flattish here in the first three quarters of 2008. How should we think about your ability to keep it flattish into 2009 either from a maintenance SG&A spend perspective or from a stores on minimum staffing level? <A – Carol Tomé>: Let me first talk about the fourth quarter. For the fourth quarter, we expect our expenses per average store to be down from what they were a year ago. Two reasons for that; primarily lower advertising spending in the fourth quarter this year versus last year; and then last fourth quarter, you may recall that we had some write-offs associated with stores that we elected not to open. There was a big write-off for a store in San Francisco. You need to remember that. We won’t be repeating that in the fourth quarter. So expenses should be down on per square foot basis. As we come back to you at the end of the fourth quarter, we’ll give you guidance for 2009 and let you know what we think about expenses on per store basis, but clearly this is an area of real focus.


<Q – Chris Horvers>: Thank you. <A – Carol Tomé>: Thanks, Chris. Operator: Our next question will come from Deborah Weinswig of Citi. <Q – Deborah Weinswig>: I apologize for the technical difficulties earlier. So Carol, originally or last quarter you had given guidance of sales to decline for 5% for fiscal ‘08. Now you’re saying potentially an 8% decline, but we’re keeping earnings guidance down 24%. Is the major difference on the gross margin side or how should we think through that? <A – Carol Tomé>: We had a good earnings quarter in third quarter. Earnings were better than our plan, so we’re able to take that into fourth quarter. As we look at the fourth quarter, Craig has talked to you about the new tools that we’re using that allow us to forecast sales, margin, and inventory now for 200 classes on a weekly basis. That has given us better visibility on what we think the margin will do in the fourth quarter and that’s giving us comfort for the guidance that we gave. <Q – Deborah Weinswig>: Okay and then also, can you talk about your inventory performance in the quarter, certainly very impressive especially in light of the environment? <A – Frank Blake>: Yes, really this is a joint effort of everybody on the team. It starts with Craig and his merchandising team and Carol and her finance team and working with them on the planning process and Marvin on the store execution side and supply chain. It really is just – it’s connecting, connecting a lot of – I mean this isn’t a very fancy answer, but it’s just connecting a lot of dots within the business in a more effective way. <A – Craig Menear>: Really the new tools are giving us great visibility and has changed how we manage the business. And quite honestly when we look at the inventory overall, it was widespread. It wasn’t concentrated in a significant – or one area. It was widespread across all our merchandising departments. <Q – Deborah Weinswig>: Frank, would you say it’s a much more collaborative effort? <A – Frank Blake>: Again, yes. I think there are lots of opportunities for us to improve our operations and these are the kinds of time periods that force us to get those and, as Craig said, develop the new tools that help us communicate better within the organization. <Q – Deborah Weinswig>: Okay. Last question, what are you seeing with regards to stores that are being serviced by the RDC network? In terms of the RDC network, how should we think about 2009? <A – Frank Blake>: One of our – Mark is here and he can address that as well. But when we put this on pause, we had a series of benchmarks that we wanted to hit before we would start again, and one of them was how are we performing with the stores in terms of accuracy of shipments and how are the stores perform in terms of out-of-stocks. And we hit those targets, which is what gave us confidence to restart the rollout process. And our plan is to continue through 2009 and 2010. Mark, if you want to... <A – Mark Holifield>: Yes, just we had opened our Winchester facility. We’re in our fourth week of operations there. We’re experiencing no significant issues and we’re pleased with the progress there. As Frank said, the main thing we’re looking at from a store perspective is the in-stock in the store and our RDC stores perform better than our other stores. We’re looking at our ability to service the stores with very accurate loads and timely delivery. So we believe on track to achieve our ultimate targeted levels over time. So we’re pleased with that progress.


In terms of 2009, we want to continue until we can serve 100% of our stores and we’re targeting 2010 for that completion. You will see openings in 2009 against that target. <Q – Deborah Weinswig>: Great. Thanks so much and best of luck. <A – Carol Tomé>: Thank you. <A – Frank Blake>: Thanks, Deborah. Operator: Our next question will come from Alan Rifkin with Merrill Lynch. <Q – Alan Rifkin>: Yes, thank you. It certainly sounds like the price rationalization program has been pretty successful in driving transactions and units and revenues. My question is though, taken together with the incremental marketing spend, has it been accretive to net income; and if so, what is your proclivity going forward to expand the program? <A – Craig Menear>: First of all, there wasn’t an incremental marketing spend per se. It was a shift of how we were using our dollars to communicate to the customer. And overall, I think that as we look at the program, part of our portfolio strategy is to drive to an everyday great value for our customer. We’ve been doing that by eliminating promotional activity that was non-nutritive. We see this as an ongoing program. It’s focused on our customer. It’s focused on driving value to our customer every day. And as we look at this program, it’s built in our guidance as we move forward. <Q – Alan Rifkin>: Okay, when you say it’s an ongoing program, will it maintain the same level or will it be intensified? <A – Craig Menear>: As we look at the market and we look at implementation of our portfolio strategy, I certainly would not see it going backwards. As the market bears, we will look at whether or not that intensifies. <Q – Alan Rifkin>: Okay and one follow-up if I may. Where are you, Carol, with respect to minimum staffing levels at the store level? And going forward if we continue to see a decelerating revenue environment, what is the opportunity to further reduce payroll at the store level? <A – Carol Tomé>: Alan, we staff by department, not by store. Marvin Ellison is here, our Executive Vice President of stores, and I’ll let him address your question. <A – Marvin Ellison>: Alan, this is Marvin. As Carol said, we staff by department, not by total store, and really it’s based on the rate of sales in a department. So if we have a department like plumbing where sales are increasing, we will beef up staffing. If a department has sales declining, we’ll pull back staffing. The other thing we’ve done is that we looked at customer shopping traffic patterns and we focus our service during those timeframes. We’ve been able to take the same number of associates and increase our service levels just based on when customers shop. We think that works for us and we’re going to continue to strive with that model for the rest of the year. <Q – Alan Rifkin>: Okay, but at the departmental level, for departments that going forward let’s say come in below your plan, is there opportunity to further reduce labor within those departments or are you pretty much at the lowest staffing levels today? <A – Marvin Ellison>: We look at it case by case. As it stands right now, we’re not at any minimum staffing levels. We just try to maintain certain level of service in our stores and we manage – the reason why departments work is because it allows us to be granular, and we can


look at it department by department and make sure that we are flexing the necessary resources in areas where we need to provide service. <Q – Alan Rifkin>: Okay, great. Thank you very much. <A – Carol Tomé>: Thank you. Operator: We’ll go next to Budd Bugatch with Raymond James. <Q – TJ McConville>: Good morning, thanks for taking the question. This is actually TJ McConville filling in for Budd, who is traveling today. The first question I had was a follow-up to a previous question on the call. Craig, I think you said that ticket above $500 was off double digit in October. I was wondering if maybe we could get a sense for where that was, in the beginning parts of the quarter or maybe where it was last year. <A – Craig Menear>: In the beginning parts of the quarter, it was mid-single digit. We believe that there was some impact of that, particularly in September, as a result of hurricane sales and the repair that was happening in those particular parts of the country, but mid-single digits. And prior to that, it ranged pretty much double digit negative. <Q – TJ McConville>: Okay, got you. The second question I had was on the geographical regions. I know Frank gave us a pretty nice update at the beginning of the call on how things were looking. I was wondering if we could get a sense for the progression of declines throughout the quarter. Maybe a better way to ask would be did the bad markets flatten out as things got worse and the good markets just got that much more bad or it was just an across the board deterioration for you? <A – Frank Blake>: I’ll be honest, TJ. I don’t have the time lapse photography on that to tell you exactly how it played out, so I’d be guessing if I gave you an answer on that. Again, you’d see a lot of variation from within the markets; some markets impacted more dramatically through the quarter than others. But honestly, I just don’t have that in my head. <Q – TJ McConville>: Okay. That works for me, guys; thanks and best of luck. <A – Frank Blake>: Thank you. <A – Carol Tomé>: Thank you. Operator: We’ll go next to Matthew Fassler with Goldman Sachs. <Q – Matthew Fassler>: Thanks a lot and good morning to you, a couple questions at this point, largely clean-up. As you disclose the monthly comp numbers, are those impacted by the calendar shift as well or are those monthly progressions distorted or are they pretty clean? <A – Carol Tomé>: The monthly comps that we gave you were the reported comps. I’d be happy to give you the like-for-like comps. <Q – Matthew Fassler>: That would be great. <A – Carol Tomé>: Okay, we reported a negative 6.5 for August; the like-for-like was negative 6.2. We recorded a negative 7.4 for September; the like-for-like was negative 5.3. And we reported a negative 10.5 for October; the like-for-like was negative 9.4. <Q – Matthew Fassler>: Got you, so negative 9.4’d kind of be the comparable number as you left the quarter.


<A – Carol Tomé>: Yes, right. <Q – Matthew Fassler>: Great. Secondly, can you try to quantify the impact that international had on the business and maybe put that in context of what you had seen year to date, I guess both overall? And then I think currency probably hurt you at least a little bit in the third quarter, having helped prior to that, so if you could help us understand that as well. <A – Carol Tomé>: Yes, our reported comp for the quarter was negative 8.3. Our U.S. comp was negative 8.4. So that gives you some sense of the positive impact that we have seen from non-U.S. businesses has diminished. <Q – Matthew Fassler>: Got you, and then obviously make the calendar adjustments comparably. <A – Carol Tomé>: That’s right. <Q – Matthew Fassler>: Okay, then the comment you made at the outset, Frank, on 15 of 40 markets having gotten better. Just to make sure I understand, you are actually seeing some sequential improvement in a number of markets. It’s just not as many markets as you thought you might as the compares get easier and probably by a lesser magnitude where you saw that improvement. <A – Frank Blake>: That is correct, both statements. It’s fewer than we thought and not as much as we thought. <Q – Matthew Fassler>: Got you. And then finally, the payables ratio looked like it was down a little bit year on year, if you could share with us whether there is any rhyme or reason to that movement and what we should look for over the course of the year? <A – Carol Tomé>: Yes, our payables ratio was 57% compared to 60% a year ago. Last year, you may recall we outsourced all of our payables processing to India and candidly, we had some disruption. The 57% is where we think we should be. Now remember that at the end of each year, it’s always a low point in that ratio. So in the fourth quarter, I would expect it to be around call it 49% or something like that. Then it will build back up. <Q – Matthew Fassler>: Got you, and finally by way of clean up since these are going so quickly, your aggregate market share number, you talked about having gained share in a number of categories. As you look at that third-party source, is there an aggregate share gain or loss that they gave you; and if they did, how does that move versus the year-to-date trend? <A – Frank Blake>: I don’t think they do an aggregate. <A – Craig Menear>: They don’t do an aggregate. <Q – Matthew Fassler>: Got you, thanks so much. <A – Frank Blake>: Yes. <A – Diane Dayhoff>: Augusta, we have time for one more question. Operator: Thank you. That question will come from Michael Lasser with Barclays Capital. <Q – Michael Lasser>: Thanks for sneaking me in here, I appreciate it. Frank, at the outset you said you expect these pressures will continue into the fourth quarter of 2009. Maybe you could expand a little bit more on that comment. And if that is the case, will it necessitate a greater store rationalization program than occurred earlier this year?


<A – Frank Blake>: Yes, we expect it to be through the fourth quarter and into 2009, as I said. Look, we look every quarter at our stores and try to make sure we’re doing the right thing in terms of the stores that we have open. I would say as we look at our orange box stores, we don’t see a dramatic change from what we saw in the first quarter in terms of the long-term value of those stores. <Q – Michael Lasser>: Okay, and a follow-up for Carol. You mentioned that the leverage or deleverage per point of comp is now down to about 17 basis points. Will there be an asymmetric leverage profile such that you’ll get much better leverage once the comp turns positive and how are you thinking about that? <A – Carol Tomé>: I’m looking for the day when that comp turns positive. Yes, there is an asymmetrical relationship as things start to move up. <Q – Michael Lasser>: But it is hard to quantify at this point? <A – Carol Tomé>: It is. We are working through that right now. And as you can appreciate, Michael, all our focus has been on running the business in this very challenging sales environment. As we look out planning for positive comps and that day will come, we’ll come back and tell you what the leverage looks like. <Q – Michael Lasser>: What has caused the downshift from the 20 basis points to the 17 basis points? <A – Carol Tomé>: Our 20 basis point rule is a rule of thumb. It’s going to be around 20. I don’t think it will ever be exactly 20. <Q – Michael Lasser>: Okay, thank you very much. <A – Carol Tomé>: Thank you.

Diane Dayhoff, Senior Vice President, Investor Relations

Thank you everyone for joining us today. We look forward to talking to you when we release our fourth quarter earnings on February 24. Operator: Thank you, this does conclude our call. We’d like to thank everyone for their participation. Have a great day.

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2008 Home Depot Inc. Earnings Conference

Economy & Finance