Original Source: FD (FAIR DISCLOSURE) WIRE
DIANE DAYHOFF, SVP, INVESTOR RELATIONS, HOME DEPOT: Good morning, and welcome to our investor and analyst conference. I would like to remind you that today's press release and the presentations made by our executives include forward-looking statements as defined by the -- in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. These risks and uncertainties include, and are not limited to those factors identified in the release and in the filings with the Securities and Exchange Commission.
It is now my pleasure to introduce the Home Depot Chairman and CEO, Frank Blake, to being our presentations.
FRANK BLAKE, CHAIRMAN AND CEO, HOME DEPOT: Thanks, Diane, and good morning, everyone. Today, we're going to talk with you briefly about our performance in 2006. We'll then focus most of our discussions on 2007, our key priorities and our financial plans. 2006 was a tough year. We faced a difficult market and we also had a lot of additional noise around our business. 2007 will also be a difficult year, but it will be a year of focus, simplification and investment, and hopefully less noise.
We'll be focused on five key priorities. Today our leadership team will take you through each of these priorities, and our investments supporting them. Our goal is to provide the best customer experience in home improvement retail, the best place to work for our associates and the best place to invest.
In fiscal 2006, sales grew by 11% to $91 billion, and diluted earnings per share were up almost 3% to $2.79. this reflected continued deceleration in the home improvement and housing markets, as well as tough year-over-year comparisons, and our reinvestment in the retail business in the back half of 2006.
In 2006, we felt sustained pressure from the housing market. this chart shows one of the reasons why I tend to the pessimistic side, and think that 2007 will be another tough year. the chart shows private residential investment as a share of total gross domestic product through GDP over an extended period of time.
As you can see, residential investment was over 6% of GDP in 2004/2005, an historically high level. We've had a substantial correction since then, and we're now just a little over 5%. But we're still above the average, and one could make an argument that we'll regress to the mean, which would say that we'd still have more corrections to come. And, as shown on this chart, we still have high inventory levels, both at existing and new homes and more time may be necessary to work this excess inventory off.
So, we continue to see short-term challenges in the market. But long term we think the home improvement market is a terrific market. The fundamental dynamics of supply and demand are strong. From 2001 to 2006, we grew nearly 7 million new households in the United States. And at the same time, our home ownership rates went up 130 basis points. This drove increased demand for housing and was part of the strength of our market.
The projections that we'll see are for the same kind of growth through 2011. We'll add more than 7 million new households, and home ownership rates will continue to grow up another 109 basis points. Third party projections for our market suggest a soft 2007, but consistent with the last two charts, strong, long term trends of approximately 5% per year. And as the market leader, we are positioned to take advantage of that growth.
Our ability to take advantage of that starts with our culture and our values. When I first got to Home Depot, I remember listening to Carol Tome talk about what makes our company unique, the special sauce that is our competitive advantage. It is our culture. And when I got this job, I realized I didn't have to come up with new slogans or acronyms. It would be tough to improve on our existing value statements and the company's embedded culture.
One element of our value system is our entrepreneurial spirit, which is linked with our inverted pyramid. This is something that is important to our entire leadership team, not just because it's our heritage, but also because it's tied directly to our customer focus culture. The inverted pyramid is in the Home Depot DNA. Our customers and our associates are at the top of the pyramid. Our associates understand this and our customers expect this. The more we live to this vision of our business, the more successful we will be.
Now, this is a simple chart, its my attempt at a concept chart and shows probably while I'll never make it as a consultant. We've spent a lot of time and effort changing organizational structure within the Home Depot. We've centralized functions that needed to be centralized, driven efficiencies, and set improved standards across the enterprise.
At the same time though, there may have been some trade-offs, in terms of speed, what Paul Raines calls our velocity of decision making, our creativity and our responsiveness to local needs. That balance between efficiency and speed is one that has to be constantly adjusted, based on our customer's needs, the range and variability of our stores, our information systems and our ability to drive organizational alignment.
What you'll hear today from George, Craig and our leaders is how we're rebalancing to drive more speed, localization, and responsiveness, without a significant loss of efficiency. Many of you have probably already seen or heard our five priorities for 2007. I certainly hope so. Associate engagement, product excitement, product availability, shopping environment and owning the Pro.
There are three introductory comments that I would like to make about this list. First, as Joe will describe for you, we've got a great set of leaders who are driving these priorities and we're taking advantage of their diverse retail backgrounds, such as Mark's experience at Office Depot, and structuring how we approach this effort. Second, you'll hear from Craig, Paul, Mark, George, and Joe Izganics about some of the specifics on how we'll drive the priorities short term and longer term.
Finally, these are pretty obvious priorities and they're not [liposhot] activities, they are broad. They cut across almost all of what we do. There are not five simple actions that will dramatically change the course of the Home Depot. As a team we know we are focused on the right things and we know it's going to take sustained effort. And we know that in addition to the sustained effort, it's going to take investment.
Investment in training and hours on the floor, investment in the maintenance of our stores, investment in merchandising resets, investment in our logistics infrastructure and investments to build customer loyalty. Carol will go through these numbers in more detail, but the impact from the reinvestment is that in a defining market, we see 2007 as a year where our earnings per share will decline in the range of 4 to 9% negative.
We are convinced this is the right thing to do for the business. For our customers, our associates and our shareholders. We have to stop our share loss, and then build on the great market position that we have. So far, I've focused my comments on US retail, but I do want to spend a couple of minutes talking about our international businesses. one general observation about these businesses, they reflect the entrepreneurial and adaptive spirit that is a core Home Depot strength.
We've been in Canada less than 15 years, but we are number one and growing. And Annette Verschuren and her team have developed new formats for different markets from urban to rural. We are constantly learning from Canada and Vice Versa. In fact, we're using Canada as the pilot for our core retail system.
We've been in Mexico less than seven years, and again we're number one and growing. Ricardo Saldivar and his team have also developed new formats for different markets, as they stretch their market coverage from one of the world's largest cities, Mexico City to small towns, that as recently as three years ago, we didn't think could even support a Home Depot store.
And finally, China. so the good news for me is that I'm not at the Harbin Ice Festival carving ice sculptures. For the company, the good news is that the market opportunity in China is significant. We have a good starting point with a company that we have a long history and shared culture with, and we have a great leadership team with Annette and Yves Chen, who [was] at Carrefour, and was the CEO of a Chinese hypermarket retailer before joining us. Our objective is to be number one in China, just as we are in North America.
At last week's earnings call, we had quite a bit of Home Depot supply and our decision to consider strategic alternatives, including a sale of the business. I wont repeat all of that now, other than to say that first, as Joe will detail, supply had a great 2006 and continues to take market share. Second, I believe that before we begin a process of greater integration of supply into our retail business, we need to determine whether we can create more shareholder value through a sale or other alternative. So we're going to look at those alternatives. And third, if we can create additional value that is the path we'll take.
Now, let me spend a minute on our capital allocation principles. As is hopefully clear, our focus is on our retail business. This is the business that drives our cash flow and defines our success or failure. As Carol will describe, we believe our retail business will continue to generate strong free cash flow. Our first alternative with that cash flow will be to return it to our investors, and in the process, we will maintain our high return on invested capital.
What then does Home Depot, particularly the Home Depot retail business look like in the years ahead? Our vision is that we will match or exceed market growth, which is as I said earlier should be somewhere in the range of 5%.
On the earnings side, we'll see some deleverage in the short term as we invest in our stores in a tough market, but in the mid to long term we should gain leverage as we see the benefits of an improved supply chain. And we should provide double-digit earnings per share growth as we return excess cash to our shareholders. We have a lot of work to do to achieve this vision, but it is a reasonable one. What you'll see and hear today is that we have the leadership, the focus and the plans to make it real.
Now, let me introduce our Chief Operating Officer, Joe DeAngelo. Thank you, very much.
JOE DEANGELO, CHIEF OPERATING OFFICER, HOME DEPOT: Thanks, Frank. I'll start with an update on HD supply, and then introduce our 2007 retail initiatives and the powerful individuals that are leading these efforts. In 2006, HD supply grew sales 162% to $12.1 billion, and correspondingly earned $800 million of operating profit. We are well positioned to deliver a 25% increase in operating profit in 2007.
Despite extreme declines in the residential housing market, with some of our markets down as much as 66% and despite significant declines in major commodities, like OSB and TBC, the HD supply team delivered 5.6% organic sales growth, exceeding the growth rates of the markets in which we participate by 790 basis points. Our market share gains, strengthen our leadership positions at every platform, and we also advanced our market position significantly via acquisitions.
For instance, in our waterworks business, we integrated the number one and number two players in the United States, National Waterworks and Hughes Water and Sewer. And in utilities we acquired Hughes Utilities in United States and Grafton Utility Supply in Canada, creating number one positions in both countries. Additionally, our combined facilities maintenance businesses grew double digit organically in 2006 where we brought together the two number one players in the multifamily aftermarket.
Turning to the Hughes acquisition. The integration of our largest deal has gone exceptionally well with the teams delivering $0.04 of earnings accretion, versus our $0.01 EPS commitment. Sales exceeded play by 1.1% even in face of both commodity pressures and a tremendous residential market decline. Gross margin was 105 basis points ahead of plan. Operating expenses were 116 basis points better than plan. Overall integration synergies exceeded plan by 85% and integration expenses were 56% less than plan.
Our ability to align sales forces day one, energize and welcomed 9800 new associates, convert 90% of our branches to their future state enterprise resource planning systems platform, seamlessly rationalize 40 facilities, effectively harmonize over 200 of our largest vendors, and launch the conversion to our single HD supply brand, speaks volumes to the strength of our integration processes and teams. Our current examination of strategic alternatives for HD supply will define the best way to unleash the shareholder value associated with this premium asset.
Moving on to the main event, our retail business. We did an exhaustive study this past summer, to listen to our customers and vendors, understand their internal dynamics, benchmark mature retailers, and model market growth rates and macroeconomics. What we heard from our customers was that they loved the Home Depot brand, they had very high expectations for service. We identified where we can enhance our performance, we have focused all of our strategy and funding going forward on fulfilling our customer needs by igniting passion in every Home Depot associate for our core Home Depot values.
By design, our Home Depot legacy was built upon a Home Depot Customer Bill of Rights, which includes; right assortment, right quantities, right price, associates on the sales floor who want to take care of customers, associates who have been trained properly in terms of product knowledge and the expectation that our associates will be there when the customers need them.
Our Home Depot Bill of Rights, aligns perfectly with the top five priorities that we are driving. It is all about focusing and delivering on a promises. We have assigned our best leadership and we have assembled cross-functional teams and associated funding to get the job done. We listen to our customers and we are focusing, funding and acting with superior velocity. I'll walk through each priority and introduce the leadership who will present today.
Our first priority is to deliver associate engagements, which is led by our Division President. Our southern Division President Paul Raines will represent the team today. Paul's broad retail and international experience and multilingual skills combined with our other diverse and experienced retail Presidents, positions us uniquely to motivate and develop associates that resonate with and engage customers in every location that we participate.
Given the nature of our business and our unique Home Depot culture, associate engagement is our single biggest point of competitive differentiation. Associate engagement provides our customers with a reason to buy today and the reason to come back tomorrow.
Our second priority is product excitement, which is led by our Chief Merchant Craig Menear. Craig's mission is to constantly create new demand. Home Depot has deep roots as an exciting merchandising company, and I can tell you from personal experience as a supplier to Craig in my past life, that he is the best in the business. Craig's team is unleashing selling power and excitement across every category.
Our third priority is product availability, which is led by Mark Holifield, our SVP of Supply Chain. Product availability is all about providing our customers with exactly what they need, when they need it. Mark's track record and exhaustive personal experience in supply chain excellence, is providing us with practical short-term solutions, while we bridge to world-class levels of performance.
Our fourth priority is to enhance our shopping environment, which is led by George Sherman, our SVP of Store Operations. George and his cross-functional team are delivering a shopping environment that is clean, organized, and efficient. George's track record as an exceptional retail operator provides the knowledge, credibility, and good old-fashioned, get it done attitude, to deliver simple, focused execution as we upgrade and maintain our store assets.
And our fifth initiative is Own the Pro, which is led by Joe Izganics. Joe and his team are focusing there Own the Pro efforts on growing share wallet with our superior, premium Pro customer. Joe is a long service Home Depot associate, who has held every operating position in the company. Joe has assembled a veteran leadership team with hundreds of years of experience, who link with thousands of associates at our contractor services desk to expand on Home Depot's foundational competency of serving our Pro customers.
Along with our clear focus on the priorities, we've also implemented an operating cadence that makes everything simpler and faster. This operating cadence has delivered rapid improvements in every priority area. In associate engagement, our new store fun fund and metric simplification, are liberating our store associates so they can focus on our customers. And the product-to-product excitement, we have implemented a deeper regionalization of the front end merchandising to drive speed and customer excitement.
We have accelerated our product line reviews. [REITs] and enhancements and product availability include target SKU, in stock root causes corrective action and alignment of inventory management and logistics to deliver supply chain synergies. Upgrades in shopping environment include a shift to programmatic maintenance and enhanced processes for our merchandising rapid refresh.
In recent actions in Own The Pro include accelerated bid room processes, and Pro credit program expansion including our new rewards MasterCard program. We're off to a fast start as we ramp up the change the game via rapid, relentless execution in our priority areas. Correspondingly, in our daily activities, we are unyielding about making simple firm and measurable commitments. We say it and we do it.
Now, I'll turn the presentation over to the five leaders who are representing the awesome cross-functional teams that are delivering our priority execution. It is my pleasure to introduce Paul Raines, the President of our Southern Division, to discuss our associate engagement priority.
PAUL RAINES, PRESIDENT SOUTHERN DIVISION, HOME DEPOT: Thank you, Joe, and good morning, everyone. You heard from Frank Blake, our CEO earlier, that the culture of Home Depot is our differentiating advantage and that all strategy starts with the customer. We believe that our business is built one customer at a time, and associate engagement is at the heart of taking care of our customers. Our orange blooded associates are our most formidable weapon and they are at the heart of associate engagement.
Now, we know that this great business was built one customer at a time. And even though we take care of millions of customers every week, our philosophy is that each and every customer interaction is an opportunity to enhance or damage our reputation. You can make a difference if you focus on one customer at a time.
The associate who wears the orange apron represents a great deal to our customers. The apron signifies that the individual wearing it has genuine interest in helping that customer. The apron is a symbol that those wearing it are knowledgeable and can give great advice on how to resolve a problem that a customer may have in their home. It means that service to the customer and others is a vital part of their job, and that they are interested in the customer's well-being and home improvement.
Lastly, that orange apron indicates that the associate is part of the Home Depot and is excited and proud to be part of an organization that defines home improvement. I'm proud to say I've worked in the aisles of Home Depot stores in six different countries, and can tell you that customers value the orange apron everywhere we operate.
Focusing on the customer is vital to our success, no matter where we are, and the orange apron signifies associate engagement. And we will be reviewing all of the key initiatives to drive associate engagement by focusing on selection, training, staffing, service and motivation. We know that our customers expect more from the Home Depot and every one of our 355,000 associates has to live up to that standard.
Now, the first step in associate engagement is our robust selection process. [To] give you some data, we receive over 17 million applications annually, and we interview over 350,000 people and to dimension that for you, that's roughly three times the population of Stanford Connecticut coming in for an interview every year.
Our recruitment process produces big numbers of new orange blooded associates as well. And over the next few months, our plan is to hire 83,000 associates through a series of mass hiring forums around the country and in-store campaigns. As our markets change, we will continue to focus on the diversity of our associate base to reflect our customer base around the country, all the while leveraging our hiring partnerships.
As part of the recruitment and selection process, we recognize the importance of having master electricians, plumbers and skilled tradespeople in our stores, and are launching a campaign to recruit more of these associates. As construction demand slows we see a unique opportunity to bring more Pros into our associate base than ever before.
Our existing partnerships with the Department of Labor, the Department of Defense and AARP among others, will serve us well as we recruit those trades. This campaign will be integrated across our employment website, AARP Magazine and targeted mail efforts. And in fact, if any of you have candidates in mind for us, please refer them to our website at careers.homedepot.com/skilledtrades.
We have created a specialized job title called Master Trade Specialists, to staff and recruit skilled trades associates in our stores. These specialists can be internal or external hires and they will complete a rigorous certification process to be placed in these job categories. Our concentration teams have created higher wage pay bands to reflect the added values these skilled associates can provide in the aisles to our customers.
We know that our skilled tradespeople need to be in the aisles when customers need them and we also plan to assign them fixed schedules to match the traffic in our stores. Now these skilled tradespeople, who we traditionally called Homers, will be focused on first and foremost, developing sales relationships with customers.
We want customers to know, and trust, [Carlos] or [Jane] in the plumbing aisle at Home Depot. And we also want them to know they can count on having that knowledgeable advisor available when they need them. Master Trade Specialists will also have a dual role of being a teacher of product knowledge and a leader of in store clinics for associates and customers.
Now, its still early in our recruiting campaign, but we're pleased to say that as of this week, we have over 20,000 applications for the Master Trade Specialists jobs, and we've actually hired close to 450 associates who …