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  1. 1. The Home Depot 2008 Investor Day June 5, 2008 Diane: Good morning, and welcome to our Investor and Analyst Conference. I would like to remind everyone today that today’s 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 our filings with the Securities and Exchange Commission. It is now my pleasure to introduce our Chairman and CEO, Frank Blake, to begin our presentations. Frank: Thank you, Diane, and good morning, everyone. And thank you for taking the time to participate in our 2008 Investor and Analyst Conference. There is a saying that change comes through repetition. So most of what you’ll hear today will be similar to what you heard last year. We’re focusing on the core, investing in our five priorities, and exercising disciplined capital allocation. I hope through the course of the morning we’ll be able to give you a good sense of where we’ve made progress and how we’re positioning the business for the long term. So speaking of repetition, I’ve used this chart, which shows a 60 year look at private residential investment as a percent of GDP, quite a bit. It provides a very rough indicator of where we are in the housing and home improvement market. At our last conference in the first quarter of 2007, we were at 5.1%, or 30 basis points above the 60 year average of 4.8%. Over the last year the market has corrected an additional 130 basis points, so we’re now considerably below the 60 year average and approaching the all time lows. On the same theme, we’ve seen a dramatic correction in sub-prime and Alt-A origination. We’re now well below the levels of 2005 and 2006, and in fact, below where we were in 2001. So a substantial correction has occurred. And again, we’ve had a lot of discussion internal and external on the impact of mortgage equity withdrawals on the home improvement market, we’re now back at 2001 levels. This is not to say that we’re through the issues that have impacted the housing and home improvement markets, far from it. You could put up almost any housing or home improvement indicator that you want, and it would be grim. We have record inventories of vacant homes, and that’s in the face of sharp production curtailments in the home building industry. Housing prices have gone from record appreciation to national declines. Mortgage credit has gone from historic availability to dramatic contraction. Foreclosure rates are at a record high. And as Carol will discuss, we see more negatives than positives for the remainder of this year, in particular, pressure on our consumers who are being affected by increased costs in fuel, food, and other essentials. So we see a continued difficult time in the housing and home improvement markets. But this just reinforces for us the importance of focusing on our existing stores, driving a limited number of important priorities, and carefully allocating our capital. Page 1
  2. 2. The Home Depot 2008 Investor Day June 5, 2008 Whatever the precise timing of the bottom of this market is, the long term fundamentals remain strong. The United States is still projected to add several million new households over the next five years. While the home ownership rate has declined somewhat, that still equates to nearly three million new households, plus our overall housing stock continues to get older. This will continue to drive the need for repairs. And I think we’re going to see new needs arise for our older homes, like energy conservation. What I’d like to do in the next several minutes is give you an overview of where Home Depot is on the path of creating shareholder value. This is a very simple chart that has four sets of activities. Focus on the core business, exercise disciplined capital allocation, increase return on existing assets, and build sustained competitive advantages. All of these are designed to maximize return on capital, which is our focus for driving shareholder value. Some of the activities are short term, some longer term, and as we go through the elements, I’ll give you my assessment of where we are on the timeline. So our first step was to focus on the core, our retail business. The major steps there are done, in particular the sale of HD Supply last summer. The other point of note on this chart is our home services business. We are in the process of refocusing that business, as Paul will discuss. It is not going to be an independent driver of growth for The Home Depot. This doesn’t mean that we’ll exit the business, but it does mean that we’re going to look at the business to drive connectivity to our core retail business. We’ve had a couple of great examples of that with our $199 whole house carpet install program, and our $89 whole house blind install program. It also means we’ll be less interested in growing the business than ensuring that we get it right. Without a doubt, our customers have a need for do-it-for-me solutions. But if we can’t effectively execute, we’ll be more interested in serving the pro who does it for our customer than in providing the service directly ourselves. We have also articulated and acted on a clear set of principals for capital allocation. As Carol will go through in more detail, we have financial guidelines for our existing stores, and we’re putting a higher hurdle in front of our new store growth, benchmarking our new store returns against share repurchases. To optimize our capital structure we’re in the midst of our recapitalization plan and remain committed to that as the business and credit markets stabilize. I’d also say that there is an important day to day element here, and maybe disciplined capital allocation sounds like too grand a concept. It’s more like stop doing stupid things. There are a lot of activities that a large organization like Home Depot does that are oriented more to the organization than to its customers or shareholders. That’s the activity that needs to be stopped, and the discipline around the capital allocation process was a very effective discovery tool for that. Page 2
  3. 3. The Home Depot 2008 Investor Day June 5, 2008 Where we focus most of our time is on our five priorities, associate engagements, store environment, product availability, product excitement, and own the pro. These are the same priorities as last year. They are very straightforward, and they’re designed to increase the return on our existing assets. In a world where we’ll be building significantly fewer new stores, we know that getting more out of our existing assets is our single most important objective. We’re confident that we have the right five priorities, in most part because they come directly from our customers. And we’re also confident that we’re making significant progress on them, even though at this point the increased financial returns aren’t there. Craig, Paul, and Mark will give you details on our progress. Let me summarize what I see as some of the high points. On associate engagement, we’ve done some important things over the last year, like improving associate compensation, recognition and reward programs, and adding master trade specialists to our stores. But I think what’s most important is our long term commitment to returning customer facing hours to the floor of the store. We’ve significantly de-leveraged our payroll as a percent to sales. But in the declining sales environment, that doesn’t translate to the number of hours we want to add for our customers. So we have to be more creative and disciplined. We have to find both additional hours and hours that we can reallocate to customer facing hours. In effect, we’re driving resource allocation using customer service as our benchmark. This is our Aprons on the Floor program, and Paul will discuss it with you in more detail. On shopping environment, we’ve been able to make some immediate improvements by increasing funding for maintenance and implementing store standards across the company. We’ve seen our voice of customer VOC stores on shopping environment go from 7.6 to over 8. We don’t need to have a store environment that’s like a Target, but our customers do want a clean and uncluttered store. And we’re clearly making progress on that. On product availability, the major activity this year and next is the rollout of our rapid deployment centers or RDCs. Mark is going to take you through that in detail. Again, the important overall point is that we’re committed to taking our supply chain from a competitive disadvantage to a competitive advantage. On product excitement, Craig and his team are establishing the foundational elements of a best in class merchandising team, from setting out basic internal processes to articulating the role and intent of our product categories, to providing the analytical and execution tools necessary to support the organization. We’ve made a lot of progress over the last year, but we’re still in the early stages. As you’ll hear from Carol, we expect to gain significant improvement in our operating margins through this merchandising transformation. We are, I believe, the only retailer anywhere near our size without basic portfolio planning tools, Page 3
  4. 4. The Home Depot 2008 Investor Day June 5, 2008 assortment maintenance tools, inventory planning tools, and centralized forecasting and replenishment tools. Our core retail effort is intended to address these deficiencies. But even without core retail, we can and are making significant improvement to our merchandising processes. And finally, on our own the pro priority, the sale of the supply business has actually helped the company focus. We’ve seen our bid room volume increase 200%, and we’re targeting our customer analytics on this key segment. So where are we on the critical objective of building a sustained competitive advantage? First, what are our key competitive advantages? The first three are directly based on the founding principals of the business, what we call the three legged stool, every day pricing, compelling assortment, and excellent customer service. We know that we have room to improve on these foundational elements. We became too promotional and perhaps confused our customers. And as is obvious from our Aprons on the Floor effort, we know we have additional work to do in improving customer service, both in the number of our associates and their training. So while our assortment is strong, we have opportunities particularly when it comes to regional variation. We know that our real estate is a competitive advantage. We have stores in areas of the country where it will be very difficult to site additional big boxes. As we take our new store count down, one of the positive side benefits is that we can focus our time and resources on those critical stores that drive enormous value for our shareholders. For example, we have more than 650 stores that are older than ten years, and these stores as a group are almost 20% more productive than the company average. We’re fortunate that we have the best brand in our space. What we need to do is now link that with best in class customer knowledge. That is our objective in developing a relationship with one of the premier companies in customer data insights, Dunn Humvee. As I said, we’re on the path of restructuring our supply chain, and we have shown that we know how to take our business model outside the United States. We are number one in Canada, and positively comp, we are number one in Mexico and have comp double-digit for the last 14 quarters. And as I mentioned on our first quarter earnings call, we are now seeing double digit positive comps in China. With Ricardo Saldivar and Annette Verschuren and their teams, we think we’ve built a competitive capability to take a great business model and successfully adapt it to new environments. Finally, our most important competitive advantage is our culture. We have passionate associates and a unique entrepreneurial spirit. The re-grounding of Home Depot in our culture is an ongoing effort. We’re farther ahead on this than I would have anticipated a year-and-a-half ago, but it’s still something we work on every day. Page 4
  5. 5. The Home Depot 2008 Investor Day June 5, 2008 So let me conclude this with a quick summary of 2008 and beyond. You’re familiar with this guidance which we gave at the start of the year. We’re now more comfortable at the low end of the guidance, since, as Carol will describe, we see more headwinds than tailwinds through the remainder of the year. To be honest, I had hoped when we scheduled this conference in June instead of February of this year that we would have a better near term line of site. But following the recovery of our market remains an exercise of uncertainty. A rough characterization, very rough characterization is that from the back half of 2006 through 2007 we saw the dramatic decline in housing construction. From mid 2007 on we saw the tightening in the credit markets, and that hit harder than expected. And now we’re facing into the combination of rising oil prices and declining home values. We’ll have a better understanding of these dynamics as we exit the next couple of months in the seasonal portion of our business. Once we’re through this, here’s what a normalized Home Depot looks like, what we look like when the current market conditions stabilize. Carol will go through this in some detail later. Without a doubt we have a lot of work to do to achieve this future outlook. And in particular, we need a positive sales environment. But I hope what you’ll leave here today with is a good sense of the progress we’ve already made, a good sense of how we’re improving the business for the long term, and the focus we have on making this outlook a reality. Now let me introduce Craig Menear, our Executive Vice President of Merchandise. Thank you. Craig: Thank you, Frank, and good morning, everyone. As Frank mentioned, we’re committed as a leadership team to creating shareholder value by focusing on our core business, but with a disciplined approach. And what I’m going to talk to you about today is how my organization is supporting that effort and creating a best in class merchandising team. So first, I’ll share with you how we’re returning to the Home Depot merchandising roots that made us the leader in this industry. And second, how we are truly affecting change in how we run our business through our merchandising transformation. And finally, I’ll discuss with you the early good results that we’re seeing from the beginning stages of our merchandise transformation. So the merchandising roots of Home Depot are found in some of the key principals that you see here. First, the company was built on national brands. And particularly those that were important to our pro customers. Merchandising fought to get these brands in the building. I’ll talk more about brand strategy in just a minute. The key customer for the Home Depot was clear. We cultivated the DIY customer, along with the small repair remodel professional. And the products that we carried for these customers went through a filter process. First, it had to be essential to repair, remodel, or maintenance. Second, we needed to have the ability to be top of mind, and the ability to be the market leader. And finally, we Page 5
  6. 6. The Home Depot 2008 Investor Day June 5, 2008 had to be able to sell it profitably. And as I mentioned, products we carried needed to meet the needs of the pro customer. That was important because our DIY customers felt that by buying those goods, okay, they knew that they were getting a product that had quality and could get the job done. Now merchants spent a lot of time creating product knowledge opportunities to assist our associates in transferring knowledge to our customers. The company educated our DIY customers on how to complete projects and to this day, service is a very high expectation at The Home Depot. And finally, we aggressively attacked the market by offering great values every day. Now the key element of our merchandising roots was our brand strategy. The Home Depot has been built into a brand that carries a 94% unaided brand awareness. We are the leader in the home improvement industry in North America, and for that matter, the world. The foundation was the national brands, and they remain critically important today. Approximately 80% of our total sales still come from nationally branded product. And we don’t see that changing in any major way in the short term. And as a matter of fact, it will be our customers who ultimately determine the path of this change. As The Home Depot became a brand itself, the addition of exclusive brands began to provide the company with some key points of differentiation. Additionally, proprietary brands came into play. And the goal in mind here was to continue with the differentiation, but also to improve gross margin dollars. These brands were built largely through imports, leveraging the investments that the company had made in sourcing. The strategy going forward for Home Depot merchandising is to marry the best of our past with a more focused, disciplined approach going forward. We will remain focused on key national brands and we’ll add back where we have gaps. Our exclusive and proprietary brands still add value from a differentiation standpoint and gross margin. And I’ll share with you in just a minute just how powerful it can be when you put the right proprietary brand and The Home Depot together. Our core customer is still the DIY customer and the small repair remodel pro. And we are refocusing on these customers and beginning to eliminate those products that divert our focus from them. For example, we are eliminating this year pet food, automotive supplies, Halloween products, and apparel will go away in 2009. Our merchant teams are engaged again in helping to drive product knowledge in the aisles of our stores. First, we’re conducting merchant monthly walks where we have the opportunity to address key store management and department supervisors in the markets around the country. And this was a key activity from our past that is both a valued activity for our associates, as well as our merchant learning. We also have other various opportunities to drive knowledge, like road shows, weekly PKs, our website to assist in transferring product knowledge to our customers. And Home Depot merchandising is focused Page 6
  7. 7. The Home Depot 2008 Investor Day June 5, 2008 on providing great value to our customers every day. And we are getting more aggressive in this approach, but we will do it with discipline. And we’ll do it using the tools that are being built to support merchandising decisions. Now in most categories where brand really matters, Home Depot carries the number one consumer preferred brand. It would be hard to have a meaningful garden or plumbing department without the Scott’s or Kohler brands. GE is a powerful brand that focuses on leadership positions in any product category that they engage in with the customer. And we also carry brands that our pros ask for. For example, in power tools, DeWalt is a pretty important brand to our professional customer. And USG has the largest market share, approximately 30% of total gypsum sales in the United States. But we must do a better job of marketing the fact that we carry the preferred brands. And Frank Bifulco, our Chief Marketing Officer, and the team will be focused on driving this point with our customers. This is also an opportunity to get brands back into The Home Depot. Warner Ladders, for example, will be added back to our assortment, and this is a key brand that our professional customers expect to see in our stores. And it does carry the leading market share position. Now when Home Depot works to create an exclusive brand for our channel distribution, we do so with powerful partners. Exclusive partnerships that we have in many cases are the leading brands in their categories. Anderson Window is a leading preferred brand by professionals for wood windows. Home Depot offers the full access to the entire Anderson line for our customers. Behr Paint is the leading consumer paint brand in the country. Custom Building Products is the world leader in tile setting material, and it offers the only lifetime warranty for a project completed within their system. Ryobi has been a fast growing consumer brand in power tools for the past several years. This brand was introduced at The Home Depot with our DIY customers in mind. However, it’s offered such great value that now many professional customers are purchasing this product in our stores. And Thomasville was introduced for The Home Depot in our kitchen cabinet business. And here we leveraged this great furniture brand and today we carry that brand in flooring, which is a natural extension, as well as our new patio furniture line up that was introduced this spring, and we have had tremendous success. So these are just some examples of the other types of exclusive offerings that we bring to our customers. And the names that you see here are additional great brands found only at The Home Depot. Now when you link Home Depot with quality product that brings innovation to the marketplace under our own brand, the consumer responds positively. Home Page 7
  8. 8. The Home Depot 2008 Investor Day June 5, 2008 Depot has two proprietary brands, Hampton Bay and Husky, that exceed $1 billion in sales. Now I can remember walking with the management team at Proctor & Gamble, and it’s a big deal in that company when they get one of their brands to $1 billion. But think about the scope of Proctor & Gamble and who all they sell. The Home Depot has now grown two brands to that level, and we are the only place customers can buy those goods. That’s a powerful marketing opportunity. So the bottom line here is we’re getting back to our Home Depot merchandising roots. Now let me talk to you about how we’re affecting true change in one end of our business. As we get back to our roots of being an aggressive competitor in the market, we’re committed to do that with a disciplined approach. And this is where merchandising transformation, which Frank referenced, comes into play. There are three key areas where we are focused to make this happen. We are redefining how we operate our business by reviewing all of our processes and driving for greater efficiency and speed. Now this is going to take time, but the early progress is strong. This will be about a two year path to rewrite and retrain all of our merchants. And this documentation will make it much easier for us to integrate new talent into our merchandising organizations. Second, we’re committed to drive our focus bay approach. And I’ll give you a framework in just a minute, but remember, this is about the role and intent for each merchandising class. This adds clarity to our actions and speed to our decision making. This is really important as we drive for line structure improvements and continue to drive the project business. And lastly, we’re building tools to support the merchants in driving execution as we redefine how we’re running our business. The goal here is to make their lives easier and to enable faster decision making. The success from aligning people, process, and tools will be the long term enabler to delivering profitable sales and share gains in the market. Now merchandising transformation starts by having the right people in place to support these efforts. The average retail experience of our officer team in merchandising is 20 years. But we will continue to add to this base with the talent, both within the company and new talent from outside the company to blend new thinking into our process. Externally we have added Dave Roth(?) as our MVP over lumber. Gordy Erickson joined the team with a tremendous experience in home center, mass, and specialty retailing. And Frank Bifulco brings 30 years of brand management to marketing as the latest addition to our team. Internally, we’ve focused on improving our connection with the field. First, the leader in this area Bruce Merino, he was our Western Division President. And Bruce brings a wealth of field operating experience to the role. But he was also a merchant for many, many years with our company. We added divisional sales managers in the field who are responsible to provide key regional input to the Atlanta merchandising team. Other key roles in merchandising leadership were Page 8
  9. 9. The Home Depot 2008 Investor Day June 5, 2008 filled with high performing operations partners that have shown strong talent for merchandising. And just last month we added the role of Vice President of Store Environment. And this position was filled with one of our top performing RVPs that has a very strong record of execution and merchandising talent. And finally, one of the most significant changes that we’ve made with people is the development of our new merchandising execution team, which falls under Bruce’s organization. Here, we developed an internal service organization that drives merchandising execution for the stores. These teams drive various sales initiatives, they drive merchandising product to the rate of sale, they ensure that programs get set properly, and they provide product knowledge and make sure it’s conducted. This program was launched in our garden department this spring. And it was probably one of the best executions of our seasonal spring business in the past ten years. Our objective in transforming process is to drive greater speed and efficiency. And as I mentioned, this will take about two years to redefine every process that we use in merchandising. Initially, we’re driving the implementation of our focus bay approach, and working on a significant improvement in our seasonal planning processes. This year we changed our work week for the merchandising team to put real focus on better understanding what our customers’ needs are, and better linkage with our partners in operations and supply chain. Merchants are back in the stores one day a week talking with our stores, talking with our customers to understand how we improve our assortment to meet their needs. We’ve also completely changed our weekly meeting cadence to foster significantly improved communication and forecasting within the business. These efforts are helping us with our focus bay approach, our seasonal planning, and improving our merchandise presentations. Now one process that’s critical to our merchandising transformation is our focus bay approach. And let me take just a minute to review the strategy behind this focus bay approach. Again, it’s defining the role and intent for each merchandising class that we carry. We cannot invest in all equally, so how do you apply your investments to project the image that you want to your customers? Additionally, this process defines tactics that you use for assortment, price, space, marketing, service, all in an effort to make decisions faster and to align with your overall strategy. So the roles that we have identified are destination, core, traffic, impulse, and emerging. And as an example, let me walk you through kind of the high level concepts of what a core class is. From an assortment standpoint, it would be complimentary and competitive. From a location and space, we would co-locate these products with destination or project starter goods. Service, we expect consistent service or it would be a solution selling opportunity. Marketing will be fairly consistent, and our key focus would be to market the breadth of the Page 9
  10. 10. The Home Depot 2008 Investor Day June 5, 2008 assortment. And we also have differentiated strategies on price as part of this focus bay approach. Now the focus bay approach is really at the heart of our changing business model. We no longer are about new store growth, we’re about driving productivity in the assets that we deploy. There are roughly 85,000 square feet, or 800 bays of selling space in a typical Home Depot store. And we need to be driving for productivity gains in each of these bays. Some may be completely focused on top line, while others will be focused on driving average ticket and gross margin dollar productivity. The example that you see here is our commercial electric builders lighting program. Frankly, this was an assortment gap identified, which we filled with this new lighting program. One category had to shrink in space to provide room for this new product to go into our stores. This was done in about a 90 day period of time once we started our resets. And the productivity in these bays has increased 60% from what was in them previously. Now that’s the type of work that needs to be completed on an ongoing basis across the store. There’s times when we can achieve this with a complete product line change out, like I’ve described here, and there’s other times where we can make that happen with simple SKU changes within a bay. And as we affect change in how we operate our business, the seasonal category is one that we can look to as an example of how this is impacting the way we manage our business. This truly is about aligning people, process, and systems to drive substantial improvements in the management of the business. We knew that there were several enhancements that we had to make in our seasonal business to drive both sales and profit productivity. We had to assort closer to the customer, we had to get below market level to the store. We had opportunities that we had to fix in terms of information flow, both internally and externally because this business moves incredibly fast. We had to improve our in stock positions. And to do that, we had to be much faster about responding to the time in terms of demand needs. And in doing so, we had to enhance the return on the inventory investment that we made in these categories. Now, let me give you an example of how we’re leveraging our merchants in the field with our Atlanta office to better assort and present product and address the customer preferences regionally. So what you see here is an example of a tile reset that’s actually going on across the country right now. Markets are now assigned to one of nine tile zones. And each zone’s assortments will vary based on size and format, regional design and style, and market appropriate price points. And as we think about presentation, we’ll keep in mind that Home Depot is an operating warehouse, and we will focus our merchandising presentations to fit Page 10
  11. 11. The Home Depot 2008 Investor Day June 5, 2008 that model. Our main priorities will be to simplify the shopping experience to a customer, increase holding capacity, and to reduce clutter in our bays. The last part of our transformation involves systems. Once we get the people and process in place, we have to support the operation of the business with new tools to improve what we’ve created. The team has delivered several new tools, four of which you see here. These tools are delivering advanced capabilities that we need to make change stick. However, we’re in the very early implementation stages of this across our business. The assortment maintenance tool allows our merchants to get below that market level, but it also provides exception reporting against their plan. So this not only gets to better assortment planning, but it simplifies the management of the process as well. Enhanced forecasting tools were put in place providing greater visibility into the business and they’ve changed really how we work cross functionally in managing these businesses. Our new math event tool drives our merchandising plans to the store, and the MST platform is a communication tool between our stores and the FSE. Now these tools are examples of how we’re making it easier for merchants to react to the specific needs of a regional area. All of this combined is how we’re transforming our merchandise approach. So let me share with you some good traction that we’re feeling early in the implementations of our merchandising transformation, and I’m only going to call out a couple of them here. First, as you recall, one of our key measurements to our success was to improve market share. And that process has begun. We have share gains happening in half of our merchandising departments. In addition, our industry has gotten pretty promotional over the past several years. However, we’ve learned that numerous promotions were not providing lift, and therefore, we’re reducing unproductive promotions. We’ve been able to hold sales volume while optimizing gross margin dollar productivity. And lastly, when I stepped into this roll in 2007, our website was completely disconnected from our business. Since then, we’ve made a lot of progress on getting it more integrated with the core home improvement business. And this is an important activity as our customer changes how they shop and research product. Now let me share with you more granularly an example of what happens when you align people, processes, and systems. Our first quarter results in garden were exactly the kind of results that we want. Our sales grew positively year-over-year, but our gross margin dollars grew at a rate of almost two times sales, while inventory was down significantly. The net result was a positive lift in our _____. We drove more gross margin dollars for every dollar that we invested in this business. So I’ll wrap up by sharing with you how we’re thinking about sustaining sales and gross margin productivity over the long term. First, the productivity that we’ve Page 11
  12. 12. The Home Depot 2008 Investor Day June 5, 2008 enjoyed this year has really come from two key things, a more rational view of promotions, and really returning to providing greater value to our customers every single day. Second, it’s going to be about improving seasonal inventory management and utilizing the enhancements that I’ve described here today. Short term, the improvements will come from our focus bay approach, driving the project business, and continuing to improve our line structures. And then the long term sustainability will come from full implementation of our merchandising transformation, supply chain benefits, and then really developing and understanding of our customers’ needs which will allow for effective solutions in driving sales to The Home Depot. I thank you very much, and now I’d like to turn it over to Mark Holyfield, our Senior Vice President of Supply Chain. Mark: Thank you, Craig, and good morning, everyone. I’d like to give you an update on our supply chain transformation here at The Home Depot. One of our five key priorities introduced in last year’s investor conference was to improve our product availability for our customers. And as we sought to deliver on that priority, our focus turned quickly to our supply chain. Last year I talked about opportunities to improve our supply chain, particularly in the areas of central distribution and our inventory management. And I’m pleased to have the opportunity to give you an update today on our progress. Last year we talked about product availability, improving our in-stock for the customer. We’ve made progress against that, according to both our internal and our external measures. We talked about improving our inventory management capabilities. We have put in place a number of improvements, including better merchandise financial planning, better seasonal planning, like Craig talked about, a more effective inventory management organization, and improved systems. We said we would develop an end state distribution network model. We have completed that model and have begun to migrate to it following it as our plan going forward. That model and optimal flow network called for increased central distribution to optimize our flow of goods and we’re moving to that network now. As Frank mentioned, we have begun an aggressive rollout of RDCs, or rapid deployment centers, and have three facilities live today. But let’s back up for a moment and review why it’s important to optimize the flow of goods. A well configured and operated retail supply chain creates great value in that retailer. And one doesn’t have to look too far to find examples of retailers who have differentiated their results from their peers by strategic investment and great execution in their supply chain. Wal-Mart, Tesco, Best Buy, and Publix Supermarkets are some of those companies that quickly come to mind. These retailers have the following in common, a differentiated supply chain strategy connected to their company’s customer value proposition, a well- Page 12
  13. 13. The Home Depot 2008 Investor Day June 5, 2008 configured DC network, state of the art systems and processes, and excellence in execution. In every case, their supply chains deliver high end stock levels, optimized inventory management, and low logistics costs, all key deliverables for a retail supply chain. But a retail supply chain does more than this. It simplifies store operations, creating more hours on the floor for associate engagement with customers. It supports product excitement through faster speed to market for new and innovative products. It creates a better shopping experience by reducing excess inventory and promoting a clean and uncluttered store. And it supports the retailer’s customer segmentation efforts through enabling support for specific customer needs, as in our case, the pro customer, where job lot quantities are critically important. In short, a good retail supply chain creates this optimal flow network. Of course, one of the most visible indications of whether you’re flowing goods properly is the in-stock position on the shelf in the store. And despite years of research and effort, this issue continues to plague retail supply chains, including ours. Leading studies of retail product availability indicate that up to 4% of retail sales are lost due to out of stocks. And these studies also indicate that a limited number of root causes are the drivers of those out of stocks and Home Depot is no different than that. In some cases, customer facing out-of-stocks are caused when product is in the store but not on the shelf. Sometimes not enough is ordered due to poor process or faulty forecasting. In some cases inventory counts are not quite right and the replenishment systems think the product is in stock when in fact it’s not. And finally, in some case, enough product was ordered, but it was not shipped on time by the vendor or filled complete by the vendor, or not transported on time by the freight carrier, or not received on time by the receiving location. That last one, late or insufficiently filled purchase orders is the number one root cause of out-of-stocks at The Home Depot. The pipeline from origin to store does not get the freight there on time and complete far too often. So great opportunity lies in improving the performance of our supply chain in landing freight at our stores on time and complete. Another deliverable of optimal flow is good inventory management. This means carrying the right level of inventory to be in stock for the customer, but at the same time managing inventory responsibly to improve working capital. This chart shows the history of inventory turnover at The Home Depot for the last ten years. The scale on the left is inventory turns, and the scale on the right is average store sales volume in millions. As you can see, our inventory turnover performance has generally tracked right along with the decline in average sales per stores, and has not delivered inventory turnover results commensurate with other leading retailers. This is in part a result of a supply chain that worked pretty well for high volume stores, but those same strategies and tactics, a one-size-fits-all approach if Page 13
  14. 14. The Home Depot 2008 Investor Day June 5, 2008 you will, do not play well for lower volume stores. Our high volume stores have no trouble making frequent orders to vendors for direct store delivery with sufficient volume to allow them good in stocks and inventory turnover. But in lower volume stores without an effective central distribution network, we are forced every day to make the tough choice of being out of stock or overstocked due to vendor minimum order quantities, long lead times, and unreliable replenishment. Keep in mind that for every one-tenth improvement in inventory turns, we free up $150 million in cash flow. So the opportunity is immense when we reverse the direction of that inventory turnover line. Let’s review for a moment the existing Home Depot supply chain. And this chart is very similar to one we showed at last year’s conference. On the left are the sources of goods we sell, on the right are our stores, and in the middle are the channels of distribution we use at Home Depot. Taking a look at our existing distribution network once again, we have five basic channels for product to get to our stores. Starting at the top, lumber and other bulk goods are processed through our lumber DCs. Next, we have the import DCs and carton DCs. These DCs are traditional stock and pick warehouses. Together, these DCs account for about 20% of our product flow. Now fourth in line there you see the transit facilities, or TFs. While they handle about 20% of our freight, they are not really distribution centers and simply pass through individual store orders across their docks on their way to stores. They don’t help us eliminate those vendor minimums, they don’t help us identify shipment shortages, and they don’t move freight particularly quickly. Finally, you can see that about 60% of our freight still moves direct to store. And this is absolutely the right answer for those things where we sell a full truckload per week in a store. But it’s absolutely the wrong answer where a vendor minimum shipment quantity is way more than a single store needs on a weekly basis. Now that we’ve opened these lower volume stores, it’s become even more challenging to make these vendor minimums. So our current supply chain, with its limited capability and one-size-fits-all approach limits our ability to achieve the priority of product availability with optimal inventory. In summary, we have too many out of stocks, we have too much inventory, and we spend too much time having to handle freight in our stores instead of serving our customers better. From a competitive perspective, our supply chain has become more of a competitive disadvantage than an advantage. So how do we get to parity, and how do we get further to a competitive advantage for product availability and supply chain for The Home Depot? By moving to a rapid, an optimal flow network that optimizes the flow of goods based on their characteristics. Consider the various types of products that we sell in The Home Depot. Some products make most sense to go direct to store. These would be products where full truckload is the weekly demand in the store, where the Page 14
  15. 15. The Home Depot 2008 Investor Day June 5, 2008 transportation costs are relatively high as a percent of sales dollars, and where the value of the product is relatively low, eliminating inventory carrying costs as a factor. Examples might be concrete, bagged fertilizer in season, mulch, pine straw. But some other products make the most sense to flow through a DC very rapidly. These would be relatively faster movers of moderate value. Demand and supply of these items are relatively predictable, especially when considered at the regional level. These are products, these are most of the products that we sell, therefore, a rapid deployment center based network is optimal for The Home Depot. Finally, some products are relatively slower moving making demand less predictable. Some products have relatively high value, making inventory carrying costs in the store high. Some products may have an exceptionally long supply chain, like imports, making supply relatively harder to predict accurately. These products lend themselves to traditional stock and pick warehousing to optimize their inventory carrying and handling costs. So determining optimal flow for a given type of product is based on several factors, the value of the goods, their handling characteristics, the predictability of demand, the reliability of supply, their origin point, and other factors. And the secret to developing a good retail distribution network model is understanding the interaction of these characteristics and creating the optimal flow network to move product to stores. As I mentioned earlier, in 2007, we used information about our product flows to develop an optimal distribution network model. This distribution network strategy effort employed industry standard techniques to map and analyze all of our existing and forecasted network product flows all the way upstream from our suppliers and downstream to our stores and customers. And through this effort, we developed an optimal flow distribution network strategy that we will use to guide all of our network development decisions for the future. Included in these results were distribution locations and sizes and a transition plan on how to get there. Our review led to a revised network design, as indicated here on this chart. The optimal flow network for Home Depot looks like this. It’s simpler, it’s more comprehensive in its service capabilities than today. Similar to the existing network, this network includes capability to handle lumber and bulk products. It does call for stock and pick DCs where products are stocked and replenished to stores on demand. But it also includes RDCs, or rapid deployment centers, for fast flow movement of goods to stores. The RDC is the primary engine and the new link in the chain, which will get us to the optimal flow of goods. Note that this model includes moving from a central distribution penetration of about 20% of product flow in the existing supply chain measured by cost of goods sold to about 75% of product flow. The optimal DC network would include more than 20 of these fast flow RDC facilities, and ideally more volume would pass through these Page 15
  16. 16. The Home Depot 2008 Investor Day June 5, 2008 fast flow RDCs than through the stocking DCs. So the biggest opportunity in front of us is to quickly rollout these RDCs and being to close the gap from 20% of central distribution flow to 75%. Along those lines, in 2007, we piloted one of these RDCs in Braselton, Georgia. So how does this work? A single RDC is designed to handle an area of about 100 stores and their volume. On the left you have these stores’ demand aggregated into a single purchase order from the supplier to the RDC. The supplier prepares the RDC order for shipment in bulk quantities and applies a standardized label to the pallet, coupled with an electronic shipping notice to the RDC. Note that these RDC level orders are much bulkier than individual store orders and require less time and effort to prepare on the vendor’s part. They are also much more efficient to ship, as they are more neatly packed in full or near full pallets. These product pallets are then shipped from the supplier to the RDC. At the RDC, the product is unloaded, the standardized bar code labels are scanned, and product is detail received against the supplier’s shipping order. It’s then sorted to the desired store location and merged with product from other vendors destined for the same store. Note that the product is allocated to individual stores upon receipt, and this postponement of the allocation decision leads to a much higher quality decision, as it has the benefit of several more days of information regarding sales and inventory at an individual store level. The product is then shipped to the store in well utilized pallets with a license plate on each pallet that identifies for the store what is contained on that pallet. This is the process that we piloted in Braselton, Georgia, in 2007. The results of this RDC pilot were better in stock at the stores, reduced lead times, improved shipment integrity, and improved inventory turnover. The concept works. Now some of you who have followed us for a while are familiar with our transit facility network and have questions on how an RDC differs from a transit facility. First, the RDC eliminates vendor minimums. The transit facility handles only store level shipments, which are subject those vendor minimum shipment quantities. The RDC makes a bulk order to the vendor, ensuring an efficient quantity for each purchase order. The RDC eliminates 99% of purchase orders, as when we issue one purchase order per RDC in a 100 store RDC it reduces the number of purchase orders by 99 for that vendor. This is a huge savings for our suppliers and for The Home Depot, as each order requires overhead to handle. The RDC picks in a bulk pick, while the transit facility’s individual store orders often result in a very inefficient pallet quantity. And because the RDC aggregates demand for about 100 stores and uses the cubic feet in a transport trailer far better, it allows for full truckload shipments, as opposed to more expensive less than truckload shipments, or even partial shipments direct to the store. Through postponement, the RDC takes lead time out of the process so that we can be much more aligned with what product needs to be where and when. Because Page 16
  17. 17. The Home Depot 2008 Investor Day June 5, 2008 transit facilities only pass through a pre-selected shipment ordered days ago from the supplier to the store, there’s no opportunity to improve the deployment decision based upon new sales and inventory information. So the RDC has a number of advantages over the transit facility, and it’s the cornerstone of our optimal flow network. As that cornerstone, that RDC is the logical place to start the migration. And there are several factors that have made RDC the focus. Simply, it represents the fastest speed to value for Home Depot. It provides an immediate scalable solution to aggregate orders and improve our in-stocks. In the optimal network model we found that 60% of the value is driven by the RDC platform. RDCs are a relatively low capital investment, far cheaper and simpler to set up than traditional large box stock and pick DCs. And because product does not sit in these centers or get put away, they have lower operating costs. So you can see that the biggest value driver for The Home Depot within the new optimal flow network are these RDCs. So let’s review our progress so far in setting up this network. Starting in April, 2007, the first pilot facility included 67 Atlanta area stores and about 20 vendors, converting part of an existing Home Depot operated distribution center in Braselton, as I mentioned, to these fast flow or RDC capabilities. And again, the results of the RDC pilot were better in stock at the stores, reduced lead times, improved shipment integrity, and improved inventory turnover. We ramped up more stores and more vendors, and today the Atlanta area RDC serves 99 stores and processes about 150 Home Depot vendors’ products through it. And we continue to add vendors to that mix weekly. Our second RDC was opened in Chicago in January. When we open an RDC is accompanied by the closing of the associated transit facility in the area, and the incorporation of those existing processes and freight flows into the new RDC. Our third RDC was opened in Dallas in March. Dallas was the largest and most challenging opening to date by far, and we had our share of start up issues. With each successive opening we have learned new things about the model and the process. We solve and put the issues behind us, and we adjust the strategy and tactics accordingly. To achieve the greatest speed to value, we are opening more facilities at a very rapid pace. This is no doubt one of the largest supply chain transformations ever in retail, with one of the most aggressive timelines ever. And with any major transformation you will encounter bumps in the road. We know this, and we prepare for this. As I said, with each successive opening, we improve the process. We remain on target to rollout our RDC strategy this year and into the future. The keys to gaining speed to value are getting more RDC buildings open and operating effectively and on boarding vendors to the program. Regarding vendor on boarding, our target is to complete 2008 and enter 2009 with 30% of RDC served stores’ product flow measured in cost of goods sold on the RDC program. And at this point we are approaching 22% of COGS on board the RDC program Page 17
  18. 18. The Home Depot 2008 Investor Day June 5, 2008 for those stores with more added each week. So we’re on target to get to 30% of COGS for served stores by the end of 2008. Beyond 2008, we will continue to open RDCs until we have reached 100% of our U.S. stores. We will also continue to ramp up vendors through the RDCs, making progress towards that end state goal of 75% central distribution. Now keep in mind that the 75% distribution target includes the existing lumber DCs and the traditional stock and pick DCs. We expect to completely our RDC rollout in 2010. We expect considerable benefit from our supply chain initiatives. We expect improved in-stock and improved inventory turnover. We also expect lower overall logistics costs. Since our logistics costs show up in our gross margin lines, that’s where the benefits will be most apparent. By 2011, we expect to gain approximately 20 to 30 basis points of benefits. Post 2011, we expect to get to as much as 30 to 40 basis points of benefits. We also expect that our supply chain initiatives will contribute to a one full turn improvement in inventory turnover over time. This will correspond to freeing up $1.5 billion of working capital. In the end, we’re convinced that our optimal flow network and other supply chain improvements will lead to great benefit for our customers and our shareholders, simplified store operations leading to better customer service, more product excitement through faster speed to market, and enhanced shopping experience with reduced excess inventory in the stores. And finally, a differentiated customer experience all around enabled by our migration to the optimal flow network. Thank you. Speaker: Okay, ladies and gentlemen, we’ll now take a 20 minute break, we will resume our conference at 9:30. BREAK Speaker: Welcome back. Hope you had a great break. So please turn off your cell phones and put your BlackBerries away. And yes, the market is open now. Before I invite our next presenter up, I do want to take a little time to do something a little unusual and that is before the end of the meeting I actually want to thank several colleagues for helping to put this conference together while at the same time we released earnings and at the same time we had our shareholders’ meeting -- and I could go on -- all this in three weeks. So I just wanted to thank my team, Isabelle, Darrell, Tiffany, Megan and Tammy, the Investor Relations team. And also thanks to the Communications team, Laurie, Julian and Mike. You definitely all made it happen. Now, let me introduce our next speaker, Paul Raines, Executive Vice President of the U.S. stores. Page 18
  19. 19. The Home Depot 2008 Investor Day June 5, 2008 Paul: Thank you, Diane and good morning, everyone. Today I’m going to share with you what we are going to focus on from a store operations perspective. As Frank showed you, customer service is integral to who we are. The customer is our top priority and every action we take revolves around improving the customer experience. Critical to our success is a commitment to service to understand our customers and our competitive positioning in the marketplace. Let me take a minute to discuss these in greater detail. First, to improve customer service we know we have to have skilled, knowledgeable labor in our stores. This is a multi-year initiative to add more ours on the floor through better expense allocation. Second is ensuring that we’re competing effectively in the marketplace, which includes evaluating the quality of our in home installation services and marrying them to the correct products through cooperation with our merchant team. Third, we are committed to better understanding our customers, especially our pro and multi-cultural customers to provide them the right services and products. The fundamental to improving customer service is having trained and qualified associates on the sales floor. We’ve been at this a long time and there is an art and a science to this. This is the science portion. Home Depot invented engineered labor studies for the home improvement industry back in 1979. As a result of these studies we set labor standards that the company used throughout the 1990s. By 2005, we knew we needed to reevaluate our labor needs and began systematically collecting new labor information across all departments and varying store volumes. We have begun to use this information in a comprehensive effort to set new labor standards. We’ve conducted thousands of labor studies over the past few years. I’ve highlighted an example of what we’ve learned through this work in our plumbing department. In any given week, approximately 52 percent of the labor in plumbing is spent taking care of customers, including helping customers in the aisles and answering customer phone calls. The other 48 percent of the labor is spent on tasking, including packing down product in the aisles, training and general maintenance. This helps us understand how to best staff the department to create the right experience for our customers. As we seek out opportunities to improve our customer service, this data allows us to focus on eliminating operational tasks to fund labor initiatives. As we think about the future, it will be difficult to add incremental expense to fund additional labor in stores. What is important to know is that we are implementing our new labor standards through better allocation of our operating expenses. While total operating expenses should remain flat, the mix within Page 19
  20. 20. The Home Depot 2008 Investor Day June 5, 2008 expenses should change so that we are spending more on payroll and less on other non-customer facing expenses. This brings us to our Aprons on the Floor initiative. Aprons on the Floor 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 reallocate $180 million. We also understand that when it comes to customer service it’s just as much about quality as it is about quantity. 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 twofold, 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. Now this was heavy lifting but we were able to accomplish it with little noise because of the personal involvement of the field team. We also closed three call centers in the first quarter, reinvesting the savings into store payroll. 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 1, we replaced our in-store human resources managers with district-based human resources teams. The savings generated by this restructuring were reinvested in store labor. 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. Keep in mind that this is a multi-year initiative. We’re committed to continuing our efforts in reallocating our expenses to get more selling hours on the floor. As you know, we have taken steps in the past year to refocus our training efforts back to hands-on, in the aisle learning. In the first quarter we introduced a product knowledge badge. This new badge rewards associates through cash compensation for completing 100 percent 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. Before an associate can be awarded a certified or expert level badge, the associate has to demonstrate in the aisle knowledge about products, carry out department Page 20
  21. 21. The Home Depot 2008 Investor Day June 5, 2008 functions such as cutting and threading pipe or using saws and must be able to readily find product in their department. Our associates are reacting positively to our investments in them and the changes they are seeing and this is good for our customers. We know 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. We are also making foundational investments to make our customer experience better. 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 store to continue to drive sales. We adopted a programmatic approach to maintenance in 2006 and since then we have touched all of our stores. We restriped our parking lots, spiffed and polished 898 floors and installed T5 lighting in nearly every store. We will continue to spend significantly more in 2008 than the historical trend. We launched the store standards initiative in fall of 2007. The objective was to create a more consistent shopping experience across our stores with a focus on decluttering our aisles and making the store easier to navigate. As a result of our foundational investments, we are seeing results. We track customer sentiment through our Voice of the Customer Survey where we hear from more than 115,000 customers a week. Clear and uncluttered, which corresponds to shopping environment, has continued to improve year-over-year. Home Services continues to be an important part of our business. Over the past year, we have focused on improving the quality of our installation programs. We do approximately 10,000 installs per day and about 99 percent of our jobs are completed without issues. We know we are making progress because we reduced our customer complaint rate. We exited programs that were unproductive such as home security, irrigation and putting greens. And we integrated Home Services more closely with core operations and merchandising to drive greater alignment. The pro customer is very important to us. They represent about 30 percent of customers in our stores. We directly service only 28 percent of those pro customers in our store through our commercial credit and managed account programs. We also know that the remaining 73 percent of pro customers shop our stores but they don’t use any of our pro services and this represents a big opportunity for us. Page 21
  22. 22. The Home Depot 2008 Investor Day June 5, 2008 This year we will focus on better servicing our pro customers and those 73 percent under-served pros. We now have the customer insights we need to provide our pros the products and services they are looking for. As you know, we have been working for some time with Dunnhumby to better understand our customers. And I’m pleased to inform you that we have now broadened that approach to focus and drill down on our pro customers. Working with our Dunnhumby partners, we have studied and visited the highly successful cases of Tesco in the U.K. and Kroger in Cincinnati. These companies have demonstrated success in building customer loyalty through insight and better knowledge of customer behavior. The time we have spent with those organizations has helped us understand the challenges and benefits of deep customer insights. We asked Dunnhumby to assist us in developing a working model of the pros’ buying habits and behaviors. In order to develop the pro model we leveraged all our sources of data, including credit, our managed account list and our SIC segmentation and even our Voice of Customer Survey responses. We also identified behaviors of pros such as types of products or days and hours they prefer to shop. Using statistical modeling, we flagged our pro transactions to separate them from the overall consumer base. In this process we have found it important to develop a pro model that goes beyond just looking at spending as pros run the gamut from super-premium to uncommitted. We have validated our model by comparing it to our known managed account list, giving us confidence that we are identifying the right types of customers. Finally, we use the model to understand product categories and SKUs shopped by pros in detail. How will we know we are successful in driving from our pro strategy? Using the model we will measure the four Rs. We’ll measure Reach through pro penetration; Results through sales; Return through sales per pro customer; and Relevancy through adjacent departmental sales. As we’ve segmented the pro spend, we are able to identify what they are buying. By mapping these items on a scale of portion of spend and frequency of purchase, we can identify leadership SKUs that are critical. The top side box on the chart represents merchandise that we should stock in deep quantities, the right assortment and competitively priced. There is big value on using data on customer behavior to drive our product decisions and we learned from our Tesco and Kroger work that our conventional wisdom can be flawed when viewed through the filter of customer data. And Page 22
  23. 23. The Home Depot 2008 Investor Day June 5, 2008 merchandising and pro teams will use this data to create strategies to drive our pro business on a category-by-category basis. In addition to better understanding our pro customers, we’re taking some very exciting actions to ensure we’re serving all our multi-cultural customers well. For example, take the Hispanic community. The Hispanic population is growing at a rate almost three percent faster than the general population and 14 percent of households will be Hispanic by 2010 in the United States. Hispanic purchasing power is growing at a faster rate than the average and buying power is expect to surpass $1 trillion by 2010. Lastly, over the next 15 years Hispanics will represent 20 percent of total home ownership growth. First I’d like to share two Hispanic ads that are running in the U.S. Spanish media today. Then I will close by talking more about what we are doing to target this important customer. Can we roll the ads please? [VIDEO] Paul: To better service these customers we have done a number of things. We have established a bilingual staffing goal to mirror our customer base in stores with a greater proportion of Hispanics. We have rolled out bilingual signage to most stores and we have integrated our Chief Diversity Officer and Vice President of Multi-Cultural Merchandising with our stores team to develop integrated human resource, merchandising, marketing and operations plans. We also have developed a scorecard to track progress against key metrics, including the percentage of bilingual associates and Voice to the Customer results. We are working on developing special merchandising and marketing programs, including partnering with our Mexico stores to identify brand opportunities and expanding the [Spanish] _____ programs with Bear(?). As an example, this is one of the [Spanish] _____ ads reflecting our Hispanic color pallet. We used descriptive names that resonate with the Hispanic community such as [Spanish] _____ and the one you see on the screen, [Spanish] _____, which means clay pot. We know we are taking the correct actions as we have already seen improvement in the first quarter. We have 86 percent unaided brand awareness from U.S. Hispanic homeowners and our share of wallet increased to 34 percent of home improvement spent. Home Depot has long been the leader in Hispanic markets for home improvement and when we say Puedes hacerlo, podemos ayudarte, we take it seriously. [Spanish] _____. In Spanish that means we know the Hispanic customer well. Page 23
  24. 24. The Home Depot 2008 Investor Day June 5, 2008 We know 2008 is going to be a difficult year. Ultimately we will succeed if we provide great customer service. We remain committed to executing the fundamentals, our key priorities and to investing in our associates and customers. Now let me introduce our CFO and Executive Vice President of Corporate Services, Carol Tome. Carol: Thank you, Paul and hello everyone. It’s so nice to see so many familiar faces. This morning my partners shared with you the progress that we’re making against our key priorities and how we are positioning the company for the long-term. What I’d like to do is tie it all together and show how our actions should create value for our investors. Today, I plan to cover five key topics. First, quickly review some highlights through 2008; second, discuss our approach to driving capital efficiency; third, provide you with an update on our private label credit card program; fourth, share with you our thoughts on normalized earnings and operating targets; and then wrap it up by revisiting our investor return principles. So let’s start by taking a quick look at our first quarter results. We’re all very familiar with our first quarter results. They reflect a challenging macro environment with sales down 3.4 percent from last year and a year-over-year decline in our operating margin of almost 500 basis points. This reflects the impact of a $543 million charge we took related to our store rationalization decision. Excluding the store rationalization charge, our operating margin declined by 192 basis points to 7.1 percent. On an adjusted basis, our earnings per share from continuing operations were $0.41 and in line with our expectations. We had positive comp sales in Canada, Mexico and China. But our business across the United States was soft, with each state reporting negative comp sales. Six of our top 40 markets, however, were positive and those markets were found in Texas and the Ohio Valley. Parts of Florida and California remained weak with double digit negative comps. We highlight Florida and California because those two states make up 23 percent of our total sales April, May and June are critical selling months for us. April and May are now behind us and we are in the midst of our seasonal business. Given the calendar shift and the seasonal nature of our business, we expect the second quarter to be our lowest comping quarter for the year. May came in on our expectations. But as we look out we see more headwinds than tailwinds for the balance of 2008. Page 24
  25. 25. The Home Depot 2008 Investor Day June 5, 2008 Headwinds include commodity price pressures, U.S. dollar depreciation, rising fuel costs, pressure on the consumer and continued housing softness. Now the economic stimulus checks are just starting to reach homes. So that could provide some tailwinds and we do start to lapse(?) easier comparisons in the fall. This is just an uncertain time for us. The guidance we set forth at the beginning of this year is shown on the right side of this chart. At this point we’re more comfortable with the low end of our guidance, which is sales down five percent and earnings per share from continuing operations down 24 percent. Now turning to our 2008 capital plan, at the beginning of the year we planned to spend $2.3 billion. Given our recent store rationalization announcements, our 2008 capital spending plan is now $2.2 billion. On this chart we give you a breakdown of capital spending. This year about $1 billion for new stores, $580 million for our existing U.S. retail stores, $118 million for supply chain, $265 million for IT and the remaining budget is for international and capital use at our store support center. In total, our 2008 projected capital spending is down $1.2 billion from what we spent in 2007, principally in the area of new stores. Additionally, our spending in our existing U.S. retail stores is down about $200 million from last year. Now a couple of points about spending in our U.S. stores. This bucket of spending includes maintenance, merchandising and operations spending. This is capital spending that supports activities inside our store to improve the overall shopping experience. In 2007, we had some catch up spending that we didn’t need to repeat in 2008. We’re also smarter about how we spend capital inside our stores. You’ve heard us talk about big remodel projects in the past. Those projects do not provide adequate returns and are not necessary as long as we maintain our stores, which we’re doing. On a go forward basis, you should expect to see us spend a minimum of $600 million each year on our existing stores. We continue to generate solid cash flow from the business, despite the challenging sales environment. We believe that our cash flow from the business will be sufficient to fund our capital spending and dividend plans. We like to have between $500 million and $1 billion of cash at all times. And we use our commercial paper program to fund seasonal peaks and valleys in our cash position. At year-end we had $1.75 billion in outstanding CP. That was reduced to approximately $500 million at the end of the first quarter. As an A2P2 issuer, we have solid access to liquidity at a very low cost. Our commercial paper spreads are about 38 basis points over LIBOR. Page 25
  26. 26. The Home Depot 2008 Investor Day June 5, 2008 Now on this chart we highlight our capital structure as of the end of the first quarter. A few things to note: First, the average pre-tax coupon on our debt portfolio is five percent and on a swap adjusted basis it’s 4.8 percent. We have staggered maturities across 28 years and the average maturity of the portfolio is 11 years. $282 million of outstanding indebtedness comes due in 2008, which we plan to repay using internally generated cash. We use a cash flow metric of adjusted debt to EBITDAR as the governor for how much debt we will employ as a company. Our targeted adjusted debt to EBITDAR ratio is 2.5 times and as of the end of the first quarter on a trailing 12 month basis the ratio stood at 2.1 times. Now moving to a discussion of our approach to capital efficiency, our focus over the past 1.5 years has been on delivering a superior capital efficiency and cash flow. It started when Frank announced the company’s intent to focus on our core retail business and rationalize non-core activities. Since then, we’ve sold our trade distribution business known as HD Supply. We walked away from plans to acquire Enerbank. We collapsed our ebusiness channel into our core business and we invested capital and expensive dollars into our five key priorities. We spent a lot of time last year thinking about our optimal capital structure given our maturing business model. In June, we announced our intent to move from a capital structure that facilitated growth to one that facilitated capital distribution and as a result we announced a $22.5 billion recapitalization plan, which we’ll talk more about in just a minute. In May, 2008 we announced plans to rationalize new square footage growth and the closing of 15 under-performing stores. As we look out, we know that our economic engine has changed from one that was driven by new square footage growth to one that is now driven by productivity and efficiency. As we’ve evolved our capital efficiency model, last year we announced a $22.5 billion recapitalization plan. We completed about 50 percent of our plan using proceeds from the sale of HD Supply and cash on hand. We actually started our share repurchase program in 2002 and since inception including last year’s tender offer, we’ve purchased 743 million shares for $27.2 billion. Now last year we had intended on raising $12 billion of debt to complete the recapitalization plan. But we’ve put those plans on pause because of instability in both our business and the credit market. We remain committed to completing our recapitalization plan but approach it cautiously given the current environment. Now we’ve spent a lot of time thinking about new square footage growth opportunities in the United States. We believe it’s important to open stores that Page 26
  27. 27. The Home Depot 2008 Investor Day June 5, 2008 serve under-stored markets as well as generate adequate returns. This chart sets forth our view of saturation in the U.S. home improvement market. The U.S. home improvement market is heavily stored with over 3,700 home improvement stores. This chart goes back to 1998. And you can see that back then, the average number households per home improvement store was about 75,000 households per store. In February, 2008, that ratio has dropped by 60 percent to almost 30,000 households per store. Our view is that market saturation is upon us, except for market growth. This means that we need to be very selective when opening new stores. We want to serve growing markets and where it generates acceptable returns for our investors. Now this perspective let us review both our existing U.S. store base as well as our future new store pipeline. And I’d like to share with you how we went about our store rationalization analysis and decision making. First, existing stores: As a young but maturing retailer, we’ve had very few store closings. About three years ago we closed 20 Expo stores and in 2007 we closed 11 Landscape Supply stores and 2 standalone floor stores. Our historical approach to closing stores was based on whether or not the store diluted our focus or if there was a strategic rationale behind the closing. We closed our Landscape Supply stores because they were dilutive to our focus and our Expo store closings were a strategic call as we exited markets where we weren’t getting adequate customer draw or conversion. Now we routinely review our stores from an accounting impairment perspective and as you know, we don’t have a history of needing to impair stores. But as a maturing retailer we believe it’s important to look beyond the accounting impairment test as we want to ensure that we’re getting the highest returns from our existing stores. We expect our stores to be four wall cash flow positive. We expect them to have a positive net present value and generate higher returns as they age. We do not open stores at maturity and consider all stores under three years old to be immature. Finally, we use return on invested capital as the benchmark for store performance. We reached our decision to close 15 stores using a disciplined approach. We started by looking at mature stores but then we ended up by looking at all of our U.S. stores and we made our decision to close stores where the net present value of closing was greater than the net present value of operating or if the store was four wall cash flow negative. Now the 15 stores had different characteristics but there was one general theme. And that was, we never should have opened the store in the first place. The Page 27
  28. 28. The Home Depot 2008 Investor Day June 5, 2008 locations weren’t(?) great and in some cases we were the third entrant into a small market. Now in May we culled our new store opening list and announced that we were removing approximately 50 stores from our new store opening pipeline. We have very targeted return objectives for our new stores and expect their return to equal or exceed the return that we earn on our share repurchases. It’s important to note, however, that we’ve looked at this from a portfolio perspective. In certain instances we will make strategic investments where our existing stores may be vulnerable or where it’s a unique market opportunity. Post-2008, we will increase our square footage by about 1.5 percent per annum and we expect the portfolio of stores we open will deliver double digit returns. Now as we look forward, our capital spending will reflect slowing square footage growth as well as the investments we’ll be making in support of our key business enablers that you heard from Mark and Paul and Craig. We expect our annual capital spending to approximate our annual depreciation and amortization expense. This suggests that annual capital spending will be in the $2 billion area. Our projected capital spending includes capital necessary to complete our supply chain initiative as well as fund IT spending necessary to complete our merchandising transformation plan. We’d now like to move and give you an update on our private label credit card. This has been a topic of a few earnings calls and investor meetings. We currently offer six products which range from three consumer-oriented cards to three cards that serve our professional contractors. Four of the cards are private label cards and two of the cards are reward MasterCards where holders get points for purchases. Until 2003 our program was underwritten and managed by GE. As the GE contract is expiring, we put the business up for bid and awarded the business to Citicorp. As part of our deal with Citi, we moved from a fixed fee arrangement to a profit sharing arrangement. Up until 2003, the card hadn’t really been viewed as a sales driver but beginning in 2003 we focused on driving sales, capturing more share of lot(?) as well as customer information. Bottom line, the focus was on growth and we achieved solid growth. In 2004 sales on our private label card made up 24 percent of total sales. By the end of 2007, the penetration rate was about 30 percent. Since 2004 the average net receivable, which is underwritten by Citi, has grown from $8.1 billion to almost $14 billion in 2007. Now as for the cost of private label credit, there are three pieces and here we’re showing you an illustration as to how the accounting works. First, deferred interest: This is a charge for any deferred financing program. In other words, no Page 28
  29. 29. The Home Depot 2008 Investor Day June 5, 2008 interest, no payments for six months. It’s a flat fee and it’s treated by us as a cost of goods sold. Second, interchange. This is a cost to us when a customer swipes one of the cards at the point of sale. It’s like an interchange fee paid for American Express or Visa and it’s treated by us as an operating expense. Third, gain share: This is our share of any profits in excess of a targeted return. The portfolio has been much more profitable than the targeted return so we have been enjoying a gain share, which is treated by us as a reduction in operating expense. The sum of all three equals the total cost of credit. As a percent of credit sales, the total cost of credit has dropped from 1.5 percent in 2004 to less than 50 basis points in 2007. Unfortunately, as we