家得寶 (HD) 2006 Q4 法說會逐字稿

Good day, everyone. Welcome to today's Home Depot fourth-quarter earnings conference call. As a reminder today's call is being recorded.

Beginning today's discussion is Ms. Diane Dayhoff, Senior Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Darrell, and good morning to everyone. Welcome to the Home Depot fourth-quarter earnings conference call. Joining us on the call today are Frank Blake, Chairman and CEO, Home Depot, Joe DeAngelo, Chief Operating Officer and Executive Vice President, Craig Menear, Senior Vice President of Merchandising, and Carol Tomé, Chief Financial Officer and Executive Vice President of Corporate Services.

Today's discussion will begin with a review of our business by Frank. Craig will discuss our merchandising results. Joe will talk about our 2007 priorities and Home Depot Supply, and Carol will complete our prepared remarks with a discussion of our financial results. Following our brief discussion, the call will be open for questions. Questions will be limited to analysts and investors, and as a reminder we would appreciate it if the participants would limit themselves to one question with one follow-up, please.

This conference call is being broadcast realtime on the internet at Home Depot.com, with links on both our home page and the Investor Relations section. The replay will also be available on our site. If we are unable to get your question during the call, please call Investor Relations department at 770-384-2387.

Before I turn the call over to Frank, let me remind you today, that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. These risks and uncertainties include but, are not limited to those factors identified in the release, and in our filings with the Securities & Exchange Commission.

Now let me turn the call over to Frank Blake.

Thanks, Diane, and good morning, everyone. Today we are going to review the Company's fourth quarter financial results, and our consolidated financial results for 2006. We will discuss 2007, but only generally. We have our Annual Investor Conference next week, so we will defer a more detailed discussion of 2007 for a few days.

Let me begin with an obvious comment. 2006 was a challenging year for us. For the fourth quarter consolidated sales were $20 billion, up 4%. For the year, consolidated sales were $91 billion, up 11%. Both sales numbers set records for the Company, but for the fourth quarter diluted earnings per share were $0.46, down 23.3% from the fourth quarter last year, and for the year, diluted earnings per share were $2.79, up 2.6%. Both of these numbers include the impact of severance expense.

Our retail business had a negative comp of 2.8% for the year, and a negative comp of 6.6% for the fourth quarter. This performance reflects two things, first, we felt the effects of the slowdown in the home improvement and housing markets. Home improvement spending decelerated throughout 2006. Existing home sales fell 8.4% in 2006, and housing starts are more than 25% lower than a year ago.

In addition to a difficult market, we also lost share in some key categories. For the year and for the quarter we grew less than our total market. We may not be able to impact the housing market or general economic conditions, but we know that we can improve our performance relative to our overall market share. That will be a central point of emphasis for us in 2007 and beyond.

Since this is my first earnings call as CEO, I would like to step outside the context of the 2006 results for a minute, and make some broader comments. The Home Depot is a Company built on a strong set of core values. Stated briefly, we want to empower our associates to be their best, and we want to provide our customers great products with excellent service. We need to make sure those core values thrive, so that our customers know we are the best place to shop for home improvement products, our associates know we are the best place to work, and our shareholders know we are the best place to invest.

These are simple statements that drive a complex business. We have hundreds of thousands of associates in this Company who understand our values, believe our values, and live our values. That is our competitive advantage. We need to unlock that competitive advantage by investing in our retail business. We accelerated this process in the back half of 2006. Our operating expenses grew faster than sales, as we invested in associate hours on the floor of our store, in our store maintenance, and in our merchandising resets.

We will continue our investment program in 2007, and we will focus our investments in five key areas. Associate engagement, having helpful and knowledgeable associates available for our customers. Shopping environment, having safe, clean and uncluttered stores. Product excitement, having great values and innovative products. Product availability, having products that are in-stock, and easy for our customers to find and buy. And own the pro, becoming the #1 destination for our pro customers.

These are straightforward priorities and a reasonable question would be, haven't you always been working on these, and why should we expect different results going forward? The answer to the first part of the question is yes. The answer to the second part is speed, focus, and resource.

Next week we will describe for you specifics around each of these priorities, the way we are approaching our decision making, to drive speed and flexibility, the things we are taking off our plate in order to provide focus, and the incremental investments that we are making aligned to each of the priorities.

Speed, flexibility, and entrepreneurial spirit are hallmarks of The Home Depot. Our international strength is an indication of that. In Canada, we had positive comps for the quarter and the year. We ended the year with 155 stores there. Mexico continued to outperform during the quarter, posting strong double-digit comps. That was true for the year as well. Today we have 61 stores in Mexico, in 40 cities throughout the country.

In the fourth quarter, we entered China with our acquisition of The Home Way. This acquisition provides us an entry point into one of the world's largest and fastest growing home improvement markets estimated at $50 billion. We have a terrific leader in Annette Verschuren, who will be responsible for guiding us to the same #1 position in China, that we have achieved in North America. We also have a great local leader in Yves Chen, who spent years in Carrefour, and most recently was the CEO of a Chinese hyper market company before joining us.

Home Way's approach to the home improvement market was modeled on Home Depot, and we trained most of their management in the mid-1990's. We have a great cultural fit with this company, and for the last month we have had their leaders visiting with Annette's team in Canada, and with Ricardo Saldivar's team in Mexico. We are not going to drive international expansion just for the sake of top line growth though. Both Annette and Ricardo have built profitable businesses, and we have the same target for China.

Let me now address our supply business, and the reasons for announcement last week, that we are considering strategic alternatives for this business. Joe will go through some of the specifics of Supply's performance in 2006. The business exceeded expectations for the year, despite softness in the residential construction market. It also clearly gained market share in the fourth quarter and throughout the entire year.

Why then would we even consider selling Supply? We are past, present, and future, a retail business. To get the most value for Home Depot as a whole we would need, I believe, to integrate Supply with our retail business.

While that integration effort might not be a complete hairball, it is sufficiently difficult to warrant checking before we begin, on whether we can create more shareholder value through other alternatives, such as a sale. Once we integrate the businesses, a subsequent sale is much more difficult. If we can create more shareholder value now, through a sale or other alternative, then that's what we will do. If not, we won't.

Finally, in 2006 we continued to return cash to our shareholders. We spent $6.7 billion to repurchase 174 million shares. Since our share repurchase program began in 2002, we have repurchased 19% of our outstanding shares. Additionally during the year we paid $1.4 billion in dividends, increasing the dividend twice.

Now I would like to turn the call over to Craig, who will share with you our merchandising results.

Thanks, Frank, and good morning, everyone. As Frank said, 2006 was challenging. During the fourth quarter we saw softness across our store. We continued to feel pressure resulting from further housing deceleration, tough year-over-year comparisons, falling commodity prices, and softness in discretionary projects, and certain big ticket spending. As we looked across the country we saw double-digit negative comps in areas most adversely impacted by the housing softness, including Sacramento, Los Angeles, and Miami.

While we reported a negative 6.6% comp in the quarter, four departments, namely Plumbing, Electrical, Garden, Kitchen and Bath, were less negative than the Company average. Lumber prices are now at 2002 levels, the decrease in lumber prices throughout the quarter resulted in a negative impact to the department sales. For the fourth quarter, lumber price deflation negatively impacted comps by 81 basis points.

We continue to see softness in big-ticket items, like special order kitchens, millwork, and flooring. The softness in these big-tickets, coupled with the drop in lumber prices, caused our average ticket to decline by 1.6% in the quarter. For the year however, average ticket was $58.90, up 1.6% driven primarily by gains in appliances.

Our momentum in appliances continued in the quarter. We saw considerable improvement in our market share and draw rates as compared to other retailers. Core market share increased significantly to 10.5% on a rolling 12-month basis as measured in units. Customers continued to respond to our innovative and distinctive products. We had success across all appliances, but particularly in the two fastest growing appliance categories this year, bottom drawer freezer refrigerators, and front load laundry, driven by innovative products from GE, Maytag, and LG.

In the fourth quarter, we took bigger swings in holiday decor and consumer electronics. In holiday, we set an expanded offering which featured broader selections of lights, trees and new merchandise, like ornaments and decorative accessories. We had great execution setting this program, and when the season ended, we cleared the product efficiently, and transitioned to our winter storage event. Holiday decor posted strong positive comps for the quarter, and our market share in storage increased significantly year-over-year.

In the fourth quarter, we went deeper into consumer electronics than our past practices. The financial results with this category were disappointing, as it was a highly competitive environment. So don't expect us to go so deep next year.

We realized the impact of better visual merchandising through our rapid refresh program. In the last half of the year, we completed a rapid refresh initiative, where we reset 100 bays in our Top 540 stores. The average lift for the bays that have been reset is over 3%, compared to the same bays in our control stores. We've seen customer satisfaction scores increase at a faster rate in our reset stores than in the control stores, as measured through our voice of customer surveys.

In January we launched Eco Options, which focuses on products that are energy efficient, and environmentally friendly. Our customers have responded positively to our Energy Star appliances, and compact fluorescent light bulbs, which posted double-digit comps in the fourth quarter. Today we carry over 2,500 environmentally friendly products in our stores.

We will also continue our accelerated merchandising resets in 2007. As we head into the spring, I believe we have done a great job of creating product differentiation, through an expanded product assortment in grills, patio, and outdoor power equipment. At our Investor Conference, I look forward to sharing with you our merchandising strategy to capture market share and drive sales.

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

Thanks, Craig. For 2007 our Company is aligned around our five priorities -- associate engagement, product excitement, product availability, shopping experience, and own the pro. Each priority has a designated executive, who is charged with leading the team to achieve our goals in 2007 and beyond. These leaders are world class talent with deep combined retail experience of over 132 years. Each is focused intensely on leading their cross-functional team, to enhance our customers experience, and build competitive advantage via clarity of purpose and speed of execution.

Our speed of decision making and execution has accelerated dramatically. Additional responsibility has been given to each retail region. We have also created two new regions, to reduce the span of control for our regional managers. This is an important investment, as it allows our leaders to be closer to the customer. Simplification of processes began with our store manager performance screen, where metrics were reduced from 35 data points to 8. Momentum is building and across the business we are driving relentless execution in 2007.

In the back half of the year, we executed on our accelerated retail reinvestment program, including a richer labor standard, additional maintenance, and incentive programs for our store associates. While we can't see yet in the numbers, we think it is paying off based on what our customers are telling us. We hear from over 200,000 customers each week, and based on the voice of the customer survey results, we are seeing improvement in each of our key metrics, including likelihood to recommend, the #1 indicator of customer satisfaction

Now let's turn to Supply. 2006 was a great year for Supply, as we exceeded our financial targets, accelerated our Hughes integration plan, and built a strong foundation for future growth. For the fourth quarter, Supply sales grew by 64%. Operating earnings grew by 20%. For the fiscal year 2006, Supply delivered sales growth of 162%, and operating earnings growth of 151%.

Supply's fourth quarter 2006 operating profit was $143 million, with an operating margin of 4.9%. The fourth and first quarters are typically lower operating margin quarters, due to the seasonality of the construction business. For fiscal year 2006, Supply's operating profit was $800 million, delivering an operating margin of 6.6%.

Since we have integrated our Supply businesses, we are now looking at organic growth on a combined basis. Overall organic growth was down 6.9% for the fourth quarter, driven primarily by the soft residential construction market. Despite the difficult environment during the quarter, Supply delivered organic growth rates in excess of the markets in which we participate of 340 basis points. For the year, Supply's organic growth was up 5.6%. Residential construction dropped off sharply throughout 2006, creating significant pressure on the 40 to 50% of Supply sales in this area.

This was partially offset by residential market share gains, a focus on commercial construction execution, and double-digit organic sales growth in our maintenance platform. In the aggregate, we delivered organic growth rates in excess of the markets in which we participate of 790 basis points. Additionally, we are extremely pleased with the integration of Hughes Supply over the last ten months. The Hughes businesses have been fully integrated into Supply.

The Supply team committed to $0.01 of earnings per share accretion in fiscal 2006. As a result of the team's focus and execution, we are well ahead of the integration schedule, and have also outperformed the operating plans, delivering $0.04 per share of earnings accretion. 9,800 associates were welcomed into the Supply family with this acquisition, and I am proud to say, that from Day one we have had an aligned salesforce, which enabled us to continue to accelerate performance with our customers, and correspondingly win in the marketplace. Our momentum is tremendous and it continues to build, as we operate as one team driving customer success and shareholder value.

During the fourth quarter, The Home Depot made two acquisitions that will be integrated into our Water Works platform. We would like to welcome Heartland Waterworks Supply and Sioux Pipe to the HD Supply family.

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

Thank you, Joe. Hello, everyone. Our total Company sales grew by 4%, or $776 million to $20.3 billion in the fourth quarter. Of the $776 million in sales growth, $1.1 billion came from our Supply segment, offset by a $360 million decrease in our retail segment. For the year total company sales grew by $9.3 billion, or 11.4%, to $90.8 billion.

In the fourth quarter sales in the retail segment were $17.4 billion, a 2% decrease from the same period in 2005. The sales decrease was a result of negative same-store sales of 6.6%, partially offset by the addition of new stores. Consistent with our guidance, the slowing housing environment, and tough year-over-year comparisons significantly impacted our comp sales. We experienced a negative 6.2% comp in November, a negative 0.7% comp in December, and a negative 11.4% comp in January.

December comps reflect our successful sell-through of our expanded holiday assortment, and while comps were double-digit negative in January, comps thus far in 2007 are running in the negative mid-single digit area. In the fourth quarter on a comp store basis, customer transactions fell by about 5%, due in part to our self-cannibalization strategy.

As a reminder, we strategically cannibalize our stores, to take pressure off of high-volume stores, and to support market growth. In the fourth quarter we cannibalized about 13.5% of our stores, which had a negative impact on comps of approximately 1.3%. For the year, retail sales grew by $2 billion, or 2.6%, to $79 billion. Comp sales for the year were a negative 2.8%, driven by a decline in comp store transactions, offset in part by an increase in our average ticket.

Sales in the Supply segment were $2.9 billion in the fourth quarter, up 64% over the same period in 2005. As Joe mentioned, we look at sales growth in this segment from an organic and an acquired perspective. Excluding acquired sales, total revenues at Supply declined by 6.9% in the fourth quarter. As Joe stated, the decline in the Supply organic growth rate reflects softness in the residential construction market. It is also important to note that we were up against tough year-over-year comparisons, as last year's fourth quarter organic growth rate was over 20%. For the year Supply sales grew by $7.5 billion, or 162%, to $12.1 billion.

In the fourth quarter, consolidated gross margin was 32.8%, a decrease of 107 basis points from the same period last year. As previously mentioned, given the growth in our Supply segment, we are experiencing a higher penetration of lower Supply gross margin dollars. In the fourth quarter, 12% of our gross margin dollars came from Supply, as compared to 8% last year. 47 basis points of the consolidated gross margin decline in the fourth quarter was a result of a higher penetration of Supply, as well as a drop in its gross margin, due to a change in the mix of businesses owned. Supply's gross margin for the fourth quarter was approximately 27%, down 137 basis points from the fourth quarter last year.

The remaining 60 basis points of contraction in our consolidated gross margin came from a decline in the retail gross margin. Retail's gross margin in the fourth quarter was 33.6%, down approximately 70 basis points, due primarily to three factors.

First, as Craig mentioned, we had an increased penetration of appliances which have a lower gross margin than the Company average. Second, we experienced wire price deflation, which put pressure on our gross margin rate. Lastly, as you heard, we took a swing by expanding our assortment in consumer electronics. They became highly promotional during the quarter, and the financial results were very disappointing.

For the year, our consolidated gross margin was 32.8%, a decrease of 73 basis points from last year, reflecting for the most part a higher penetration of Supply's lower gross margin dollars.

In the fourth quarter, consolidated operating expenses increased by 153 basis points, to 24.9% of sales. This increase was due to several factors. First, in the fourth quarter we recorded $129 million of pretax expense associated with executive severance. This caused 64 basis points of operating expense deleverage. Second, we stayed true to our accelerated retail reinvestment program, so operating expenses in the retail segment grew faster than sales. Third, we saw some expense deleverage in Supply.

For the year, consolidated operating expenses increased by 11 basis points, to 22.1% of sales. As a result of our lower gross margin and soft retail sales, operating margin in the retail segment was 9.2% in the fourth quarter, down 171 basis points compared to last year. For fiscal 2006, our retail operating margin was 11.4%, down 34 basis points compared to last year.

In the Supply segment, our fourth quarter operating margin decreased by 181 basis points to 4.9%, in-line with our expectations given the change in mix of businesses owned and normal fourth quarter seasonality experienced in the construction and infrastructure businesses. For fiscal 2006 Supply's operating margin decreased by 28 basis points to 6.6%. Supply's operating margin for the year was more than 100 basis points better than its plan. Consolidated operating margin for the fourth quarter was 7.9%, down 260 basis points from last year, due to the factors I just mentioned. For the year, consolidated operating margin was 10.7%, down 84 basis points from 2005.

Net interest expense was $123 million in the fourth quarter, up $96 million from last year. For the year, net interest expense was $365 million, up $284 million from fiscal 2005. During the year on a net basis, we issued approximately $7.6 billion of debt, which caused our interest expense to increase. Our long-term debt to equity ratio at the end of the fiscal year was approximately 47%, compared to approximately 10% at the end of fiscal 2005. In the fourth quarter, our income tax provision rate was 37.4%, and for the year was 38.1%. Consolidated net earnings totaled $925 million for the quarter, a decrease of 28% from the fourth quarter of 2005. For the year, consolidated net earnings totaled $5.8 billion, a decrease of 1.3% from 2005.

Diluted earnings per share decreased by 23% to $0.46 for the quarter, and increased by 2.6% to $2.79 for the year. Executive severance incurred in the fourth quarter cost us $0.04 per share. Diluted shares for the fourth quarter were 2 billion shares, compared to 2.1 billion shares last year. The reduction in outstanding shares is due to our share repurchase program. In the fourth quarter, we repurchased 78 million shares, and cumulatively since 2002 when our share repurchase program began, we have repurchased 451 million shares, and spent $16.4 billion, under our $17.5 billion authorization.

Now I would like to share some of our operational metrics. During the fourth quarter we opened 34 new stores, including three locations with ten new stores in Canada, and three new stores in Mexico. As we announced in December, we also acquired 12 new stores in China. Approximately 11% of our store base operates in Canada, Mexico, and China. Today we own 87% of our retail stores.

In the Supply segment, we lease most of our locations. Today we have about 1,000 branches in the United States and Canada. At the end of the fourth quarter, selling retail square footage was 224 million, a 4.2% increase from last year. The average square footage per store was 105,000 square feet, the same as last year. Reflecting the sales environment, sales per square foot were approximately $305 for the quarter, down 8.6% from last year, and $358 for the year, down 5.1%.

Turning to the balance sheet, at the end of the quarter total inventory was $12.8 billion, an increase of $1.4 billion, or 12.5% from last year. On a per store basis, inventory was flat to last year, and the year-over-year dollar increase was really attributable to Supply. Consolidated inventory turns were 4.7 times, down slightly compared to 2005.

Computed on a beginning long-term debt and equity for the trailing four quarters, return on invested capital was 20.6%, a decrease of 180 basis points from last year, reflecting our retail operating performance, and lower returns in our Supply business, as we are earning back acquisition premiums paid over time.

We ended the quarter with $52.3 billion in assets, including $614 million in cash and short-term investments. This is a reduction of approximately $193 million in cash and short-term investments from the end of fiscal 2005, reflecting cash flow generated by the business of approximately $8.1 billion, along with the net proceeds of $7.6 billion from debt financing activities, offset by $4.3 billion paid to acquire new businesses, $3.5 billion of capital expenditures, $6.7 billion paid for share repurchases, and $1.4 billion in dividends paid.

As tough as 2006 was for our retail business, our strong financial condition allowed us to invest in our business and return significant dollars to or shareholders.

We are holding our Investor Conference next week, at which time we will share our outlook and guidance for 2007. We thank you for your participation in today's call. We are now ready for questions.

Thanks. [OPERATOR INSTRUCTIONS] We will take our first question from Danielle Fox from Merrill Lynch. Please go ahead.

Thanks. Good morning. My question is on Home Depot Supply. I am wondering what companywide initiatives are on hold, as you decide the fate of this business?

Frank, you mentioned that in the future you might consider integrating retail and supply more aggressively at the store level, to better serve your pro customers, so presumably what you decide to do with Home Depot Supply, would have some bearing on how you configure and invest in your supply chain. I am wondering sort of what's in limbo, until we get some clarity around the future of Home Depot Supply?

Right, Danielle.

You gave one example, so we have some cross-selling opportunities that we have been exploring with our stores, and with the branches in Home Depot Supply. It is not that we are going to stop what we are now doing there, but obviously we wouldn't roll that out further.

Additionally, there were a number of activities that Joe was looking at, in terms of how you could drive potential synergies between the orange box, and Supply and purchasing pricing. You go logistics you go down that list, and those are the kinds of things that we would not be proceeding with as we make this decision.

Okay. So just a quick follow-up. Conceptually, how do you think about evaluating P&L investments in retail in a negative comp environment, since we are still seeing some comps deceleration obviously at a decelerating pace, at a slowing pace, but how do you know whether the investments you are making are the right investments, if you've still got negative double-digit comps in January?

Right. That is something we have spent a lot of time on internally. Obviously for you all it is very important, and we will look at market share as a key criterion. How are we doing in our markets? Are we gaining share as we think we should be? And we will also look at what our consumers are saying, both our voice of customer, and third party assessments of the consumer experience.

Thank you.

Danielle, this is Diane. Aren't you due like today?

I already had my baby, but thank you for asking.

Congratulations.

Congratulations. That's great.

Thank you.

We will take our next question from Steve Chick from JPMorgan. Please go ahead, sir.

Thanks. Congratulations, Frank. I guess I have two questions. One is another related to Supply. The question we get a lot is is that, you know, as of even the first part of the year, you know, you are obviously very committed to it, and as you are on this call, but can you discuss a little bit on the background of what kind of discussions occur to really decide looking to evaluate strategic alternatives for the business, and is it anything related to, did you say it was organic rate of decline of 6.9% for the quarter? Did I catch that right?

That's correct.

Okay. Can you give us a little more color behind the discussions? Did it have to do with the new member of the Board, and a little pressure on that end, or maybe you could clarify?

I will give you my perspective on this, and the discussions that we've had internally, and first off just, as Joe went through, the Supply business had an exceptional year in 2006, and as Joe said, gained share throughout the fourth quarter, so it had absolutely nothing to do with the performance of the business.

As I stepped into the job, I have a couple of strong points of view in terms of Home Depot, and what Home Depot should be for the future. One part of that was, it is Home Depot. We are one entity. We are not going to be a conglomerate structure with different business segments, and so early on one of the significant organizational moves was taking our online and catalog business, which had been a separate business, and say no, that goes to merchandising because it is all part of Home Depot, and it has to be an integrated strategy.

Similarly with Home Depot Supply, as you see one of the first moves was making Joe the Chief Operating Officer across all of Home Depot. The request to Joe was, okay, look across the whole Company and how would this work? How do we think about this as one entity, and drive an enterprise-wide advantage from the Supply business and the orange box?

Got a lot of thoughtful analysis on it. It is something we can do. As I said in the comments though, and Joe and his team were, kind of did a pretty good analysis on this. It is a fair amount of heavy lifting, and in the scheme of things, given my sense of where we are on retail and the focus needed on retail, I concluded and recommended to our Board, that the best alternative would be to look at our other options at this point, because once Joe and team are launched down the road of integrating, doing a do-over becomes very hard.

It is these things become integrated, and it is very hard to separate them out. That was exactly the thought process.

Okay. And is the business per se integrated where if it were monetized, the idea is that it would sell in its entirety?

We are exploring all alternatives, and as is obvious from my comments, there is no, don't assume anything from it. We are just taking this as the natural point in time to say, look, again, for me it is, you don't want a foot on the dock and a foot on the boat. Let's figure this out.

Right. That's fair. One separate one if I could. Just on the retail square footage growth rate of 4.2% for the quarter, that was down from 6.3% from the third quarter, and I think a little below maybe what you had guided for the year. I don't think your guidance included China back a year ago. Can we think about that as we look to what you might say next week, and the 400 to 500 new stores targeted for 2010?

No. This was pretty consistent with where we thought it would be.

That's about 105 new stores up year-over-year. That's consistent?

Well, we gave a range of here is the number of stores that we are going to be opening, and we are well within that range. Carol, do you want to add some more?

Absolutely. A year ago January we said we would open 400 to 500 stores between now and 2010. We are on target to do that, and we will give you more color next week.

Okay. Great. Thanks.

We will take our next question from Matthew Fassler from Goldman Sachs.

Thanks a lot, and, Frank, congratulations, too.

Thank you.

I would like to start the first question by following up on a couple of the comments you made about the U.S. versus Mexico and Canada. I guess the first piece of this is, if Mexico is up double-digit and Canada was positive, how much softer than the aggregate number of negative 6.6 was the U.S. on a same-store basis? Was it 100 basis points or so?

That is about right.

Got you. As a follow-up to that, obviously the U.S. has a particularly striking macro slowdown, and also an older store base than you have overseas, but is there anything else about the way those businesses are run, you know, culturally given that they were somewhat removed from the U.S., with different and probably more autonomous leadership, that you think you can claw back to Home Depot U.S., in terms of Best Practices and lessons learned as you look forward to '07?

That's a good question, Matt, and it is a good observation that both Canada and Mexico have, I would say a more aligned decision making process, and that is clearly going to be a focal point for us in 2007 as we look at the U.S. retail business, and already we are seeing that with Joe and Craig and the Division Presidents, how we get alignment within the U.S. back to that making things a little simpler, a little faster, just to get everybody on the same page, but that's, I think that's an accurate observation.

Just a follow-up on Supply. As you consider what would lead to you sell this business, as you run the numbers and look at the proportion of income that you generate from Supply, and kind of the range of comparable valuations, kind of the high-end to the low end of the range doesn't really make that much difference, of a dent on Home Depot consolidated EPS. It could be a couple percentage points one way or the other. So is there anything other than price as you conduct this review, you know, that will influence your decision on whether or not to divest the business?

I think there are as I said in the comments, what will be the driving determinant here is what we think creates shareholder value. There are a number of ways of creating shareholder value. There is the shareholder value created by either holding on to it or selling it, and there is the shareholder value that may be implicit in the additional focus on the retail business.

Okay. Thanks so much.

We will take our next question from Gary Balter from Credit Suisse. Please go ahead, sir.

Thank you. Frank, one question follows up a little bit on Matt's. One reason to go into HD Supply among many others, was because there is this view you were maturing out in the core. As you think about selling it now, and you go back to the core, what's going, what changes from that viewpoint? How did we get growth back in the core? Thanks.

Thanks, Gary. The way I look at this is, I guess my starting point is The Home Depot ought to be growing as the market grows, and then some. That should be our objective as we look at our core business, our retail business. When you think of a market that again we understand 2006, the back half was a tough year for this market.

2007 is going to have challenges with it, but long-term, this is a market that people are projecting to grow faster than the retail market generally, pick your number, 3 to 5% growth, and then say a reasonable objective for this business is to be outperforming the market. That is pretty significant growth, and then we would want to drive on top of that EPS growth faster than our sales growth. So that would be the overall growth prospective for Home Depot, and we will give you some more details on that next week.

I appreciate that. Following up on that, whatever the second question is supposed to be called, if your fifth bullet point is own the pro, why and we have heard for the last few years about the synergies between the Pro business, or HD Supply, and the retail. Why just decide all of a sudden before you even had a chance to test that, and I heard the whole thing about integrating it, but why not see what some of the opportunities are before making that brash a decision to explore it?

Yes. Well, I would say within the orange box itself, we have enormous opportunities to improve our performance with the pro. I will give you one small example of this.

We are now using for developing our customer data and an understanding of our customer [Dunn Humvee], and getting just some great information from them, and just take these numbers kind of directionally more than anything else. 2% of our customers drive nearly 30% of our sales. I am talking retail orange box now. Not surprisingly that 2% of those what we call our 'super premium customers' tend to be pros.

We also have an effort, again orange-box focus to have managed accounts for our best pro accounts, and we have had tremendous success with increasing our Customer Service, and the degree of customer spend within those pro managed accounts, so then we went through the exercise of, okay, let's do a pairing of the premium, the super premium customers that Dunn Humvee is identifying for us, and what we self-identified through our managed accounts, and it was about a 7% overlap.

In other words, out of that universe of just those super premium customers, we were only covering about 7% on our managed accounts. I look at that and I say within the context of, that own-the-pro strategy is as true from an orange box perspective as a combined perspective.

Thank you. I look forward to seeing you next week.

Thanks.

We will take our next question from Dan Binder from Buckingham Research. Please go ahead, sir.

Hi. It is Dan Binder. A couple questions. I think we think about integration on different levels, from basic integration of systems and human resources, to more detailed and more comprehensive integration. I am just curious when you talk about Hughes being integrated into Home Depot Supply, how would you characterize that from a merchandising and distribution, and so forth, and then, if you look at one of the potential outcomes is that you don't sell Home Depot Supply. What kind of integration that actually requires, and the cost behind that, based on your estimation if you were to integrate it with the total company?

Dan, this is Joe DeAngelo. The first question is how integrated do we have Hughes and HD Supply, and that's 100%. So the way we look at it is, the first thing we do, if we have businesses that are participating in the same vertical, which we had four overlapping verticals with the Hughes business, when we did the acquisition, we completely integrate them from a human resources standpoint, from a systems standpoint, from a branch standpoint, so you rationalize the facilities so they truly become one company in total, and that is why you saw that when we report our comps, we weren't reporting businesses we only had a year ago, because of the fact that when we put our facilities maintenance business together, our construction supply business together, our Water Works business together, they truly are only one company. So one leader, one organization, one set of systems, one operating process, one set of merchandising inventory and execution.

Also on top of that within HD Supply, what you do is what we have done, is work to be able to make sure that we had consistency across the businesses, in terms of payroll systems, human resources, financial systems, supplier data warehouses, so you can run that as a combined business unit, and get the effectiveness across both specific verticals and across all of the businesses in totality.

When you step back and look at the Home Depot integration, what that would really require is an organizational integration around the functions. What you is you take the supply chain leaders we have in Home Depot Supply, and the supply chain leaders we have within each of the Home Depot Supply businesses, and we would integrate them organizationally, into Mark Holifield's organization. We do the same thing on a sourcing basis, into Craig's Merchandising organization.

So that was the process we were embarking on, to be able to make that operate as an entire enterprise. I think the real defined difference is we had a strategy that was driving businesses, so we did have profit and loss centers of which Home Depot Supply was designed to be a single profit and loss center. The change in strategy of having everything as an enterprise requires you to do the human resources integration, and then subsequently all the systems integration associated with it. So you get the same warehouse systems, you get the same financial systems, everything would be integrated as an enterprise, which we are in the process of doing on the direct business moving it into Craig's business.

So I don't have a number that I can pop out for you, but it is certainly a lot of moving parts, in terms of rationalizing organizations, and rationalizing systems, and picking a point of convergence, because we are retooling our retail business concurrently. So as you rolled out a core retail system, you have to be able to plan when you plugged the wholesale systems into that.

It is Carol. I will jump in, not a lot of incremental cost if we were to integrate the companies, but a lot of heavy lifting as you heard from Joe.

How many integrated verticals do you have within the Home Depot Supply business at this point?

Right now we have ten verticals.

And they are all fully integrated?

Yes, they are.

Okay. Great. Thanks.

You are welcome.

We will take our next question from Colin McGranahan, Bernstein.

Thank you. It is Colin McGranahan. Had a hairball there in my throat. Sorry.

First focus back on the retail business for a minute. Carol, maybe if you can give us more detail on the retail gross margins, I think you said appliance penetration, wire price deflation, and then the holiday consumer electronics category. Can you give us some detail on where appliance penetration was, and maybe disaggregate that 70 basis points between those three, just so we understand the gross margin pressures there, and then how much of that might have been just markdowns on seasonal goods, and how that relates to the inventory position flat on a per-store basis with sales per store down 6 to 7%?

I would be happy to. As we mentioned, the retail gross margin in the fourth quarter was 33.6%, down approximately 70 basis points, and if you look at the three big drivers of that, appliances was the biggest. It cost us 33 basis points in the quarter.

The penetration has increased, last year it was about 3.5%, today it is about 4% of our total sales, so that year-over-year increase, coupled with the appliances were fairly promotional in the fourth quarter. So that year-over-year increase with some promotions cost us about 33 basis points.

Wire price deflation cost us around 16 basis points. The rest was in the consumer electronics bucket. Candidly we didn't make any money on consumer electronics. In fact, we lost money on the sale. So we took a swing, we learned a lot, and as Craig said, don't expect us to go so deep next year.

Okay. Then just following up on the inventory.

Yes. Inventory, we are very pleased with the levels of inventory in our stores. Down just slightly on a per-store basis. This is an interesting time of year for us, because we start to build inventory for spring. Despite the softness that we see in the housing market, we do know our business is seasonal, and we are starting to go bring in spring products today, so the quality of the inventory inside our stores is very good.

Okay. Just a quick follow-up for Joe or Frank. Back on the Supply business, clearly a very significant deceleration in organic growth. I know you outperformed your market. Joe, do you have any sense of where the construction supply maybe on the residential side is, given the housing starts numbers that we saw for January, and then what you saw in commercial, and, Frank, if you could maybe respond to the criticism that has been said, that you bought, for instance, Hughes when the business had 20% organic growth, and now you are trying to sell it or certainly evaluate alternatives, when the organic growth is down in the negative mid-single digits. How do you respond to the criticism that you bought at the peak and you are selling at the low?

Joe, why don't you take the first part?

I think if you look at the markets we saw a significant deceleration as everyone else did in the U.S. housing starts, so for our year the market that we participated in all-in blended, the U.S. housing starts, plus the heavy construction infrastructure, the maintenance businesses, the markets were down 2.3%. In the fourth quarter, those markets were down 10.3%.

So you can see that that is a significant slowdown, a big chunk of that residential, but we are also seeing slowdowns in construction going forward. As we look forward into the year, it looks to be low single digit down next year versus we were calling it flat to slightly up, so we continue to see a decrease, both on the residential side and on the new construction side out there in the markets, and then it looks like once we get through 2007 is gets to be some normalized markets with 2 or 3% upgrowth years for the next several years.

Okay. Thank you.

And on the buy high/sell low discussion, I would say a couple of things. First is I think that does not take into account the dramatic improvements that Joe and his team have made in that business already, and second as I said, we are looking at strategic alternatives. If it turns out that the path to creating shareholder value is to hold the business, that is what we will do.

Okay. Thank you. See you next week.

Yes.

Darrell, we have time for one more question.

We will take our final question from Budd Bugatch from Raymond James. Please go ahead, sir.

Good morning. My congratulations to Frank, as well, and also to Danielle if you are still on the call. A couple of areas. The decelerating comps at retail, could you put a little flavor on that, in terms of juxtaposing that versus the market and what you think, and I realize 2007 is something you will address in more detail, but maybe conceptually where do you think the year unfolds on a comp basis?

I am happy to jump in on the fourth quarter. As we talked about a negative 6 in November, basically flat in December, and a negative 11 in January, first of all, it is important to think about what we were up against last year. Last year comps in November were close to 7%. December they were 1. January, 5%. So the easiest comparison year-over-year was in December.

Also the timing of Christmas actually did have an impact on comps between December and January. It was about 100 basis points of comp differential between those months, if Christmas had fallen on a day other than Sunday, so there was a little bit of noise there. The most important thing we think is we came out of January, and we are now back into the mid-single digit negative area. It is not a comfortable area to be in, but it is within our expectations, based on what we are seeing in the macro environment.

Okay. And outlook as opposed to where do you think, 2007 looks like it is going to be a year of a couple of different dimensions, in terms of the way it is going to unfold. A, would you agree with that, and, B, would you want to comment on how you look at that? I know broadly before the conference.

We will talk about this some more next week, but we anticipate continuing headwinds in 2007. There is a lot of inventory to work through in housing, and I don't know if you look at the back half of '07, we are not terribly optimistic, but we could see things start to improve then, but it is gradual. It is not going to be, in our view, it won't be a dramatic turnaround.

Okay. My last question is, Frank, with your speed dictum, and with one foot on the dock and one foot on the boat, and you are looking at the strategic alternative, can you kind of frame for us what the speed of that decision is going to be? Obviously you don't want to take a long time to do this now that you made--?

That's, I will stop giving, stop making little sound bites. I don't think we want to comment on the timing of the decision.

Okay. Thank you very much.

All right. Thank you all.

Thank you. Thanks everybody for joining us. We look forward to talking to you next quarter.

Once again, ladies and gentlemen, thank you for your participation. You may now disconnect.