Bob Nardelli Explains Himself

By Maria Bartiromo

Home Depot's (HD ) hard-charging, lavishly paid chairman and CEO, Bob Nardelli, has been on the firing line lately because of his decision to, in effect, treat shareholders at May's annual meeting as a nuisance even as the stock price remains depressed. At the same time, the queue of Depot customers with complaints about service has been stretching out into the parking lot. On my CNBC show last week and again in the extensive interview below, Nardelli acknowledged missteps and, to his credit, made clear that the buck stops at his desk.

Why did you ask your board not to attend the annual meeting? People who were there said the meeting was bullying, clocks were timing questions, you didn't answer questions about your pay and the stock performance. What were you thinking to conduct such a meeting?

I tried a new format; it didn't work. I take full responsibility for it, and within seven days [after the meeting], I said I was committed to going back to the other format. Directors will be [at the next meeting]...we will do a business review.

People feel as though you are closed to shareholders and analysts. In addition to the botched shareholders' meeting, you changed the metrics on which you are gauged in the middle of the game. You signed on to the idea that your performance would be gauged relative to the stock price. That didn't go well, so you changed it so that your performance is tied with the performance of earnings. Why is this acceptable?

It's not exactly correct that I signed on relative to the stock price. So I'm not sure where that notion comes from.... A few years ago, we introduced the long-term incentive program for senior managers in the company. It was the first time that we put in place a long-term incentive plan. It was tied to a retail index -- and I am happy to share who was in the index -- but basically you would see variations of: down 30% one year, up 20% the next, then down 30%. These were retailers that were totally different [from Home Depot]...companies like Amazon (AMZN ) and Dollar General (DG ). I felt, and the board felt, that we should measure our leadership team as it relates to those things over which we have direct control, like earnings per share. And with full board was agreed that we would modify the measurement to earnings per share, and that is what we have done going forward.

[Home Depot's] financial performance has done well under your leadership, though shareholders have yet to benefit. The stock is down 30% since you took over.

I am very proud of what the team has accomplished. Sales have gone from $45 billion to $81 billion. Earnings per share have gone from $1.10 to $2.72, a 147% increase in five years. Our operating margin has grown by 250 basis points. Return on invested capital is up 28 basis points, from $19.60 to $22.40. We have returned $15 billion to shareholders in the form of dividends and opened 900 stores.

But some people want you to take a pay cut. How do you justify a $245 million pay package with shares down 30%?

First of all, let me say that of the $245 million reported, over 80% of that is tied directly to equity that is still held by the company, and of the 80% of equity, 60% is related to stock options. So if the stock doesn't go up, there is no cash payout to me. Therefore, I really feel no one is more aligned with shareholders than me, and no one has more of a vested interest in wanting the stock to reach the intrinsic value that it should. Clearly, that value is not reflected in today's stock price.

Why do you think that is?

We are going through a transformational period as we redefine the business, building off of our core, adding services for an aging population that has shifted from do-it-yourself to do-it-for-me and that has shifted to shopping online. Certainly, building off of the 30% of professional customers, extending product offerings [to them] is one of the most defining moments in our history. We will look back on this as a turning point in positioning the company for the next leg of expansion.

What about your decision to stop reporting comparable store sales -- a key industry benchmark? How are shareholders supposed to keep track of your business if they can't get a read on same-store sales every month? Will you reverse this decision?

We made one of the boldest decisions in the history of the company to go to segment reporting, where we break out the wholesale business from the retail business. By doing so...we significantly increased the level of transparency to our shareholders. But right after the shareholder meeting...I spent five days meeting with 500 to 600 associates across the country. The following week I talked with analysts and investors about the annual meeting and the comparable sales. We committed to revisiting the decision [on same store sales]. If we reverse it, we will do so at the second-quarter meeting [in August]. We are giving it serious consideration.

Is it fair to say the decisions you have made in the past six months lead people to question other decisions that you make pertaining to the direction of the company?

I certainly hope not. The decision on the shareholder meeting was my decision, and I take full responsibility for that. But it would be unfortunate if this one event would negatively impact five years of what I would classify as very solid financial performance.

Talk to me about strategy. Critics say you bought your way into the supply business by overpaying for companies like Hughes Supply, among others. Why is this part of the business important, and how can you win support for this strategy?

Clearly we did not overpay for Hughes or any of the 40 acquisitions that we have done during the last four years. Hughes is a glove fit. This is a defining moment that has allowed us to build off the 30% of our revenue [coming from professionals].

The customer-friendly culture that was once a hallmark of Home Depot seems to have deteriorated on your watch. Has cutting costs at the expense of customer service backfired?

I think when you are in retail, you wake up every morning focused on customer service. We are blessed to be No. 1 in home improvement. We can never rest on our laurels. We recognize that every day you have to improve in every aspect of retail. We have demonstrated that by taking our average ticket from $38 to $60. We are responding to the customer. We are continuing with self-checkout to reduce lines on the floor. We will spend $600 million this year on training for hourly associates. We have added signage, points of purchase. The stores are brighter, cleaner, and more navigable.

So why has Lowe's (LOW ) outperformed Home Depot by such a margin during the longest bull market in housing we have ever seen?

I think Lowe's is certainly a good competitor. We have developed a strategy [based on the fact] that we are further along on the maturity curve. We have done a great job of redefining ourselves, being sensitive to the markets and customers, and if we stay on strategy, that will manifest itself in the stock price.

How big an impact will the housing slowdown have on your bottom line?

We prepared in November for downward pressure in the housing market. We built in a fluctuation.

So no impact on earnings?

That is right.

Tom Taylor, executive VP for merchandising and marketing and a 23-year veteran, resigned on July 7 -- the second marketing EVP to depart in the last year. He was considered Home Depot's only remaining retail expert, and Wall Street sees his departure as a serious blow. A report by Credit Suisse First Boston (CSR ) analyst Gary Balter on July 10 questions whether Home Depot has any retail expertise left in the top ranks. What happened?

This is totally Tom's decision, and to help us with an orderly transition, he has agreed to stay on as a consultant. If you look at our merchants who are in place under Tom, they have in total hundreds of years of we are blessed and are steeped in merchandising experience.

You spent much of your career at General Electric (GE ) and helped build GE Power Systems into a $20 billion business. How would Jack Welch critique your performance as CEO of Home Depot?

That's a good question. You probably ought to ask Jack. I wouldn't want to put words in his mouth. He can do that for himself.

Maria Bartiromo is the host of CNBC's Closing Bell

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