百思買 (BBY) 2001 Q4 法說會逐字稿

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Ladies and gentlemen thank you for standing by and welcome to the Best Buy fourth quarter and fiscal 2001 yearend conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. At that time, if you have a question, you will need to press 1 on your touchtone phone. As a reminder, this call is being recorded for playback, and will be available at noon, central time today. If you need assistance on the call, please press 0 and then the * key and a specialist will assist you offline. I would now like to turn the conference over to Mr. Richard M. Schulze, Chairman and CEO of Best Buy. Please go ahead sir.

Thank you Lea. Good morning everyone. Thank you all for joining us this morning. With me today are Darren Jackson, our newly appointed Chief Financial Officer, Treasurer and Senior Vice President of Finance. John Walden the President of BestBuy.com, Wade R. Fenn our new President of Entertainment and New Business Development, Kevin Freeland the President of our Musicland group, Susan S. Hoff, the Senior Vice President of our Investor 2 Relations, Mark Gordon our Vice President and Corporate Controller, and Jennifer Driscoll, our Industrial Relations Director. As always these comments made by myself or others representing Best Buy may contain some forward-looking statements, which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. Well, today we are extremely pleased to report another record quarter and a record year for Best Buy. Despite a cooling economy, we earned a record $190 million or 89 cents per diluted share for the quarter, 7 cents higher than the current consensus estimate, bringing us to a record $1 and 86 cents per share for the fiscal year. Our earning during the quarter was also bolstered by changes in product mix and an increasingly profitable assortment. As previously announced, we also reported record sales of 5.5 billion for the quarter and 15.3 billion for the year. Our 23% increase in annual sales was driven by the addition of 62 new Best Buy Stores along with positive comparable store sales. I would like to take this opportunity to publicly thank all of our employees for their 3 role in achieving this new level of performance.

A few significant highlights this past quarter included earnings for the quarter that increased 16%, reflecting changes in our product mix and lower levels of promotional activity, compared with the third quarter and for the year earnings increased 14% excluding the cost of our Musicland acquisition and some other nonrecurring expenses, you will hear about again this morning. Our earnings grew by 26% in the quarter and 19% for the year. It was really a solid performance versus any of our own measures. Our sales, which increased 27% in the quarter, were in line with our expectations. Most of the growth was derived from the new stores. We opened 6 Best Buy stores in the fourth quarter and 62 for the entire year, 11 of which with a smaller market format. In addition, we increased comparable store sales despite an increasingly challenging economy. Consumers continue to embrace digital products including DVD, cameras, camcorders, and television. And digital products, in fact, represented fully 15% of our total sales versus 10% in the prior year, a 50% increase. During the year, we also announced three strategic initiatives to drive our future growth including our acquisition of Musicland's 1300 stores and 4 Magnolia's Hi-Fi's 13 high-end consumer electronic stores, as well of course as our planned expansion into Canada. These moves were designed to leverage our strength as a specialty retailer to extend our product [________________] on the eve of a new digital era and to feel our growth beyond the time when we become fully stored over the next four years.

Darren will now elaborate on our record financial results and our outlook for fiscal 2002, then I will provide an update on our businesses as well as the industry, and we will conclude by answering as many questions as time permits. Darren?

Thanks Dick, and good morning everyone. My comments today will be twofold. First, I will hit the highlights and describe the underlying fundamentals that drove our very successful fourth quarter and year. Second, I will talk about our assumptions for the current fiscal year. As Dick noted, earnings increased 16% for the quarter to a record $190 million or 89 cents a share. For the year, earnings increased 14% over last year to $396 million or $86 a share, also a record performance. The quarter in year-to-date results 5 include, 4 cents of dilution from the Musicland acquisition, plus 4 cents of write-offs of certain investments in e?commerce companies. Our ability to exceed to Wall Street's expectation was due to solid topline performance and better than expected gross margin. A more favorable merchandise mix accounted for most of the margin rate improvements. The slower rate of comp-store sales growth, the acquisition and integration cost of Musicland, as well as the minority investment write-offs in the quarter, put pressure on our SG&A ratio. Overall, excluding the cost from Musicland and the investment write-offs, the core Best Buy operating margin rose to a historical high of 6% of sales in the quarter. We are pleased to report strong year-over-year increase in earnings in this challenging environment. As we reported on March 8th, our sales for the quarter were record 5.5 billion, representing a 27% increase over last year. Sales for the quarter benefited from the 53rd week, which added $280 million to our sales. In addition, Musicland and Magnolia contributed sales of $160 million for the quarter and the year. Best Buy comparable-store sales increased 1.8% in the quarter that was on top of double 6 digit increases in the fourth quarter in each of the three previous years.

We were satisfied with comp-sales growth in light of the softening economy and the challenging comparisons. We did not report quarterly comp-store sales from Musicland, as they were included only for one month. For the year, comp-store sales increased a healthy 4.9% on top of the 11.1% increase last year. Our Best Buy store count at yearend stood at 419 compared with 357 stores one year ago. Average sales per store grew to $39 million more than twice that of our nearest competitor. Our gross margin rate in the quarter improved to 160 basis points over last year to 20.4% of sales, for the full year our gross profit margin rate was up 80 basis points. Both periods benefited from the continued growth of digital products and our richer product assortment. The inclusion of Musicland results for February, added 40 basis points to the gross margin for the quarter and 20 basis points for the year. We are finding that consumers have continued to show interest in the higher-end, more fully featured products. Our sales mix continue to shift to a higher proportion of consumer electronics at the expense of the lower margin home-office category, 7 although I should add, the home?office category is benefiting from a higher margin mix of products within the category. When we gave our guidance for the fourth quarter, we had assumed some moderation in the promotional activity from the intense third quarter levels. It turned out to be the case. In the end, we were able to achieve a better overall margin rate performance than we expected as a result of a more profitable mix. We also benefited from clean post holiday inventories as well as outstanding execution of the model transitions. From an SG&A perspective, our expenses for the quarter were higher than we had expected on account of the investment write-offs.

The write-offs added 30 basis points to our SG&A rate in the quarter, and 10 basis points to the year. Our SG&A ratio for the quarter was 15% of sales, up 210 basis points over last year. For the year, we were up 120 basis points to 16% of sales. Musicland's impact including $7 million in merger-related expenses added 70 basis points to our SG&A rate in the quarter and 20 basis points for the year. With all of our initiatives this past year, we continue to maintain an SG&A to gross margin ratio of less 8 than 80%. We continue to invest in our future. BestBuy.com was successfully launched and 15 more stores were opened than we opened in the prior year, including the New York market stores which was a major undertaking. As a result of these investments, we saw an increase in our expense rate of approximately 80 basis points on a year-over-year basis. Our overall financial results for the fiscal year benefited from our strategic relationship with Microsoft. We initiated 1.3 million MSN subscribers in the past 12 months. Net interest income for the quarter was $12 million compared with $10 million in the quarter last year, as we benefited from higher cash balances. Interest expense on Musicland debt and lost interest income and cash used to acquire Musicland impacted net interest by approximately $4 million in the quarter. For the year, net interest income was $37 million compared with $23 million last year. Moving to our financial position, we finished the year with $747 million in the bank, despite spending $500 million in cash to acquire Musicland and Magnolia. We also assume $260 million in debt; $95 million was retired in March. Inventory management continues to be a strength of Best Buy, our terms were 7.6 times compared to 7.2 9 times a year ago.

Inventories were 1.8 billion at the end of the year. Of the increase, $400 million was related to our acquisitions. Inventories at Best Buy on a per store basis were down nearly 3% from a year ago, and we ended the year with clean inventories. Our capital spending for the year was $650 million as we invested in new stores, enhanced existing stores, and upgraded our systems. We also opened a new distribution facility in Dublin, Georgia, and began spending on our new corporate headquarters. We currently expect Best Buy's capital spending in fiscal 2002 to be about $600 million, which we currently plan to fund internally. Depreciation for next year is expected to increase to $250 million compared with our $170 million this past year. We anticipate continued use of sale leasebacks and other off balance sheet financing to support the real estate portion of our store growth separately, and in Musicland we expect capital spending of approximately $75 million as we begin to integrate, re-merchandize and transform the Musicland business. We plan to open 60 Best Buy stores in 2002 including 20 of our smaller market stores. The remaining 40 stores will be in our 10 45,000 sq. ft. format and they will incorporate features from our SLP-2 concept now co-concept 5. This format offers customer-centric layouts that are adjacent to the product and accessories, faster checkout and improved merchandizing. We do not plan to retrofit existing stores with this concept in fiscal '02. Two years ago, we began using EVA to measure how well we utilized the company's assets in producing earnings. Our EVA last year was a solid $138 million on top of a $178 million the prior year.

We would expect our recent investments to propel our EVA in the upcoming years. I'm proud to add that our return on equity, another key financial measure, was 26%. These returns reinforce our position as a top quartile retail performer. Now I'd like to turn to the financial assumptions for the upcoming year. I will start with the core Best Buy stores. In the first quarter, we expect consumers to remain skittish and we're up against a 9.5% comp-store growth figure from last year's first quarter. In addition, we expect sales of personal computers to remain soft. As a result, we expect to see comparable store sales decline by low single digits in the first quarter, and to be essentially flat in the second quarter. However, 11 in the second half of the fiscal year, we expect that improving consumer confidence as a result of interest rate and tax cuts will translate into increased store traffic. We expect comps in the second half to be positive with low single digit growth in the third quarter and solid mid-single digit growth in the fourth. So for the year, comparable store growth is expected to be in the low single digit range. Sales at Best Buy stores, given these assumptions, should be in the range of $17 to $17.5 billion for the fiscal year up from $15.2 this past year. Now, I'd like to discuss Musicland sales, which were $1.9 billion last year. In the first half of the year, we do not plan to make any changes to the business while we test the introduction of consumer electronics at the Sam Goody Stores. We plan to rule out the expanded product assortment by late fall, at which time, we would expect sales at those stores to increase. We anticipate total sales per Musicland's existing businesses for the year to be flat to slightly positive, with a small decline in the first quarter, and finishing with small gains in the second half, actually similar to Best Buy's comp's.

Collectively, the sales assumption for 12 the Best Buy Enterprise will range from $19 to $19.5 billion for the current fiscal year. Now, I'll spend a few minutes on gross margin assumptions starting with the core Best Buy business. The promotional activity is expected to maintain it's current level. Our mix should continue to benefit our margins, which will help offset the impact of the commoditization of our products. Overall, we would expect to see continued expansion in gross profit margins, although less than last year. Historically, gross margin rates at Musicland have been higher than Best Buy's due to the nature of the product mix; it was 37% last year. We expect the gap to narrow as we broaden the product assortment combining Best Buy's expected improvement of 60 basis points with Musicland's higher margin mix of products, should add approximately 180 basis points to 200 basis points to last year's annual reported gross margin rate of 20%. Next, I'd like to discuss our outlook for SG&A for our two segments. We believe that our comp-store sales decline will reduce expense leverage in the first half of the year. However, we should be able to achieve expense leverage in the second half. As new stores come online and as comparable store sales increase, we should be able to benefit from 13 the fact that most of our new stores this year will be in markets where we already have a presence. That enables us to leverage existing advertising and distribution expenses. In addition, we expect to leverage our investments in BestBuy.com, as spending decreases and sales volumes increase. SG&A expenses at Musicland for the last year were approximately $613 million. We would expect that figure to increase as a result of higher merger integration costs and store transformation planning efforts.

These costs are expected to be highest in the first three quarters of the year. The EPS impact is somewhat skewed because of the seasonality of Musicland's sales and profits which disproportionately occur in the fourth quarter. Lost interest income and goodwill are consistent throughout the year. We expect Musicland to reduce EPS by 7 to 8 cents in each of the first three quarters, and then add 20 to 25 cents per share to our earnings in the fourth quarter as we begin to realize plan synergies. Our estimates of Musicland impact on earnings assumes we continue to recognize approximately $16 million per year in goodwill amortization. In the event that the accounting rules change, 14 the cost would be reduced. We're also expecting the effective income tax rate to grow to 39.2% in part because of the impact of goodwill. All that being said, we expect, Best Buy's consolidated earnings in the first quarter would decline nearly 30% to an estimated 23 to 25 cents per share. The decline reflects negative comp-store sales with 7 to 8 cents of dilution from Musicland to annualizing the cost including depreciation related to initiatives started and stores open in the prior year. We intend to recover the losses in the second half of the year. So for fiscal 2002, we expect earnings of $2 and 15 to $2 and 20 cents per share as we benefit from new stores with continued strength in the digital product cycle and the shift to a more profitable consumer electronics mix of merchandize, overall, a solid 16% to 18% improvement for the year. Now I'll turn it back to Dick for review of the industry and our business.

Thanks Darren. First I'd like to provide some comment on our sales forecast for the Best Buy stores. I'll begin with home-office sale, of course, our largest category. We expect continued strength 15 in the sale of notebooks and configure to order computers. Sales of peripherals are also expected to be strong as computer owners look to extend the value of their investment. The PC is increasingly seen as an enabler as it uses these peripherals to expand in the form of CD read/writes, home networking, and digital entertainment. We expect to continue to see strong increases in the sale of personal digital assistance and our accessories as well. We expect continued softness in unit volume of desktop computer sales, which will be negatively affected by household penetration, and in the first half by the product cycle. Another factor is MSN's new marketing program which includes a 3-year Internet service with the purchase of a computer or $200 off on a 2-year subscription to MSN. We believe that MSN's new marketing program will be a less of a stimulation for unit sales, particularly impacting lower priced PC's, but will increase the attachment rate of the Internet service provision. This relationship should help us sign up over 1 million new ISP subscribers again in fiscal '02. Overall, despite strength in the areas I mentioned, we expect weakness in PC sale to lead to a decline in home-office sales, overall, next year. Remember again, this 16 is the most competitive and lowest gross margin category we sell.

We believe that sales of consumer electronics will continue to grow faster than our other categories driven by consumer demand for digital cameras, camcorders, wireless communications, DVD players, and other newly introduced digital products. I'd like to highlight digital television in particular, we're currently seeing large market share gains in Big Bob and high-end televisions including big screen and digital television. Sales of digital television in the fourth quarter represented only 10% of all of our television sales, five times the percentage in last years corresponding fourth quarter. The average selling price of digital television is considerably higher than that of the long?standing analog sets were approximately $2300 per unit. Average price points are down about 10% from this point a year ago, and could fall below $2000 by yearend, which should help to drive our continued expanded sale volumes. I should add that we expect the digital product cycle to continue to drive sales as well. With a fourth quarter in fiscal 2002, we expect digital products to represent between 18% and 19% of our 17 total sales, compared with 15% in the fourth quarter of fiscal 2001. Sales of music and movies are expected to be flat in the aggregate with softness in music being offset by continued growth in sales of both DVD hardware and software. Sales of DVD software will continue to benefit from an increasing install base of hardware. We essentially made the market for DVD and continue to post triple digit gain in sales of DVD software in the face of widespread distribution.

Finally, appliance sales are expected to be flat, consisted with expected trends in consumer spending, interest rates and housing starts. We remain committed to the sale of major appliances. In fact, we have formally gathered a dedicated full-time team to reengineer our appliance practice from end-to-end. Results of these initiatives are not expected to have a significant increase, however, until fiscal 2003. Anticipating the need to continue our growth at our historical levels, we began to launch new avenues of growth. Through Musicland, we have now 1300 mall-based and rural stores with over 300 million new touch points of customers each year, including teenagers, women, and rural consumers. We see potential for up to as many as 18 1000 rural market stores where we can extend our reach and leverage, our building and expanding Internet capability. We also have increased our share of the music and movies business, which positions us to be a market maker in all forms of media distribution. Through Magnolia Hi-Fi, we have access to a higher-end consumer. We also have an awful lot to learn from Magnolia Hi-Fi's, high-touch consumer service and of course, it's state of the art design and service center. Finally, our new experience with different consumer segments, service models and store formats are expected to help us determine the best way to approach the international consumer. Beginning with our planned move to Canada, we have a dedicated team in place and expect to open the first Canadian Best Buy stores in calendar 2002. Our new organizational structure put the teams in place to advance our new growth strategies while continuing to focus on growing our own Best Buy Stores, our core business.

Of course, what I most appreciate about the new structure is the time that it now gives me to do what I have enjoyed the most and that is working with the new teams to identify opportunities for our growth and developing new 19 business. In my 35 years of Best Buy, I've never been more excited about the company's potential than I am right now. I believe that we have the right people and the right strategy to achieve our goal as a top quartile performer in terms of future earnings growth and shareholder return. With that I conclude my formal remarks and turn the call back over to Lea, and we will take questions from the analysts for as long as time permits. Lea?

Ladies and gentlemen, if you have a question please press the 1 on your touchtone phone. You will hear a tone acknowledging your request and your questions will be taken in the order they are received. If your question has been answered and you would like to withdraw your pulling request, you may do so by pressing the # key on your touchtone phone. If you are using a speakerphone please pickup your handset before pressing the numbers. One moment please for the first question. Our first question will come from Dan Wewer from Deutsche Banc Alex. Brown. Please go ahead.

Good morning. A question about the appliance promotion that you were 20 advertising this week and in the Sunday circulars. If you could discuss the elasticity of this category with respect to the 10% off [________________] and the 18-month interest rate? And what kind of a volume increases you would need to maintain the same kind of EVA in this category?

Wade, do you want to respond to this?

There is clearly elasticity in this kind of offer, but I would not want to give up the kind of list matrix that are associated with any one promotion, and I would also say that I don't believe you can measure EVA by week. You really have to look at promotional offers as a series of ways to stimulate a long-term market place. In terms of overall EVA, we have got work to do in appliances, I think we have been public about stating that and we have got a fulltime team lead by senior officer of the company now, really working on supply chain, reengineering, creating best practices in the retail stores, reengineering our assortments to focus greater attention on our set of customers, etc. 21

And just one other question and I'll hang up. Could you discuss the performance in the smaller markets during the fourth quarter, and does Benchmark get the major market locations?

You are asking about our 30,000 foot rural market store sales?

Yes.

Dan, I can take that. In terms of what we planned in the fourth quarter, I am pleased to say that the smaller market stores will ride on their plan for the quarter. As you know, we invested a little less in capital in those stores. So our expectant overall return on invested capital is typically better. So, the good news is they made their plan in the fourth quarter and they were slight ahead of their plan for the year.

Right. Thank you.

Dan, I'd like just to followup on a little bit on your appliance question as well, as it is relates to previous discussion we have had about the marching orders for the next couple of years. In particular, the 22 company is aggressively moving to enhance its strategic partnership with the key suppliers so that we can become infinitely more efficient in the management of the supply chain. The logistical piece that impacts the real costs that differentiates this business from the other three that we are in, need to be managed much more effectively than it has in the past and are to improve its EVA performance and for many, many years we have been disadvantaged, we perceive, as it relates to the mix of merchandize not matching up with the customer demographics. So, we are working aggressively at improving the mix or assortment on the floor, and working on the backend, in particular, with our suppliers so that we can improve that end-to-end capability to enhance the overall profitability and begin to switch around the EVA performance of all categories.

Specifically, you are [________________] to taking the assortments higher than where you are today?

Correct.

Yeah. Right. 23

Thanks Dan. Next question please?

And that will come from David Shick from Robinson-Humphrey. Please go ahead.

Good morning David.

Hi, Good morning, congratulations.

Thank you.

Just a few quick questions, I guess I can ask them all upfront. First, what in the very brief amount of time, is there anything in Musicland or the Magnolia businesses that we are going to see show up in the Best Buy stores, not specifically, but themes or things that you have learnt thus far that we'll see in the Best Buy stores during this year or ongoing? Second, assuming, you talked a little bit about the mix shift in the CE business driving gross margins. Can you break out or give any granularity there, for instance digital television and that migration, what that's doing for gross margins? And, the third would be, you know, obviously, the industry with players moving 24 in different directions, is there any change that you can talk about with vendor relationships that can think about going forward? Thanks.

Thanks David. I think in response to the first question, clearly the movement of initiatives or product offers from Musicland or Magnolia, clearly, we see this as something moving the other way. The whole basis around which we made a determination to acquire the Musicland chain was to revitalize its business plans and begin to shift somewhat away from the complete dependence on software to incorporate digital technology. The lower cost, fast moving, light-weight, and much more profitable products assortments that Best Buy has been riding the curve on in our own business, certainly will integrate well to the Musicland group, both the on queue or smaller rural stores as well as the mall stores. The Magnolia chain is something that we're standing back and spending sometime, obviously just expanding its position in place out on the west coast. Plans this year call for opening for an additional Magnolia stores. So, I think you are really going to see a lot more work here on, how we can enrich the mix and assortment of the Musicland 25 offering, and we can continue to study the Magnolia business strategy to get a better handle on, in particular, their service capability and some of the work they do in the installation side of their business, certainly as it can impact us across a broader spectrum of stores. With respect to television, it is certainly not a secret that gross margins from digital television are substantially greater than that of the higher average sale PC category.

In fact, on an average, at least double and depending on segment of the business, triple the gross margin rate, so, with the type of expansion that we had in the fourth quarter on television sales, we would expect to see that continue to grow year-over-year for the next several years, probably 5 or 6 years, and with that shift, correspondingly, as high definition television becomes better understood and more broadly distributed, there will be more and more consumer interest, so it's wiser to say that while we expect and had planned all along for the home-office category to diminish units total size, against our complete mix, the consumer electronics sector will continue to grow in the other direction, it wouldn't be a bit surprise to see these two categories shift in their total 26 financial contribution to the company over the next 4 to 5 years, with consumer electronics becoming thrown away to larger category with much stronger gross margins. So, that's about all, I think we can say on this subject of television or digital electronics right now. Was there a third question?

The industry.

Bred Anderson and [________________] as two individuals, right now are characteristically participate in our quarterly and annual conference calls are both in Japan, and the report that we got before departure was that we have the strongest level of meetings with the highest level of representation from our supply community that cuts across consumer electronics, photography, digital product manufacture, and it's a pretty exciting time for us, clearly, the acquisition of the Musicland group has developed a growing level of communication with the major players in the software business. Our continued market share growth in consumer electronics has solidly positioned our product requirements for next year to the highest level it has ever been, and so we 27 certainly would expect to receive most favored nation treatment from our supply community, perhaps not even in the actual cost of the products we acquired, although you all know that has a direct correlation with the quantity that one is able to purchase, but more importantly, we think the ability to manage the flow of inventory to reduce the support cost or logistical cost or the end cost of doing these businesses, so that we can continue to become more efficient and productive.

Thanks a lot.

Thank you David. Next question?

And our next question comes from Budd Bugatch from Raymond James. Please go ahead.

Yeah, good morning. This is actually Jessica Simmons for Budd.

Hi! Jessica.

Good morning. I'll ask a couple of questions and then let you guys answer. First of all, I'm wondering what kind of changes, I may discuss that you were gonna wait a 28 little while on Sam Goody to roll out the electronic assortment, but I am wondering what, if any, other types of changes you have made to any of the Musicland store models, systems, distribution, network thus far? Secondly, on the $15 million e-commerce write-off, I'm wondering if that is completely related to the Etown investment or if there's anything else involved, or if in fact that is what that is? And, thirdly, I was wondering if I could get an update on the New York market roll out?

Okay, thanks Jessica. Kevin do you want to respond to the Musicland portion of Jessica's question?

I believe I heard two parts of that question, merchandise mix changes in the other three concepts as well as back office changes. In terms of merchandise mix changes, we have not, at this point, changed the merchandise mix of the other three concepts, although there are a number of tests that Musicland had under weighed prior to the acquisition looking at different merchandise possibilities and we are currently scrutinizing the results of those tests, but there are no 29 changes planned in the immediate future. In terms of back office integration, in fact we have integrated logistics, HR, finance, legal, communications, advertising, and it affected hundreds of employees and an announcement at the end of February as those teams are integrating into shared resources and would expect to see significant cost savings as a result of that predominantly in the back half of the year.

Thanks Kevin. John, do you want to talk a bit to Etown and our other write-offs?.

Sure, you are right, most of that write-off is Etown. There is a smaller component with another minority investment in a company that provides wireless services and we made a determination, given the current environment, that investment is impaired to the degree that we ought to write part of it off, but most of it is Etown.

And with respect to New York, Jessica, Darren has got some numbers, I think the overall is that we continue to labor in New York, trying to find suitable real estates and ramp it up in an efficient time frame. As we 30 have previously indicated, the New York market entry was the most expensive in our company's history. It certainly launched strongly, but candidly in the face of the economic environment through which we began, the sales numbers have not reached the projected levels, I understand that the projected levels were considerably higher from that of an average Best Buy store in place elsewhere in the country today, and clearly the reason for that was a combination of the density of population in the New York market and also the fact that we were pretty substantially under stored, so the reality is that in the face of much higher expenditures to launch and continue to promote the marketplace, we had fewer stores operating under that umbrella, but obviously those that were there were getting some benefit from the additional opportunity to draw consumers a bit further. Having said that, the real estate market continues to be strong, I guess we're only going to put four stores in next year.

Yeah. That's the preliminary plan at this point. The other thing I would add Jessica is, we are behind our plan on sales and clearly our profit plan for the year. 31 Now, the good news is in the fourth quarter, we actually were profitable in that market, so be it behind our plan, we did make a little money in the fourth quarter short of our plan. We are diligently looking for more sites. We realize, given the cost of real estate New York that it pays to get the right site, so we can drive the right productivity to bring that market to a level of profitability we find acceptable.

Many thanks.

Thank you. Next question please?

Our next question is from Aram Rubinson from UBS Warburg. Please go ahead.

Hi guys, congratulations. A couple of things, one, I guess just from visiting some of the Sam Goody Stores, including ones of the one's that's been already, I guess converted to some extent, it turns out there are some exclusive lease arrangements in the malls where by you might not be able to carry certain products because of sort of exclusive arrangements. Can you talk about to the extent that you are encountering that? 32

Kevin, do you want to respond to that?

This is Kevin Freeland, during the due diligence process, we reviewed the exclusive use clauses in all of the Sam Goody Stores and that was a factor taken into the account in the acquisition of the company. As a general rule, devices that playback music or playback movies are authorized in virtually all of leases, and we are moving rapidly to put those products in the stores. Things that would be generally affected by some, although not all of the leases, would be the wireless category and to a lesser extent the gaming category. We are currently in discussions with our landlords looking at changes to those used clauses overtime, so matter of record, two thirds of the Sam Goody leases are removed in the next 3 years which gives us an excellent opportunity to sit down and discuss about landlords, a longer relationship with them.

We might also remind you all once again that the original plan for the Musicland acquisition had us moving to a comprehensive re-merchandizing strategy in the 33 first year, which essentially was an expansion of skew assortments in the product categories that Kevin talked about, which is certainly the baseline Musicland group business which was CDs and movies. So, we are expanding our hardware components and other related peripherals and accessories off of those two major categories. The second and larger undertaking was the transformation strategy, and that is not something that's going to see the light of day in this coming fiscal business year. There will be a lot of testing going on relative to just how we will position an expanded offering of products. And that really also allows us the opportunity to familiarize the real estate community within needs that we perceive are real in repositioning the store to be more vital and a larger contributor to traffic and revenues in these mall stores. So, it's really going to be an undertaking that will, if I am right, Kevin, will last something close to 3 years by the time, you know, we actually launch it and then move through all 600 plus stores of Sam Goody as they presently exits.

The second question was on the margins, if you sort of are around the 34 same gross margins by categories you did last year, you get some improvement, but I don't get anyway near the 100 basis point improvement that you saw. When you say improvements in mix does that assume that the video margins actually show improvements, because it is sort of on the product and not that category, is there anything else in gross margin that would lift it whether it's warranties or other things like that, as well just let me help get to the full number?

Are you talking of a 180 to 200 basis point increase that we have talked about?

No, for the 4th quarter that you reported, there was about 100 [_______________] of that basis point improvement in just the core Best Buy Stores, and if I just take sort of the mix you give us, the sales by category, and apply sort of similar margins the last year that doesn't quite get me even halfway there. I did not know if there was anything else that you did not mention in the margin line that was help for whether it is warranties or anything else?

Yeah, I think, the short 35 answer is mix within the categories clearly benefited us as well. I mean, if we had to roughly break it down, mix in itself was probably worth about 50 basis points in the Best Buy business. Rate, probably added 70 basis points to the core Best Buy business, so the core Best Buy business in the quarter was up about 120 basis points. When you're factoring Musicland for one month and their higher margin mix that added 40 basis points, so that's how you get to the 20.4 and the Musicland is just simply math.

Very helpful, thank you.

Thank you. Next question please?

Our next question is from Scot Ciccarelli from Gerard Klauer Mattison & Company. Please go ahead.

Hi guys, two questions related to the change in the MSN rebate program, first of all can you tell us generally where consumers were spending that rebate money on, was it just a PC or were they taking it and spending it elsewhere to a degree you might have a feel for that and then related to that, can you give 36 us any more color regarding the expected impact of the change in the MSN rebate program. Obviously, there is a little bit more than just a decrease in subs, you know, it is kind of a two part first question. The second one is if you, kind of, exclude all the charges in the 4th quarter you guys obviously had an even better 4th quarter than the printed number. So given that, and the numbers you are talking about for next year, for 215 or 220, is there is any one reason why the numbers wouldn't be a lot better. Is there something else going on is that just kind of taking a conservative approach? Thanks.

Wade, you want to respond to Scot's first question?

I'll start with your first two questions. First of all, your question of what was the $400 rebates being spent on. Basically, roughly, 60% of the attachment was the PC's and the other 40% was the non-PC's, most of all the customers would buy large ticket items like televisions sets or sign up for MSN at our service counters in addition to PC attachment. There wasn't a lot of evidence that the $400 rebate was driving significant incremental basket dollars, if that's the nature of your question, 37 to our average ticket, so, for example, our average ticket during this $400 period did not change substantially from the period before we had the $400 rebate. On the second part of the question, what are we expecting to happen, I think we said that in the front part of the call, which is, we will expect a modest slowdown in units due to being a less promotional offer in the marketplace with a higher encashment rate overall of MSN. The one-year free, actually, of all the offers we've tested with consumers, benchmarks very highly, probably the greatest impact of the $400 rebate will be on the low end of the marketplace. We have not, at this point, seen any kind of dramatic change from what we were at before the $400 rebate in large parts because there were several factors going on in the market place, and its hard to distinguish one from the other. We are in the middle of transitioning to new models. There is clearly a consumer pullback, and I think with the number of different offers that are out there in the marketplace what tends to happen when the customer gets confused as a general pullback, and I think if you follow the industry commentary, which you're seeing is the general pullback in 38 purchasing desktop models right now.

And Scot, as to earnings of 215 to 220 this year, I don't think we disagreed that we had some unique items this year, and you can do math different ways to come to a higher number, I think it is more prudent given the economy out there, and I think if you think through our guidance, we essentially said comp-store sales will be up slightly for next year, you know, that's in the face of some pretty large increases, in say, utility bills across the country, healthcare costs, so I thinking, as we're thinking about it, it's coming in the second half, its prudent, given that comp-store sales assumption to plan our expenses prudently. Clearly, we are going to monitoring it though out the course of the year, and if we see a break we would make the related adjustments and expectations, but at this point, 215 to 220, given all the uncertainties that is out there really is in line with what we were estimating at this point.

Okay, thanks guys.

Thanks Scot. Next question please? 39

Our next question comes from Rick Fradin from William Blair & Company. Please go ahead.

Thank you. Good morning. I'd like to ask, kind of, the opposite of the last question, which would be, given how well your business performed in this last quarter in the face of a very difficult economy and it sounds like your expectations are relatively optimistic again in the face of a tough economy for this coming year, I wonder if you can, may be step back a little bit and give us some perspectives on what are few of the key things that are enabling you to manage the business so much and better and manage inventory so much better today, than you were able in past slowdowns.

Oh boy, maybe the best way to approach that is to comeback to our process to profits initiative which commenced about over 3 years ago now, and the levers that were reengineered in our marketing group has continued to bear fruit for us as the refinement process continues to get stronger and stronger. As you all know, Kevin Freeland who ran the 40 inventory management for Best Buy as long as 4-5 years ago when all these initiatives began, is now, with that knowledge in place over at Musicland, and the team that is here with his movement has continued to refine the process. I think Kevin's stated goal at the beginning was that he saw inventory returns, a potential of fully [8 turns] per year, and as you can see from what was just published the move from 7.2 to 7.6 would illustrate that even with Kevin's movement to Musicland beginning as long as 5 to 6 months ago as this whole process commenced, but the team has continued to improve that strategy in a meaningful way. Our leadership continues to expand the efficiency of our advertising continues to improve. We just think that we are probably now in a refinement phase from an operational perspective and continuing to move towards efficiency and productivity. The next steps of course will be a link to distribution. I think its safe to that we are looking for leverages and synergies in the distribution pieces of our business. We are looking to expand our service capabilities and improve the productivity of our service, so I think the operating efficiency and capability of the organization should continue to strength 41 year-over-year. Is that Rick, getting where you need to go?

Yeah. That begins to get there. Let me ask just one other one. I think you had mentioned that you expected appliance sales in the coming year to be about flat year-over-year, I just want to clarify are you talking about dollars or accounts there?

Accounts.

And I think Rick, we said slightly negative in the first half and then a pickup in the second half consistent with the interest rate cuts and consumer sentiment picking up as well.

Okay.

We did a pretty exhaustive study on the appliance business, probably more in depth this last year, than any of the other past years, primarily in the face of new levels of competition, meaningful competition in the form certainly of the building supply group, and candidly while, as we acknowledged earlier, this has not been an easy A positive business for the entire time in which we have 42 been engaged in it. Our sense is that to walk away from this business, particularly with the unique distinction of the customer group that we serve, we think it would have been much more difficult to try to reassemble in the face of the remaining product categories, in light of the fact that we already had market leading position in that space, so our sense is that it really provides an opportunity for us to partner, as I said earlier, much more strategically with our suppliers and wring some cost out of the backend of that business and connect the product to the consumer in a more efficient manner as we also strengthen the assortments, and as Wade pointed out that Joe [_______________] of the senior officer of our company who was engaged in the operations side of our business has now undertaken that responsibility. He just recently was responsible for the strategic partnership that was built with Hewlett?Packard in particular in the home?office side of the world where we think we probably has as fine a strategic relationship as we do with any supplier with whom we do business, so his passion and his understanding of what's going to be required to make that a much more efficient business 43 strategy, we think is going to pay dividends over the next year or two, and I wish we could say that that the growth opportunity in that business is immediate, but it clearly is going to be longer term, but we are convinced that its going to be there, so we are continuing to invest where we think its appropriate and build a kind of strategic partnerships that we think are going to be needed to manifest our business.

Okay thank you.

There's only time for a couple of more questions, so next question please.

And that will come from Matt [________________] from Goldman Sachs. Please go ahead.

Good morning, thanks a lot for all the detail. Just a couple of followup questions, in terms of getting rid of the tone of the underlying business and assessing the improvement that you expect between now and the end of the year. How much of that presumes an improvement in underlying consumer demand in terms of the broader economy and how much of it would you say is [________________] specific 44 product trends or sales initiatives that you have underway?

I think, we have often taken a position that if the consumer is fully employed and confident in their own personal employment prospects, together with the growing asset base which has been created over the last several years that we would have a consumer that was eagerly willingly to take on more debts. I think we all know that that's not been the case most notably over the last 4 to 6 months in particular. We remain somewhat concerned about the layoff prospects that are taking place in various industries and obviously as consumers look towards the prospect of future employment, there is always a question that gets asked if they read too much about major layoffs. Now in some parts, you know, of course they have been from the e-commerce or dotcoms base, which is also new, that literally it has been coming down as fast as it went up, but we know that its going past that into baseline traditional economic sectors, so we think that's the greatest basis for pause right now amongst the consumers, as they begin to look around to see how things are going to shape up for the entire year. That 45 together with the lack of directions from the stock market, the reduction in real asset base has consumers more cautious about what they are willing to spend. Now, having said that, I think you can see that new technologies have historically come over the top of that, and we are in a great position right now particularly with digital television and the introduction of new digital products. Most of our manufactures with whom we confer on a literally weekly basis continue to report strength in the sale of personal digital products, the lower cost easier to use products that facilitate other components within the industry. So consumers are interested in new technology. They are spending for new technology, and we are in the right spot to receive the benefit from that. So because of the seasonality of consumer electronics, I think you know that well, car audio might be strong in the spring and summer. It's not a category that drives huge levels of revenue and gross margin powered contribution, where television on the other hand and DVD certainly do. So one of the reasons why we are not in a position to project a stronger first and second quarter is the seasonality of the television business, which, 46 for the most part of will strengthen in the late summer going on into the fall and winter. So we continue to expect all of those digital and television businesses, in particular the consumer electronics sector, to continue to grow all year long in the face of an uncertain economy, and we also expect our home-office business will continue to come back a bit certainly in the last half of the year, and I think, maybe we didn't point out but consecutive order and notebooks do continue to show strength in their respective sales. It's really the lower priced entry-level desktop business where we have got a lot of topline reduction right now, and we expected that's going to be at least a six?month proposition, if not maybe even nine months. So that's pretty much how we would profile the year.

Okay, and just a quick second question if I may, on the concept-5 or SLP-2, can you give us a sense of what the financial implications are of the new prototype? Are you seeing better sales productivity? Are you seeing a higher gross margin? Is there an impact in the cost structure or the returns, just as you transition to this new format and to its new futures, what impact 47 could we see on the P&L?

I'll take a shot at that, Matt, well you its four stores and what we are seeing is that the four stores that we did this year, you know, we used them as a lab, if you may, for different learning's, so they are parts of the concept that we took away, digital cameras might be an example, where we are going to move them up front, and we think we will get a lot higher velocity selling on digital cameras. So pieces of that will help us, as we learn to drive the topline we are also finding in other parts of the business, say in the labor model, we can more efficiently allocate labor and dedicate labor to save the consulting pieces of the business within those stores. So overall, we would be making these investments to drive the overall productivity of the stores, utilizing some efficiency in the expense areas while also providing, as we said, faster checkouts for our customers and ultimately improving the overall contribution on the stores. So, I think the take wave is, you know, there were four stores, we used them as a lab, we found certain things that were going to help us on the topline, certain things that will help us in terms of efficiency, 48 in terms of these expense lines, and in terms of capital, how much money we have to put into the stores, its essentially a wash but what we are investing in stores today.

Got you, thank you.

Thank you Matt. Last question please.

And that will come from Harry G. Katica from Southwest Securities. Please go ahead.

Good morning. I'd like to ask two questions. First of all if you can extend your guidance from the first quarter to the second quarter in terms of what you're expecting generally in terms of earnings per share, and if you could also share with us the assumptions on in the fourth quarter, what percent of Musicland's sales or Sam Goody's sales will come from products that are introduced this year? [_______________] work particularly.

You know, I'd answer the question this way, Harry. The guidance that we did give on the second quarter is essentially 49 flat comp-store sales, you know, in part as Dick said we expect the softness especially in our desktops to continue. We expect 70 cents of dilution from Musicland, and overall the guidance was, we expect to pick up any losses in the first half and pick them up in the second half of the year. But we don't have any specific point estimates at this time for the second quarter, and as to your second question, can you repeat it?

Yes, you know, you've indicated that you're not necessarily going to change the whole format but that you are going to introduce hardware into the Musicland stores of this year. Could you comment on what percent of the sales you think that could account for in the fourth quarter.

First of all, the business is that we will be expanding are businesses that they are in today, and as, an example, Sam Goody carries games in 200 stores today, video games. They carry a modest selection of consumer electronics. So these would be enhancements or additions to categories they're in today. Additionally, Sam Goody is 50 about 40% of the volume of the company, so approximately 60% of the chain would be unchanged. Booking would actually offset the expected soft performance in the music business. So the changes that would be seen in the overall mix would be modest compared to what you see today.

Okay, thank you. If I could ask one last question? In terms of the appliance inventory have you made any changes in the way you're handling that now, have you entered into any partnerships with suppliers where they are taking more of the inventory risks?

You know, I think, Harry, it is safe to say at this stage of the game it's too early in the game to really comment on the details of that strategy, but it's fair to say that two suppliers in particular have stepped up in a very major way committing their own teams to work with our teams, and we think the integration of what we're trying to do together will move us in that direction rapidly, we don't want to budget for gains in that area this year because of until we actually realize them, and we know how far each side can travel, and what can 51 be done. It's very difficult to stick your chin out and say that there is going to be some real economic gain in the year. So, that's why we said, probably going to be fiscal 2003, but the suppliers understand that this model, as it exists, needs to be reengineered. We won't be the first one standing in line saying that the way it is today it is not going to work tomorrow. So it's really difficult for us, as you can tell us that, you know, lead with aggressive estimates of how quickly these things can be put together because it's not just something that we're dependent on, you know, internally, whenever you've got factions working externally, as you know, you've got to create a win-win relationship, you know, in the discussions, and in the planning, and in the investments, and that's what's being [________________]right now. It's not a case where you can just shift cost and inventory burden to the other side, and the other side doesn't have some benefit or a way in which, you know, it can gain from that. So, I think we hate to be weary, I think, you know, we try to be as concise as we can in every answer and in every situation, just we understand, you know, the jobs you guys have to do, but when we really don't 52 know specifically, we'd rather not, you know, be out there, you know, giving you best guesses, we'd rather just take the conservative road here and say that, yes, it's moving, we're on it, we think the outcome is going to be positive or we wish we could quantify, and we also wish we could tell you exactly when, but its in progress.

Thank you very much.

Thank you.

I would like to thank everyone again and to let you all know that from our vantage point it is extremely gratifying to be in a position to launch so many new avenues of growth and to increase our sales during such challenging economic times. As a leader in our industry, we also expect to continue to add market share, and a result of our strong product assortments, our interactive and front shopping experience and our brand reorganization, we expect that we'll continue to get more than our fair share of the business this year and beyond. Through our diverse portfolio brands and through our presence online, we intend to continue to grow by offering the products and services that consumer wants most. Where they want them, when 53 they want them, and how they want them. We're dedicated to serve the customer and that's been our credo for 35 years. We think that's why we're still here, we think that's why we're still growing, we think that's why we still are creating opportunity, and we certainly appreciate your participation. We thank you very much, you know, for your attention during this conference call, and we hope that consistent with the new fair disclosure regulations, we were complete, concise, and in detail on information for you so that you've got as much as we know right now, and thank you all here internally for your participation, and thank you all. I would look forward to talking to you again in our next quarterly call.

Ladies and gentlemen, this conference is available for replay beginning at noon central time today through tomorrow April 4 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1800-475-6701 and entering the access code of 571-311. Again that number is 1800-475-6701 and the access code is 571-311. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may all now 54 disconnect.