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Operator
Good day ladies and gentlemen. Thank you for standing by.
And welcome to the Best Buy fourth quarter conference call for fiscal year 2002. 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 depress the one on your touch-tone phone.
You may remove yourself from the queue at any time by depressing the pound key.
As a reminder, this conference call is being recorded for playback and will be available by noon Eastern Time today.
If you should need any further assistance, please press zero, and then star.
I would now like to turn the conference over to Jennifer Driscoll, Director of Investor Relations.
Jennifer, please go ahead.
- Director, Investor Relations
Thanks, Leah, and good morning, everyone.
Thank you for joining us today.
With me are Dick Schulze, Founder, Chairman and CEO, who will provide an overview of our performance, Al Lenzmeier, President and Chief Operating Officer of Best Buy, who will cover Best Buy and Musicland, and Darren Jackson, the CFO, who will give our financial highlights and outlook for the first quarter and for fiscal 2003.
, President of Future Shop, is on the call from Vancouver, and he will update us on our international business.
Also available for Q&A with me here in the room are Brad Anderson, Vice Chairman and CEO-elect,
, Senior VP of Public Affairs and IRO, and
, VP of Finance for Best Buy, and Mark London, Senior VP General Merchandise.
As always, comments made by me or by others representing Best Buy may contain forward-looking statements, which are subject to risk and uncertainties. Our SEC filings can contain additional information about factors that would cause our actual results to differ from management's expectations.
I'd like to remind all of you on the call that the media are participating in this call in a listen-only mode.
Also, in case you miss a portion of the call, I'd like to remind you with the replay instructions.
Simply dial 320-365-3844. That's 320-365-3844, and then enter the access code of 571319.
With that, I'll turn it over to Dick Schulze.
- Founder, Chairman, CEO
Thanks, Jennifer, and good morning, everyone.
I'm very pleased to report that the company's earnings for the fourth quarter of fiscal 2002 rose 84 percent to a record $350 million or a record $1.62 per diluted share. That is 22 cents per share higher than our original guidance in January of $1.35 to $1.40 per share and a one-penny above the current analyst consensus of $1.61 per share.
Our fourth quarter earnings per share also happens to be one penny shy of our total annual earnings per share that was achieved in fiscal 2000.
All three of our businesses exceeded expectations for the quarter.
Best Buy stores operating earnings grew 60 percent, reflecting sales increases, gross profit expansion and tight expense control. Musicland contributed 17 cents per share of accretion, a penny better than our original forecast of 16 cents.
For the first fiscal year of operations, Musicland contributed earnings of one cent per share, in line with our original guidance. Future Shop contributed earnings of five cents per share for the quarter and the partial fiscal year, well ahead of our outlook of one to two cents per share.
These strong results are very meaningful given the economic environment under which we produced. I also view this level of performance as an affirmation of our strategy and of customers preference for our format.
I'd like to thank all of our employees and our vendors for helping to make it happen.
Twice during the quarter we raised our guidance due to higher than expected sales and margins and lower than expected expenses.
December, as you know, brought very strong holiday sales. Sales were flat in January, then picked up modestly in February.
When the quarter finished, gross margins and expenses were even better than we had forecast, and the result was the 84 percent increase we announced this morning.
To me, the highlights of the quarter were, one, we achieved a four-and-a-half percent comparable store sales gain and a very strong 260 basis point improvement in the operating income rate at Best Buy stores, our largest business.
The increases were driven by the digital products cycle, advertising effectiveness and a strong in-stock performance, as well as an outstanding execution at the point-of-sale and a focus by the entire Best Buy team on exceeding our customers expectations.
Secondly, we have positive overall comps of 1.2 percent for the quarter at Musicland, despite a significant decline in music sales nationally, as well as substantially reduced mall traffic after September 11th.
Comp sales in Musicland's mall locations outpaced, by seven percentage points, overall mall traffic figures, which showed an average decline of six percent for the year.
The positive comps were driven by gain in sales of movies, as well as video gaming.
Sales of movies slightly surpassed sales of music for this quarter, consistent with our strategy of diversifying the overall revenue mix.
Thirdly, results at Future Shop were significantly above planned, despite the integration activities.
Sales and margin rates were well ahead of plan, while integration costs were lower than we expected.
I'd like to take this opportunity to congratulate our Canadian employees for their very strong performance.
And also like to recognize our US employees for helping with this entire transition. We're off to a truly great start.
At Magnolia Hi-Fi, comparable store sales declined by the low single digits, demonstrating an improved trend all year. Magnolia Hi-Fi continued to be significantly impacted by unemployment in the Pacific Northwest, which is currently the highest in the country.
California stores, in contrast, posted positive comps, a sign that the business can grow beyond its Pacific Northwest roots.
We're anticipating positive comps for fiscal 2003.
Including the impact of opening six new stores, sales for Magnolia Hi-Fi are expected to increase by about 20 percent to approximately $120 million.
For a more detailed and extensive report on Best Buy stores, I'll turn the call over to Al Lenzmeier, formerly our president of Best Buy, who has assumed the role of President and Chief Operating Officer of our entire enterprise.
, the President of Musicland who now reports in to Al, is traveling this morning. So Allen is going to cover the Musicland business as well.
Allen?
- President, COO
Thanks, Dick.
And good morning, everyone. Our results for Best Buy stores are detailed in the news release.
So I will focus on a few highlights and the outlook before turning to Musicland.
First, I would like to acknowledge and thank our Best Buy enterprise employees for their extraordinary performance this past year.
It was, arguably, one of the most difficult economic environments, coupled with three acquisitions, which makes me particularly appreciative of the results.
In the fourth quarter and in the year, we were simply hitting on all cylinders, with comp stores up, margin rates increasing and expense rates coming down.
First, we achieved leverage in SG&A expense for the first time since the first quarter of fiscal 2000. We, historically, have gained expense leverage whenever comparable store sales increase by three percent or better.
In this case, the leverage was greater than expected, due to December's high level of sales productivity and the importance of that month to the fiscal year.
We also have done an outstanding job of managing headcount, advertising and other expenses.
This performance demonstrates the value of huge leverage as we fill out the country over a more fixed cost base.
Second, we continue to lead the retailing industry in several respects, including sales productivity, gross margin per square foot and inventory turns, the results of our core competencies and training, merchandising, supply chain management, advertising and retail standard operating procedures.
According to PC data, our national market share, excluding appliances, continues to increase, finishing the calendar year at 13.8 percent, up 1.9 percentage points from the prior year, as we continue to meet our customers' expectations.
Third, in the fourth quarter, we saw positive unit sales growth in laptops and a more moderate decline in desktop PCs.
I attribute this performance to our industry-leading supply chain management, including our inventory management, merchant teams and our logistics network. Our sales in the category continue to lead the industry.
Inventory turns slowed slightly, reflecting the change in product mix, including fewer high-turning desktop PCs, as well as a conscientious effort to increase in-stocks in selected categories. Inventory per average store increased six percent.
The increase in inventory was principally related to video gaming hardware and software, as well as personal computers and digital products, specifically digital televisions.
Fourth, our product mix continued to shift away from the lower margin home office category and toward digital products.
We also continued to improve at providing customers with what we call complete solution selling. And this includes the sale of accessories, peripherals, PSPs and ISPs with the associated hardware sales.
The changes in our sales mix, combined with more targeted pricing and lower costs associated with financing offers resulted in the gross margin improvement of an extraordinary one-and-a-half percent of sales. At the same time, we were able to curtail the growth -- curtail the growth of expenses, decreasing our SG&A rate by 110 basis points, reflecting a reduced advertising expense as a percent of sales and higher employee productivity, as well as other cost controls.
As a result, our operating income for Best Buy stores rose to 8.3 percent of sales in the quarter, up by 260 basis points.
Our outlook for fiscal 2003 includes comparable stores sales at Best Buy stores of three to four percent for the first quarter, as well as for the full fiscal year of 2003.
I anticipate that the comp store sales gains will be driven by strength in digital products and video gaming, as well as modest improvement in our home office and appliance categories, slightly offset by continued softness in the sales of pre-recorded music.
Several of you have been interested in the status of our process for re-engineering our appliance business.
We believe that appliances are a key part of the mix for us. And we are very pleased with the reception of our -- the reception our ideas are receiving from our vendors, who are attracted by the demographics of the core Best Buy customer.
We have completed our discovery process and have determined our plan for changing this business. The action steps are being taken this year, with the primary changes affecting the customer experience, including the labor model, our point of sale system and product assortment.
We expect these changes to begin to have an impact this summer, allowing us to increase our conversion rate with customers who visit our appliance departments.
Some of the other changes we plan to make have a longer-term horizon.
And I will update you on these initiatives when we get closer to making them happen.
Others of you have asked about the music business, as well, which, from an industry standpoint, last year was down five to six percent on a per unit basis.
And I think is forecasted, actually to be some -- down somewhere around 10 to 12 percent unit-wise in calendar 2003. Obviously, this affects both Best Buy and Musicland.
And we can't sit on our hands. We are actively exploring ways to increase our sales of music over the Internet for the enterprise.
Yet, we must be pragmatic.
Therefore, we are assuming that music sales will continue to be soft in fiscal 2003 for both Musicland, as well as the Best Buy retail stores.
And, really, this is driven by continued file sharing, as well as increased competition with the discount channel and more competition for the entertainment dollar from this customer for purchase of DVD and video games.
The good news is that because of our broad portfolio of products in the software category, which also includes computer software, the company's software sales overall are up and are contributing to high levels of traffic in our stores.
Our capital expenditures for budget -- for this coming year includes approximately 350 million to open 60 new Best Buy stores, half in our and our standard 45,000 square foot format, using the concept five design and half in our 30,000 square foot smaller market concept five format. That total also includes any remodelings and relocations.
We are also -- we also expect to make continued system investments, including support for certain inventory management systems, our e-commerce infrastructure platform and customer relationship management systems. All told, Best Buy stores cap ex budget will be approximately $800 million, which also includes our new corporate campus.
Next, I'll cover Musicland highlights and forecast. We were pleased to achieve our operating targets at Musicland for the fourth quarter and fiscal 2002, including one cent per share of accretion for the first full year of operations.
We achieved that goal largely through expense reductions, including lower than expected levels of store expense, advertising and administrative and interest cost.
While comparable store sales for the year were down less than one percent, we achieved modest comparable store sales gains in the fourth quarter, despite reduced mall traffic.
Our positive comps reflected our improved mix of business, including faster growing products such as DVD software and video gaming, which offset continued declines in the sales of pre-recorded music.
In fiscal 2003, Musicland will continue to see gross margin rate declines as we anniversary the product mix changes as part of the re-merchandising strategy.
Margins are expected to decline nearly 150 basis points due to a higher sales mix of lower margin DVD movies and video gaming.
However, we expect comparable store sales to grow modestly as a result of the shift and mix combined with continued softness in the sales of music.
We do expect expense reductions to offset the margin erosion, as transpired in fiscal 2002.
We purchased Musicland in order to transform it as we did earlier at our Best Buy stores four to five years ago.
In fiscal 2003, we intend to increase investments to transform these stores and reposition the business to gain a larger share of wallet from our current customers, which are really the music, movie and gaming enthusiast.
We plan to continue to improve the sales experience in the stores and to diversify the product offering, including an expanded selection of DVD software and video gaming and consumer electronics as well as accessories.
We anticipate that these investments will drive value in the longer term, but they will reduce Musicland's operating results by approximately $40 million in fiscal 2003.
And this $40 million reduction is probably comprised of one-third in gross margin and two-thirds in terms of operating expenses.
And the operating expense is really driven by labor that will be incurred to re-merchandise all of the Sam Goody and On Cue stores as well as additional depreciation expense that will be incurred in terms of the investments in these re-merchandising as well as new point-of-sale systems that will be installed in all of our Sam Goody and On Cue stores that -- to provide and sell other solutions to the customer, as well as some additional labor costs to upgrade the wage costs in our stores to enable us to provide a better level of service to our customers.
We believe these steps are critical in the evolution of the Musicland brands.
An example of increased investments was announced in a separate news release this morning. Our test of the Sam Goody name with our small market stores has proven very successful.
Sales of small market stores with the Sam Goody name have significantly higher sales than identical stores with the On Cue name beginning with the first few days of operation.
In addition, establishing a common identity for the two brands allows us to further leverage advertising as well as field support for this brand.
As a result, we expect that we will remain a Sam Goody, all of our 200 plus On Cue stores by this fall. We also plan to move forward aggressively with re-merchandising these stores, as I described earlier, in terms of an expanded assortment of DVD software and also the addition of gaming to these stores, which was not added in fiscal 2002.
These small market stores are less expensive to build and to operate and have a higher EVA than the other mall-based Sam Goody locations. For those reasons, we plan to continue to expand our store count, adding 30 small market Sam Goody stores this fiscal year.
Our long term goal continues to be opening approximately 750 additional small market stores at a rate of approximately 75 stores per year starting next year, the calendar year 2003.
Consistent with previous years, we expect 20 to 25 percent of our existing leases to reach contractual expiration during the fiscal year.
The company performs EVA analysis on each renewal to ensure that locations meet financial expectations and closes those stores that do not meet these standards.
As a result of this renewal process and new store openings, we expect that the total number of Sun Coast and Media Play stores will remain unchanged during the year at approximately 400 and 75 stores, respectively.
Our goal by the end of the year is to operate approximately 800 Sam Goody stores including mall and small market locations.
We anticipate over the long term that the number of Sam Goody small market locations will eclipse the number of mall stores.
The actual number of stores operated year-end also depends on negotiations with landlords.
Given our business strategy and current business conditions, we are expecting comparable store sales gains at Musicland stores of one to two percent and total sales to be unchanged as a result of a reduction in store count.
The capital expense budget for Musicland is approximately $90 million, including new stores, the re-branding of On Cue, re-merchandising of Sam Goody stores, and technology investments such as a new point-of-sale system.
Now that we have operated Musicland stores for over a year, Musicland comparable store sales will be included in our total company comp calculation beginning with the first quarter of fiscal 2003.
Aggregating our US businesses, we are expecting comps of approximately four percent in the fiscal year, including three to four percent in the first quarter.
In addition, it is our intention to change our segment reporting effective with the first quarter to re-define our reporting as two business segments -- domestic and international.
The primary reason for this change is significant product and market overlap, the leveraging of our buying and distribution functions, and the merging of many of our back office functions into a shared service operation. As a result of the change, the operating results for Musicland and Magnolia Hi-Fi will be included with that of Best Buy stores into the domestic segment.
Looking at our domestic segment, improvement in profit margins are expected to be harder to achieve on top of the major gains that we experienced in fiscal 2002. My outlook for gross margin is that it will be essentially flat for the domestic business.
That assumes continued improvements in product mix at Best Buy stores, which will drive more margin, offset by planned margin declines at Musicland related to the change in the product mix I discussed earlier.
SG&A leverage will be limited in the first quarter, due to the impact of lower sales productivity and inflation.
We expect to achieve leverage in the second half, resulting in full year leverage of approximately 15 basis points in fiscal 2003 for SG&A. Our operating income would advance another 15 basis points as well on top of this year's gain of 80 basis points.
Now, I'd like to turn the call over to
, President of Future Shop.
- President
Thanks, Al, and good morning, everyone.
We had a very strong fourth quarter at Future Shop. Our 16.5 percent comp store sales gain was driven by triple digit growth in video gaming and double digit growth in DVD software.
We also had double digit increases in the sales of digital products, particularly digital televisions, DVD hardware and digital cameras.
Our operating margin expanded by 120 basis points on a pro forma basis, reflecting the expense leverage that high comparable store sales enabled.
The gross profit margin declined modestly due to key changes in the product mix, specifically an increase in sales of video gaming and DVD software, which carry lower margins.
Our primary goal in fiscal 2003 is to launch a Best Buy stores in Canada.
We will be opening six to eight Best Buy Concept Five stores this fall in the greater Toronto area, which will be the first international stores for the Best Buy enterprise. I'm very pleased to be charged with this exciting responsibility.
Our second goal for fiscal 2003 is to invest in the infrastructure required to support the Best Buy stores in Canada and to leverage into Future Shop the Best Buy retail practices that were identified during the post-merger integration process.
Our third goal is to execute the Future Shop business plan, which includes the opening of another eight to nine new stores across Canada.
We remain optimistic about fiscal 2003 and are anticipating comparable store sales growth of seven to nine percent, reflecting the continued expansion of the digital product cycle.
Total sales growth for the fiscal year is estimated at 21 percent on a pro forma basis or total sales of US 1.63 billion, reflecting a comp store sales gain and new store openings.
Operating margins in our core Future Shop business for the fiscal year are expected to improve by 30 basis points on a pro forma basis to 2.2 percent of sales. Gross margin is expected to increase by 20 basis points.
And SG&A is expected to fall by 10 basis points on a pro forma basis.
We are pleased that Future Shop will contribute eight cents per share, which is higher than our previous forecasts of five cents per share.
We plan to continue to collaborate with our US partners to establish best practices, as we believe we can benefit significantly from Best Buy's supply chain management and advertising effectiveness practices over the course of the year.
Our Canadian Best Buy stores will require an upfront investment to replicate the Best Buy customer experience, train our people and launch the brand.
We are estimating dilution of four cents per share to execute this plan. And this plan is still in the early stages of development.
And we will update you once it is finalized.
Our total capital expenditure budget for fiscal 2003 includes approximately 70 million US, the majority of which will represent new stores and a Best Buy Canadian IT system.
Next, Darren Jackson will recap the quarter's financial results and provide the company's outlook for the balance of fiscal 2003.
- Senior Vice President, Finance, Treasurer, CFO
Thanks, Kevin.
And good morning everyone.
Now that we have explained our expectations for our business segments for the first quarter and fiscal year, I'd like to share with you my analysis of our financial results for the entire enterprise in the past quarter and year, as well as our guidance for fiscal 2003.
One of the principal questions we're expecting this morning is the sources of our earnings out performance in the fourth quarter and how much of the improvements are sustainable.
In order of magnitude, the drivers were: one, better than expected sales.
Comp store sales rose four-and-a-half percent, or six-and-a-half percent adjusting for the calendar shift. Our internal estimate was three percent comp store sales gain, which means the actual comp gain was one-and-a-half percentage points higher than we expected.
We tend to get an SG&A leverage when comps are three percent or better.
Furthermore, each additional sales dollar over planned generally flows through to operating income at a rate of 15 cents on the sales dollar.
Two was expense control, the principal areas where we achieve leverage were in advertising expense, employee productivity and a reduction in outside consultant fees.
Three was improved gross margins.
The gains were driven by changes in product mix, as consumer electronics carries higher margins than home office products, as well as reduced mark downs. We also experienced lower costs associated with financing offers, due to the lower interest rates and a consolidation of our credit card business with household finance.
A number that we focus on as an organization is
, our barometer for success. In fiscal 2002, I'm pleased to report that our
improved by $70 million.
Our return on average equity was an industry-leading 27 percent, as well.
Lastly, before we turn to our guidance for fiscal 2003, our cash position stood at a very solid $1.9 billion as we closed the year.
Now I'd like to turn to our guidance for fiscal 2003. We anticipate total sales growth of 17 to 20 percent, which translates to 23 to 23-and-a-half billion dollars of annual sales.
Those sales include the impact of new stores, comparable store sales gains and the inclusion of a full year of Future Shop revenues. We expect gross margin rates for the enterprise to remain essentially even with the prior year for the reasons Al mentioned earlier.
We expect expense leverage of perhaps 15 basis points, principally in the back half of the year. Summing it up, we expect enterprise operating income to approach 4.9 percent of sales for fiscal 2003.
We expect interest income of $6 million, reflecting lower interest on cash balances, as well as interest expense on our convertible debt. Last year, as you recall, we had expenses of $8 million related to the retirement of Musicland debt.
We also expect depreciation and amortization expense to increase by nearly $100 million, in part due to the spending of $1 billion in capital, as Al discussed, with the primarily elements being new stores, remodelings, investments at Musicland to transform and reposition that business, as well as the development of our corporate campus.
Assuming a tax rate of approximately 39 percent, we are projecting earnings per diluted share of $3.15 to $3.25 for the year, an increase of 20 percent in total for the year.
The first quarter is expected to be constrained by lower contribution from Musicland, the inclusion of Future Shop results, which seasonally incur a loss in the first quarter, and the annualization of significant depreciation costs on system investments.
Our earnings guidance for the quarter is approximately 30 to 32 cents per diluted share, an increase of 20 percent over last year.
It is lower than the current consensus, but it reflects our best thoughts, as well as some of the structural profit formula changes that have occurred with our recent acquisitions and the timing of profitability. But make no mistake about it, we are very upbeat as we turn the page on a new fiscal year.
With that, I'll return the call to Dick.
- Founder, Chairman, CEO
Thanks, Darren.
Such strong results and such positive guidance for next year are indications to me of the success of our strategy, along with the future strength of the digital product revolution, which is just beginning.
Clearly, Best Buy stores are the center piece of that strategy.
And it remains the key driver of our growth for the next several years. That growth will be derived from new stores, including an increasing percentage of our smaller market stores, as we fill in the country with our well-known yellow tag.
That growth also will come from strong, comparable store sales, spurred by the expanding digital product cycle with products like digital television, which still have a very low household penetration rate.
The wild card for us, of course, is the desktop computer business, where our focus will remain on offering customers strong alternatives from which to choose.
Our Best Buy stores out-match every other retailer we track on the measures most important to us. We have the industry's highest sales per square foot, at approximately $830; the industry's highest inventory turn, at approximately seven-and-a-half times; and the industry's highest return on equity of 27 percent in fiscal 2002.
We have an experienced management team, which has faced and surmounted many challenges in the past decade. We also have in excess of 600 million customer visits each year, which I view as one of our most significant opportunities.
After all, these other brands sell similar products and use the same vendors while offering a differentiated customer, more women, more young people, more rural consumers, high-end consumers and, of course, our
international consumers. All of us throughout the Best Buy enterprise are quite optimistic about the year ahead of us.
We feel very comfortable with the business plan that we have agreed upon for continuing our growth well into the future.
Now I'd like to ask
to open it up for questions from our investor audience.
And we'll do the best we can to respond to any and all of your questions, as time will allow.
Operator
Very good.
Ladies and gentlemen, once again, if you have a question, please depress the one on your touch-tone phone.
You may remove yourself from the queue at any time by depressing the pound key.
One moment, please, for the first question.
Our first question will come from
from Salomon Smith Barney. Please go ahead.
- Founder, Chairman, CEO
Good morning, Bill.
Good morning.
Thanks and congratulations.
I just want to point -- first of all, just a point of clarification.
As I understand it, you said that as far as you can tell the difference between consensus for the first quarter guidance is the timing of the profitability of your acquired businesses. Is that correct?
- Senior Vice President, Finance, Treasurer, CFO
Bill, this is Darren. That's part of it.
Part of it is when you look at our profit formula -- and I'll use the example of depreciation expense -- many of our system investments come on board in the fourth quarter.
And as you know, we're going through a significant ERP implementation.
So, in this upcoming year one of the things we'll phase is significantly more depreciation and amortization expense in the first quarter, which, by its nature, has lower sales productivity just because of the seasonality of the business.
So, we are both experiencing this seasonality of some of those types of investments plus some of the acquisitions.
And as I said in my comments, Musicland, too, will be somewhat lower in the first quarter than what it was last year.
But the overall Best Buy business it's very healthy in the first quarter.
OK. That's helpful.
Unidentified
Hey, Bill, we might also comment that, if you recall a year ago, we had actually guided the street to a number that was below that we were -- that we had accomplished in the previous year for pretty much the same reasons that Darren has just outlined.
And, of course, as you can tell from this guidance, we're about 20 percent ahead of what we did in the first quarter last year.
So, I think we're gaining good efficiencies and good economies, recognizing that the first quarter is certainly not our strongest.
OK. Darren, you also mentioned that part of the upside in the fourth quarter was due to employee productivity. And if I read between the lines here, I'm guessing you may have hired as many employees for your holiday season as you normally would have.
How sustainable is that looking forward?
- Senior Vice President, Finance, Treasurer, CFO
Bill, I would characterize the employee productivity is more corporate productivity.
I think in terms of our stores we absolutely -- if we're going to make any reductions we're going to make it in the stores last because that touches the customer first.
So, I think we made a very conscious decision this year to try to hold down headcount in corporate given the economic times.
And we didn't let off of that, and we continue to monitor it closely in an effort to deliver the results we delivered in the fourth quarter.
OK, great. Thanks very much.
Unidentified
Thank you, Bill. Next question, please.
Operator
Our next question comes from
from Deutsche Bank.
Please go ahead.
Good morning. Two questions.
First, in understanding the repositioning of the merchandise mix in the mall Sam Goody stores and the bigger focus on DVD movies, it looks like there's going to be a flurrying in the position between Sun Coast and Sam Goody's and that there's a risk that your Sun Coast could actually be cannibalized by the change in mix in the Sam Goody locations.
Unidentified
Yeah. I think that's not tremendous risk because we see for the next several years substantial growth in the DVD product category.
And Sun Coast has a very, very -- some very specific customers, very different from the core customers visiting a Sam Goody stores. It tends to be more male.
It tends to be older.
The Sam Goody store has the female customer who's younger.
And so both we've got growth in the -- tremendous growth coming from DVDs on a sustaining basis and we have a differentiated customer in the two brands. So, we don't expect much of a problem there.
Unidentified
There also -- Dan, there is a location advantages. With Sun Coast and Sam Goody, they're almost never close by each other.
And as you know, over two-thirds of those stores are in major regional malls.
So, we have a geographic dispersion in where those locations happen to be located for either Sun Coast or Sam Goody.
So, we get the benefit of tracking consumers from different portions or sections of the mall.
And then also one question for Al on the -- your appliance business.
In the month of December, as I recall, the -- that category comped up about 15 percent, but for the quarter as a whole, as I recall, it's down about five. If you could discuss and why the changes that you implemented in December seem to have lost traction in the following two months and perhaps if you could just go and discuss for that business is trending early in the first quarter.
- Senior Vice President, Finance, Treasurer, CFO
I think we had a positive comp for the entire quarter, Dan, for appliances -- major appliances, OK.
OK.
Unidentified
I believe it was 15 percent, though, wasn't it?
- Senior Vice President, Finance, Treasurer, CFO
No.
But if you just look at major appliances by itself and exclude vacuum cleaners and microwaves and that type of thing, the major appliance business was up for the quarter. And I guess -- it's trending positive so far this quarter as well.
And the industry, I believe, is up about five percent year to date. Would you be running in line with that?
- Senior Vice President, Finance, Treasurer, CFO
Yeah. We really don't want to get into ...
OK.
- Senior Vice President, Finance, Treasurer, CFO
... specifics at this point.
We'll talk to you about it at the end of the quarter.
OK. Great. Thanks.
Unidentified
Thank you. Next question, please.
Operator
And our next question comes from
from Goldman Sachs. Please go ahead.
Excuse me. Thank you very much, and good morning. I'd like to talk first about the timing of the investment in the Musicland stores.
You all made reference to, I believe, roughly $40 million of earnings dilution that you expect to take for a variety of the moves you're making in that business.
Can you talk about the timing of those, I guess, one-time items?
Unidentified
Well, the $40 million is split, like I mentioned before. About one-third of that is margin, Matt.
Right.
Unidentified
And that's due to the change in mix. The movie and the gaming business obviously is at a lower gross profit margin than music.
So, that margin erosion has really spread throughout the year and in proportion to the sales. They're spread out.
And then the other things I probably -- I would expect depreciation again -- that's going to be spread evenly throughout the year. The labor cost in terms of going in and re-merchandising the store, that's all going to take place during the first two quarters of the year.
That's for both Sam Goody as well as On Cue.
And is that labor piece roughly one-third of the $40 million?
Unidentified
Well, no.
I'd say it's probably 20 percent or so.
Got you. So, the first half will get a bit disproportionately ahead.
Unidentified
Yeah. We're spending a lot of money in the first half in the benefit. Most of that benefit is really going to be derived in the second half.
If you look at it, On Cue, in terms of all the changing of the name, we're going to expand the movie assortment, I think, at something like 35 to 40 percent in the On Cue stores.
The On Cue stores didn't receive gains, or I think it was very limited last year.
So, that's going to be a fairly big expansion in terms of gains. And all of that will be put in place by the end of August.
And then on the Sam Goody side, again, we're going to increase both DVD and gaming assortments in inventory, anywhere from 35 to 40 percent. All of that will be accomplished by the end of September.
We're also changing within the store in terms of where some of the product is merchandised so that there's more clearer delineation between musics -- between music, movies and games as well as the interactive devices right now.
They're kind of bunched together for games and they're going to be put adjacent to the specific gaming platform. So, it'll improve traffic flow.
We're also going to change where we've merchandised a lot of the accessories. We're also looking at probably adding apparel into both Sam Goody and On Cue, apparel that again mixes with the music, movies or game theme.
We're also looking at probably adding instruments in some of the larger Sam Goody stores as well as the On Cue stores.
And also, we're making a concerted effort, just like we did with Best Buy starting back in '97, in terms of improving the service level of both really all of the stores, the whole -- the Musicland, the On Cues, Sam Goody and Sun Coast, but particularly Sam Goody and On Cue.
I think there's a big opportunity to substantially improve the level of service. And with the new point-of-sale will enable us to branch out and sell more accessories and solutions to the customers.
So, we think there's a big opportunity to sell a wider array of accessories and solutions to this demographic that we currently serve on the music and movie and gaming hardware side of the business.
Got you. Thank you.
A second question, if I could.
You had eluded during your discussions of inventory to the PC sector being one piece where the inventories are a bit higher.
If you could just elaborate on what the drivers of that are, to what degree that was planned and what the status of that overall sector is in terms of inventory for you.
Unidentified
We made conscientious effort to improve our in-stocks. We started that really back at Christmas time.
Right.
Unidentified
And also, following through the end of the year, in the PC I think there was a slight difference in model changes this year versus last year. And we just want to make sure that we were in a good position and a strong position.
And I think based on what we've done, the results that we have seen so far have certainly demonstrates that what we did in that particular area has had payoffs.
OK. And ...
Unidentified
So, as you can see, with -- some of the reports from some of our competitors in terms of out-of-stocks, you're not seeing the same thing at Best Buy stores.
Right. Third and finally, you made reference to increased investment in the rural small town store format, you know, the historic on queue format. Given that you look at your return so closely, I'm curious, what the financial returns on opening those stores look like compared to some of the other uses of your capital, particularly opening new Best Buy stores?
Unidentified
Well I think if you look at that compared to mall operation, you're looking at, you know, rent of $8 a square foot versus $42 a square foot. Your labor rates are less expensive.
And actually, the volumes of those stores are kind of coming together. There's not that big of a gap.
So there's, you know, obviously a little less competition there as well. So it's -- we look at it, you know, as a big opportunity.
Really, I mean comparable to what we, you know, put into it in terms of returns we get on a Best Buy store.
Great. Thank you very much.
Unidentified
Thank, Matt. Next question please.
Operator
And that comes from
from Lehman Brothers, please go ahead.
Yes, I would like to add my congratulations as well.
Unidentified
Thanks, Allen.
With respect to the 200 on queue stores that are going to be converted, can you tell us what that expense will be in total? And will that capitalized or expensed?
And what type of a disruptions if any -- do you think you may see of these 200 stores during the conversion process?
- President, COO
Well first of all, in terms of capital versus expense, I mean obviously, all of the signs that we put are capitalized.
And I think basically the old signs are probably -- I would expect they're pretty well depreciated or it's a minimal amount.
In terms of what we do in the store in terms of merchandising, all of the labor associated with that, you know, it's a policy in Best Buy as well that all of those expenses are expensed.
You know we'll put some probably some new fixtures in. We talked about putting a new point of sale in.
Let's see what else?
Unidentified
I think also, Allen you should know that there really is not much disruption, even though there's a lot of physical activity going on in the building.
Historically whenever we do those kinds of remodels, it almost signals a buying excitement or opportunity for consumers. So we don't look for really roll off in revenue out of those stores.
- President, COO
Yeah, and we've go a team that we use from Best Buy as well, to, you know, is very experienced in going in and doing remodels so this is a relatively quick process that doesn't cause a lot of disruption.
Unidentified
Yeah, we're very proud of the fact that last year, the Musicland team actually re-merchandised 450 Sam Goody stores out of the 650 in something like a 90 day period of time.
So they know how to do that.
And of course on queue now to be Sam Goody rural stores are going to go through a bit more extensive remodeling because we're going to sharpen the focus of the offering to these stores.
As opposed to some of the looseness that, you know, pre existed in just putting smatterings of a wider variety of product in their, we're going to have more intense focus. So I think at the end of the day we'll get a lot better ability to brand to that strategy in the rural market as well for a broader section of the rural consumers.
OK. And one follow up if I may, with respect to, you know, Circuit City, if the company embarks on yet another remodeling program over the next few years, is there anything like proactively that you will do to try to target, you know, their consumers during the remodeling period?
- President, COO
You know, I don't that it's, you know, I don't know that it's realistic to expect that, you know, we're going to do anything other than what we would traditionally look to do.
And we think that there's been market share shift occurring over the frame work of the last year-and-a-half. We like to credit the fact that our store format has been instrumental in, you know, creating a preference for consumer.
And our inventory team has done much better job too. And including the point Al made about a six percent increase in the level of the inventory carried in the stores to make sure that we're in stock all of the time, every time as often as we can be.
And in the spirit, I think, of just building on a better shopping experience, our take away is that there is an evolution here that will happen naturally if we execute the way we should, at retail. And we think we'll continue to take market share as a result of it.
OK. Thanks a lot.
Unidentified
Thank you, Allen. Next question, please.
Operator
And that comes from
from UBS Warburg, please go ahead.
Thanks, guys. I had two questions. One you mentioned, that the store opening program for fiscal '03 would be about half-half on 30K stores versus 45K.
Could you tell us what that same ratio was for the year that's just passed?
Unidentified
Yeah, it was two-thirds, one third.
Unidentified
Two-third 45, one-third 30.
OK. And then the second question is, on the music business it sounds like that's going to get incrementally weaker at least based upon industry forecasts.
What are you planning on doing to offset that? Is there going to be something to watch on the pricing standpoint or things like that?
Or are you itching to let that business get a little weaker?
Unidentified
You know, the business is continuing to decline.
We are going to look at ways of trying to garner a larger piece of the pie, even though the pie is shrinking. We want to go out there and try to, you know, obtain a bigger percentage of that pie.
So, you know, one of those avenues is obviously the Internet. And we're continuing to make investments to improve, you know, the platform that we operate on.
One of the other things that we've done this year is our best buy dot-com segment is now being incorporated under our best buy retail business unit, reporting up to
. And we want to integrate much tighter the BestBuy.com experience into our brick and mortar experience.
And we think there's, you know, there's some big opportunities to greatly expand what we do on the Web particular in the software entertainment area.
So that's one of the areas that we see that we can, you know, hopefully, you know, pick up a significant amount of business.
And we're also obviously looking at ongoing from a, you know, from a marketing standpoint, as well as a store standpoint, what can we do more effectively gain more business, you know, in the music.
But at the same time, I think we have to face the fact that that industry is going through a significant change. There's something like 3.6 billion songs are downloaded monthly.
The number of, you know, hot new releases that sell a lot continue to decline each year. We're dealing with a much more diversified population in terms of music taste.
We think there's some opportunities to maybe more effectively address that on a regional basis.
But it's also an industry issue that obviously we need to participate in to try to come up with a solution to I guess be in better -- or be in a position to provide a better value to the consumer, you know, over the next two to four years.
But in the interim in term of the transition, we recognize that we've got to look at some different ways of trying to garner a bigger share of the business.
Unidentified
We might as ask,
, we might ask Brad to comment a little bit also here about -- now he was at
a few weeks ago.
And I know that the music industry is looking towards to Best Buy as a player that could have considerable influence in stimulating, you know, some interest from consumers about new release, new artists, obviously, you know, the ongoing catalog sales. So Brad, maybe you might just want to talk a bit about, you know, the task force you put together, you know, internally to create that more of full core press.
- Vice Chairman, CEO-elect
Well I just -- I think there's two things, one of which is that the industry because of the difficulties it's facing is willing to consider doing things that they were not willing to do before. Now this is very early stage.
And as Al, has alluded to, we're looking for with a team here to see if we can help lead. It's a very critical category to us and one that we care a great deal about, so we would expect to exert a leadership role in the industry.
Again, not dismissing what's currently going on, facing up to what's going on. But over the long haul we help to -- we expect to play a protagonist role in helping to build a stronger business here.
Unidentified
And remember, too, we have four distinctive categories of software. As Al had pointed out in his comments, the combination of computer software, video gaming obviously along with DVD which is certainly the fastest charging segment video gaming and DVD certainly has moved to help offset to softness in music.
So we do have the, you know, the opportunity in our stores to draw traffic, stimulate the integration and cross selling of hardware and software across four different categories. So the store still has a tremendous amount of excitement in it.
But we are very meaningfully looking to find ways to see if we can't diminish the effects of, you know, the softening CD business or music business.
Unidentified
And I would expect, just like what transpired in the consumer electronic business over the last 10 years, that as a result of that pie shrinking there's also going to be a consolidation in terms of music retailers that will happen as a result of this.
Thank a lot.
Unidentified
Thank you,
. Next question, please.
Operator
Our next question is from
from Bank of America, please go ahead.
Good morning. Two questions.
Could you tell us what the advertising expense was as a percent of sales in the fourth quarter? And then as it relates to the year ago period?
Unidentified
I think the only comment on that is as a percent of sales it was less, it doesn't mean we spent less, but, you know, as a percent of sales it was less.
Didn't mean we spent less, but as a percent of sales it was less. And we did not decrease the level of advertising that we did.
In fact, I think it was pretty much the same as the prior year.
But obviously with more sales, we were able to leverage up. Plus, obviously with the downturn in the advertising business, we were able to get more for the value the entire fiscal year.
Unidentified
We would look to gain continued leverage on the advertising side of the equation as well. Obviously, as most of our fixed based cost of operations in place, I would expect that certainly with a national position as established we'll have the opportunity to continue to make some gains there.
Unidentified
And that kind of leads into the second question. You had such tremendous improvement in productivity in your Best Buy stores in the fourth quarter.
Do you see any further opportunity in that division in the fourth quarter, or is there still room for more margin improvement?
Unidentified
Well, I think from a margin improvement like we talked, because we made some fairly significant changes this past year and you've got, again -- you've got product mix that's happening as we talked about games.
It's still going to be a big driver and it'll drive more comp store sales, but again at the lower margin. You've got digital products, which are on the other side.
So, it's a combination of things.
And I guess we're probably looking at more of a flat margin overall.
Again, that's driven by Musicland being down 150 basis points, and some slight -- obviously, we're going to have some slight improvement in gross margin on Best Buy due to some combination of both mix and rate.
Unidentified
OK. And then finally the Sam Goody stores relative to the On Cue stores, those boxes in terms of productivity, where -- when you're converting them and moving forward, where do you expect operating margins to net out at the end of the day?
Unidentified
Yeah. I don't think we've got that broken down. I mean, we're still kind of relatively new into this in terms of understanding what's going on with the customer and continuing to experiment with different things.
I mean, I just think that there's a lot of customers there that we have an opportunity to do a better job of serving those customers and to garner a bigger share.
Unidentified
Would it be safe to say you would think that the operating margins will still be higher than those of the Best Buy stores?
Operator
Ladies and gentlemen, we do apologize. We have lost the host line.
One moment, please, while we attempt to reconnect.
And, ladies and gentlemen, thank you once again for standing by.
We are reconnecting the host at this time. The conference should resume momentarily.
Unidentified
Hi,
.
Hi.
Unidentified
We got cut off.
And we'll assume that the question that didn't get answered was will the returns operating margins of Sam Goody rural be better than those of Sam Goody mall store. And I think the short answer is yes, in part because of lower labor costs, in part because of lower rent costs.
And to Al's earlier comments in the script, what we're seeing is a very nice productivity pick ups when we convert those stores.
And they're maturing a little faster.
And that is what is driving part of our decision in order to convert those stores as well as the brand synergy of being able to nationally advertise. So, the answer is yes, but we're not in a position to quantify and give you that number.
We know what it is. We just don't give those numbers out at this point.
- Director, Investor Relations
We have time for one final question.
Operator
Very good. One moment, please.
And that question will come from the line of
with Sun Trust Robinson Humphrey. Please go ahead.
All right. Two questions. First is could you give, if you're willing, either breakdown in unit or dollar trends for digital versus analog and TVs and your expectation for that this year?
And the second is you noted less use of financing in one of the supports to gross margin this past quarter. Could you talk about what you're doing today in use of financing and how you see that impacting gross margin in the next year?
Unidentified
Michael, maybe you can address on follow the ratio of digital TV to analog, probably particularly in the big screen area, David. Is that what you're interested in?
Yes, exactly.
Unidentified
In the big screen area, it's about 75 percent digital.
And we also see about 50 percent of sales currently in the 16 by nine wide screen format. So, digital's biggest strength is in the larger screen sizes.
Unidentified
I guess if you look at total television, 25 percent of our TV business is digital. That's the total TV business total.
Unidentified
Yeah, up from 11 percent last year.
Unidentified
And that's all revenue.
Unidentified
In dollars. In dollars.
Unidentified
What was the other question?
The other question was on use of financing.
Unidentified
Specifically, David -- I'm sorry, I was looking for digital TV information.
Sure. It was -- in the fourth quarter you noted less use of financing as one of the supports to gross margin. Could you talk about your plan for use of financing, what you're doing today?
Is that -- it looks a little bit like finances make its way back in the marketplace in general. Is that accurate or is it not? How are you thinking about using that this year?
Unidentified
David, the way to think about it is volume and rate. So, in terms of financing offers, I think it's fair to say we had a similar amount of financing offers.
Where we're really seeing the benefits is in lower rate. So, when interest rates decline -- and I don't plan to get into the details of how our external relationship works -- but we benefit in the marketplace when external interest rates decline.
And we're seeing that show up in our gross margins. And that was the principle benefit that we saw in the fourth quarter.
OK. Understood. So, does that mean that you'll be using -- I guess I'm thinking about it more from the going to market standpoint or even as a customer would think about it.
Are they going to be seeing that more? I'm thinking more on the top line, what we can expect to be hearing about in terms of promotions.
- Founder, Chairman, CEO
I think it's a tool that we use with our many levers that we use when we go to market. Sometimes it's the amount of SKUs we advertise, sometimes price, sometimes financing.
We evaluate all those offers to see which has the biggest impact for our consumers.
Fair enough. Thanks.
- Founder, Chairman, CEO
Thank you, David.
And thank you, everyone. It was obviously a record quarter and a record year.
And I'd like to take this opportunity to certainly thank you, our investors, for your continued support and interest in what it is that we are doing at the Best Buy enterprise as we build for our future and would also like to certainly add our thanks to all of our employees of 90,000 strong who continue to support us in elevating the level of their execution day in and day out.
We're looking forward to a great year next year and we'll obviously be keeping you in total contact quarter by quarter as we discuss those results. So, thank you.
And, Jennifer, I'll turn it back over to you.
- Director, Investor Relations
Thank you, Dick.
Thank you for participating in the call. Again, this call will be available for replay by dialing 320-365-3844 and then enter the access code of 571319.
or you can hear a replay of our call on the Web at www.bestbuy.com then click on "Investor Relations" and "Recent Presentations".
If you have additional questions, please call me directly, Jennifer Driscoll, at 952-947-2350.
And with that, we'll conclude out call.
Operator
Ladies and gentlemen, that does conclude your conference for today.
Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.