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Operator
Thank you for standing by.
Welcome to the Best Buy second quarter earnings conference call for fiscal 2003.
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 one followed by four on your touch tone phone.
As a reminder, this call is being recorded for play back and will be available by 12 p.m. eastern time today.
If you need assistance on the call, please press star zero on your touch tone phone.
I would now like to turn the call over to Ms. Jennifer Driscoll, vice president of investor relations.
Jennifer Driscoll - VP Investor Relations
Good morning, everyone.
And thank you for joining us today.
With me here at Best Buy are Brad Anderson, vice chairman and CEO, who will provide an overview of our performance.
Al Lenzmeier, president and chief operating officer will give a report on our domestic and international stores.
Darren Jackson, executive vice president and CFO, will provide the outlook for the second half.
Kevin Layden, president of our Canadian operations is on the call from the road.
Also with me in the room and available for our question and answer session are Mike Keskey, president of Best Buy retail stores;
Kevin Freeland, President of Musicland stores;
Michael London, executive vice president, General Merchandise Manager.
Susan Hoff, senior vice president and Chief Communications Officer.
Bruce Besanko, vice president of Planning and Performance Management and Shannon Burns, senior investor relations manager.
As always, comments made by me or others representing Best Buy may contain 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.
I'd like to remind all the participants that the media are participating in this call in a listen-only mode.
Also, in case you missed a portion of the call let me give you replay instructions.
Simply dial 973-341-3080 and enter the personal identification number of 3488174.
I'll repeat them at the end of the call.
With that, I'll turn the call over to Brad Anderson, who will begin our prepared remarks.
Brad Anderson - Vice Chairman and CEO
Thanks, Jennifer.
Good morning, everyone.
This was a difficult quarter as consumers in July suddenly reigned in their spending in reaction to weakness to the economy and in the financial markets.
The significant change in consumer behavior, coupled with our inability to cut expenses quickly, and the expected decline in the gross profit rate, precipitated a decline in the company's earnings for the second quarter in fiscal 2002 to 62 million dollars.
Earnings per share decreased 27 percent to 19 cents per diluted share and these results fell in the middle of the earnings range we provided in early August of 17 to 21 cents per diluted share.
Our revenues for the second quarter as reported on September fifth rose 20 percent to five billion dollars.
The revenue increase included the impact of new stores opened in the past 12 months, the addition of Future Shop's revenues and a comparable store gain of two percent.
The slow down in comparable store sales growth is in line with the experience of other retailers in the quarter.
Consumer electronics generally performed better than other product categories and the quarter began much stronger.
However in June, and June was in line with our expectations with comparable store sales gains of five percent.
However, in July, comparable store sales began to flatten and received only modest gains in comparable store sales in July and August.
While we are less than satisfied with the quarter's results, the good news is that we are taking action.
We recognize the change in the competitive landscape, including a more value conscious shopper, a trend of savers commodity retailers and we have 11 verse we can pull in response to this trend.
Furthermore given the pressure on the telecommunications industry we expect our vision of the networked home to be somewhat further delayed as well and we are slowing down investments we made to prepare for that development.
We have also tabled for now any international expansion and likewise do not expect any major acquisitions within the next 18 months.
These decisions to delay or take off the table certain strategies will allow us to focus our energy on our core growth engines.
I've outlined to employees four point plan for improving our profitability and growing our market share in the second half.
I'd like to talk about the four point plan and then I'll recap the quarter's business highlights.
Afterward, Al will review our results and the performance of our four product categories and finally Darren will outline the company's outlook for the remainder of the fiscal year before we open up the call for your questions.
Our four point plan for improving our profitability and market share is as followings.
Number one we plan to reduce costs in areas that do not impact the consumer.
Such as reducing hiring of corporate employees.
Reducing the use of outside services, cuts in discretionary advertising.
Tighter control of field expenses and delays of projects that are not mission critical, or that have uncertain or slow returns.
We will not cut labor in Best Buy stores or reduce our core marketing activities.
Two, we expect to push forward with our new store opening programs.
We expect to finish the fiscal year with 70 new domestic Best Buy stores, including 35 stores opened in the second half.
That's ten more stores than we originally planned.
And in general the store openings are occurring somewhat early in the year than they usually do.
We believe that this will put us in a strong position for the holidays.
We also include - excuse me.
We also plan to continue with our existing growth plans for our other plans including new Future Shop stores, 30 new mall market Sam Goody stores, and six Magnolia Hi-Fi stores by the end of fiscal year.
Three to drive shares in market share we will focus our energy on popular products such as home theater digital products and video gaming which will continue to drive sales in the second half and beyond.
We will leverage our outstanding vendor relationships to provide a compelling assortment that responds to current consumer behavior.
Four, because we recognize that employees are a key competitive advantage, we will continue to work to enhance their capability to offer the best customer shopping experience possible.
Now let me return to the topic of the second quarter.
The business highlights were as follows.
First we continue to grow by opening new stores.
We opened 22 new Best Buy stores in the past quarter, including four stores in Salt Lake City, the last major U.S. market for Best Buy to enter.
We also launched Best Buy stores in Canada with our first location in Toronto and opened three Future Shop stores as well.
Finally, we opened three rural Sam Goody stores and closed a dozen mall based stores that were not meeting our profitability target.
Second we continued to benefit from the growing acceptance of digital products.
Digital television, DVD players, DVD movies and digital cameras all experienced strong growth in the quarter as consumers increasingly recognized the superior quality of these products over their analog counter parts.
Satellite systems also showed double digit growth as consumers looked for improving signal quality and programming variety.
We believe that Best Buy and Future Shop will continue to benefit from the move to digital products for some time.
Earlier adopters of this technology current to upgrade their equipment while mainstream consumers are still discovering the technology and buying the superior products for the first time.
Digital products now comprise 20 percent of the total sales which is an increase of five percent over the same period last year.
Third, we completed the rebranding of our On Cue stores to Sam Goody which contributed to a lift in sales in these stores.
During our tests average sales at the rebranded Sam Goody stores increased almost 20 percent over their On Cue counter parts.
In addition, the new rural test stores that opened under the same goody brand generated 40 percent higher sales than the stores that opened as On Cue.
With that, I'm going to turn the conference over to Al Lenzmeier, president and CEO.
Al Lenzmeier - President and COO
As Brad mentioned, the landscape is changing.
However, we believe we can continue to compete successfully against mass merchandisers and other consumer electronics retailers.
We offer a differentiated customer shopping experience which includes greater assortment and an exciting in-store experience, the ability to sell solutions and a reputation for offering value.
All of us on this management team have been through recessions before.
We have firsthand lived through the challenge of facing adversity, making adjustments and emerging with an increased market share.
We have achieved that by offering more of the products and price points that consumers are seeking without come compromising profitability.
Given the talents of our employees and their capacity to innovate, I have no doubt that we're well positioned for today's unique challenges.
The comparable store sales gains within our domestic segment which includes Best Buy, Magnolia Hi-Fi and Musicland stores was two percent.
Reflecting lower than expected levels of customer traffic versus a year ago.
The comparable store sales gain was 2.7 percent at Best Buy, which accounts for the largest percentage of the company's sales.
Digital products and video gaming had the strongest results as expected.
We also saw a doubling of our on-line sales during the first half which contributed to the comparable store sales gain.
Musicland comp decline of 3.4 percent was below our expectations reflecting the decline in mall traffic, heightened competition from other retailers and continued weakness in sales of prerecorded music.
The impact for Magnolia Hi-Fi was the comp decline in the low single digits.
While we sold a greater percentage of higher margin digital products and a lower percentage of low margin desk top PCs, our gross profit rate declined by 40 basis points.
Margin pressure came from lower margins in our home office business, as well as the continued shift in product mix to lower margin movies and gaming products at Sam Goody stores.
As expected, we also saw an uptick in the promotional environment relative to last year.
The selling, general and administrative expense rate increased by 100 basis points.
Reflecting the increased expenses mentioned in our press release as well as the addition of new stores.
These factors, as well as the inclusion of Future Shop results, contributed to a drop in the operating income rate of 140 basis points.
Our international segment in the second quarter included Future Shop stores and a you days results of the Canadian Best Buy store located in the suburb of Toronto.
Comps at Future Shop were 6.9 percent the gross profit rate increased 70 basis points but SG and A expenses as a result of percentage of sales increased by 240 basis points.
The SG and A rate increase was due to plan investments to improve the future efficiency and profitability of that operation, similar to the process-to-process initiative that we implemented in the United States several years ago.
And also to support the launch of the new Best Buy stores in Canada this year.
The international segment operated an operating loss of one million dollars for the quarter, modestly better than we expected.
Later this year we plan to test a 20,000 square foot format for U.S.
Best Buy stores that will utilize aspects of the concept pride design.
If successful it will give us a way to reach markets with the population of less than 125,000 draw.
We believe this store size could give us an opportunity to open an additional 150 locations, bringing us to one thousand Best Buy and Future Shop stores in North America over time.