百思買 (BBY) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Best Buy fourth quarter conference call for fiscal year 2004.

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 on your touch-tone phone, followed by four.

As a reminder, this call is being recorded for playback and will be available by noon eastern time today.

If you need assistance on the call, please press star zero, and an operator will assist you.

I would now like to turn the conference call over to Jennifer Driscoll, Vice President of Investor Relations.

Thank you Maria.

Good morning everyone.

Thank you all for joining us today.

With me here in Minneapolis are Al Lenzmeier, President and Chief Operating Officer, who will give report on our operations and an update our four strategic initiatives, and Darren Jackson, Executive Vice President and CFO who will comment on our earnings drivers for the fourth quarter.

He'll also elaborate on our earnings outlook for fiscal 2005.

Kevin Layden, President of Best Buy Canada, is participating on the call from Vancouver and Ron Boire, Executive Vice President and General Merchandise Manager is joining us by phone as well.

Also with me here in the room and available for our Q and A session are Mike Keskey, President of Best Buy Retail Stores and Shannon Burns, your Investor Relations Manager.

I'd like to remind that you that comments made by me or by 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 expectation.

As usual the media are participating in this call in a listen-only mode.

Also, in case you miss a portion of the call it is available for replay.

Let me give you the replay instructions.

Simply dial 973-341-3080 then enter the personal identification number 4630518.

With that I'll turn the call over to Al Lenzmeier, Chief Operating Officer who will begin our prepared remarks.

Thank you, Jennifer.

Good morning everyone.

By the way Brad sends his regrets.

He's at home with a bad cold so I will give his report this morning.

I guess I couldn't be more proud of our employees given the impressive results that we will review today.

We enjoyed a strong performance from nearly every corner of the company this past year.

Comparable store sales rose 7.1%, revenue rose 17% to $24.5 billion, earnings from continuing operations jumped 29% to $800 million.

It was our 7th straight year of double-digit increases in operating income.

Our strong cash position enabled us to initiate a quarterly 10-cent dividend and to resume repurchases of our common shares.

This overall performance placed us among the best retailers last year.

Our quantitative measures support this conclusion.

We believe that our market share attained a new high, including significant gains in several product groups that will be key to our future success.

Customer loyalty, customer satisfaction, brand awareness and employee attitude measures, also hit all-time highs for us.

We have an incredible set of employees running our stores and supporting our business.

I would like to thank them for the results they achieved in fiscal 2004.

They are the reason I'm excited about the possibilities ahead of us and optimistic about the future.

In addition, they will be even more important in the coming year, the year in which we begin to roll out our transformation to a consumer centric organization.

This year will be critical in our journey toward a deeper connection with the customer and our front-line employees are key to making this happen.

I will comment more on that later in the call.

Next I would like to focus on several factors that I believe will contribute to our continued strength.

One, the market share gains we achieved in the holiday selling season.

Two, customers' adoption of the computer as the hub of their digital entertainment systems and equally impressive turnarounds in our CD and major appliance businesses.

Three, the improvement in results from our Canadian operations.

Four, the scheduled rollout of the Geek Squad, and five, our many efforts to increase efficiency.

First, during the holiday selling season our merchants took advantage of consumers' enthusiasm for our digital products to gain market share.

We added both inventory and store labor to make sure customers found the products they wanted at our stores.

As a result, we gained market share on a number of key product areas.

For example, we gained share in both desktop and notebook computers.

Best Buy sells over half the notebook and desktop computers sold by major retailers in the United States.

Digital cameras and digital camcorders have been an area of significant market share gains as well and we believe we also gained share in digital, LCD, and plasma televisions.

We anticipate that these market share gains will have a continuing impact on revenue as customers return to Best Buy stores for additional products and services to enhance their experiences and to redeem the rewards on certificates earned when they made their initial purchases.

We have signed up nearly 2.5 million Reward Zone members who shop our U.S. stores more frequently and who give us helpful insights on our journey to customer centricity.

Our internal analysis shows that members' shopping frequency is more than double that of non-members.

External data shows that our comparable store sales performance has separated us from the Goldman Sachs retail index by three to five percentage points since the program's introduction.

We also expect continued membership increases in fiscal 2005.

We remain very pleased with this program and view it as an excellent tool for gathering important customer insights.

Second, the clear pattern of resurgence in demand for desktop computers has been a pleasant surprise to everyone in the industry.

We believe that the consumers' recognition of the functionality of the computer as a hub for storing and distributing photographs, music, movies, and games is an important step toward building a personal entertainment library.

Best Buy, with our hundreds of customer touch points and thousands of knowledgeable sales people, is uniquely positioned.

We can help customers better understand the benefits of managing their digital content in one device and distributing it from there to any number of different channels and portable devices.

Finally I am very pleased with the continued strength in our CD and appliance businesses.

Comparable store sales of CDs increased by strong double digits in the fourth quarter while appliances comparable store sales rose by mid single digits continuing the improvement we have seen for that category.

The turnaround in these two product categories is a reflection of outstanding teamwork between our merchants and our stores.

Third, our Canadian operations delivered outstanding results for the fourth quarter.

That business achieved a 7.9% comparable store sales gain with particular strength in entertainment software and digital TVs.

Our dual branding strategy continued to drive overall share gains in markets where we have introduced Canadian Best Buy stores.

Our national market share in Canada, excluding appliances and entertainment, is currently about 29%, up from just under 25% at this time last year reflecting gains in both brands.

The gross profit rate remained under competitive pressure however, the impact was more than offset by SG&A leverage and expense controls.

Our fourth quarter operating income rate from our international segment improved significantly over that of last year's period bringing our fourth quarter operating income to $47 million for fiscal 2004 compared with $21 million for fiscal 2003, an increase of 125%.

Fourth, we are taking steps to capture more of U.S. households spending on services which we estimate as $20 billion annually.

Beginning in April we will start rolling out the Geek Squad to a total of approximately 425 existing Best Buy stores in 45 U.S. markets.

Currently this 24-hour rapid response computer support task force is available in only seven U.S. markets.

The Geek Squad expansion is another step forward in our "Win the Home with Service" initiative, which is helping build trust and loyalty among our customers.

Our goal is to make the Geek Squad North America's largest national provider of in-home computer repair and installation services, and we believe that over time it will become a significant factor in improving comparable store sales.

Consumers have told us that our Geek Squad agents consistently deliver premium service while alleviating the pain often associated with technology.

Those of you who have seen the Geek Squad can appreciate its incredible brand image.

This highly valued customer service also has the power to upgrade our services business in the stores.

In each new market the Geek Squad enters the local Best Buy stores existing tech benches will be given additional training, joined by Geek Squad team members and rebranded with their logo.

This integration of our in-store technicians and the Geek Squad allows us to maximize agents' time between house calls while offering a clear path to our existing service technicians in the stores.

Finally, as part of our commitment to increase efficiency, in the fourth quarter we developed a plan to adjust the management structures at our retail stores to reflect store revenue not just store size.

As part of the change, which we implemented in March, we decreased management expense and reallocated some of the savings to customer service-level employees.

In addition we have begun exploring the use of vendors to augment some of our corporate support functions.

For example, in the fourth quarter we reached an agreement with Accenture to work with us to build innovative new HR capabilities and to provide transactional and administrative HR services to Best Buy.

We currently are exploring a similar arrangement for our IT area and for the management of our call centers.

The goal is to deliver new capabilities with greater speed and innovation at reduced risk and cost.

We believe that working with third-party expertise we can streamline some of our corporate functions and accelerate the company's transformation.

And now I will turn the call over to Darren Jackson, our CFO who will comment on the fourth quarter's results and our outlook for fiscal 2005.

Thank you, Al, and good morning, everyone.

I am very pleased to report the outstanding results we achieved for the fourth quarter and year.

It's particularly gratifying given that we started the year expecting comparable store sales to grow 4 to 6% and earnings per share to grow 14 to 16%.

Obviously we are thrilled that we are able to deliver a 7.1% comparable store sales gain and a 29% increase in earnings from continuing operations, nearly double our expectations from the beginning of the fiscal year, while at the same time making long-term investments in customer centricity.

One of the highlights of the fourth quarter was the gross profit rate which improved 30 basis points.

The primary driver was the rate not mix and improvement was broad-based.

For example, our stores and merchants did a great job improving sell-through and developed more effective promotions.

These margin gains were partially offset by the cost associated with Reward Zone which were just over 40 basis points.

Increases of computers in the revenue mix and more promotional environment in Canada reduced margins.

Our SG&A rate was essentially flat, performance-based incentive comp increased our SG&A rate by approximately 60 basis points in the quarter.

The increase was driven by a couple of factors: First we had an outstanding year versus our very modest bonus in the prior year, second we expensed restricted stock yet we reduced the number of options granted annually which reduced future dilution.

Separately investments made in our customer centricity initiative also added 40 basis points to our SG&A rate in the quarter.

These increases were offset by expense leverage associated with our 9.7% comp store sales gain, a larger store base, and cost savings from efficient enterprise.

Those savings included a 7% fixed headcount reduction, administrative and overhead cuts, and a reduction in our average cost to build new stores.

Other highlights are less obvious include, one, we reduced our capital expenditures $150 million versus our original plan of $700 million for fiscal 2004.

Two, our 20,000-square-foot pilot stores are on track to deliver an ROIC of 20% or better based on a strong start.

Three, our debt to capitalization ratio including cap leases declined to 57% from 67% last year, a decrease of $1 billion as a result of our divestiture of Musicland.

Four, our [inaudible] shareholder return for fiscal 2004 was a satisfying 86%.

A hot button for investors lately has been customer centricity spending so I will elaborate on that subject next.

We disclosed our customer centricity spending for fiscal 2004 today so that the improvement in our expense rate of our core business would be more transparent.

Given our comparable store sales gain would you expect us to deliver more expense leverage than we initially reported.

Our core SG&A rate for fiscal 2004 and for the fourth quarter included approximately 30 and 40 basis points respectively of expenses related to customer centricity.

Those costs include outside consulting services and developmental costs, labor and training to prepare for implementation and ongoing incremental labor in the stores.

Much of this expense could be considered development cost and the cost per store is clearly not representative of what we would expect rollout cost to be upon scaling.

But by focusing on expenses you lose sight of the big picture.

The main point to think about is that customer centricity stores led the company in comparable store sales gains in the quarter and the year and the gross profit rate also improved.

Moreover we will not implement any customer segments that do not earn that right in terms of ROIC.

From my vantage point customer centricity is about winning with the customer including satisfying their needs and increasing customer loyalty.

Customer centricity is a vehicle for growing the business, boosting productivity and ultimately increasing our return on invested capital.

It's not about spending.

We view it as a key driver of our competitive advantage as we look to the future.

The fine performance in the fourth quarter gives us as much confidence as we begin the new fiscal year.

The earnings guidance given in our news release was based on our review of fiscal 2004 strong comparable store sales gain we've enjoyed in March and our budget for fiscal 2005.

I'd like to elaborate on those assumptions we've made.

Given our new store opening plans, historical new store productivity trends and our outlook for comparable store sales, we anticipate revenue of approximately $27.5 billion for fiscal 2005, an increase of 11 to 13% over fiscal 2004.

We outline new store plans in our news release during January and they have not changed.

We anticipate that as usual the majority of new stores will be opened in the third quarter so that they are ready for the busy holiday season.

For comparable store sales estimate we assume comparable store sales of 7 to 9% for the first quarter and 4 to 6% for the fiscal year.

We believe that comparable store sales gains in the first half of the fiscal year will benefit from strong consumer demand for digital products, increased brand awareness and customer loyalty, Reward Zone, individual income tax refunds, and easier comparisons.

The second half, because it's farther away is harder to estimate.

At this point we expect comparable store sales gains to moderate somewhat in the second half based on the impact of last fall's tax rebates and the tougher comparable store sales comparisons.

Yet, we remain very optimistic about our potential to increase market share and outperform in fiscal 2005.

In today's release we talked about an improvement of approximately 30 basis points in our operating income rate.

We view our fiscal 2004 performance simply as a good start.

We see more opportunity for improvement primarily on the SG&A side.

On the plus side is the anniversary in July of our launch of Reward Zone so that our year-over-year redemptions will have less of an impact on our gross profit rate.

We also have our new sourcing capability in Shanghai, China.

We have set an aggressive goal for sourcing from this office this year but make no mistake this is the year which Best Buy will be focused on reducing its cost structure.

We intend to reengineer our business to be more efficient, faster, and smarter in terms of capital investments.

We will increase the flexibility of our supply chain in order to enable customer centricity.

We intend to lower our supply chain expenses by sharing demand information with our vendors all the way back up our supply chain which will help us take cost out of the system.

We also intend to handle more of the transportation ourselves so that we can decide closer to the time of sale which Best Buy retail location most needs the inventory.

A second example of efficiency is how we're managing payroll.

For instance, our U.S. retail stores recently adjusted their management structures based on sales productivity.

Previously their management structures were based solely on store size.

Some of the savings will improve our expense rate and a portion of the savings will be redeployed to increase customer service and drive sales.

Partially offsetting these factors are the impact of customer centricity initiative and our "Win the Home with Service" initiatives.

Specifically we assumed we'd expand customer centricity to approximately 100 additional stores and roll out Geek Squad to a total of 45 markets.

The guidance we provided today for operating income and the income rate includes the assumptions related to all of that work.

In addition, I would point out that we are pursuing these two initiatives because we believe they will be in the long-term best interest of our customers and our shareholders.

When we sum it all up we arrive at earnings from continuing operations of 30 to 35 cents per diluted share for the first quarter, an average increase of 55%.

We also estimate earnings of $2.80 to $2.93 per diluted share for the fiscal year, an increase of 15 to 20%.

Now, Best Buy doesn't traditionally give guidance on the balance sheet but I will note that our current capital expenditure estimate for fiscal 2005 totals approximately $700 million.

Of that sum approximately $350 million will be used for more than 70 new store openings and various U.S. and Canadian remodeling and store projects.

We plan to make significant investments in strategically choosing market renovations given the age of some of our stores.

Given the strength of our balance sheet we plan to continue our quarterly dividend program.

We plan to review the size of the quarterly dividend prior to our annual shareholders meeting and annually thereafter.

We continue to believe that we will not make any material acquisitions over the next 18 months.

As mentioned in our news release we repurchased our common stock in the fourth quarter and now have $200 million remaining under the existing authorization.

Given our current stock price and our sizable cash balances we will continue to review this program as well, as always our goal is to maximize shareholder return while ensuring adequate liquidity for ongoing demands of the business.

To conclude I want to pause, and I want to thank our Best Buy employees for their unwaivering commitment to excellence which drove our performance this year and certainly gives us much confidence as we look to the future.

With that I will now return the call to Al Lenzmeier.

Thanks, Darren.

It clearly has been a banner year for Best Buy and we are very optimistic about the coming year as well.

I would like to wrap up our call with a brief update for you on the company's progress with our four strategic initiatives.

One is consumer centricity.

After more than 10 months our consumer centricity store tests are proving excellent insights to improve our business.

While we will continue to test improvements to consumer centricity, we will make our go-forward decisions based on the test results through today.

We have worked very hard in our 32 lab stores to focus on profitable customer segments, tailor our offering to those segments and create more of an owner-operator culture in those stores.

Our customer centricity stores collectively led the company in comparable store sales gains in the fourth quarter.

The next step is to determine which customer segments we should roll out, which ones may require more testing, and which ones, if any, do not provide a sufficient return on invested capital.

We already have a team developing plans for how to scale and implement customer centricity.

Finally, one of the customer centricity outcomes is the discovery of several best practices that we consider simply good retailing.

We already are beginning to implement some of these learnings at all of our stores.

We will have more information on our rollout plans by our analyst day meeting in early May.

Two is a more aggressive remodeling program.

As part of our efficient enterprise initiative we are taking a look at existing stores that are eight or more years old.

We believe that by expanding our remodeling efforts we can better serve customers in these markets, so we are developing a more aggressive rejuvenation program.

The new store platform will combine the best of our digital life test stores with elements of our consumer centricity test stores.

As mentioned earlier, we have recently adjusted our store management structures based on volume rather than only size and we have lowered the cost of building new stores also.

Three is the expansion of our service offerings.

As part of our "Win the Home with Service" initiative, prior to the holiday we launched Best Buy services.com, a site through which customers can monitor the status of their repairs.

The site offerings free performance checks and PC maintenance services.

We also enhanced our service offerings in the appliance area.

Finally, we completed plans for the expansion of Geek Squad into a total of 45 major markets by the back-to-school season as mentioned earlier.

All U.S. markets with three or more Best Buy stores will have Geek Squad service this year.

Four is our success in entertainment.

As a result of our win and entertainment initiative in the fourth quarter we had strong double digit gains in comparable store sales for movies and music.

We believe we gained significant market share in music including results from our Rolling Stones exclusive, the Four Flix DVD, which attained 14 times platinum in sales.

It's gratifying to me that we are making so much headway with our strategic initiatives particularly in the quarter that delivers the largest portion of our annual revenue and earnings.

At the same time we have delivered outstanding service based on customer loyalty and employee attitude metrics.

On both fronts we attained new highs which is tremendously positive for our near-term profit outlook.

I would like to thank our employees for the fine work they have done with both the core business and our four strategic initiatives.

The coming year will be a critical test for Best Buy.

The initial earnings guidance Darren outlined is achievable and it shows our commitment to long-term growth initiatives such as consumer centricity.

We will be running hard in our core business while we begin the work of transforming to a more consumer centric organization.

In other words, we are attempting our transformation during a period of success and prosperity.

Our role as leaders will be to keep our 100,000 employees inspired and focused on the new marketplace, less success erodes our resolve to change.

Fiscal 2005 promises to be an exciting year.

It begins a journey to focus our organization on increasing our operating income rate while growing the top line.

Specifically, we have set an internal goal that we call Seven by Seven.

That means we are shooting for an operating income of 7% by fiscal 2007.

At the same time, we want to drive double-digit revenue growth.

These are ambitious goals.

We will to have pioneer excellence throughout the Best Buy enterprise in order to achieve them.

All employees will need to become customer centric and tie their work more closely to the customer.

Our five priorities for fiscal 2005 are as follows: One, launching consumer centricity at up to 100 more U.S.

Best Buy stores and transforming our corporate and field support teams to enable consumer centricity.

Two, forming consumer alliances that enable to us increase our efficiency and respond more quickly to changing customer needs.

Three, making our supply chain and customer contact centers much more customer driven.

Four, expanding the value-added services we can offer to customers principally through the expansion of the Geek Squad as we move toward a more network home.

Five, upgrading and renovating our existing stores in key markets to ensure we remain competitive over the next decade.

Clearly we are on a journey of transformation.

While our work will not be easy we are confident that it is the right direction for Best Buy.

If successful, customer centricity can widen the gap between us and all our competitors.

With that, Maria, we will now take questions from our investor audience.

Thank you.

The floor is now open for questions.

If you do have a question or comment please press the numbers one followed by four on your touch-tone phone.

If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key.

We do ask that while you pose your question to please pick up your handset for optimum sound quality.

Please limit yourself to one question in order to allow the maximum amount of participants to ask their question.

Once again, that is one followed by four to ask your question.

Our first question is coming from Bill Sims with Smith Barney.

Please go ahead with your question.

Good morning.

Congratulations on an outstanding quarter.

Just one question.

I've had a chance to read some of Larry Seldon's work on customer centricity and if you adhere to his thesis it sounds like you would to have remodel all your stores with two to three years.

Based on the guidance of 100 stores you're providing today, it doesn't sound like you'll hit that mark within the next two to three years.

Can you tell us how your strategy differs from his thesis and what the rationale is to come up with the 100-store remodel effort?

Well I think, first of all, we did 32 lab tests this year, and from the 32 labs, you know, it was, we learned a lot of things, and this was a tremendous undertaking on the part of the organization this year and we took a lot of key executive talent, for example, Mike Keskey who is here with us, President of Best Buy Retail Stores.

Mike's sole responsibility was leading the consumer centricity effort.

As a result of what we've learned through those 32 labs we feel that you know, rolling that out to an additional 100 stores at this time is an appropriate number of stores to do that in.

Now, in terms of remodeling, some of the things that we've learned from these tests also is this is not so much investing in a lot of hardware.

It's really investing in I guess what we would call software or the intellectual capital of our organization.

And why don't I let Mike kind of expand on that a little bit.

So this past year, myself and a number of leaders have been working on customer centricity, studying it and testing it, and, you know, for those of you, customer centricity, the foundation of it is really segmenting our customer base based on profitability behaviors and needs and segmenting our stores so that we understand the customers that are around these stores, and then building an operating model in these stores to meet the needs.

In doing so we've built value proposition elements to meet these customer needs.

Now, what we've found is clearly there's a lot of learning to do, and we have picked a number 100 this year as we continue to learn, but as we move forward over the next two to three years we clearly intend to accelerate that number.

So I don't feel that it's out of the realm of possibility at all to meet this three years that's in it, that you had mentioned.

Yeah, just one quick follow-up.

I recognize that 100 stores are only an estimate but can we assume the number is not going to expand to 200 stores this year and it's going to stay within that 100-store range?

Yeah, it will stay within the 100 stores because this is not easy to do it's fairly complex.

And that's why it's also difficult, going to be very difficult for someone else to copy what we're doing here.

Great.

Bill, it's the difference between doing it right and doing it fast and if you think about a retail store what we want to do is also manage our capacity to have the change happen successfully.

It's like a learning curve.

The first 100 are going to be tougher than the last 100.

So I would think about it that way.

So we want to manage it effectively so we get the right returns out of the process too.

This is Mike Keskey again.

I think it's also really important to note that what we've learned is this is not about, as Al mentioned, deploying capital and remodeling our stores.

Obviously there will be some capital deployed and some remodeling done of our stores, but we're finding that the bang for the buck really comes from the softer side of the business, or from the store employees, and how we look and leverage the human capital out there in our business.

I mean this is about instilling an owner-operator mentality at the store level and moving the decisions down closer to where the customer interaction is.

Thank you and congratulations again.

Thank you.

Thank you.

Next question.

Thank you.

Our next question is coming from Mark Rowen with Prudential.

Please go ahead with your question.

Thanks.

Good morning.

I have a couple of questions.

One, you talked about being a lot more aggressive in your remodeling program.

I was wondering if you could tell us the number of stores you're planning to remodel in the year, what the cost of the remodels will be and is that going to be focused on specific markets or will that be pretty much across the country?

Second, Darren, on the gross margins, domestically they were up 40 basis points, and it's pretty impressive despite the fact that computers, I think, were probably a bigger portion of your mix this year than last year.

So given that, how did you accomplish the gross margin improvement with the bigger mix of computers?

Did your people sell more accessories and warranties with the computers than a year ago, or was it something else that was going on there?

Yeah, let me, on the remodeling program, there's probably, I think, 60 stores that we're looking at in, I mean there's a combination of factors that we look at.

First is probably age of store.

We are getting a lot of stores that are up, you know, seven to eight years old, and then also looking at the competitive conditions in the particular marketplace to make sure that we're, you know, stores that are older are not getting outpositioned by competitors coming in on top of us.

And in terms of gross margin, I think the other thing to keep in mind, too, we talked about gross margins being up 30 basis points or so in the fourth quarter.

Also included in that is Reward Zone that cost us, what, I think 40 basis points.

So if you back out Reward Zone there's a gross profit improvement of about 70 basis points that really is a combination of factors.

I think it's the integrated promotion planning that we're doing between the merchants and the retailers are much closer coordinated.

The stores are just doing a great job of selling the total solution, which is the computer, the peripheral, the accessories, the stores are doing a much better job in terms of moving out open box product and doing a much improved job of managing margin erosion.

I don't know if you've got anything else to add to that Darren.

No, Al, I think you've hit it all.

As I said in my comments, Mark, it's all rate improvement, and, as a matter of fact, mix actually went against us.

I don't think we would focus on PSP's as being the key driver.

I think when it comes down to essentially we improved sell-through's throughout the whole process from the merchants to the stores, and if you recall a year ago, when we talked about transforming the merchandising in stores we talked about the integrated operating model.

I think we're seeing those benefits today, both by in terms of the merchant organization and a successful execution at the stores.

It's all rate driven, which is typically driven by those two organizations.

Great.

Thanks.

Next question.

Thank you.

Our next question is coming from Don Trott with Jefferies and Company.

Please go ahead with your question.

Good morning.

Could you give us some insight into your ongoing expansion opportunities that remain in North America beyond simply what's happening in the new fiscal year?

I think our plans are, Don, we're still looking at 60 stores this year as well as the next one or two years in United States and in Canada I think has another 60 stores or so to open up over the next three years.

Yeah.

And again we talked in the past, the composition of the size of those stores, you know, will change this year.

There's probably a high proportion of 20,000 and 30,000-square-foot stores than there was last year, so that composition is changing, and I don't know, Darren, you want the add anything onto that?

Don what we've said publicly is, if you think about North America we see a thousand superstores, and we are still committed to 1,000 superstores in North America.

That being said, we're doing more work.

What we're finding is in our U.S., in our major metropolitan U.S. markets, in certain markets we enjoy up to 30% market share.

In other markets we only enjoy 15% market share.

So I think we're at that point where if we're thinking about saturation, I think saturation is only, could be a figment of our imagination as we better understand in certain markets we have 30 share, so what do we have to do in order to improve share in other markets in the U.S. to bring it up to those leading practices.

And we don't have that all figured out at this point but we're certainly putting more energy to figure out can that store count go even higher, and I think that's what you'd expect us to do.

We're clearly learning in Canada where we have 29 share of the Canadian market that you can profitably operate at those type of levels and we'll continue to look for more ways to extend the runways of our stores as we look to the future.

I think Don also, we're also getting some really important insights from the tests that we've done in these 32 lab stores in terms of consumer centricity, in terms of some of the segments that we've identified that we're serving, in terms of, really, it's kind of more the unmet needs that exist out there that we also think there may be opportunities for further expansion from that.

That's very helpful.

Thank you.

Next question, please.

Thank you.

Our next question is coming from Colin McGranahan with Sanford Bernstein.

Please go ahead with your question.

Good morning and very nice quarter.

Question on direct sourcing.

Darren, you said you set some aggressive goals.

Can you maybe give us a little built more color on where you are organizationally, what capabilities you have versus what you need to build, and we would love to know what those aggressive goals are especially relative to your competitors' move today that looks geared toward accelerating their move into direct sourcing and private label.

This is Al.

You know, that is, you know, one of our key initiatives this year is direct sourcing.

We set up an office in Shanghai last year and really just got started last year.

One of the things we've more recent changes we've done is we've taken Mike London.

As most of you remember, Mike used to be our General Merchandise Manager and then last year shifted over to lead one of the segments under consumer centricity.

He's now moved back and is actually heading up our direct sourcing effort.

Mike has 30-plus years in this business and I think will be able to take to us a new level in terms of direct sourcing.

And we think direct sourcing obviously fits, you know, is a critical component going forward in terms of profitability and so forth and we think there's, with us being the largest CD retailer in the world there's tremendous opportunities to buy product at more competitive prices but also, you know, have earlier insight into what's happening in the marketplace and there's just a list of real pluses that are going to come out from this, and in terms of what exactly those numbers are that's not something that we share with the public at this point.

And just following up, what might we see in the stores over the course of the next year in terms of product categories or the areas that you'll be pushing more proprietary branded product?

You know that will tend to be more opening price point product, really, and, you know, some of the accessory area, primarily those two at this point.

Thanks.

Thank you.

Next question, please.

Thank you.

Our next question is coming from Matt Fassler with Goldman Sachs.

Please go ahead with your question.

Thanks a lot.

Good morning.

Hey, Matt.

If you could talk a bit about your inventory plans for the year, you're starting off with a pretty robust position and obviously you've been selling through that well of late but can you talk about where that inventory is focused and as the year progresses and presumably your forecasting take comps moderate a bit how you would expect that inventory position to be worked down.

I think when you, why don't Darren, you go ahead and address that.

Matt, you can see from our year end inventory numbers if you looked at our inventory on a comp store basis we're up just shy of 14% versus our 10 comp for the quarter.

And that's principally driven by what we've been sharing with everybody all year that we have made a deliberate decision to improve our stock position for the year.

And secondly, as we have also shared with people, we've made a deliberate decision principally in the computer business, the video business, as well as our music and movies to better position those in-stocks as well.

What I can tell you is as we look across the year, we are looking at new forecasts every 30 days and our inventory management systems in good times and bad we've been able to manage our turns in that six and a half times ratio and that's what we see as we look out for the balance of the year.

Great.

My follow-up question is where is your field trip going to be?

I'll have an announcement about that at the end of the call.

And please, callers, use your handsets rather than your speaker phones because we're getting some feedback.

Thanks so much.

Thank you.

Our next question is coming from Gary Balter with UBS.

Please go ahead with your question.

Hi, it's Brian Nagel.

Hi Brian.

First off Gary wanted me to pass along his congratulations on your very strong showing.

He had to unfortunately get off the call early because he's down in Arkansas today.

I had one question.

With regard to Geek Squad, in the markets where you guys have rolled this out already have you seen a commensurate pickup in comp store sales in particularly in products that require more services?

Well, what we have seen is I think from a customer loyalty standpoint it's actually doubled, and we're also picking up, you know, we really didn't have any revenue in terms of in-home installation.

We're also gaining that, plus they're selling accessories and that type of thing.

Plus, we're also seeing an increase in the revenue in terms of the in-store service as well as in-store installation.

And I think, you know, some of this is kind of a delayed reaction, you know, particularly in customer loyalty, it has a significant impact on customer loyalty which we've seen in other situations does drive return business.

Thank you.

One other question, too.

You guys mentioned in your press release that you've seen sales remain stronger in March.

Has there been any shift in the product mix as we've gotten away from the holiday season?

No, I think when we talked about the fourth quarter, you know, being particularly strong in the digital area, I mean, desktop computers, notebook computers, DVD, music, digital cameras, appliances, all of those continue very strong.

Great.

Thanks a lot.

Congratulations again.

Thank you.

Thank you.

Our next question is coming from Dana Telsey with Bear Stearns.

Please go ahead with your question.

Good morning and congratulations.

Thank you.

Can you talk a little bit about the 20,000-square-foot stores?

What are you seeing there performance wise and profitability wise and you also mentioned better matching store expenses to revenues.

How much cost savings will there be, what's the impact on the stores and is there more to go there?

Thank you.

Thanks, Dana.

So our 20,000-square-foot stores we started with two pilot stores, we're up to six that we would call in the pilot category.

We're seeing as you would you expect, those stores have traditionally have been in smaller markets, less densely populated but the good news is we're seeing productivities in those stores that are $700 a square foot in terms of their projected run rate.

Some of them will exceed well over $800 bucks a foot.

So we're very pleased in terms of top-line sales productivity.

We've been pleasantly surprised that their operating income rates are actually on a trajectory that beat our pro formas.

And our projected ROICs for those stores are in line with company ROICs of 20-plus percent.

So we're feeling good about the pilot stores that we have launched so far.

We see opportunities for them not only in the rural markets but actually using them in some of the more densely populated markets as a fill-in strategy.

So testing and confirming before we roll, many of the concepts that we've used as we've looked at customer centricity as well, and that's one of the things I'd want the audience to take away.

That we test things and then we work through them before we roll them looking to achieve our financial goals.

Two, in terms of the matching of expenses to the store cost structure, I think it goes back to what Al said early, as we look at the structure in our stores, we're finding that we can adjust the structure based on sales productivity in the store and I'll be honest, we're not bottom lining all of those results, in many cases we're taking some of those management dollars and redeploying them on the floor to drive higher productivity.

We will save some money but we will reinvest some of those dollars in terms of improving the customer experience, too, net driving a better bottom line outcome.

The savings is not a number that we're divulging.

Mike?

I was going to say, I think it's really important to note as mentioned that we will not implement initiatives until they earn their right in ROIC.

And we started with the 20K stores, we started working on them a little over two years ago, two-and-a-half years ago, and as you know, we have not really rolled these out.

And the reason is, is because we have been working on the productivity of these stores, and clearly what has happened over the last two-and-a-half years is we have found the key to unlock the top-line revenue as well as to unlock the bottom line earnings of it, and clearly you will see more of these rolling out as we move forward.

Thank you.

Next question, please.

Thank you.

Our next question is coming from Jack Murphy with Credit Suisse First Boston.

Please go ahead with your question.

Good morning.

A few quick follow-up questions on customer centricity.

Recognizing that it's not a lot of capital could you give us a sense how little it is on the 32 stores that you've done so far?

Secondly, could you be a bit more specific on how much of the 40 basis points on the gross margin is ongoing versus one-time development?

Lastly, could you just talk about how you can isolate the sales lift on the stores that you have done versus, you know, third factor like what market it's in or any other factor?

Yeah, I guess with respect to the capital on the first 32 stores, I think you've got to look at this as it was somewhat what we would call R&D.

We spent, you know, a lot more capital on the first group of stores that we did versus the last group of stores, and, you know, when you do something like this you tend to throw things against the wall and see if they stick, and you find out that they don't and as you open up more test stores you don't repeat the same mistakes.

So from a capital standpoint in terms of the 100-store rollout I think Darren indicated that we've got a capital budget of $700 million this year.

The capital that we've got allocated for the 100 stores is included in that $700 million that we have.

What were the other?

Gross margin.

Yeah, the gross margin on, was that in Reward Zone?

Just the impact on customer centricity.

That was an SG&A impact.

Pardon me, SG&A.

I think from a budget -- Darren, why don't you cover what we did there.

Yeah, Jack, that's a good question.

As we alluded to in the call there are a number of those expenses as Al pointed out that are development expenses or what I would characterize as learning and in some cases non-recurring expenses.

The way we'll put together the expense plans for the stores going forward to be really clear is similar to our past practices that we have certain return on invested capital, goals that we're looking for.

As Mike alluded to, in terms of the Cap Ex that we will spend and the incremental expenses that we'll spend, tied to now the insights that we have in terms of comparable store sales growth and gross profit, we will, on a store-by store, or a segment-by-segment basis, develop the plans and the roll out strategy focused on achieving that return on invested capital.

So it's not fair to say that every store is going to be X or Y, they'll vary a little bit by customer segment but what won't vary is our goals in terms of return on invested capital.

So that is built into our expense base for next year.

It's built into our capital plans, and like many other times we set aggressive goals and we will go out and execute to deliver on that profit expectation that we set today.

In terms of the revenue growth in those 32 lab stores, again, we haven't shared that.

My only comment on that is, I think when we have our analyst day in May we will share, you know, more details of the results of those tests because they really have to, there's a lot of information here and you've got to have the right context when you talk to this, and we will be in a much better position to share a lot of things with you on that day.

Okay.

Thanks.

Next question.

Thank you.

Our next question is coming from Stacy Widelitz with Fulcrum Global Partners.

Please go ahead with your question.

Hi, thanks.

I don't know if you guys can quantify what warranties were versus last year to just help us with a little color on that.

And also if you can tell us a little bit about the gross margin enhancements or how much that had an effect on gross margin this quarter.

And then as you go forward and think about comps, I guess, can you tell us maybe what portion you're looking for that to come from ticket and what portion from traffic?

Thanks.

Hi, Stacy this is Darren.

We don't give out warranties as a percent of sales.

It's integrated back into all the product categories, and again we view that as part of the total solution.

It's fair to say, though, warranties in the current quarter and current year were not drivers in the overall gross margin rate improvement we saw for the quarter and the year.

Yeah, in fact, actually our comps and warranties were actually probably down from their prior year because we focused a lot more on really the total right solution for the customer, the product, the accessories, the peripherals, and actually probably ended up doing better on the gross margin as a result of that.

And, you know, as to as we look forward in terms of what's driving the comp store sales gains as we look out to the next year, I'd tell you, I think if you think of it just in terms of ASP or traffic, we're missing some of the other key components.

As we look to next year we think about we need to improve our close rates.

We need to improve our overall ASPs.

We need to improve our units per transaction that the customer is walking out of the store with, and we must improve the traffic of our overall stores.

So what we saw this year is that fortunately on all of those measures, they were moving in the right direction.

We'll talk more when we get to the customer centricity discussion that we're seeing particularly in those stores when we focus on driving those levers they have a disproportionate positive impact on our comparable store sells and we're counting on all of those elements more on certain of those elements than others in order to drive our comp store performance next year and we recognize that we're up against some easy comparisons in the first half of the year where we should benefit from more tax refunds being in the system.

That being said we recognize in the second half of the year we'll be up against the prior year's tax rebates.

All that being said, we're still feeling pretty confident for the year as a whole that it should be a very good year.

Thanks so much.

Excellent job.

Thank you.

Thank you.

Next question, please.

Thank you.

Our next question is coming from David Schick with Legg Mason.

Please go ahead with your question.

Hi.

Good morning.

Question.

You mentioned the consumers are in the midst of a PC upgrade, desktop PC upgrade cycle for handling digital content.

Can you talk about where you think the consumer is in that?

What inning of that cycle, and, you know, what the opportunity is for '04 and '05 versus what's already started to happen?

Ron, you want to address that?

Yeah.

I think, as it relates to what inning we're in, I think we're pretty early into this.

People have been talking about conversion since, you know, the mid to late 90s, and I think we're finally starting to see products that offer the solutions that consumers are willing to pay for.

So I believe we actually really just started to see that in the last 12 to 18 months and we started to really executing against some of those opportunities this year.

So the growth of online digital services, the growth of digital photography, and the coming new categories of online gaming and online movie and television show distribution is going to continue to drive this.

So I think we're in the reasonably early innings of this as it relates to PC's, and we're yet to even play the game as it relates to set-top boxes which is coming in '05 and '06.

Thanks.

Next question, please.

Our next question is coming from Gregory Mallick with Morgan Stanley.

Please go ahead with your question.

Thanks.

Just on the performance-based compensation, could you split out of the 60 basis points that it hurt the SG&A, was any portion of that a catch-up from the starting of your new plan and basically the starting expense in your stock option as opposed to the improved results?

Hi, Greg.

This is Darren.

Hey, Darren.

The short answer is, the majority of it, so 90-plus percent is going to be related to our short-term incentive program.

I think it was a really small amount, a relatively small amount in terms of the restricted stock expense that we booked in the fourth quarter.

It certainly was incremental expense year-over-year, but the key driver in this fourth quarter is that we book a disproportionate amount of our performance comp in the fourth quarter because that's when we earn all of our profits, and as you recall last year in the fourth quarter, if memory serves, we were just up over 10% in earnings.

This year, in terms of our fourth quarter we're up closer to 25% of our earnings and 29% of the year.

So the fourth quarter really absorbed a disproportionate amount of the load of expense in relation to the prior year.

But, you know, on that type of 30% profit performance, we are thrilled to deliver that to our shareholders and reward the greater employee base at Best Buy with that type of bonus.

Then a follow-up on the share buybacks and Cap Ex.

Why was the Cap Ex come in at 550 for the year?

Did something happen in the fourth quarter?

Projects get delayed?

Or what drove that?

Three things.

We have been talking for a year about being more aggressive in terms of getting our cost per store down, and our overall cost per store as a company in relation to where we began the year and where we finished the year came down nicely.

Two, you would expect us, as we look forward to customer centricity, we did pull back on some of our store projects this year in anticipation of reinvesting those dollars for higher returns in the future as it relates to individual store projects.

And then three, you're right, in certain of those project we killed some and we didn't complete some that will carry over to next year.

An example of that would be we will end up finishing our Ardmore distribution center early next year versus getting that complete this year.

Thanks.

Next question, please.

Our next question is coming from Alan Rifkin with Lehman Brothers.

Please go ahead with your question.

My congratulations as well.

Couple of questions.

Darren, stripping out some of the R&D costs as it relates to customer centricity, by how much do you anticipate the cost per store in 2004 to be versus the cost per store earlier in the stage when you were testing the format in '03?

And then secondly, Al, I find your comment, the 7 by 7 goal, you know, particularly interesting.

That would imply, you know, north of $4.25 in earnings in fiscal '07, and even assuming, you know, modest double digit top-line growth, can you just shed some color on exactly how you think you can get to a 7% operating margin by that time period?

Okay.

You go first.

Why don't I go first on that one.

That's going to be due to a combination of factors.

One is, what we call I guess our efficient enterprise initiative, and a lot of that deals with supply chain.

We think we've identified significant opportunities that are there for us, you know, if, you know, in terms of operating this whole mechanism much more efficiently.

And that's a combination of building additional systems to do more accurate forecasting, to manage transportation, and a lot of it really, frankly, it's upstream between us and the vendors in making that part of the supply chain much more effective and much more efficient.

This is work that's been done by other retailers, so this is not leading edge stuff.

And we feel pretty confident that there's sizable savings that we can get from that that will reduce SG&A, will improve gross margin, and also will drive more sales.

And we're also really focusing on all of our support structures in terms of making sure that we run a lean organization and we think there's been some excesses that have been built up over years and we intend to get that back to running a very lean machine from a corporate and a field support standpoint.

The other piece of this is really consumer centricity.

From what we've seen is there's big opportunities in terms of improving the return on investment at our store level by managing this business, by looking at it as a portfolio of customers and understanding what segments are profitable, which ones aren't, which ones can we gain a bigger share of the customer's wallet.

The ones that aren't profitable, you know, how do we find a more efficient way of serving those customers.

So there's a lot of dollars out there that we've identified that we've got a plan put together in terms of taking us where we are now to get to that 7% by fiscal '07.

Okay.

Alan, I would just add to that, that we're also counting on our Canadian business in terms of its dual brand strategy to deliver sizable improvements in its operating income rate over the next number of years in order to help support that.

The core Best Buy U.S. business today runs at about a 5.8 or so operating income rate.

In terms of the levers, comp store sales, margins and SG&A are all part of the equation so it will require all 100,000 employees to participate.

Alan, as to your second question, I think to simplify it you're saying we spent a number of dollars in terms of the 32 [inaudible] scores what's the pro forma that we'll spend going forward?

And earlier in my comments what you should have taken away is that the pro forma by customer segment is going to be a little different.

Our sales expectations based on whether it's a gross business or based on whether it's a customer segment that's near and dear to our heart that we want to protect or it's a segment that we see substantial productivity.

Those investments will be a little different by segment and platform.

What won't be different is our expectations over the pro forma period in terms of the return on invested capital.

We are literally doing the work now based on the insights and some of the insights we already talked about.

Our comp store sales performance in those customer centricity labs for the quarter and the year led our overall store performance.

So we're thrilled that good things are happening.

We saw gross profit rates improve in terms of those customer centricity stores as well.

And we know that we put a number of expenses up-front.

We received some outside consulting services.

All of those helped us work through the developmental period.

Now we're doing the harder work in terms of what will the next 100 stores look like and how do we ensure that we drive that return on invested capital that makes sense over the long-term.

In our analyst day we'll give you some more insights on that in terms of where we're going but we're really pleased in terms of where we are on this part of the journey.

That's great.

Thanks, Darren.

Okay.

Okay.

I think that pretty well wraps it up.

Again, I want to restate that in terms of consumer centricity this coming year it's all about driving incremental return on investment in terms of what we're going to invest this year and getting incremental benefits from what we're going to do.

Otherwise we wouldn't be doing it.

Again, I guess I couldn't be more proud of our employees given the impressive results we reported today.

We enjoyed a strong performance from nearly every corner of the company in fiscal 2004 and we look forward to another very strong performance in fiscal 2005.

We believe that our performance ranks us among the best American retailers.

In the coming year we pledge to continue to press forward with the five priorities we discussed in order to continue to widen the gap between other retailers and Best Buy.

Thank you for joining us on the conference call today and I look forward to seeing you at the upcoming analyst day.

Before you leave here, Jennifer has some housekeeping items in terms of the analyst day.

I actually have two housekeeping items.

First our Web site gives you new store opening plans by quarter, ranges for that, and by square footage for use in your earnings models so please refer to that.

Second, please mark your calendars for our 2004 analyst day.

It will be held in sunny Los Angeles, California, on Monday, May 3, and Tuesday, May 4.

Our focus for analyst day will be on customer centricity.

We'll include hands-on visits to three lab stores in the L.A. market.

We will kick off the event with dinner on the evening of May 3rd during which time we'll give you a conceptual understanding of customer centricity and customer segmentation at Best Buy.

That understanding will help you get the most out of our store tours on May 4th which will depart from our airport hotel bright and early.

We promise to finish up by 1:30 p.m.

Pacific time on the 4th so that you can arrange for an afternoon flight home.

More details will be sent to you by e-mail and RSVPs are required.

I look forward to seeing you in L.A.

With that, thanks for participating in our fourth quarter earnings conference call.

Before we end may I remind you that this call will be available for replay by dialing 973-341-3080, then enter the pin number of 4630518.

The replay will be available from noon today central until midnight next Monday, April 5.

To hear the replay on the Web visit us at www.bestbuy.com and click on "For Our Investors."

If you have additional questions about our fourth quarter or fiscal 2005 outlook please call me, Jennifer Driscoll at 612-291-6110 or Shannon Burns at 612-291-6126.

Reporters may contact Sue Bush, PR director at 612-291-6114.

Thank you.

That concludes our call.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.