百思買 (BBY) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Best Buy first quarter conference call for fiscal year 2005.

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 star 1 on your touch-tone telephone.

As a remind, this call is being recorded for playback and will be available by 1:00 p.m. eastern time today.

If you need assistance on the call, please press star 0 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 Allen Lenzmeier, President and Chief Operating Officer who will give a report on our operations, Mike Keskey, President of US Best Buy retail stores, who will discuss our customer centricity work.

And Darren Jackson, Executive Vice President and CFO, who will comment on the earnings drives for the first and second quarters.

Brad Anderson our CEO is with us by phone from New York City, he will give you an overview of our news today from his perspective.

Also, Kevin Layden, President of Best Buy Canada is participating in our call from Vancouver.

With me here in the bordroom and available for our Q&A session are Ron BOEHRINGER Executive Vice President and General Merchandise Manager, Michael Linton, our Executive Vice President and Chief Marketing Officer, Bruce BASANKO, VP of Finance, and Shannon Burns Senior Investor Relations manager.

I would like to remind everyone that 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 our actual results to differ from management's expectations.

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

Also, in case missed a portion of the call, it's available through replay.

I'll give you the replay instructions.

Simply dial 973-341-3080 and then enter the personal identification number 4861883 that is 4861883.

With, that I will turn the call over to Brad Anderson, our CEO who will begin with the prepared remarks.

Thank you, Jennifer and good morning, everyone.

While investors recently have focused more on the tougher comparisons in the coming three quarters, my thoughts this morning center on the first quarter result and our long-term outlook.

I view our first quarter results as impressive, because we achieved earnings growth of 63% to $114 million.

Revenue growth of 17% drove our earnings, including the impact of new store openings and a comparable stores sales gain of 8.3%.

Increased traffic at our stores and websites led the comparable stores sales gain.

We also held our gross profit rates steady despite discounts associated with our rewards zone program.

Clearly, our strong revenue increase was not the result of aggressive pricing.

Best of all, we collapsed our expense rates by 90 basis points.

While the largest portion of the improvement related simply to the expense leverage associated with revenue growth.

Our efficient enterprise initiatives also had a positive effect.

And I would like to thank our employees for finding ways to cut expenses and boost their productivity.

They're a hard-working team, and I truly appreciate their individual strengths and talents.

I also am very optimistic about our long-term potential.

I believe customer centricity is a tool through which we can boost the return on our core assets, namely our people and our store.

If we can unlock the talents of our employee, we can truly win with our customers.

Successfully implements customer centricity could help us achieve several more years of double digit growth without having to look outside of North America.

More over, customer centricity is the right thing to do for our customers, and I believe that the days are numbered for retailers to remain product-centered.

Michael Keskey will talk about this initiative during his portion of the call.

Of course, I understand analysts concerns about tougher revenue comparisons, particularly in the second half.

Our own guidance for fiscal 2005 assumes that the comparable sales gain will moderate in the sec half.

We're watching closely how customers respond to changes in interest rates, employment levels and international events.

With that said, we're very excited about the opportunities ahead of us.

Furthermore, our goal remains to deliver double-digit revenue growth and top cortile financial performance over on an economic cycle.

Our customer centricity stores will help the top line.

We're making changes to cut expenses further to meet our goal for the year.

Al and Darren are going to describe some of those changes later on in this call.

With, that I will turn it over to Allen Lenzmeier, the President and Chief Operating Officer.

Al.

Thank you, Brad, and good morning, everybody.

I would like to discuss several factors I believe will contribute to the continued strength.

One, the second-quarter plans to expand our assortments with advanced televisions and computers.

Two, our success in entertainment software and, three, new ideas we are pursuing as a result of our consumer centricity work, including the continued expansion of geek squad services, our magnolia home theater test inside of Best Buy stores, and the opening of a uniquely entertaining new store in West Hollywood, California.

Our advanced televisions and notebook computers have been strong sellers in recent quarters.

We expect that trend to continue.

Revenue from our advanced televisions alone grew more than 50% since the prior year's period.

They represented more than 2 percentage points of our comparable store sales gain for the first quarter.

To capitalize on our customers' interests in these products, we plan to expand our product assortment in the next six months.

While DOP and LCD projection televisions are very popular because of the excellent picture quality and value they offer to our customers, most of the incremental assortment will be flat-panel, LCD and plasma televisions.

We expect to increase our product offering in these two categories by approximately 50%.

As the market moves to those technologies, we want to maintain Best Buy's position as the market leader with the greatest selection for our customers.

In another popular television subcategory, mobile video, we expanded our assortment in the first quarter and rolled out a significantly larger display fixture to highlight the number of choices we are offering.

Our U.S.

Best Buy stores now display five overhead mobile video systems, up from three a year ago and two in-dash systems.

A completely new product offering this year.

The new fixtures enable us to showcase working displays of our five portable DVD players as well.

In notebook computers, we believe we're continuing to gain market share to meet our customers' changing needs and to build on top of last year's tremendous success, we are currently expanding our assortment.

We expect to complete the changes in time for the critical back-to-school shopping season.

Our Best Buy for business customer centricity stores developed a new, more customer-friendly display unit that is being rolled out to all of our stores.

The new unit makes it easier for customers to try various models of notebook computers while continuing to provide product security that unfortunately is necessary in this area.

The new unit enables us to display about twice as many models as we did last year, so we will be offering approximately 25 different notebook choices to our customers.

Finally, the new display makes it easier for our sales associates to demonstrate the capabilities of the various notebook computers we offer, and we have invested in additional training for our store associates to ensure they match the correct computer to the customers' lifestyle.

Second, I want to point out our significant revenue gains in the first quarter from entertainment software, particularly CDs and DVDs.

CDs had a comparable store sales gain in the mid-teens and DVDs achieved the gain of more than 20%.

In music, we continued to take market share.

Our customers see us as the pre-eminent source for their music.

DVD sales benefited from a strong new release schedule, and we also had success with our deep catalog of popular titles.

We're committed to being a leader in entertainment, not only in package media, but also in digital audio and video opportunities.

My third point today concerns three separate ideas that emerged as a result of consumer centricity.

Consumer centricity has changed how we view our business.

Our new way of thinking helped us see opportunities that previously we had not considered, specifically I want to talk about the geek squad expansion, which appeals to several of our customer segments.

The magnolia home theater tests which, appeals to our more affluent customers in our West Hollywood store, which makes shopping in our retail stores almost an entertainment event.

These three ideas give you a sence of the capability we are building at Best Buy in services, displays, brands and customer experiences.

I'll start with the geek squad.

In our Analyst Day in May, we announced that we would be rolling this out, the 24-hour rapid-response in-home computer support [inaudible] to all of our U.S. markets.

Early on, we saw geek squad as a great fit for Best Buy for business lab stores.

We saw a spike in customer loyalty in the labs because small business customers valued this new service.

Then we found out that it appealed to other customer segments as well.

Along the way, we discovered efficiencies which, was more good new.

Now, we're making plans to bring geek squad services across our northern border.

I'm pleased to say our agents will be patrolling the precincts in Canada by the end of fiscal year 2005.

This is just in the Best Buy stores in Canada.

We believe that week geek squad can become North America's largest national provider of in-home computer repair and installation services.

As of today, we have successfully rolled on out the first four of nine waves of geek squad rollout.

We're delivering premium service in 18 new markets while alleviating the pain often associated with technology.

At the same time, we have rebranded the existing tech benches in the 212 stores in those markets and upgraded the surface capabilities we offer our customers.

In the store on the phone, on-line or at home.

Integrating the in-home services maximizing the efficiency of our agents' time.

They can assist customers in our stores when they're not off on the road where, whether they're eradicating the sasser virus or simply making technology more fun for our customers.

The geek squad is an incredibly powerful brand, and based on our labs, believe that it will drive customer loyalty in comparable same-store sales.

Let me give you an example of the power of the geek squad when combined with Best Buy for Business.

The customer buying a laptop was identified as a Best Buy for Business customer by one of our business pros who told him about geek squad.

The customer, the owner of a chain of stores called back to Best Buy for on-site support and a geek squad agent spent the entire day at the customer's business.

The customer was so impressed that he came back to the store the next day and worked with the business pro on a plan to equip all of his 17 stores, including notebook computers for every salesman.

The total package will include approximately 60 notebook computers, 30 desktop computers and a few servers, as well as set-up, training, and service provided by the geek squad.

A package worth close to a quarter of a million dollars, stemming from the expertise of the geek squad and our Best Buy for Business pro.

Another idea that emerged from consumer centricity was our new Magnolia Home Theater stores in May, we began testing the store within a store concept within two Best Buy stores, one in San Francisco and one in Costa Mesa, California.

This idea emerged as part of our efforts to increase our [inaudible] to our more affluent customer, basically our [ Indiscernible ].

A few weeks ago, I visited both stores.

While it's still early to declare a trend, I'm very enthusiastic about our initial successes.

Let me tell you a story that illustrates the results that we can achieve at those stores with Magnolia.

A customer came into the Best Buy store to purchase some media in the media area and I was talking to the media representative who wanted to call up, so the person took him back to the Magnolia Home Theater describing the new concept on the way back.

We got [inaudible], and he in turn spent $26,000 on a plasma television, a receiver, and a full audio system, as well as $3500 on installation.

While these test stores are not material to our business, such stories speak to the power leveraging the two brands and we are very excited about the opportunity that we see for expansions.

Finally, another offshoot of our consumer centricity initiative was our new store in West Hollywood, Los Angeles.

This store incorporates a unique Best Buy store design and is a prototype for the retailing experience of the future.

For us, it's a breakthrough.

Features of the new design include experience hubs in home theater, home essentials, computers and entertainment connections to create a solution-based retail environment.

Its special product displays provide a holistic customer experience that ties together all four of our product categories, setting the stage for the era of home networking and personal networks.

The new design also allows for better traffic flow throughout the stores.

We believe that we're uniquely positioned to demystify the complexity of device and content integration and to explain entertainment solutions to customers.

This innovative format is a testament to our leadership role in this space.

I think you will agree that a lot has happened since our Analyst Day in Los Angeles in May.

And now, I will turn the call over to Michael Keskey, President of U.S.

Best Buy retail stores who will give you an update on our consumer centricity initiative.

Good morning, everyone.

I would like to talk to you this morning about our customer centricity lab stores and rollout approach.

We spent the past six weeks determining the customer segments, the best match, the customer base and demographics of every store we will be converting to customer centricity.

We have also re-examined the results of the 33 lab stores to make sure that the assumptions on which we're basing our rollout plans are correct.

Based on that work, we expect the Best Buy for Business will be represented in about 35% of on our converted stores.

We plan to aim 24% at the family man looking for technology, but with value, roughly 23% will serve our high-end customers, another 21% will be focused on suburban moms and finally, 18% of the new customer centricity stores will serve the young, active and early adoptive segments.

You probably noticed some of these percentage exceeds 100%.

That is because some of the individual stores will be designed to appeal to two of the five segments we have defined at this time.

For example, our last indicated that a couple of combinations appear to have synergies, such as berry, Jill, or [ Indiscernible ] in Best Buy for Business, and [ Indiscernible ] As we noted in our news release, the lab stores collectively continue to achieve a comparable store sales and gross profit that surpass those of other domestic stores for the first quarter.

The comparable stores sales list versus other domestic Best Buy stores was nearly 6 percentage points and the gross profit benefit was approximately 20 basis points.

We are encouraged by those results because they indicate we're endearing customers to Best Buy.

That's job one.

The next part is translating that success to the bottom line then rolling it out to more stores, which we expect to be easier.

Our power zone is is around honing profits and scaling new store concepts, as we have proven over the last 10 years.

Yes, the expense rate for the lab stores was approximately 220 basis points higher than the company average.

The seasonality of the business, as well as the distraction of management changes contributed to that figure.

Driving SG&A was -- driving SG&A was increased labor and customer research.

But I will tell you this is a misleading figure.

Consider the following three things.

One, lab stores are treated differently.

Their focus is to try new ideas that help us win the customer and focusing on expense rates will kill innovation.

Tow, labs were conducted with minimal corporate support from the Best Buy infrastructure and its wisdom on issues such as such as labor optimization and local marketing.

Now that the tests are completed, we are integrating our customer centricity teams with what we called our core business and we can tap the entire organization expertise.

Three, we learned a lot in our lab stores.

In October, we planned to roll out only what we view as a successful elements of customer centricity.

In sum, we believe that the pilot stores will meet our expectations more quickly as they will have the benefit of lessons learned by the lab stores that proceeded them.

As we move to the scaling process, we will continue to hypothesis test and verify at our lab stores while we hone our SG&A at our pilot stores.

We are learning what investments matter to the customers, and we will continue to learn from our lab and pilot stores.

For example, we will strive for a better balance between labor to full fill our SOP requirements and labor to provide certain value proposition elements.

We plan to reduce the frequency of freight deliveries and rush orders in some cases.

We also will take a look at how we balance our mass marketing with personalized and local marketing we use in customer centricity.

We also believe that we can improve the profitability of all stores by applying what customer centricity has taught us about the habits of customers whom we call extreme price shoppers.

Over the past year, we have tested several changes to promotions aimed at minimizing losses with these customers.

In numerous tests, store traffic didn't suffer.

In fact, as you, we saw improvement in comparable store sales and we continue to draw a broad range of customers with our offers.

Other changes were made in areas such as rebates, clearly the lessons of our many tests will be applied across our network of stores.

I look forward to continuing to report to you on a progress in rolling out our customer centricity.

At this point, we expect that approximately 70 California stores will be converted to customer centricity in the third quarter.

In fact all of them are scheduled to launch in October.

That gives us three months to conduct the necessary training any prepare.

The experience of converting 70 stores at a time will be helpful to us as we develop our plans for converting the remaining U.S.

Best Buy stores in the next couple of years.

Some of you have asked why we're beginning in our California stores.

Simply put, the labs in California performed the best.

To be specific, it was the readiness of the leadership and talent and the resources there and the -- that the practical issues that we would take advantage of a single advertising umbrella.

And now, I will turn the call over to Darren Jackson, our CFO, who will comment on the first quarter results and our outlook for the second quarter.

Thank you, Mike.

Good morning, everyone.

It's really fun to be here in a quarter when we did so well.

As we reported earlier in the month, we achieved an 8.3 comparable store sales gain and a 17% increase in our totally revenue.

Today, we announced earnings from continued operations of 34 cents a share, which was a 62% improvement over last year's 21 cents per diluted share that we reported in the first quarter of 2004.

The gross profit rate was 25.4% revenue, which was flat with the prior year.

Having said that, the gross profit rate benefited from assortment, it benefited from higher sell throughs, and effective promotion.

It was partially offset by rewards zone in the quarter.

Rewards zone added 650,000 new members in the quarter.

We now have over 3 million members in rewards zone, and their purchases represented more than 25% of the revenue in the quarter and we had higher redemption rates in the quarter as well.

All in all, [inaudible] decreased our gross profit rate by about 80 basis points in the quarter.

While that sounds like a lot, what we would say we view it as part our overall promotional mix, similar to rebates and 0% financing.

It's also a very effective way to find our most loyal customers, and, in fact, more than two-thirds of our Reward Zone members rank in the top-three profitability in the country.

Next, I would like to talk about is, G&A in terms of the quarter.

To tell you, I am very proud of our employees who achieved an improvement of 90 basis points in our SG&A rating in the first quarter.

We benefited from the leverage of higher comparable store sales, as Brad mentioned, and a larger store base.

We also continue to recognize savings in our efficient enterprise, including streamlining our corporate, our regional, and store management structures, which contributed to the overall improvement in the quarter.

Now, we did make investments that Mike talked about.

We made investments in customer centricity, which added approximately 40 basis points of SG&A rates in the quarter.

However, we did keep the expense rate flat when you compare it to the fourth quarter of last year.

When you look at it in total as Mike said, and move towards the pilot stage we're looking to streamline that investment as we open the 70 pilot stores in October of this year.

Our strong performance in the first quarter does provide a good foundation for the rest of the year, we recognize that the balance of the year presents more challenges, specifically our comparable story sales comparisons in the next three quarters are 6.7%, 8.6% and 9.7% respectively on a GAAP basis.

The earnings guidance in our news release reflects the difficult comparisons we will face in the upcoming quarters.

Our projections for the second quarter earnings is 47 to 52 cents per diluted share.

An average increase of 18% over the second quarter of the fiscal 2004.

This guidance is based on anticipated comparable stores sales gain of 5 to 7%.

We expect the gross profit rate to be flat in the second quarter, and we expect SG&A to keep coming down despite the costs associated with preparing to introduce more of the customer centricity stores in the second quarter.

And I would remind you, we're up against a prior year when we did very well in the second quarter.

Our earnings were up 70% last year in the second quarter and we didn't take the SG&A rates down 100 basis points last year.

For the fiscal year as a whole, we continue to look for earnings of 280 to 293 per diluted share, based on our projection of comparable store sales being in the 4 to 6% range for the year.

We remain confident our customers, our products and employees' abilities to meet customer needs will drive those gains in the second half of the year.

We believe we can continue to outperform the industry and continue to gain market share through the superior execution of our store level team.

Now, when we turn to the balance sheet, we ended the quarter with more than $2 billion in cash and that's up $500 million versus the first quarter of last year.

We continued our quarterly dividend program and as I mentioned, as we mentioned in the news release, we repurchased $82 million of common stock in the quarter and we now have $118 million remaining on the existing authorization.

Earlier we announced we will use $355 million of our cash to repurchase our [inaudible] that were due in [inaudible].

And our goal still remains to maximize shareholder return while ensuring adequate liquidity to grow our business and meet the ongoing demands of the business in the future.

At the end, I want to thank our Best Buy employees for their dedication and energy in the quarter, driving an 8% comparable store sales gain, driving a gross profit rate of 25.4% and essentially hitting a home run driving our SG&A rate down. 90 basis points was the difference in the quarter.

Thank you for all of your commitment and energy in making that happen.

With that, what I would like to do now is turn it over to Marie for questions from our investor audience.

I would like to remind analysts that we would ask you to give us one question at a time, and I prefer they not be two and three part questions.

Thank you, the floor is now open for questions.

If you do have a question, please press star 1 on your touch-tone telephone at this time.

We do ask when you pose your question, that you please pick up your handset to provide optimum sound quality.

Once again, Ladies and gentlemen, that is star then 1 to ask a question at this time.

Our first question is coming from Matthew Fassler with Goldman Sachs.

Thanks a lot.

Good morning.

Need to see how to work within your new ground rules here.

[ Laughter ]

I really want to focus on inventory and I guess my question is: Can you give us a sense of the composition of the inventory increase and in that vein, how much of that reflects your flat-panel business or your advanced-TV business building inventory in anticipation of the second half that you discussed.

I will let Darren and Ronald address that, Matt.

Yes, here's what I would say.

In terms of our overall average inventory per store at the end of the first quarter what, we're seeing is a total 8% increase in average store inventory, and as you would expect, we are making those investments in the video category, digital categories, um, our computer categories are up in terms of recognizing the sales trend.

The in-stock we're trying to achieve and, quite frankly, some of the price points that go with some of the businesses that are hottest for us.

And so, what I will do is I will let Ron give you a fire more insights in to how that aligns with our strategy and how we see the balance of the year.

Sure.

No surprise we continue to invest in the digital categories as a fundamental driver to our, um, and in the case of flat-panel margins, um, so the other improvement I'm thinking, we talked about it previously way back into December was the improvement of customer availability, customer encounter of in-stocks and we have seen, although we don't quote the number of significant improvement in customer availability, which we also feel is a driver of comps.

And you're comfortable with the higher levels of inventory, even in the context of the anticipated moderation of comp sales store growths as the year progresses?

Yes, I think we're very comfortable.

Gotcha, and just a natural segway, not a follow-up.

On the flat-panel side, Al, your comments on the additional commitment to flat-panel, they were quite interesting.

Are you comfortable the price points are going to come down sufficiently in that pure flat-panel business to achieve the sell-through of inventory that you hope for.

Ron, I'll tell you what.

I think we feel good about on our flat-panel position, specifically we're taking assortment of about 50% in flat-panels.

We continue to take share in visual television year-over-year and on a 12-months' trend, and we also continue to see our ASP rise in television broadway, in specifically in digital television.

So, we're pretty comfortable with our position.

We, um, we are comfortable with our share targets and we are, I think, on a very nice path, to achieve our share targets and flat and total digital.

Yes, of course, Matt, you would expect the analog investment to be coming down at the same time, recognizing that we are going to make those investments, the parts of the business that the consumer is voting with their dollars.

And the customers comfortable with price points where they are now?

The flat panel?

Yeah, I think so.

And were seeing continued year-over-year, um,d price points move more and more into the power zone.

We talked about that the last 12 months or so.

The results are, we are seeing our growth in flat-panel to digital at more than twice the industry growth rate.

Thank you so much.

Next question, please.

Thank you, our next question is from Aram Rubinson with Banc of America Securities.

Thanks.

Boy, I'm trying to do a little math here.

So, hopefully you can help me out on.

I get a little dangerous when I do that.

The Reward Zone math, if it was 25% of your domestic business would be about a billion 2 in revenue.

If I divide that per average Reward Zone member, is that like about $450 in the first quarter and if I annualize, that I get something like 2,250 on a full-year basis.

Is that ballpark?

Michael Linton will answer that question.

Yeah, first of all, I want to give you contacts and then answer your question.

When you think about Reward Zone, I think, what we believe is we're building know who of the best promotional tools that we're going to have in terms of driving demand in connection with our customer, and we see the ability to migrate some other less direct and focus tools like rebates and financing and other things towards this tool.

When you think about Reward Zone, there is the initial sign-up, which usually get attached to a big, often gets attached to a very big purchase and over time, becomes more of a mainstream kind of customer loyalty building program.

So, you're right on your initial math, but over time, they're not all, unfortunately, coming in to buy four or five big-screen TVs or notebook computers, though we wish they would.

There are a couple of factors on Reward Zone that I would like to put on the table, or at least directional math that we're seeing.

The first is that Reward Zone members are shopping nearly twice as often as nonmembers.

When they come in, they're spending, you know, more than two times as much as nonmembers, and I think as Darren pointed out, the Reward Zone members we're finding out, are showing up in our top file of profitable, top couple dosiles of profitable customers.

So, what you have here is an ability to reach our best customers, the most profitable customers in the market and drive them back to our brand.

Over time, think about what we can do with some of the less target promotional tools like rebates as we target them to these customers.

So, I don't know if I have answered your question exactly, but I gave it a good shot.

And then, just the last thing, did some other math that would kind of show me that about a 70% redemption rate.

I don't know if that's something I can actually get to.

But is that also ball park?

I hope not.

No, it's nowhere near that in terms of -- when I say that here in terms of we're -- the redemption rate is running slightly ahead of what have we said before, but 70% would be high.

Okay.

All right.

Thanks, guys.

Thank you, Darren.

Next question, please.

Thank you, our next question is from Mark Rowen with Prudential.

Thanks, good morning.

Question on customer centricity.

When we met in Los Angeles in early May, the comps in the 32 test stores were running about 17%, and I think gross margins were up about 50 basis points.

Now you're saying the first quarter, 14% comps and about 20 basis points of gross margin improvement.

Is that regionally-based, um, that drop and what is causing that to come down.

Is that just the natural evolution?

Did you expect that?

Thanks.

Yeah.

Thanks Mark.

This is Darren.

A couple of things.

We got the round down.

It's actually closer to 25 basis points in terms of martial up improvement.

As Mike pointed out in his comments, if the truth be told, we had transition in terms of management teams, as we're getting prepared to launch pilot stores.

I would say in the first two months of the quarter, um, we saw a dip in terms of some of the gross margins and a modest slowdown in some of the comp store sales.

All of that being said for all the things that we are doing, we continue to see them outperform the pack, we continue to see California lead the ways.

There are regional differences.

We have some stores in the group that are over 100 basis points in margins and others, quite frankly, that are flat.

What you will see is the corelation that when we had the slowdown in comparable sales growth, I know you used to be in retail.

You get to slowdown in the comps a bit and you get the slowdown in terms of the sell-through, as you feel a bit of it in the gross margin rate.

Again, as we pointed out, we have learned a bit in this fourth quarter of the test.

Still, when we look at the test over the 12-month period, you know, we see that level of consistency of outperforming in terms of top-line and outperforming in margin that, you know, the margin thing, to honest, we would like to see it be a little higher, or confident as we go to the pilot stores, we'll use the thing this worked on the sales in the margin and try to turn back the expenses.

Not try, we will turn back the expenses to make the bottom line come out.

And I think, Aram when we were in Los Angeles, in May at the analyst meeting, I think we said the spread between the CC stores and overall stores was like a 7% spread.

Yup.

And we're now 6%, pretty much in which line what the overall comp stores have come down from the first quarter to the fourth quarter as well.

Okay, if I could segway.

Just a quick question for Brad.

You have been following what is going on in the UK as far as warranty disclosures and what that has done to sales of warranties there, and do you think there is and risk of any kind of legislation in the U.S. anytime soon for something like that.

That's a great question.

I think most of what going on on in the UK, yes we have been following carefully.

We've got pretty good relationships with a number of UK retailers so, this is an issue that has impacted them very directly, and one that we have talked directly to them about in terms of their experience.

I think most of the circumstances that you see in the UK are what is driving that is, is there is a different press environment and there is a different degree of regulation.

So there are a lot of differences from what you see in the U.S. and this has been the presignaled in the UK for a number of years.

This isn't just a -- this is a recent action, but there were indicators of this kind of trouble coming on on the horizon for quite awhile in the UK.

So, we don't see any of that in the U.S. at this stage, but it's certainly something we're very aware of.

I don't think it would have the same impact, however in the U.S. even if exactly the same thing happened as it's having on the UK retailers.

Okay.

Thanks very much.

You bet.

Again, one question per analyst, please.

Operator.

Thank you, our next question is coming from Danielle Fox of Merrill Lynch.

Thanks, good morning.

My question is also on the customer centricity stores.

I just wanted to confirm you'll be converting 70 stores rather than the 110 that you outlined as a possibility in May.

I'm wondering why that is is and if you open fewer, should you spend much in aggregate.

Mike --

Um so, in California, on Analyst Day, we said up to 110 stores.

I'll tell you this is a great example of applying learnings from our labs.

One of the things that we learned in our labs was that we needed a solid foundation of leadership, talent and SOP, and SOP, standard operating practice and without that, um, we can't maximize what customer centricity brings us.

I know there has been a lot of questions around Chicago and Washington and what we found was those two markets didn't have this solid foundation in place.

So what we have done is we have developed an assessment that measures the head.

Do the leaders really understand what we're trying to do?

The heart, do they believe in it, and the hands execute it.

And as we have gone through and assessed our on entire chain but more specifically, the 110 stores in regions 8 and 10, which is essentially the west coast of the United States, we found that some of the stores aren't executing at the level we need in SOP, then they're not executing at the level we need as it relates to the leadership, understanding exactly what we're doing.

So, I think this was a mistake that we made in our labs.

We have learned from that mistake.

We have put together this assessment.

We're now using this assessment to measure the readiness of the stores because clearly that foundation must be in place as we found it was in place in our California labs in order for us to maximize the results.

So that's the first thing, is we eliminated some stores because of the readiness.

Secondly, we think that it just makes good logical sense to consolidate our pilot stores in California because of the consolidation of the leadership and it's just -- it just makes sense for us to do it.

Clearly, we're going to be able to put more appointed resources at these stores, keeping them in California and we also feel that the number 70 is a really good number for us to learn from as we move forward and scale this across the United States.

So, that would be the reason that we said up to 110 and why we're now somewhere around 70 to 74 pilot store.

Okay.

There is one other thing, too, I would add to that, Mike, which is we see an advantage in doing a number of stores essentially concurrently.

We think we'll sensing some about the leveragability about the customer centricity initiative so that the 70 was about the right scale we felt to do was sort of a one times concurrent effort.

Is there a certain number of customers interested in the stores that you need to ref leverage the fixed investment?

For example, field organization or some of the things that --

Well well, yes.

I think from a leverage standpoint, we are, you know, concentrating, really, on on the state of California, and you look at San Francisco, San Diego, and Los Angeles.

We are getting a leverage in terms of regional support, district support, as well as advertising coverage in those particular markets, and I guess, you know, this isn't really going to change our, we said we're still comfortable, I think with the earnings range we put out there at the beginning of the year.

At this point, there is no change in terms of the impact on that earnings number.

The other thing we're attempting to share with this conference call is that you have to look from a leverage standpoint.

Not just at what we're directly doing with the customer centricity stores, as Al alluded to, what we're finding with the geek squad, we never would have rolled anything to the geek squad anything like this time fram without what we learned in the labs what.

We're learning in the relationships, the Magnolia relationship, we covered several being leveraged.

What we're learning in terms of some of our on, what was referred to earlier in terms of margin enhancement by not spending dollars chasing customers that have no economic return for us.

Those things are levered across the entire system.

So, you've really -- when you look at what we're learning, you have to look at what is happening with the customer centricity store themselves, but also the benefits of the overall enterprise.

Thank you.

And all that is part of leverage investment.

Thank you very much.

Thanks Brad, and next question, please.

Thank you, our next question is from Sharee Madison with Wachovia Securities.

Good morning.

You have $355 million in cash needs in the second quarter to meet the redemption of the [inaudible].

Does that in any way change the way you think about it returning capitol share holder, by the way of dividend buyback or would you just treat this as a one-day event and given the fact that that has no impact on your plans in term of returning capital to shareholders given you the expected improvement in EPS cash flow gains.

Darren will answer that question.

Yeah.

The short answer, it doesn't change our view, which is an upbeat view in terms of on our cash return strategy.

So, we do view this as a one-time economic event to take those shares in, as you recall last year, we returned in cash 30% to our shareholders, between dividends and repurchases of stock.

We're supportive of that and we're supportive of taking these bonds out of the markets because we think at this point, the economics of taking them out of the market makes more sense than leaving them in.

So that 30 percent, I don't want to call it target, but the 30% excludes the cash need for redemption.

That's correct.

Thank you.

Thank you, our next question, please.

Thank you, our next question is from Dana Telsey with Bear Stearns.

Good morning, you talked about some of the categories that you're expanding.

Can you talk about which categories you're taking from to expand the TVs and other items, and what do you expect the margin impact to be.

Thank you.

Okay Ron.

Thanks Dana.

Well, the -- [ Indiscernible ] we are harvesting analog space to grow our digital and flat-panel space.

We continue to take a portfolio view of products and product categories.

And invest in those categories where we see, um, a significant strength emerging, so examples of that, would be harvesting more conventional audio categories to invest that space in and inventory dollars and to grow some digital categories, such as notebooks, digital cameras, wireless, networking, and, of course, flat-panel TV.

So, as far as impact on margin, we see our -- on we see our margin continuing to, -- as you saw in the last quarter, continuing to be pretty healthy, and we're always looking for ways to improve margin.

We feel that some of the opportunities that we have in digital and some of the harvesting we have done, particularly thing like PDAs, which where significant EBA drainers, will continue to help us optimize the margin.

And any update on your own brand or what the plans are there?

We are on on course with our private label strategies.

I think we have a pretty thoughtful strategy in how we're going to continue to enhance the brands that we have, and bring in new brands that will value for our customer.

We don't have a significant changes to that strategy now.

Thank you.

Thank you, Ron.

Next question, please.

Thank you, on our next question and is coming from Colin McGranahan with Sanford Bernstein.

I think Dana snuck in two questions there.

I will hold myself to one.

Darren, can you give us the margin mix impact from the strength in new releases and entertainment software and your view of that category going forward with what the new release schedule looks like.

Ron, you want to --

That's a good question.

We actually -- new releases were a little weak in the last few weeks and had a positive margin, in fact, there.

I think in general what we're trying to do with new releases is balance the impact of traffic to the cost of that traffic on your release.

Um, so, I would say that we're not expecting a material impact because of new release schedules.

And we're going to continue to try to optimize how to use these guys as a ways to traffic, you know, when you sell an item for $3 less than you paid for it, you need to get a return on that $3 investment, the question was -- [ Indiscernible ] They're not sure that it's always going to be that big of an investment or that we always need to be that deep to drive the traffic and get some benefits in there.

We're going to continue to play with this, the new release pricing.

I guess you look at our on top margin for music exceeded our comp sales percent in the first quarter.

Right.

And, Colin, maybe a way to frame it is, to Al's point, our margins improved in the entertainment software category in the first quarter, and I would say as I'm looking at it, 80% of it came from mix and 20% of it came from rate.

So within, despite the new lease schedule, and despite, um what, new releases do for our overall traffic in the store, how it's mixing out to the consumer and what we're seeing as a register is actually, um, margins not only holding but improving slightly, and 80% of that margin improvement a mixed improvement versus a rate.

Okay.

Thanks.

Thank you, that was Ron, Al, and then Darren.

Next question, please.

Thank you, our next question is from Greg Mellic with Morgan Stanley.

Great.

I wanted to talk more about Reward Zone.

The 80 basis points hit got worse than it had in the last couple quarters.

I think it was 30 and 40, and I guess it's one question about Reward Zone with two parts.

[ Laughter ]

Like a split infinitive.

I try it every time.

Basically do the 80 basis points include any catch-up for the fact that the redemption rates were coming in higher this quarter than you would provisioned for in the third and fourth quarter last year.

As a follow-on or related to that, when you talked about these customers being your top three dociles of profitability, did does that include their first purchase, which might be a big screen TV on or does it look at just their spending after they make the first purchase of the Reward Zone card.

I will take the first -- this is is Darren Jackson.

I will take the first part of the question.

The of the Michael Linton will give you insight to the docile.

So, Greg, you're right.

So the first quarter, as you know, is seasonally our lowest revenue quarter and the 80 basis points was driven by three things versus the 40-basis points that we have been experiencing, I would say up until the first quarter.

One, we did see a pick-up in what I would call the attachment rate.

So, more consumers using the Reward Zone customer -- using the Reward Zone card versus what we had planned.

So we saw a pickup in utilization of the card.

Two, we did see a pickup in the overall redemption rate in the first quarter, and you're right, just by virtue of how you account for redemption rates.

Unfortunate -- I don't know.

Fortunate or unfortunate, coming off the fourth quarter into the first and the first quarter ended up bearing the brunt of that estimate for higher redemption rates.

So, even if it's modest, because it's the first quarter, you get a disproportionate higher impact on your gross margin rate.

And then, three, as Mike alluded to earlier, we are seeing and this is where the plus is in all of this, we're seeing higher repeat utilization from those consumers.

We're seeing higher ASPs in terms of their overall tickets and that's factoring in as well.

So, I think we would be nervous, um, if we were thinking about it only in isolation.

I think the fact is that if we can attract our best customer, get insights on the customers using the card, they may fit in the top three dociles, versus just blinded rebates.

I think the tradeoff, what we're seeing to date certainly a tradeoff economically that looks to make that.

Mike.

Yeah, this is Michael Linton.

We are seeing big profitability when they sign up, but we're also looking at the math two ways.

We take out on the initial purchase and we're tracking them versus the base line.

And what we are finding is they do start out very profitable and fortunately, so far, they're staying profitable.

And continuing to visit the store.

For every buck they spend on Reward Zone, redeem, they're turning up with an extra $3 in purchase.

So, they start out profitable and so far in the program, they're staying very profitable.

So, still early but it looks like a very good start for Rewards Zone and we'll keep you posted as it develop.

it's probably fair to say, Mike, we're at a stage where we get to test all the dimensions of the reward zone in terms of the levers and we'll continue to monitor it over on the course of the year.

right.

Just to make clear, the top-three dociles, that includes the initial purchase in.

If we factor it, we can factor it in both ways and it's still the top-three dociles if you include or exclude the initial purchase.

The next question, please.

Thank you, our next question is coming from Alan Rifkin with Lehman Brothers.

Yes, I have a question and a followup if you don't mind.

Can you provide some color on the finance related purchases in the quarter and what proactive steps with respect to financing can you do to combat the eventual higher rates we're poised to see.

Do you mean 0% financing, Alan?

Yes.

So, Alan, more specifically is the question is 0% financing a bigger drag in the first quarter than it was a year ago?

Right --

And how do we see the future in the financing category in.

Yes.

Yes.

So here's the frame I would give you, so whether it's rebates, Rewards Zone, costs or opening price points, we view those all as levers that we pull in term of the pricing strategy.

On an absolute basis when I look at this year to last year, I would say financing's running about the same rate.

So I'm not troubled by that.

You are right in the event we see an increasing interest rate environment.

That will impact our cost of financing and historically, the merchant's team have done is they make those tradeoffs, again between rebates, Rewards Zone, opening price points in order to blend the overall margin income that we're looking for.

We're sensitive to that and to try to project it in terms of if it goes up, I think what we would do is look at different things making sense in the mix of overall mix of promotion.

Okay, thank, Darren.

One quick question on customer centricity.

You mentioned the Cap Ex and the pilot stores would be less than anticipated.

Can you maybe quantify relative to the $400,000 that I think, you know, the latest phase was running where will the pilot stores be running in relation to the 400.

Yes, just a -- I will have Mike give you the, just to frame the $400,000.

That's not -- it's a per store cost.

It's specifically related to customer centricity and, you know, at this point, we have not come off that average, Alan, in terms of what it's going to be.

You can assume by the absolutes by bringing in 110 to 70, that the overall cost to the program, so we're in that phase right now of getting them planned and rolling them on out.

Getting them planned for rollout.

There is not information that says it is materially more than that or less than that on a per-store basis for the customer centricity elements.

Okay, thanks, Darren.

Thank you, Alan.

Next question, please.

Thank you, the next question is from Kelly Chase with Thomas Weisel Partners.

Yes, hi.

I wanted to actually ask there's a large amount of LCD and plasma capacity coming on stream here in the second half of this calendar year.

I wanted to get an understanding of what kind of changes can you make to either on selling strategy, et cetera, to make sure you get your fair share of, you know, hopefully the increased demand that we will see from that and how that's going to change the promotional environment or your promotional stance at all.

So, um, we have already talked about the significant investment we're making in major resets.

Uh-huh.

Taking on assortment from about 45 panels to about 60 which we think in our space would be an industry leading.

So I think that the two things we're doing to take advantage of that, number one, taking the assortment up significantly, but, number, two continuing to work with our retail team on more [indiscernible ] selling strategies.

So,um, some of the things you're beginning to see in the stores some of the things that Alan referenced, on the West Hollywood is a good example of thinking differently about how we present digital television and integrated digital experiences.

We believe that the capacity coming online is going drive pricing that will continue again to fall into our power zone.

We, again, are continuing to grow at twice the industry pace for flat panels and digital television and the industry is growing at a very aggressive pace and we're [inaudible] real estate, and the way they continue [inaudible] in those categories.

We don't anticipate having any issue in terms of gaining access to the supplies that we need.

We feel good about the supply.

Not only in flat panel but in micro-- [ Indiscernible ].

We have locked up commitments from our vendor, and we are pretty comfortable with the supply.

Great.

Thank you.

Thank you, Ron.

Al, did you want to comment -- .

Yeah, they're -- just a -- [ Overlapping Speakers ] She asked me that question about appliance, which I'm surprised.

I don't want to miss out on it.

Actually our appliance business continues to be very strong.

We have a double-digit sales increase in the major appliance categories this quarter, and the test we talked about before, for one reason in terms of looking at a different sales model and investing more in training and the caliber of people.

That model is is continuing to prove that there's real opportunities here.

We're real excited about it.

Okay, I think we have time for one last question.

Thank you, our final question is from Bill Sims with Smith Barney.

Thank you, good morning.

I wondered if you could give us an update on your Gateway relationship in terms of two parts.

One in terms of have you now fully taken possession from the Gateway inventory from the closed stores, and, two, can we look forward in terms of your PC strategy, if it suggests you would start on Gateway branded PCs.

Are they going to replace an existing brand or is it part of your strategy to bend your PC merchandise.

Thanks.

Ronald, take that.

Yeah, I'll comment on that.

Gateway, currently we have agreed to take close-out products in the CD area from Gateway.

This is clear, an opportunity buy.

They had an inventory situation when they closed the stores.

We think it's an opportunity for our customers and shareholders to benefit from.

Going forward, we are talking to Gateway on a number of difference fronts, as we talked to a lot of our vendors.

We have -- [ Indiscernible ] for a long time.

We have not made any decisions as to how we are going to [ Indiscernible ] PC.

So just to clarify that, inventory is now completely in your possession or are you still in the process of taking inventory from Gateway?

We will be taking inventory from Gateway and closeout goods in the next 30 day.

All right.

Thank you.

Okay.

Thank you, everyone, for participating in our first quarter earnings call.

I apologize to those of you who are in the queue, I will get your names and numbers and give you a holler.

Before we end, may I remind you this call will be available for replay by dialing 973-341-3080 and entering the personal identification number of 4861883.

The replay will be available beginning at 1:00 p.m. eastern until midnight next Monday, June 21.

To hear the replay on the web, go to www.bestbuy.com and then click on for on our investors on the lower left sided.

If you have additional questions about the first quarter, please call me, Jennifer Driscoll at 612-291-6110 or Shannon Burns at 612-291-6126.

Reporters may contact Sue Bush at 612-291-6149.

She's working remotely but will check messages.

Thank you again for participating.

That ends our call.

Thank you, this concludes today's teleconference.

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