百思買 (BBY) 2006 Q1 法說會逐字稿

[OPERATOR INSTRUCTIONS] Welcome to Best Buy's conference call for first quarter of fiscal 2006.

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

Thank you all for participating in the investor conference call for the first quarter at Best Buy.

With me here this morning is Darren Jackson, Executive Vice President Finance and CFO of Best Buy, who will cover today's results as well as our earnings guidance.

Brad Anderson CEO will give you his perspective on the quarter's news via telephone from New York.

Brian Dunn, President of Retail, North America will update you on our progress for the five goals for fiscal 2006 from the road as well.

Available for our Q&A session today either in person or by phone, are Al Lenzmeier, Vice Chairman;

Ron Boire, Executive Vice President and General Merchandise Manager;

John Walden, Executive Vice President, Customer Business Group;

Kevin Layden, President of Best Buy Canada, Jim Muehlbauer, Senior Vice President-Finance;

Susan Hoff, Senior Vice President, Chief Communications Officer;

Shawn Score, our Senior Vice President Sales Development; and Charles Marentette, our new Senior Director of Investor Relations, who along with me is a contact person for both buy side and sell-side investors.

I'd like to remind 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 expectations.

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, 6146761.

The replay will be available from approximately 1:00 p.m.

Eastern time today until midnight on Monday, June 20.

I'd like to remind callers that we will invite questions after we conclude our prepared remarks.

And as usual we respectfully request that analysts and investors limit themselves to one question so that we can respond to a larger percentage of those listening.

With that I'll turn the call over to Brad Anderson, Vice Chairman and CEO who will begin our prepared remarks.

Thanks Jennifer and good morning, everyone.

It's my pleasure to be here this morning to discuss our first quarter results and our improved outlook for fiscal 2006.

Let me give you the highlights of the first quarter.

First, we significantly outperformed our earnings guidance for the quarter.

Second, we continue to accelerate customer-centricity by preparing the years first wave of stores for a conversion to our new business model.

Three, we saw early dividends from our business model and from changes across the organization.

Those included our supply chain and our Canadian operations to name just a few.

Four, we announced three major developments in our growth agenda, including plans for more new Best Buy stores in North America, stand-alone Geek Squad stores and and Lab stores in China.

We also announced the creation of a $1.5 billion share repurchase program.

In short, we continue to make significant progress with our transformation.

That brings me to a key point.

This transformation is broad, it's touching all parts of the organization, and all parts of the business model.

Such sweeping changes are the only way to achieve step changes in our bottom line, like the ones we're reporting this morning.

However, transformations are not quick.

This quarter was two years in the making, in addition, we must remember that transformations are not linear.

They don't neatly fit into budgets.

They can have their ups and downs, and the quarter's highlights, of course, illustrate what positive outcomes can come with a transformation.

We celebrate -- we celebrate them even as we consider the challenges ahead as we continue in our transformation and as we continue to build our culture around growth and innovation.

Now, as usual, I'll elaborate on the highlights we enumerated earlier.

First, we dramatically outperformed our earnings guidance for the first quarter, reporting earnings per diluted share of $0.51, an increase of more than 80% from last year.

We cited the earnings drivers in our news release, better than expected revenue growth, a significant improvement in our gross profit rate and strong results from converted stores and a lower effective tax rate.

What was the common denominator?

From my perspective, the real driver was our employees who excelled at delivering growth and innovation.

Our employees in their quest for growth accelerated the service business and adroitly executed on key opportunities.

Such as interest in MP3 players, digital televisions, and the launch of Sony's PSP--PlayStation Portable.

The thirst for innovation drove our employees to improve in-stocks of high-margin accessories and increase our own private label and global sourcing business.

Our emphasis on profitable growth and innovation propelled employees in our converted stores to continue to exceed expectations even though they're only in their second full quarter of operation.

Across the organization, we had very solid execution and a high degree of teamwork and I'm very proud of our employees and the work they've done this quarter.

The year is off to a great start.

Second, we spent three months preparing the stores for this year's first wave of conversions to the customer centric operating model.

On June 3, these stores -- these segmented stores officially launched in markets from Phoenix to Boston.

The same markets will be the focus of the remaining waves of conversion this year.

And we selected the markets for this criteria based on a combination of offensive and defensive criteria.

As well as our internal measures of store readiness within these markets.

As part of the conversion process, all 45 stores received extensive training on the customer segments.

The new product and service offerings, on business acumen and business model changes including what's a key one, the morning chalk talks, which occur with all employees.

We also promoted employees into new positions within those stores, such as home theater installers, small business professionals, and special agents for the Geek Squad.

The stores General Managers were given more flexibility on decisions from labor spending to displays.

Along with the flexibility comes a responsibility, of course.

And so General Managers were also given daily P&L's in order to set the business outcomes of the experiments they took on.

Finally, in most cases, there were modest changes in fixtures and product assortments based on the needs of specific customer segments in each store.

I'm pleased that many of the stores converting this year will be located in cities that are home to our institutional investors such as Boston and New York.

And we hope that you'll take time to visit a segment store and experience firsthand the difference in how we engage with our customers there.

As CEO one of my favorite parts of the job is visiting with store employees.

I can tell you from those visits, excuse me, that the employees are looking at their operating income, their comps, and the scorecard on a daily basis.

When I visit with these employees, of the segmented stores, I sense a different feeling.

And a different level of energy.

One I really like to see.

While we're learning and while the muscles we're developing are still very new, I see and hear a higher level of engagement of our employees with their stores.

And a higher level of engagement of those employees with our customers.

As we indicated before, we believe that Best Buy has passed the tipping point in our transformation from a product centric company to a customer centric Company.

This transformation has evolved from a small initiative involving select employees in into a broad initiative involving all employees down to the line level.

It has evolved from as set of Lab stores to a whole new business model that has touched all parts of the business.

And it is evolved from encouraging test results to material impact on a total company performance.

More important, our very culture, our fabric, is evolving into building an environment that celebrates our employee's unique talents and that encourages growth and innovation from the customer experience.

Three, we saw early dividends from our work in transforming our business model.

As we view our business through a customer lens, we see more opportunities to improve our business model.

As an example, we've expanded our use of new tools such as price optimization software, which has long been used by soft line retailers.

Our private label business continues to grow as we added our Geek Squad accessories, added Dynex SKU's and a whole new brand called INIT which we're using as a line for carrying cases.

Four, we announced three major developments in our growth agenda.

We added approximately 200 stores to our ultimate plans of new store openings in North America, based on the success of achieving high productivity in our smaller stores, and reducing the cost of building new stores.

We set a goal of 20 to 50 new standalone Geek stores in the next 18 months or so.

And those smaller stores enable us to get closer to customers who are seeking Geek Squad services.

And we began building a relationship in China, creating options that even surveying -- and even surveying potential sites for Lab stores in China.

Finally, in light of our optimism for the future and our stock price performance this past spring and the financial strength of our company we repurchased more than $200 million of common stock in the first quarter.

The amount of activity was similar to our trading volume for the -- for all of fiscal 2005.

We heard your input on this issue and we have acted in manner that we believe is aligned with our shareholders interest.

Again, we are very pleased with the quarter.

We attribute these outstanding results to the efforts of our employees to transform the business model using the customer as our lens for viewing that business.

As with that, I'd like to turn it over to Brian Dunn.

Brian?

Thank you, Brad.

I'd like to echo Brad's comments about teamwork, the passion, commitment, and partnership of our retail and corporate teams drove the outstanding financial outcomes we had in the first quarter.

More important, by collaborating with each other, they have created a better experience for our customers.

I think they are an awesome team, and I'd like to publicly thank them for their contributions.

Here's an overview of the progress we've made this quarter with our five goals for fiscal 2006.

First, we're accelerating our transformation to customer centricity.

Our segmented stores, as you know, give store employees more ability to satisfy the unique needs of the people who shop in the store.

All stores now know the segments they will be focusing on so that they can begin their own transformation.

The first phase of business acumen training for our core stores is also complete.

Meanwhile, we're on track to open or convert a total of 150 to 200 segmented stores by the end of this fiscal year, including two more waves prior to Thanksgiving.

By year-end, we continue to expect that we will be operating a total of 250 to 300 stores in this new model.

We continue to apply what we have learned to all stores regardless whether they have been fully converted.

For instance, all U.S. stores are now beginning to focus on at least one customer segment, as they prepare for full conversion over the next two and a half years.

A decision we made with input from our retail teams.

The core stores are not standing still just because the rollout wave is in the future.

The lessons and benefits of the current waves are positively impacting our entire retail base.

Our research and development Lab stores also continue to be a critical source for supplying new customer insights and new value propositions.

For example, they are actively working on new segments that will help us identify a higher percentage of the customers who are currently shopping in our stores.

Examples of employee driven growth and innovation come across my desk every day.

For example, the team that launched the Magnolia home theater stores opening inside Best Buy stores this quarter, found several ways to cut the cost of converting these stores.

While improving the look and feel of our store, for our customers.

That made it a win for customers, and for shareholders.

Another example is how store managers handled product transitions this quarter.

We gave them better and faster visibility to product transitions, along with business acumen training and they managed the model transitions much more effectively as a result as you saw in our gross profit rate.

Second, we are expanding and strengthening our service offerings.

We've hired more than 1500 Geek Squad agents this quarter.

Bringing the total to approximately 8500 agents.

We expanded our Geek Squad service offerings to include teaching consumers how to get the most out of their digital cameras and MP3 players.

We also brought all of our U.S. home theater installation in house.

We now have 650 installers across the country covering all U.S. stores.

We continue to leverage the experience and knowledge of our Magnolia team in this respect.

As a result of these changes, and the national rollout of Geek Squad last summer, our service revenue more than doubled.

We believe that consumers seeking a digital lifestyle will increasingly rely on our employee-based service delivery model, where we have a superior degree of control over the customer experience.

We believe that the key to customer-centricity is what we call employee-centricity.

So, third, we form teams of leaders to find new ways to boost employee retention.

By retaining our employees, we will be better able to deliver superior customer service.

At the store level, we're focusing on creating environments where individual employees can perform their best work.

Across the retail chain, we're exploring changes to our incentive systems in order to encourage new levels of both performance and retention.

Fourth, we continue to develop our individualized marketing capabilities, complementing our skills in mass marketing.

As part of that effort, we're focusing on building customer loyalty through Reward Zone, direct mail programs, our call centers, and community events.

Our decision to eliminate mail in rebates also was driven by customer insights and we successfully reduced our rebate volumes this quarter, which is the first step.

Fifth, we continue to simplify our internal processes so that they can flex with consumers needs.

Brad already mentioned some of the specific initiatives related to our supply chain, including price optimization in private label or global sourcing.

In addition, this quarter we began offering tailored market assortments in more product groups.

We now anticipate that up to to 20% of our product categories will be tailored to the local market by the end of the fiscal year.

Another example of simplification was evidence in our Canadian segments profitability.

Our international segments operating income rate rose by 90 basis points this quarter due to simplification efforts and improved inventory management.

I would list our tax rate as part of this efficiency work as well.

In essence, our employees are looking for all methods to reduce our core cost structure.

So we can invest more in customer efficient activities and grow the business.

Finally, I would like to be very clear that the Best Buy story is about growth and innovation.

I believe our new customer-centric business model is the key enabler for both.

And that our employees are the driving force that bring this model to life.

Successfully scaling this model will add length to our runway in terms of organic growth potential.

Meeting customer needs is a phenomenal opportunity and the size of the prize is much larger than simply selling consumer electronics.

We're excited about what the future model holds for us as we continue to evolve our business model.

With that, I'll turn the call over to Darren Jackson, our CFO who will elaborate on earnings guidance and wrap up our prepared comments.

Thank you, Brian.

Good morning, everyone.

This quarter was a pleasant surprise on many fronts.

It confirmed that our transformation efforts are touching all parts of the business in P&L.

I plan to discuss the key drivers of the Q1 performance and the outlook for the balance of the fiscal year.

Starting with our top line, our revenue grew 12% versus last year, to $6.1 billion.

Combination of new stores, and the 4.4% comparable store sales improvements supported the revenue gain.

Our segmented stores were up 9% plus in the quarter to lead the way.

We did experience lower customer traffic overall.

However it was offset by higher conversion rates in average tickets.

Over all the comp store sales gain of 4.4% was ahead of our plan and came on top of an 8.3% comp gain last year.

The story for the quarter was the gross profit rate improvement.

It was up 160 basis points versus Q1 a year ago.

We certainly planned for the rate to improve, the 25.5% gross profit rate reflected considerable rate gain versus benefits from mix.

The key drivers included a less promotional environment, and benefits of our sourcing, private label, price optimization, and service strategies.

In addition, lower Reward Zone costs and the improved gross margins at our segmented stores added to the rate improvement in the quarter.

Looking forward, we'd be thrilled to have our gross profit rate rise 160 basis points for the year.

It's suffice to say our plans are considerably more conservative based on how early we are in the year.

Finally, our average or comp inventory was up 4% at the end of the quarter, which was in line with our comp store sales.

Turning to expenses, our SG&A as a percent of sales was up 40 basis points year-over-year on a comparable basis.

The increase in SG&A as expected was driven by further investment in customer-centricity store conversions, as well as the increased store relocation costs.

That said, the SG&A rate was better than our expectations for the quarter as we enjoyed leverage from higher than expected revenue increases and favorable timing on certain items, which will likely fall in Q2.

Moving down the income statement, interest income was favorable by $13 million for the quarter.

Driven by primarily by higher yields on a larger investment balance, as well as the year-over-year impact of the repayment of a portion of the Company's convertible debt.

All this brings us to taxes.

The effective income tax rate for the quarter was 32.5%, down 560 basis points from 38.1% a year ago.

The first quarter's tax line included some items that were one-time in nature.

Specifically, we finalized certain state income tax matters, which benefited the tax expense line.

Aside from these one-time gains, we are lowering our effective annual tax rate range to 34.5 to 35% which is a 200 basis points improvement versus our previous guidance of 36.5 to 37%.

As we stated in our news release, the reduction in our effective income tax rate is really a function of higher levels of tax exempt interest and increased income tax benefits from our foreign operations, which we focused on as a part of our efficient enterprise initiative.

The final highlight that I want to cover for the quarter is our share repurchase activity.

As you know, the Board authorized an increase in our share repurchase program to $1.5 billion in April.

During the quarter, we were active buyers of our stock, repurchasing more than 4 million shares for approximately $207 million.

Some of the purchases in the quarter apply to a prior authorization so the remaining balance on the current authorization now stands at $1.4 billion.

My wrap up comment on the quarter is that 85% earnings improvement was driven by transformational, not incremental changes to our business model.

I'm very pleased by this performance given it comes on top of a 60% improvement in Q1 earnings a year ago.

So what does the balance of the year hold?

The good news is we're off to a fabulous start.

The comparisons get easier and the lion's share of the benefit of segmenting more stores is still ahead of us.

We remain committed and confident in our 4 to 5% comparable store sales gain for the year.

We expect it to be closer to 4% in Q2 as a result of the intensity of work to convert stores and train employees.

Conversely, we expect the back half comps to benefit disproportionately from the segmented stores differentiated customer experience, the growth of our Geek Squad services, and improved capabilities including the implementation of tailored market assortments.

Our second quarter earnings guidance range is $0.51 to $0.56 per diluted share based on a comp gain of approximately 4%.

We're tracking to both targets month to date.

The mid point of the EPS range is an increase of 37% versus last year's $0.39 comparable EPS.

I would remind everyone that we had $0.07 worth of legal expenses and asset impairments included in the $0.39 last year second quarter.

We anticipate that our operating income rate will modestly expand in the second quarter.

Specifically gross profit rate gains will allow us to fund segmentation of our store base and the expansion of services.

Finally, earnings growth is being constrained by the timing of SG&A that we planned in Q1 that will hit in Q2.

Such as certain training, HR, and consulting expenses.

Our first quarter performance coupled with our continued optimism for the balance of the year, does allow us to increase our full-year guidance.

We are raising our guidance range to 3.10 to 3.25 per diluted share, up from 2.95 to 3.10 a share.

We're are flowing our Q1 performance into our full year expectations less the impact of expense timing that did not hit in Q1 but will hit later in the year.

Overall, our new range reflects an average increase of nearly 20%, versus last year's $2.65 comparable EPS.

Now, my sense is that many of you will conclude that we're being very conservative on our guidance.

Given our gross profit rate performance in Q1, the lower income tax rate guidance, and the share repurchase activity.

We hope we're being conservative.

More importantly, we're reserving the flexibility over the next three quarters to invest and further accelerate our transformation via more store conversions, adding more new stores, and enhancing our service strategy.

So we remain bullish on the year and on our future the constraint on further earnings upside is not economic or competitive.

But self-imposed to maintain flexibility to further invest to accelerate our transformation.

One final thought on the quarter, we made progress on all of our initiatives that we had laid out to get to a 7% operating income rate.

We saw benefits in supplies chain, we saw improvement in Canada, we also saw benefits from IT, we certainly saw benefits from services, and the segmented stores.

As Brad stated so well, the one common denominator across all of these elements continues to be changing how we do business to see it through the lens of our customer.

And unleashing the power of our employees using that mind-set.

Although we have a lot of work to do, and a lot to learn along the way, we have zero doubt that this is the right strategy to transform our business model.

With that, also, we are now ready to take questions from our investor audience.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Mark Rowen with Prudential.

Please go ahead.

Thank you.

Good morning.

Congratulations on a great quarter.

Thanks, Mark.

A couple of questions on customer-centricity.

I know you said, Darren, that the comps were 9% plus.

Can you look at those adjusted for the California market, in other words, is California business in general better?

And is that accounting for some of it?

As you roll the customer-centricity out to the 12 new markets that you started last week, what are some of the challenges that you're seeing?

John Walden and Darren Jackson will answer that.

Why don't I -- Mark, what I'll do is I'll frame the number.

Then I'll have John talk about just what we're experiencing in California in terms of what's driving those fabulous results.

So, like, if you separate out California, you have two phenomenon.

So these stores are doing nine comps.

Nine plus comps in the quarter.

And they are anniversarying numbers a year ago that would have been closer to I'd say upwards of 12 to 14 comps.

And they're running at sales productivity levels in terms of sales per square foot that are $1000 plus a foot.

So the phenomena of thinking is it just California, are they anniversarying easy numbers.

I would say they have got three things that they're up against and they're overachieving those expectations.

One, simply they're some of our highest productivity stores in the chain.

Two, they're better than eight years old.

Typically, stores peak at eight years and start coming down.

Three, they're lapping comparable store gains that are simply the highest in the chain.

So, I think what we're seeing overall is that it's about how we're driving customer-centricity.

And we're improving on already highly productive and successful stores.

Mark, it's John Walden.

I think the only thing I can add to that is, to Darren's point, we look at a lot of different metrics.

We look at changes relative to control stores to try to get comparable stores to look at.

And we look at growth year-over-year based on a pretty high base last year.

We're pretty confident that the sales gain, in fact, are unique to customer-centricity and are attributable to the new things we're doing in those stores.

But as we also have described in our release and in our statement this morning, it's not just at the sales line.

You saw material benefit in the margin rate expansion of these stores versus the rest of the chain.

You, in fact, saw not only improvement in our expense rate, but we actually saw positive expense rate relative to the rest of the chain because the leverage we've got in the sales line and control -- improved controls on our expenses.

The net of it all, was material operating income growth across the board.

So we're seeing a lot of good data across our segmented stores.

Again, as always we've mentioned, it's the second fall quarter of performance.

So we're not ready to take complete victory laps yet.

But we sure see enough signs that give us tremendous optimism and confidence that the work that we're doing is actually the cause of the improved performance.

Okay.

Just a follow-up to that, Brad mentioned that the engagement of the employees in those customer-centricity stores.

I was wondering how you keep them motivated as time goes on, since you don't have bonuses tied to performance.

I was wondering if you have given more thought to tying to pay to performance?

That's a great question.

And it's one that actually I put to -- I was just in California last week.

And put to a number of our employees in the stores.

I think one of the things that is there, is that this is -- as we're growing the business off of these initiatives, you can kind of imagine if you were an employee in the California store, there's all sorts of opportunities opening up to you.

You're getting new knowledge and expertise and we're adding to the kinds of jobs and the quality of jobs in the stores.

Which is reducing the turnover in those stores specifically.

We're also developing new skill sets and new career paths.

That was a thing I really resonated with the employees.

Is I'm seeing that I'm learning how to do things that I didn't perceive that I could do before.

I know that that can take me places throughout my career that I wouldn't see.

I was nervous about the same issue.

I think we really are beginning to build a sustainable model here.

Because the employees genuine value to us and to others is increasing as they're learning how to do this stuff.

Great.

Thanks.

Thank you.

Thank you, Brad.

Next question, please.

Thank you.

Our next question is coming from Erik Mace with CSAM.

Hi, thanks.

Thanks for the comments on the unit volumes in TV's relative to the ASPs in the release.

Could you elaborate a little bit on the profitability of the segment relative to the ASP declines?

Yes.

This is Ron Boire.

We, as I think we talked about in the last quarter, we see probably a little more pressure in the back half than the front half of the year on digital television with a lot of the acceleration happening then.

We have seen a little bit of a slowdown in the anticipation of price declines.

I think a little more rationality on the factory side.

So where last quarter we were estimating as high as 35%, we may not see it that severe in the back half.

Largely we've seen rate improvements in the TV business, largely do to better execution.

Our retail team has done a phenomenal job of better identifying customers.

And I think making a better sale.

That's resulting in better margin.

Excellent progress on supply chain and tailoring assortments in the market.

Last year as you recall, television was one of our big three initiatives.

And is now one of our big three comp drivers.

We don't think coincidentally at all.

So the investments we've made in the store experience, the work that the retail team has done on improving execution in the store and the work that the merchants and supply chain team have done on tailoring markets, some work on price optimization are really benefiting us this quarter.

Okay.

Great.

Thank you very much.

Thank you.

Thank you, Ron.

Next question, please.

Our next question is coming from Bill Sims with Citigroup Smith Barney.

Thank you.

Good morning.

Good morning.

Congratulations on a terrific quarter.

My question is regarding SG&A growth.

When we look at SG&A growth on a year-over-year basis, can we expect up, down, or similar to what we saw in the first quarter, roughly 17% improvement or increase?

Thank you.

Yes.

Hi, Bill.

It's Darren Jackson.

So I would say there's a couple things.

So in the first quarter on a comparable basis, comparable meaning stock option expenses both this year and last year, were up 40 basis points.

I'd remind you, a year ago if you looked at our Q1 performance, our SG&A was down 100 basis points it terms of overall improvement as we look to the second quarter too.

When we look forward, I think what we see for the year is that our overall operating margins will expand.

That expansion will come from gross profit increases.

We do expect that our SG&A rate will rise this year in part because we're being deliberate in terms of the conversion costs of our segmented stores, the expansion of our services business.

The other thing is the -- as Brad and John talked about earlier, as we evolve the segmented store strategy.

And we evolve positions in the store and we improve our overall labor model.

We expect that that will be a higher cost model too with much higher level benefits in terms of top line and margin.

All right.

Thank you.

Our next question, please.

Our question is comes from Dan Wewer with CIBC.

Two of the catalysts that you had called out for the improved gross margin rate was less promotional activity and the benefit of pricing optimization.

Which could signal the industry is becoming a bit more rational than it had been.

Brad, I was curious as what has changed since the fourth quarter?

Anything structural and perhaps who is leading the more benign promotional environment?

Ron, would you like to take that one?

This is Ron.

I think that -- I think everybody saw a rather promotional environment in Q4.

And I personally can tell you what one point of share in digital television cost.

I won't do that, but I could.

As a team we sat down and decided where to make our bets.

We had a lot of great learnings around price optimization and how consumers various customer segments are responding to offers.

Frankly, it was the retail team, the merchant team and the centricity team sitting down and making more rational decisions on where we were going to extract value and what we're going to focus on.

I would say that our team is really leading some of that rational behavior in retail.

We -- I think were kind of up front in the last quarter that we had made some mistakes on pricing and made some -- bet a little too aggressive in certain markets and in certain categories in Q4 and didn't really see the gain for it.

It was an outsized investment.

We were pretty up front about the mistakes we made last quarter and not repeating them this quarter.

I'll emphasize again, the execution on the retail side has been phenomenal in the last quarter.

You heard higher close rates and higher ASP's.

That doesn't come without 100,000 highly engaged employees being out there.

I see that as a major driver.

Ron, do you think it will be easier to achieve this more rational pricing initiative in the non-holiday season?

I mean, historically I would say other than one day, no.

I mean, I don't think that -- I don't think there's a significant difference in the competitive mindset in our industry quarter-to-quarter.

It's all relative to the volume, of course.

But we're in a pretty competitive industry and have been for a long time.

Yes.

There was another factor that we saw over the holiday season.

Which is I think we saw some dissipation in demand versus expectation.

And because everybody sort of builds their business models to an expectation.

I think that's part of what you saw -- we saw worked out in the fourth quarter last year.

It was -- the consumer electronics for a number of years consecutively has been the hottest give gift and we were less so last year than we have been.

It's one of those variables and wild cards that it's hard to call what it's going to look like this year.

Thank you.

Dan, can I build on one point, though.

It's that -- promotional environment, less promotional was part of it.

But we shouldn't lose sight of that when we actually look through the numbers and look at our efforts underneath in terms of global sourcing initiative and our private label initiative, those businesses will build by a multiple this year of last year's businesses.

So structurally underneath, the things that are driving margin, though they turn out to be rate improvements, is things that we're -- been pushing and building for the better part of two years, principally in the sourcing and the private label areas of the business.

Price optimization is a tool and a competency that are helping us make better decisions.

All of that, plus a little more rational environment.

The thing that gives us more confidence going forward is the sustainable capabilities that we're building in those areas of the business to help us compete more effectively when the promotional environment does yo-yo up and down.

Because we know it will.

Thank you.

Those answers were from Ron, Brad, and Darren.

Next question please.

Our next question is coming from Gary Balter with CSFB.

Please go ahead.

Thank you, and I'll add my congratulations on a great quarter.

Thanks, Gary.

Just following up on Dan's question.

This isn't my question.

Just on the (Laughter) -- the 160 basis points, Darren, that you were just talking about, to put that in perspective how much would you say is from the -- how much is from opportunities we're going to continue to see and how much is from a modest promotional environment, which may or may not happen?

Is there a way you can quantify that?

If you give me a minute.

I have to turn on my crystal ball.

What we said, Gary, and I'll have Ron give you the color on this.

Is that I generally meant in our comments, that if we could predict 160 basis points for the balance of the year we would be thrilled to do that, it's early.

I'm just saying in this quarter to give us some basis to understand what drove it this quarter so then we could build our models off of that?

Gary, this is Ron.

Just from a color commentary point of view.

We saw very clean transitions in PC and in digital television which helped us.

We saw, as Darren just spoke about, significant growth in our sourcing and private label, which I think is a structural change.

We saw price optimization begin to take hold this quarter, which I believe is a structural change.

Yes.

We saw some tailor market assortment, although small on tailor market, primarily focused on our centricity stores with the employees being able to tailor their individual assortments and pull inventory which I think is beginning to make some impact.

So, a little bit of a balance between better execution of supply chain, better execution through the merchant, supply chain, and retail organization on transitions, and some structural stuff around how we manage price, how we manage assortment and frankly, the focus on sourcing.

Just one more thing on sourcing, notebook computers last year, as you recall, Gary, were one of our big three resets.

And is one of our top drivers of comp with significant double-digit comp growth.

Mobile computing accessories, which we didn't talk a lot about as the reset last year, but because of how we manage the reset, are up almost eight times the rate of computing with as you know significant improvements in margin.

Yes.

So structural things like that, we also did in the floor.

The teams ability, Brian's team's ability to build a better experience, a better basket for the customer are material I impacts to the margin.

I'll say this for you guys.

But whatever happens in the promotional environment, there are significant drivers to gross margin that are happening structurally.

Generally, is that fair to say?

Yes.

That is fair to say, Gary, because -- and John pointed this out too.

Services, we didn't talk a lot about services.

But services is a structural change to our business that we -- we foresee growing in the future and will further enhance our margin opportunities as we go forward.

Thank you very much.

I won't ask my question today.

Thanks.

(Laughter) Thanks, Gary.

Appreciate it.

Next question, please.

Thank you.

Our next question is coming from Scot Ciccarelli with RBC Capital Markets.

How are you?

Actually, I had another question similar to what Gary was just talking about.

Just in terms of services, is there any way to get more color on what kind of impact that's had.

Obviously you guys have also -- not only has it been growing rapidly and helps your gross margin, but you've been spending like crazy as well I'd assume with all the additions to Geek Squad and bringing the whole installation business in-house.

So is there a way to kind of give us an idea that the impact on gross margin and operating margin?

And then is it fair to assume this business becomes increasingly profitable as it grows as that infrastructure gets built out?

Thanks for pointing that out.

Actually, I think I have seen seven or eight Geek Squad commercials over the course of the last weekend.

Hopefully, some of rest of you have seen those as well.

We are making a major investment there.

And trying to build that brand.

I think as it relates to your question around margin.

While we don't get into specifics around services, I think margin dollars, obviously continue to grow as we see returns on these investments.

From a rate standpoint, I don't see a material change, but certainly from a mix standpoint, much, much more importantly from a total customer experience standpoint, our customers are telling us where you help me do it better, when you make it easier for me, I reward you.

And I reward you with a higher ticket.

I reward you with better margin.

I reward you with more visits.

And all of those things kind of work together for us.

So, I'm sorry, Scot, I can't give you to the pits where we're going.

We're very, very happy with the general trend line.

We're happy with the rate of growth.

As you heard, in the comments in the script, we are investing further in services with stand alone stores this year, which we expect to provide even more learnings on how to drive value for our customers.

We're very excited about, not just from a revenue standpoint, but we -- and profit standpoint, but even more importantly from the experience that it gives our customers and the loyalty it's building with our customers.

And from a longer term standpoint this is central to -- as we see the business becoming much more complex and integrated, and going into more spaces.

This kind of capacity is kind of -- we sort of see as a requirement to play in a lot of the spaces that we expect to see emerge.

That's all right.

I guess maybe the question should have been, is there a point where this business starts to leverage all of the infrastructure investments?

Yes.

It's clearly we're making major up front investments.

We're -- as we announced, hiring 1500 people in the last quarter, you, doing the -- getting the advertising platform, adding to the capability, that is -- anything but a point of time in which you leverage or optimize your earnings.

Not to be lost here, we took our home theater installation direct last quarter also.

So not only did we hire 1500 Geeks, we hired 650 home theater installers specialists.

We're expecting, again, the returns on that experience and the returns on that investment to grow.

So in the current quarter, you have all of the training and all of the development and putting these things into place for the first time.

So, it will be some time before they get fully leveraged.

Okay.

Thanks a lot.

Guys.

Thanks, Scott.

Next question, please.

Thank you.

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

Please go ahead.

Good morning.

Two quick questions.

First, you talked a little bit about some of the changes that you're thinking about in terms of the incentive plan at the store.

I was hoping you could just give us a little bit more detail there.

And then secondly, probably a question for Ron.

A little bit more color on the tailored marketing assortment. 20% of the assortment.

Which categories?

How many SKUs can be tailored at the store level?

And any anecdotal data or evidence you've seen on the segmented stores that have done some of this already.

Brian, do you want to talk about incentives?

Then I'll talk a little bit about TMA.

Still there, Brian?

John Walden will comment on that.

I'd be happy to.

I think in terms of specific changes, we don't see anything that's material at this point.

I think we're -- the biggest change at this point is the addition of new positions, higher skill positions, new opportunities for our store employees.

That's generating a lot of energy with our employees.

We continue to look at compensation changes over time as we continue to try to make the stores operate more and more like owner operator units and give the employees more and more opportunity to do different work.

But in terms of specific plans at this point, we really don't have any to talk about.

Although we continue to look at it.

So am I reading correctly in that you're looking at maybe hiring some people at higher absolute hourly levels?

That's right.

Essentially in some of the berry type stores?

Yes.

We actually do that right now.

We actually do that across the board.

We have, as our stores are segmented, we have not only new experiences, we call value propositions, new fixtures, and other experiences in the stores.

We also have different labor models with some higher skilled positions in almost every single of our segmented stores.

Yes, we already do that today.

And as our employees are adapting new value propositions, they're actually creating new kinds of positions that have higher skilled requirements and therefore higher incomes.

Then Colin, on tailored market assortment, as you can imagine, and I think we spoke of previously, the ability to tailor to a store, systemically to it is critical to the success of centricity and the work that Bob Willett, supply chain, and IT team have been doing is critical.

Just a little bit on color -- in the centricity stores today, the Store Manager's, Supervisors, Segment Managers have the ability to change displays, have the ability using what is kind of the version 0.1 if you will of some of the changes we've made and pulling inventory and using telson and say you know what, I know my mid/max on this product is a 3 and 6.

I really need a 12 and an 18.

And really be allowed to make bets where they think the bets are appropriate.

And do that somewhat systemically.

As the systems continue to get built out, I think we're 12 to 18 months from having that fully systemized and supportable.

And it's a key driver.

From a percent of assortment standpoint, we really don't know, I mean, our most highly diversified assortments could be in select categories, such as television, 20% differentiated.

We think a lot of the power, if you think about large numbers, broadly we're not going to be buying a different assortment.

We're going to be placing it in different places, right.

So a lot of the power is going to be around a segment manager that understands her market better.

And therefore, pulls differently as opposed to we go to a different factory and find something completely different.

I don't know if that was exactly your question.

Yes, that's it.

Yes.

So it's much more around the 80 for the 20 is true in assortment.

It's also true in the store giving the store the ability to control, 10, 20, 30% of what they pull and driving a lot of value.

Because they understand the customer and frankly, driving a lot of loyalty and the employees you have.

They really feel like they own the process.

We think that's a win all the way around.

But systemically to get it really pure, really probably another 12 to 18 months.

But we are starting, as I said, to see some benefit from TMA.

It's pretty exciting

Great.

Thank you.

Thanks.

Next question, please.

Thank you.

Our next question is coming from Jack Murphy with William Blair.

Thanks, congratulations on the quarter.

Thanks, Jack.

I'd like to get back to an earlier question about digital TV.

On the flat panel digital TV's in particular, could you talk about how sales and margins came in relative to where you thought they were -- would in this past quarter.

And the ASP declines as well.

I think we saw ASPs kind of on track, maybe a little slower decline as I had said before.

We had anticipated the back half to be more aggressive.

That's still going to be the case.

Although, perhaps not the 35 that was kind of the high end of our estimate.

I think you could probably extrapolate from the numbers we exceeded our sales plan on digital TV.

Slightly and it was a material impact on the comps.

And we saw as we said before, improved margin yield, largely due to some of the things I've talked about before, the management of transition, price optimization, a little bit on tailored market assortment.

And just a tremendous execution at retail.

On the margin in light category, or like products, year-over-year the margin rate actually went up?

I would say that yes, it did.

But it was really, again, some of the drivers that we talked about were around the execution and the new systems in place.

It's not a matter of necessarily being able to buy better.

I don't think that's the case.

And when you look forward to the balance of the year in this category in particular, could you talk a little bit about how you're thinking about inventory and, are you going to have a much bigger bet on advanced TV inventory this year, year-over-year?

Relative to the expected growth rate, I'd say no.

I think we're cautiously optimistic.

I think the team -- we're getting better every day at supply chain.

Our largest -- two of our large -- actually our two largest vendors are now pretty well integrated on CPFR or collaborate planning forecast and replenishment.

So we're implementing systemic solutions that are tightening the supply chain.

I would say we would not be placing outsized bets.

But doing more of what we've done in the past.

Which is very tight collaboration with the major suppliers and ensuring our supply chain and frankly, working together to drive the top line.

Thanks.

Thank you, Ron.

Also, we'll take one final question.

Thank you.

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

Thanks a lot.

Good morning, and terrific quarter.

Matt, you just made the cut.

Thankfully.

I have got two follow-ups that hopefully add up to one full question.

And I think they're both directed to Darren.

Darren, you guys have spoken in answer to my colleagues questions about the drivers of gross margin.

Is it possible to rank their contribution to the increase that you saw in the first quarter?

Anything is possible, Matt. (Laughter)

Yes.

Matt, the way I would characterize this, and this was in the prepared comments too.

Is that gross margin moves up or down for one of two reasons.

Either we've had rate improvements or mix improvements.

And in the quarter, by and large, the majority of the improvement is all rate improvement.

When you look across rate improvements, I would roughly rank order, what is driving those improvements.

Services, what's driving those improvements.

Segmented stores, what's driving those improvements.

Global sourcing, private label initiatives, and some of the store execution things that Ron alluded to earlier.

The other rate improvements which are I'll call more environmental is that we saw a decline in the promotional environment, that's true.

We did see some improvement as we looked across in terms of Reward Zone and other programs were actually less costly in the quarter too.

But by and large, the overall driver, which makes us feel more confident as we look to the future, was levers we were pulling, versus environmental factors that were coming down on us.

And was there anything on the mix front, given that TVs were quite strong and services I guess could count as mix as well.

Was there anything in mix that worked against you in the quarter?

Oh, we think cellular worked against us a little bit Matt.

We talk about the struggle a little bit in cellular for us as the carrier model shifting.

We're still working to get the labor zones exactly right in the store.

The one thing I'll add, Matt, also to Darren's comments.

Is to re-emphasize, as we talk about global sourcing, a 7 to 8 times growth in mobile computing accessories, versus mobile computing.

A lot of that growth is in private label accessories.

So it's kind of a multiplier there.

Got you.

So it's good and good activity.

Fair enough.

Then the second follow-up, Darren, you talked about retaining the flexibility to invest more aggressively, presumably in centricity rollouts over the course of the year and that that influenced your guidance.

I guess the question I'd ask, does the guidance that you gave us include a higher level of investment than you'd previously contemplated.

Or would that be incremental?

It includes -- it contemplates a higher level of flexibility, Matt.

Fair enough.

Thank you so much.

Okay.

Thank you all Thanks to our audience for participating in our first quarter earnings conference call.

Before we end, may I remind you that this conference call will be available to you for replay by dialing 973-341-3080 and entering a personal identification number of 6146761. .

The replay will be available from about 1:00 p.m.

Eastern time today until midnight next Monday, June 20.

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 first quarter earnings or our second quarter and fiscal year outlook, please call me, Jennifer Driscoll at 612-291-6110.

Or Charles Marentette at 612-291-6184.

Reporters should contact Sue Busch, at Director of Corporate Public Relations at 612-291-6114.

And that concludes our call.

You may disconnect your lines at this time.

And have a wonderful day.