百思買 (BBY) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Best Buy's conference call for the second-quarter fiscal 2006.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded for playback, and will be available by 1 p.m.

Eastern time today.

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

You may begin.

Thank you, Elsa.

Good morning, everyone.

Thank you all for participating in our investor conference call for the second quarter.

With me here this morning are Brad Anderson, CEO, who will give you the second-quarter highlights, Brian Dunn, President, Retail-North America, who will update you on the domestic and International Segment.

John Walden, Executive Vice President, Customer Business Groups, who will give a deeper dive on our rollout of segmented stores, and Jim Muehlbauer, Senior Vice President - Finance, who will cover today's results, as well as our earnings guidance for the fiscal year.

Also available for our Q&A session today in person or by phone are Allen Lenzmeier, Vice Chairman, Darren Jackson, Executive Vice President - Finance and CFO, Ron Boire, Executive Vice President - General Merchandise Manager, Mike Linton, Executive Vice President and Chief Marketing Officer, Bob Willett, Executive Vice President - Operations , Kevin Layden, President of Best Buy Canada, Mike [Patelli], Senior Vice President - Consumer Electronics, Susan Hoff, Senior VP - Chief Communications Officer, Shawn Score, Senior VP - Sales Development, Mike Gordon, Vice President - Finance, and Charles Marentette, Senior Director of Investor Relations.

Got a full house.

I would 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 expectation.

As usual, the media are participating on 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 and then enter the personal identification number 6417019.

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

Eastern time today, until midnight on Monday, September 19.

I would like to remind callers that we plan to take your questions after we conclude our prepared remarks.

Now we sometimes are asked about how we handle the queue for Q&A, as we often can accommodate only a fraction of the callers, and there is a perception that public companies offer unequal access.

It may surprise some of you that we do take analyst questions based on the order in which they are received; however, we have noticed that some sell-siders dial us up and punch in a request for a question long before the call begins.

That increases the cost of our call, and can result in the same group of people getting to ask questions each time.

And we would like to include a broader group in our quarterly process and reduce our costs, so Investor Relations respectfully will move to the end of the queue those callers who were able to ask management a question on the last call.

And if that goes smoothly, we will use this new procedure going forward.

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

Thank you, Jennifer.

Good morning, everyone.

Before I discuss our second-quarter earnings, I would like to make a comment on Hurricane Katrina.

The damage brought by Hurricane Katrina goes beyond words.

All of us at Best Buy were deeply concerned about the intensity of the damage done to the communities across the Gulf Coast, and shocked as the damage expanded into personal tragedies.

At Best Buy, our culture of values prompted us to rally behind the cause.

For example, we offered to match customers' donations to the Red Cross, and we were pleased to double our grant to $2 million after only one week, because customers had already achieved our targeted gift.

We also kept on the payroll more than 1200 Best Buy employees who work at stores closed in the flooded areas, and created a website, so that we can stay in touch with them.

That is simply the right thing to do, but the neatest thing about the situation was the speed and generosity with which our employees responded.

Without us asking them to do so.

They not only know our Company's values, but they live them.

Our culture and values enabled employees in the Gulf Coast and here at headquarters to be more nimble and responsive, than you would expect a Company of our size to be.

For example, they quickly reached out to the United Way, Red Cross, and our own Schulze Family fund to pinpoint needs, and coordinate relief efforts.

They sent trucks with emergency supplies to affected areas.

They found apartment buildings, so we could offer temporary housing to those who were displaced.

One of our stores is currently serving as a cross dock for supplies to the area.

Across the country, a lot of people are stepping up and reaching out, and I am struck by the strength of our people, who have acted with hope and courage in the face of enormous challenges.

I also applaud our employees in the Gulf Coast who consistently put the greater good above their personal and family needs.

As we disclosed earlier this quarter, our second-quarter earnings totaled $0.37 per diluted share, which was at the high end of the earnings range we gave last June, adjusted for the stock split.

We hit the high end of our earnings range, primarily because our operating income rate improved more than we expected.

As reported, we finished the quarter with revenue of $6.7 billion, up 10%.

Our comparable store sales gains were 3.5% modestly below our expectations, and our revenue growth was driven by the opening of new stores, an increase in the average ticket price, and the benefit of operating more segmented stores.

I was pleased to see the growth come out of both the top line and the bottom line.

Our employees' successes delivering on both fronts at the same time, while investing in our growth drivers.

It is another positive indicator that customers are responding to our transformation.

The transformation, as you recall is about giving employees more power to satisfy the needs of the unique customer segment.

It is a complex transformation.

It includes a new business model in our stores, which we refer to as segmented stores.

Yet it is much more than that, it also includes our push to expand our service business, a complete overhaul of our supply chain, and the outsourcing of our information system.

In essence, our front-end is becoming more complex, and decision making is shifting closer to the customer.

So we have got to simplify our back end in order to support that.

The complexity of this transformation makes it challenging to manage, yet we believe the complexity also makes it more meaningful to customers, more interesting to our employees, and more difficult for our competitors to copy.

In short, a more sustainable engine, and hopefully more rewarding for our shareholders when we are finished.

As I look at the second quarter, I notice several successes worth calling out, all related to our transformation.

One, in the past quarter, we continue to accelerate customer centricity by converting mores stores and opening all new stores as segmented stores.

The pace of the conversions challenged our teams, and I compliment them on a job well done.

Two, our segmented stores significantly outperformed the rest of the chain once again, in terms of comparable store sales gain.

These stores also improved their operating income rate and operating income dollars, and we remain very pleased with our results.

Three, we continue to expand our service business.

We enhanced our service capabilities by adding almost another 1,000 Geek Squad agents, bringing the total number of agents to more than 9400.

And we also operate ten stand-alone Geek Squad locations, to get closer to the customers than we can with our Best Buy stores, in addition we employ about 950 home theatre installers, so that we can offer a better customer experience around digital TV.

Four, we saw improvement in our employee retention rates.

Brian will give you details on that later in the call.

Based on the strong efforts, we are seeing from our transformation efforts so far, we announced plans for a more robust and more aggressive rollout of customer centricity, specifically, we announced a fourth quarter wave of segmented stores to be completed as early as February.

This timing balances the need of our stores to complete the holiday, with our desire to press our competitive advantage as hard as we possibly can.

We also announced a dozen more new Best Buy stores in the U.S. than we originally planned.

All of these additional stores will operate as segmented stores from day one.

Also early in the quarter, we split the stock 3-for-2.

We decided to up our dividend to $0.08 per quarter adjusted for the split, and effective with the dividend payable in the third quarter.

As a result on the quarter, I see significant progress towards our vision of customer centricity, and I remain committed to a complete transformation of our business model, which I believe will result in achievement of 7% operating income.

I said last quarter that our transformation is broad, touching all parts of our business model.

Also remind that you transformations are not quick.

The tremendous results we have received so far this year were two years in the making, and in addition, if you recall, I said the transformations are not linear.

They can have their ups and downs.

Our management team is focused on the long term, and on how well we build a culture of growth and innovation.

We believe such a culture will provide a sustainable growth engine, not a temporary bump in performance.

And I would like to give you an example of how our culture works to support the transformation.

At one of our segmented stores in California, Geek Squad agents wanted to figure out how to make buying a computer a more satisfying experience for busy moms, one of the customer segments they were trying to grow.

All on their own they created an Internet-based shopping system, and then they built an easy-to-use store display, that attracted computer buyers to the experience.

The result: The store not only sold more computers, but it also sold more attachments, actually four times as many as the average store.

Selling attachments tailored to each customer, improved customer satisfaction while creating a more profitable business mix.

That, for me, is a green indicator.

And as I look over the chain, I see a lot of green indicators.

Again, I want to recognize our employees for the hard work they are doing to transform our business model, using the customer as our key lend.

With that, I would like to turn it over to Brian Dunn, President of our stores, to update you on the progress and key goals for the year.

Brian.

Thank you, Brad.

I would like to echo Brad 's congratulations to the team.

We asked a lot of our employees this quarter, and they delivered.

I want to take this time to talk about our progress with Company goals, including customer centricity, employee retention, the expansion of our services business, and boosting our Canadian profitability.

First, we've been asked a lot about Hurricane Katrina's impact on our domestic stores.

The answer is that 15 stores were affected in some way, either by reduced hours or by flooding.

Nine reopened fairly quickly, and we expect four stores to reopen by the end of the month.

In other words, by October, all but two stores will have reopened, and will be meeting the immediate needs of their communities.

The more critical thing for us, however, is the safety of our employees.

Once the storm is over, our people immediately began working around the clock to locate more than 1200 Best Buy employees in Louisiana, Mississippi, Alabama, and Florida.

Our General Managers and store teams in the district travelled from shelter to shelter searching for their people, wearing those familiar blue shirts and offering assistance.

Even though they had not recovered from their own personal losses and extreme fatigue, their leadership and commitment paid off last Friday, when we found the last employee displaced by the hurricane.

Today all have been accounted for, and all are okay.

I met with our district team last week, and in their eyes I saw unwavering courage in what truly are life and death situations.

Now we will begin the hard work of rebuilding the stores, as the communities rebuild.

In the meantime, we are giving Gulf Coast employees the choice of helping their families, helping their co-workers, or volunteering in their community.

It is simply the right thing to do.

Next, let me give you an update on our Company goals.

Segmented store results this quarter were impressive, as John Walden will discuss later in the call.

I am pleased with the way our stores are seizing the opportunity to change how they do business, for the benefit of our employees and our customers.

We believe that by providing a better experience for our employees, we can provide a better experience for customers.

The good news is that the changes we are making already have influenced our retention rates, and the second quarter, our employee retention rate rose by 300 basis points compared with a year ago.

In addition, we recently learned from Gallup that employee engagement which is measured semi-annually, in July hit an all-time high.

Based on the green indicators we are seeing, we are accelerating our transformation to customer centricity, as Brad mentioned.

We want to press our competitive advantage in the marketplace as hard as we can.

For the same reason, we announced this morning we now plan to open approximately 72 new U.S.

Best Buy stores during the fiscal year, an increase of 12 stores, and those 12 new stores also will be segmented.

We believe that we offer the best shopping experience in the country, and we want all consumers to have access to Best Buy.

One thing we learned from our customers as part of this work, is the importance of services.

As our products become more complex and more connected to each other, consumers are shifting it from do-it-yourselfers, to do-it-for-me.

So we continue to recruit Geek Squad agents, that provide computer services over the phones, in the stores, and in homes.

As Brad mentioned, we now employ more than 9400 agents in the U.S. and Canada.

Thanks to a National advertising campaign and PR, we also have a significant national awareness of 30%, only one year after the national launch of this service.

We also employ approximately 1,000 home theatre installers, one short quarter after we announced that we would take this business inhouse.

As a result, our services business nearly doubled in the second quarter on a year-over-year basis.

We continue to invest in services because it will enhance our profitability over the long haul.

Results also improved for our International Segment, which is comprised of Future Shop and Best Buy stores in Canada.

As you know, we view our U.S. business as a portfolio of customers.

In Canada, we view our business as a portfolio of brands.

We operate Future Shop stores and Best Buy stores, as close together as the same strip mall.

We also opened our first stand-alone Geek Squad store in Canada this month.

So it is now three brands, rather than two.

We continue to be proud of the results in our International business.

In the second quarter, we made headway with several corporate initiatives.

For example, we refreshed and standardized our Future Shop brand image across all customer contact points to increase its impact, including the stores look and feel, the advertising, print, and online presence.

We reset our home theatre and digital imaging departments, so that we can connect more effectively with customers in those areas of the stores.

We realigned our field organization of streamline decision making and reduced costs.

Today our Canadian market share stands at roughly 30%, thanks to our successful dual branding approach.

Keep in mind, we accelerated from zero Best Buy stores in Canada three years ago to 34 stores today, and 44 stores are expected to be open for the holiday selling season.

Because of our new stores, improvements to the business model and execution, we doubled the operating income dollars and rate in Canada.

These results came despite a reduction in customer traffic, which caused flat comparable store sales, and deleverage in our Canadian expense structure.

In addition, we are in the early stages of certain investments in infrastructure, such as last fall's expansion of our distribution center near Toronto.

We expect to see significant leverage from these assets, as we continue to open new stores, including the launch of Best Buy into Quebec.

Again, we are very pleased with the progress that our International Segment is making.

We see a strong foundation of leadership and talent, a foundation on which we plan to build a customer centric strategy in the future.

So as we rapidly approach the Company's fourth holiday season, we are confident about the back half of the fiscal year.

I am personally been here for 20 of those years, and if I have learned one thing during that time, it is that our employees are the key to everything we do as a company.

From winning with our customers during the holidays, to responding to natural disasters with unparalleled courage and resolve.

That's why we continue to devise new and better ways to retain our best employees, and why we expect another strong holiday season.

We know that when our employees are unleashed to build relationships with customers, and help them make the most of today's technology, we are creating an experience that our competitors simply can't duplicate.

With that I will turn the call over to John Walden who will elaborate on our customer centricity activity.

Thank you, Brian.

From my vantage point, we had a lot going on in the second quarter, and I want to thank the entire team for their hard work.

As we have described over time, the foundation of our customer centricity transformation is enabling our store employees to meet the needs of our customer segments, which in turn will shape the solutions and exciting new services we offer, and guide the simplification of back-end infrastructure.

As a reminder, during most of the last fiscal year, we operated R&D layouts dedicated to each of five customer segments.

In these labs, we developed new offerings and labor models, which we first introduced at scale last October.

At that time, we converted 67 stores targeted at specific customer segments, and deployed our new customer-centric operating model.

Once converted, we call these segmented stores.

During the holidays, we demonstrated that customer centricity was a superior operating model to our prior product-centric model.

So we made the decision to convert all of our U.S.

Best Buy stores within three years, and established a goal of converting or opening an additional 150 to 200 stores in fiscal '06.

We are off to a good start.

Year-to-date including the first few days of Q3, we are roughly two-thirds of the way to our store conversion goal for the year.

The balance of stores to reach our goal are on the schedule, between now and late October.

As you know, we are so encouraged by the operating results of our segmented stores and by our capability to efficiently convert stores, that we are adding an additional group of approximately 50 stores to be segmented as early as February.

Plus an additional 12 new store openings which will open as segmented stores.

Including the original stores we converted last year, we now expect to have at least 350 segmented stores by the end of this fiscal year.

I am very pleased about that.

That's the macro view.

Now I would like to comment on the second quarter work specifically.

For most of the quarter, we were operating 130 segmented stores.

To do the math, we had 67 original converted stores, 7 lab stores or stores where we performed R&D on customer experiences, we returned these stores to segmented store status. 35 conversions launched on June 3 of this year, we call this Wave 1.

And 21 new store openings with the customer-centric model.

These 130 stores collectively performed well, consistent with the strong results we have previously reported for the stores converted last year.

The 130 stores collectively generated a 9.4% comparable store sales gain during the second quarter, well ahead of our goal of double the balance of the chain.

They also showed higher operating income rates and stronger operating income dollars versus last year and continued to lead the chain.

Moreover, these results were somewhat consistent across all five customer segments.

I am excluding, of course, training costs and one-time training expenses associated with the June launches.

And I am excluding from the 130 store count, our 11 current R&D labs.

Now let's take a closer look at the results, based on when the stores opened.

Specifically, I would like to talk with about the results at the 35 stores converted in Wave 1, which had their first three months of operation under the new model in the second quarter.

While we recognize that it is still early, the Wave 1 stores generated a 9% comparable store sales gain, significantly higher than the chain as expected.

The Wave 1 stores also had operating income rates in their first quarter roughly flat with the nonsegmented stores, as employees adjusted to new roles, and a new operating model.

Again, this was as expected.

The initial focus is on implementation, and then we optimize from there.

We believe that Wave 1 stores will get up the curve, just as last fall's segmented stores have.

We have confidence in how it will play out, because the Wave 1 stores achieved these results in markets across the country, not just in one region.

We are confident that this model will produce sustained improvements in productivity and margins.

Keep in mind, the collective results of customer centricity stores may vary from quarter to quarter, based on the percentage of stores early in their learning curve, yet we are very encouraged by the results thus far.

It is very difficult in retailing to make changes that show positive results in a malter of months.

Especially for an effort so complex, and so far-reaching.

We frankly can recall very few initiatives in our history that have had such results so soon.

Turning to execution issues, the second quarter was challenging, because we had two overlapping waves of converting stores to customer centricity.

At the same time, we were training and launching our 57 Wave 2 stores, and began the process of preparing 58 Wave 3 stores for launching in October.

With each wave, we get more effective and more efficient.

For example, we continue to lower the capital costs associated with converting a store to the customer centric model, we have also sped up the remodeling process, and we have gained a clear idea of how training demands, effects staffing at the floor level.

Finally, we have used the opportunity to make other needed updates to the stores, to enhance the customers' experience.

We are pleased to announce today our plans for a fourth wave of conversion this fiscal year.

As Brad alluded to earlier, we are able to accelerate our transformation due to the success and therefore our confidence in the future.

We expect Wave 4 conversions to launch as early as February.

Wave 4 is exciting for us, because we are confident in the new operating model, and the stores are excited about their conversions.

At the same time, we are mindful of managing within our bandwidth.

We are asking a lot of our retail team, and our #1priority is protecting the customer relationship.

In deciding to add the 50 wave 4 stores, we were confident that we could execute at the same high level.

This is in large part due to the feedback we have gotten from earlier stores, which we used to improve the process, therefore freeing up capacity to accelerate the work.

Some of you have asked how we determined the rollout plans.

We selected markets and stores, based on a list of criteria.

Two important criteria were size of market and store readiness, which we measure in terms of leadership, talent, and operational effectiveness.

If I think back to the beginning of the year, we describe this year as the tipping point in our transformation.

At the end of this year, more of our U.S. stores will be customer-centric, than will be product-centric.

Our services business is gaining momentum, driven by our customer insight.

The simplification of our back office also is gaining momentum, and feeds our success.

It is certainly a lot of work, but we are energized at the prospect of beginning fiscal 2007 in such a strong position, and with more than 50% of our U.S.

Best Buy stores, focused on specific customer segments.

To discuss the financial implications of our transformation work, and our plans for the back half, I would like to turn it over to Jim Muehlbauer, Senior Vice President of Finance.

Thank you, John.

Good morning, everyone.

This quarter was the continuation of the transformational efforts and positive results we saw in the first quarter.

Fiscal year-to-date, our earnings were up 63%, and we are off to a very solid start to the year.

We met the high end of the range of our second-quarter earnings guidance, even with a comparable store sales gain that was slightly below our expectations.

We also remain upbeat on the second half of the year.

As you recall from our call in the first quarter, we wanted to preserve flexibility to further invest in our transformation.

The addition of 50 more segmented store conversions, and 12 additional new store openings, are primarily examples of this type of investment.

These efforts will require investment spending in the second half of this year.

Yet we have left the full-year earnings guidance unchanged.

I plan to discuss the key drivers of the second-quarter performance, and our outlook for the balance of the year.

Starting with our top line, in the second quarter, revenue grew 10% versus last year to $6.7 billion.

The combination of new store openings, and a 3.5% comparable store sales improvement supported the revenue gain.

Overall, we believe that increases in average ticket and customer close rate offset modest declines in traffic.

Similar to the first quarter, the story for the second quarter was the improvement in gross profit rate.

The 25.5% gross profit rate was modestly higher than our expectations, and up 130 basis points from the prior year.

Key drivers included continued expansion of our services business, and benefits from our supply chain initiatives.

Our price optimization capabilities, global sourcing, and private label activities continued to deliver improved results during the quarter.

Our number of private label SKUs, or Shop Keeping Units, has doubled to more than 400 compared with last year.

Also more product categories are benefiting from price optimization, a capability that allows us to utilize supply and demand curves to find the right price.

These structural improvements in our capabilities and improved execution at the store level, offset a heightened promotional environment, and double-digit price deflation in the flat-panel TV and notebook computer product categories.

Finally, we were pleased that the average inventory per store was essentially flat to the end of the second quarter.

Our SG&A rate of 21.6% was up 80 basis points year-over-year.

As you may recall, last year we incurred $39 million of one-time expense items during the quarter.

After adjusting for these items, SG&A increased 140 basis points year-over-year.

Investments in transformation activities increased this SG&A rate by approximately 60 basis points, while lower-than-planned sales also slightly deleveraged our SG&A rate versus our expectations.

Overall though, the SG&A dollars were in line with our expectations.

The transformation and investments related primarily to the launch and operation of more segmented stores, and the near doubling of Geek Squad services.

We also incurred costs to prepare the next waves of segmented stores, for launch in the second half.

In addition we made larger investments to support our broad transformation efforts, including the reorganization of our retail field team, and I.T. investments to support new storm systems and supply chain initiatives.

Finally, some SG&A spending shifted to the second quarter from the first quarter, a timing issue we called out when we reported our first-quarter results.

Overall, we are encouraged by our results by the second quarter, as well as the entire first half of the year.

Our optimism results from the sustainable improvements we are making to our business model.

We have many controllable elements in our favor as we look to the second half of the year.

For example, we expect sales and income benefits from expanding our service business, and from operating more segmented stores.

We expect to realize more margin benefits from our private label activities, price optimization capabilities, and other supply chain initiatives.

Yet our optimism is tempered by the mix factors in the macro environment.

For example, while unemployment and consumer confidence were better than last year, prior to Hurricane Katrina, we believe that employee discount offers for automobiles, may be reducing consumer spending on other product categories.

We also are concerned about the influence of rising gas prices.

But we quite frankly don't know yet how to think about $3 gas prices.

It is hard for us and others to predict the effects of these trends on North American consumers.

So we believe that it is best to share with you an outlook that does not encompass a wide consumer swing in either direction.

We are taking a middle-of-the-road approach to our second-half assumptions.

For the fiscal year, our outlook remains substantially unchanged.

We are reiterating our full-year earnings guidance, and updating our estimate for comparable store sales in the second half, to a modestly more conservative view, a gain of 3 to 5% rather than our prior guidance of 4 to 5%.

Widening the comparable store sales range is a function of the economic factors discussed earlier .

We believe that we can make up for a smaller revenue increase with a higher gross profit rate, as we did in the first two quarters.

To be clear, we continue to expect earnings per share from continuing operations of $2.07 to $2.17, or an average increase of approximately 26%.

This range includes investments to convert approximately 50 more stores to customer centricity, and to open 12 more U.S.

Best Buy stores than we originally contemplated.

Our initial guidance for the third-quarter earnings is a range of $0.28 to $0.32 per diluted share, or an average increase of 20%.

Our assumptions include a comparable store sales gain of 3 to 5%, and a modest improvement in our operating income rate.

The guidance for the third quarter and fiscal year excludes any potential direct impact from activities associated with Katrina.

As Brian mentioned earlier, it is too early to have accurate estimates; however, given the number of stores in the path of the storm, and the information we have today, I can tell you that the impact to Best Buy does not appear to be material.

To summarize, we are very proud of the entire team.

We are asking a lot of our employees, and they continue to deliver.

Our transformation can only work if we have 100,000 employees engaged in it, and as our first half results demonstrate, they are up to the challenge.

This is ultimately what differentiates us in the marketplace, and how we expect to sustain our growth going forward.

With that, Elsa, we will now take calls from our investor audience.

Thank you.

The floor is now open for questions. [OPERATOR INSTRUCTIONS] Our first question is coming from Rex Henderson with Raymond James and Associates.

Please go ahead.

Good morning and thank you for taking my call.

Good morning, Rex.

How are you doing?

Good.

A couple of questions about gross margin.

First of all, did mix contribute at all to gross margin expansion in this quarter?

And if so, can you kind of rank what products contributed? -- to gross margin expansion?

Hi, Rick.

This is Darren Jackson.

What I will do is talk broadly about it, and then Ron Boire will give you a couple more insights around the product categories.

By way of background, mix did contribute somewhat in the quarter.

The primary driver was in the rate for the quarter, and that again is coming out of structural improvements that we are making the business, so price optimization is taking hold in the business, the private label parts of our business are taking hold, and sourcing are taking hold, as well as on the mix side, what we are seeing is structurally services are taking hold.

We did see improved execution at the store level in the second quarter as well, and I would say the rate and mix gains were somewhat tempered by -- if we look at Q2 versus Q1, we would probably say the promotional environment in Q2 was a little hotter than Q1.

So most of the gains that we are seeing we are pleased to report, are coming in the structural and execution buckets in the second quarter.

Following up a little bit on that promotional issue, HDTV price compression, you commented on that as being a little bit slower than you expected on the last quarterly call.

What are you seeing now?

Year-over-year, we look at, kind of, price per inch.

And so year-to-date, we are seeing kind of mid-teens price compression per inch, which we expect to accelerate into Q3 and Q4.

We are still forecasting total year somewhere in the 20 to 30% range.

If you want to fix a number, I think we're still fixing at around 25%.

Over the past 12 months we have seen about that rate on LCDs.

If you look at price per inch, we have seen somewhat less than that on plasma, and we have seen projection somewhat less than that, or micro device somewhat less.

A follow-up on that.

If 25% price compression at retail, how much of that is lost margin on your part, and how much of that is lower prices from your suppliers?

Well, we are comfortable with our margin yields right now.

We don't talk specifically about margin rates at a category level, but we think we are managing this transition very well.

Okay, thank you, Ron.

Thank you, Darren.

Next question please.

And please restrict your question to one part if you could.

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

Please go ahead.

Good morning, Gregory.

Hi, how are you guys doing?

Good.

Good.

Good morning.

In terms of the new stores you are putting up, you announced a few months ago that the bulk of them will be the 30,000 format, as opposed to a more typical or historic average of 40,000, or above.

I was just curious, could you walk us through how the operating model on those new stores are different than what we have seen historically from you guys, in terms of labor model, what we should expect from gross margin, SG&A, et cetera?

Greg, this is Darren.

What I'll do is frame the economics, and maybe have Brian give you a little insight as to the progress we have been making specifically with our new 20K format.

By way of background this year, we are really across the board.

Think about it in terms of a third at the 45K level, a third at the 30K, and a third at the 20K level.

What we see in terms of economics, which differentiates those three models, typically is sales productivity.

So the 45Ks will run closer to the Company average as we look out at $900 per foot.

Whereas the 20Ks are going to be in that range closer to 700, and that has more to do with people density in the markets.

And one of the things that we have been specifically focused on, and a criteria across all of those formats are, can we generate returns from a Return on Invested Capital point of view, close to 20%.

And honestly I think when we started with the 20Ks, we were a little below that target.

Over the course of the last year, as we have been working the operating model, we've touched all dimensions of that, where I am pleased to stay the 20K trajectory is not only equal, on trajectory to equal that of the balance of the formats, but longer-term as we deploy these urban markets, we can see those being a little higher.

I might ask that Brian Dunn to talk about the changes that we are making in those operating models from capital to the labor model, which is making a difference.

I will start by commenting that the incremental 12 stores we are opening, we are very excited to have 12 more segmented stores up and operating, and they will represent a mix consistent with the mix that Darren outlined, relative to 45s, 30s, and 20s.

What we are very enthusiastic about, is getting our operating models -- the segmented operating store model in the hand of retail team, and they are working through and consistently quarter-over-quarter to Jim's point, making progress with those operating models making the yield even greater.

John do you have color or commentary you want to add to that?

No, I think on the segmentation of those stores as we open them as segmented stores, the difference between those and what might have been traditionally opened as nonsegmented stores, is largely around the specialty positions.

So what's happening in the stores is we will have different kinds of roles in those formats.

For example -- let me give you an example.

If we have a store that is focused on working mother segment.

The concept there that we found works very well is something we call a personal shopping assistant.

You will see that specialty labor category in that store.

You would also see some of that then balanced against some other positions that might get reallocated.

Overall, the labor model might be a bit higher, but it would have a different structure, in terms of the higher specialty skill sets.

Just as a follow-on, and Jennifer this is the same question -- [LAUGHTER] -- the 45,000 store might have 125 people.

If you open a store that's half the size, you don't proportionately reduce the labor.

It might come down less, but you would make up the difference by product categories that might have more margin?

Is that the way we should think of about it?

Greg, the way I think about it in one of our learnings was, last year when we went across all the store base, think about the management structures, the fixed cost structure.

We began to band the stores and the size of the management structure more closely aligned with the overall volumes of the stores.

So one of the ways we got ROIC up is just just the recognition in the management structures in particular that, you know what, we could variable flex those structures down with the volume in those stores, and then two, and one the things that we are working on as part of the transformation, is tailored market assortments, and getting the mix not to have all the same mix, in all the same stores.

I would tell you two years ago, the mix was much wider in those stores, and over the last two years we have been working to refine the mixes in those stores, because as we look forward, one the capabilities that we are excited about, not only for the smaller stores but all the stores, is our tailored market assortment capabilities, that we are beginning to touch right now, and actually see more upside in the future as we build those capabilities.

Okay.

Thanks.

Thank you Darren.

Before that, that was John Walden.

Next question please.

Thank you.

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

Good morning, Dave.

Hey, good morning.

Good morning.

And thanks for taking my question.

I question is a detail on your comments on the operating income rate of the segmented stores.

You mentioned that the operating income rate is higher than nonsegment stores, but I guess a little clarity would be helpful.

What are these stores doing in operating margin year-over-year?

I think you gave us sort of the pieces, but I think with the first wave versus other waves, it would be -- if you could give us a little more detail on how operating margin is tracking year-over-year for the same stores?

Sure -- I can give you -- in general I can give you some color on it.

They are -- the story is fairly consistent across the stores we have opened, whether we are talking about the stores opened last fall or even, frankly, the Wave 1 stores, which we only got three months of experience with.

We are seeing growth across the board.

So as we talked about, we are seeing pretty meaningful comp store sale increases, both year-over-year obviously, as well as against the balance of the chain.

We are seeing the same thing on operating income rate.

So we are seeing year-over-year growth, and we are also seeing margin of improvement, relative to the balance of the chain.

Is that -- is that linear between the two, so if the comps are running double, is the opt margin gain double or -- ?

No, no, we are not seeing that level of difference, but we are seeing a meaningful difference in both, the leverage we are getting is largely driven by sales leverage.

The fact that we are seeing operating income growth -- or operating rate growth and rate growth relative to to the balance of the chain, is wonderful, and that just adds to the leverage to get to operating income dollars.

Okay.

Great.

That's helpful.

Thank you.

You are welcome.

Thanks, Dave.

Next question.

Thank you.

Our next question is coming from Dan Binder, Buckingham.

Please go ahead.

Good morning, Dan.

Good morning, it is Dan Binder.

Also focusing on customer centricity.

At what point, given the fact you are doing a lot of sharings of learnings with non-customer centricity stores, do some of these metrics become somewhat less relevant?

And so, when would you anticipate perhaps not providing that kind of detail any longer just so it is not a surprise?

And also what is the extra spending costs going to look like in the back part of the year, as a result of the additional customer centricity store conversions?

Dan it is John Walden, and I will take your first one, and then maybe give it to Jim Muehlbauer who can talk to you about spending in the back half.

You asked a good question about what metrics make sense, as we introduce additional waves.

We talked about in the call, how we are introducing and segmenting stores in waves.

We are past wave 1, into wave 2, 3 and 4 are coming.

It will be very confusing to isolating different waves, and isolating the metrics across each one of those.

I think frankly we haven't figured out yet the best way to provide you with both clarity and indication of how the success is working, in a way that we are not just confusing the issue.

But I think we will have to figure that out.

In general, if we had to pick one way to look at the success here, what we're -- I guess what we're really looking for, is operating dollar growth.

We want to be mindful of the operating model underneath it, so that we keep the ratios in a place that demonstrates the model works, and the model is dependable going forward, but in general assuming the model holds tight, we are really looking for is to leverage a consistent model and generate dollar growth.

With that in mind, we will have to find a simplified way to talk about it, and in the next call that will be particularly important, because we will have several waves behind us, and be looking at half the chain segmented, and the distinctions then become less meaningful.

Maybe I will build on that and turn it over.

This is Darren.

Way to think about it too, we are in the implementation phase of the segmented stores.

John is absolutely right.

We are getting operating income dollar growth at a very high rate given the comp store sales, but it is still early in the implementation phase, as we get through implementation, then we will be into optimization as we better share learnings, better see how the operating models work.

So the rate improvements, if you rewind the tape to the beginning, we said we hope to just travel with the chain, and the good news, is we are travelling in terms of operating income dollar growth ahead of the chain, so it is early implementation, optimization is still to come as we look down the road.

Now in terms of the cost in the second half, Jim.

Yes, Dan, when we look at cost in the second half of the year.

First we would like to say we feel like we are in a very good position to have the opportunity to invest in advance of FY '07, by having not only 50 more segmented stores, but as Brian mentioned, to have 12 new NSOs above and beyond the historical run rate.

As we look at the expenses in the back half of the year, clearly we will not get the leverage on those store openings that we might get had those stores been opened before the holidays, but we are looking at a couple of pennies impact in the back half of this year, as a result of the 12 new store openings, and the 50 additional segmented stores.

Great.

Thanks for the feedback.

Thank you, John, Darren, and Jim.

Next question please.

Thank you.

Our next question is coming from Michael Baker, Deutsche Bank.

Please go ahead.

Thanks, guys.

Good morning, Michael.

You had mentioned the 7% operating margin, you didn't give the timeframe that you have given in the past.

I guess my question is, does this acceleration in new store growth and in the centricity stores, does that help you to achieve that 7% operating margin by February of '08, what you had talked about previously, or does that impair that timing?

It is substantial help.

The faster we move into this transformation on all fronts, including the back end of the business and the supply chain, the easier it gets to get to that number.

So when you said 7% but didn't say February '08, that wasn't conspicuous by its absence?

You would still say the same thing if not sooner?

I would say the faster we move on all of this transformation, the more comfortable a shareholder should be, that we believe our odds of getting there become easier.

Okay.

And just to follow up with that, all the things you talked but just mentioned, Darren, the year-over-year increase in rate, and the centricity stores, et cetera, all that excludes the up-front training cost.

Is that true?

Yes, by and large.

Keep in mind there is labor.

Incremental labor in those stores, and the productivity in the learning curve dollars are in those investments.

So what we try to do is segment out really precisely, you know, what our specific launch and -- I was going to say nonrecurring, but the reality is, we are going to be converting these stores all the way into next year, so it's not appropriate to think they are nonrecurring, because we will have training costs going on for the better part of another year ahead of us.

At least we are building some of those into the base.

Right, that's why the SG&A will be higher in the back half of the year, even with the centricity stores generating better margin rates.

Because of that up-front investment?

Yes.

There will be higher costs in the second half.

Having said that, we will start to lap some of those costs that are in the base, because we launched the 67 last year in the back half of the year.

There is also a key part of this story that I think it becoming clearer as we move through here, which is the amount of organizational knowledge we have about the marketplace, and about what our options are, increase with every single month.

So the more deep -- the more we transform from a product centric company to a customer centric, and the more we deeply engage our employees for innovation, the more total organizational knowledge there is, and there is a clearer plan, in terms of how to go capture earnings.

This month than there was last month, which was greater than the month before, and there is a remarkable improvement in terms of total organizational intellectual content.

Great.

Make sense.

Thank you.

Thanks.

Thanks Mike and Brad.

Next question please

Thank you.

Our next question is coming from Danielle Fox, Merrill Lynch.

Please go ahead.

Thank you.

I have a question on the sales mix.

Given what you saw this quarter in the sales mix which favored high-ticket categories, you know, how are you thinking about driving traffic, especially this holiday season?

In other words, what are some of the ways that you can compensate for weakness in Entertainment Software, because typically we think of DVD movies and CDs as real traffic drivers.

Hi, Danielle, this is Ron.

We see -- first of all, major drivers for the back half of the year.

DTV we expect still triple-digit comps, MP3, same kind of trend line.

Strong comps in games driven by PSP with some help from X-Box 360, satellite radio, and mobile AD, Notebooks, and Appliances.

I think we are going to continue to see strong growth.

Traffic really around in the hardware side, MP3 and DTV.

As it relates to software, and in particular DVD, we have a number of tests actually in the market right now, to try to balance the promotional spend versus traffic, against the lifetime value of, if you will, a new DVD customer.

So with centricity and a lot of the work we have begun to do on looking at customers more than transactionally, we are kind of changing our thinking about the cost of acquiring that customer with DVDs.

So we are thinking a little bit differently about how to use, how to balance initial margin versus lifetime value of those customers.

So it is a balance between some of the ultra-hot categories, like MP3 and Digital Television and parts of the gaming business, with what we are doing on pricing of Digital Television.

In addition, as we have talked about in previous calls, we are investing in reflowing the center of the store, and rebalancing the total entertainment experience, and we will have somewhere near 100 stores done by the end of holiday, and have a good idea of how that impacts the customer experience, and our authority in the category.

Just a quick follow-up on the sales mix issue.

Should the roll out of Geek Squad eventually help lift the Home Office comps, which were kind of flattish in the quarter?

Absolutely.

Where you are seeing Geek right now is on the margin line, and we believe as you build a much more satisfying customer experience and sell a complete solution, which includes not just great consultation in-store, but in-home installation, and after-sales service.

You will bring that customer.

We know that customer comes back and shops us more often, and spends more money.

Thank you very much.

Thank you.

Thank you Ron.

Next question, please.

Our next question is coming from Mitch Kaiser, Piper Jaffray.

Good morning, everyone.

Good morning.

Just a question on the 7% operating margin by 2007.

At the top end of your guidance range, you will probably end the year 52 or 53.

So that leaves about 170, 180 basis points for the next two years.

How should we be thinking about, you know, what are kind of the one-time rollout costs associated with centricity, and then how should we see that progression kind of between '07 and '08 then?

Yes, hi, Mitch.

This is Darren.

So maybe just to remind the group, that 200 basis-point improvement are coming from four key areas, so we are counting on giving our I.T. costs down as a percent of sales from 2% closer to 1.5%.

Honestly, we are not planning on big gains this year, in terms of taking down the total cost of ownership.

They are a little further out in the curve, as we optimize the back end of our house in terms of I.T.

Our supply chain private label, we couldn't be more thrilled in terms of what we are seeing in gross margin.

The gross margin gains through the first half have been 140 basis points, and we can directly correlate those to our structural changes, so we feel like we are making good progress in that bucket and helping offset deflation.

Three, in terms of Canada, Brian talked about the fact that we doubled their operating income in the quarter.

So we are making good progress on that front.

Where we are putting the investments, in terms of segmenting the stores, building services.

I would take you back to our comments about, we are in the implementation phase.

One of the things that Best Buy over time does exceptionally well, is begin to take this institutional knowledge, and this GAAP management competency, and start to rework the operating models, and honestly part of our anxiety and excitement to go faster, is that we know when we get to that phase of the journey, that's part of our culture and our DNA, so when we look out we are not necessarily at all concerned that it's -- you know we have got to work harder toward the back half of that 7x7 goal to get there in FY '08, but as a matter of fact, it works into our strength as an organization, in terms of optimizing profit models as we look forward.

Okay.

Thank you.

I know it is a follow-up, but can you just, tax rate for the remainder of the year?

I know everybody is going to want to know that.

Jim.

Yes, so I think our previous guidance was 34.5 to 35%.

You know we should be in the 34.5 to maybe slightly lower than that for the year, as we look at some one-time events that have happened, due to the settlement of various federal and state income tax matters.

Okay.

Thank you.

Thanks.

Thank you, Jim and Darren.

Next question please.

Our next question is come from Dana Telsey, Bear, Stearns & Co.

Good morning, everyone.

Hi, Dana.

Hi.

Can you talk a little bit, as you look at the traffic trends as you look throughout the quarter.

Would you need a traffic acceleration to hit the comp guidance that you had given, and could you also give us an update on the supply chain, given the acceleration of customer centricity?

Thank you.

This is Ron.

I'll talk a little bit about traffic and then we'll have Mr. Willett talk about supply chain activity.

We do not need a significant change or a material change in traffic, in order to hit our guidance.

Our ASP as an enterprise for the first half of the year was actually up.

And we are pretty pleased with the mix of product that is delivering the revenue line, driving the comps that we forecasted.

Bob?

In terms of the upside about supply chain, as Darren said, we are very pleased with price optimization.

Tailored market assortment, which is about aligning the product offer with the customer in each location, that's going a little slower.

Forecast replenishment always, there are 17 different projects, and all of them are broadly where we thought we would be.

There are two of them that are significantly ahead, but overall, I think we are where we expected to be.

The benefits are broadly in-line, with one or two that are performing better than expected, costs are in-line with where we thought we would be, but as I keep saying, this isn't a sprint, this is a marathon.

This is very much a three-year program, and we are on-track.

But there is of change involved, and I am pleased to say that Brian's team in the field is doing an excellent job in absorbing that change without getting indigestion. [LAUGHTER]

Limited indigestion. [LAUGHTER]

Thank you, Ron.

Thank you, Bob for that.

Thank you.

And Elsa, at this point we are going to conclude the call.

I want to thank all of the Best Buy management team here, and thank all of you for participating in this conference call, and before we end, I want to remind you that the conference call will be available to you for replay by dialing 973-341-3080, and entering the personal identification number of 6417019.

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

Eastern today, until midnight next Monday, September 19.

Or to hear the replay on the web, visit us at www.BestBuy.com, and click on 'For our Investors'.

And if those don't work, if you have any additional questions about the second quarter, please feel free to call me, Charles Marentette, 612-291-6184, or Jennifer Driscoll, 612-291-6110, and reporters should contact Sue Busch, Director of Corporate Public Relations at 612-291-6114.

With that, Elsa, can you please conclude the call, and thank you all very much.

Thank you, this does conclude today's teleconference.

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