百思買 (BBY) 2015 Q1 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by.

  • Welcome to Best Buy's first-quarter fiscal 2015 earnings conference call.

  • 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 12 PM Eastern time today.

  • (Operator Instructions).

  • I would now like to turn the conference call over to Mollie O'Brien, Senior Director Investor Relations.

  • Please go ahead, ma'am.

  • Mollie O'Brien - Senior Director, IR

  • Good morning and thank you.

  • Joining me on the call today are Hubert Joly, our President and CEO, and Sharon McCollam, our CAO and CFO.

  • As usual the media will be participating in this call in a listen-only mode.

  • This morning's conference call must be considered in conjunction with the earnings release that we issued earlier today.

  • They both contain non-GAAP financial measures that exclude the impact of certain business events.

  • These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons but should not be considered superior to, as a substitute for and should be read in conjunction with the GAAP financial measures for the period.

  • A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning's earnings release.

  • Today's earnings release and conference call also include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

  • These statements address the financial conditions, results of operations, business initiatives, growth plans, operational investments and prospects of the Company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

  • Please refer to the Company's current earnings release and SEC filings for more information on these risks and uncertainties.

  • The Company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

  • In today's earnings release and conference call we refer to consumer electronics, or CE, industry trends and our market share.

  • Share gain is determined by reference to information from The NPD Group and other industry sources.

  • The CE industry as defined by The NPD Group includes TVs, desktop and notebook computers, tablets not including Kindle, digital imaging and other categories.

  • It does not include mobile phones, gaming, movies, music, appliances or services.

  • We would also like to note that in today's earnings release and conference call we began referring to comparable store sales as comparable sales.

  • We believe this change in nomenclature better reflects our multichannel business, particularly in light of the continued strong growth in our domestic comparable online sales.

  • I will now turn the call over to Hubert.

  • Hubert Joly - President & CEO

  • Thank you, Mollie, and good morning, everyone, and thank you for joining us.

  • I'll begin today with an overview of our first-quarter results and then update you on the progress we have made against our Renew Blue priorities.

  • Then I will turn the call over to Sharon for additional details on our quarterly results and commentary on our financial outlook.

  • But first our results.

  • In the first quarter we delivered just over $9 billion in revenue and a better-than-expected $0.33 in non-GAAP diluted earnings per share.

  • So as expected domestic comparable sales declined 1.3% in the context where sales in the consumer electronics industry continue to decline.

  • Nevertheless, we achieved market share gains in the US fueled by our improved price competitiveness and an enhanced customer experience focused on advice, service and convenience.

  • This was evidenced by our 250 basis point year-over-year improvements in net promoter score.

  • Our non-GAAP operating income rate improved 30 basis points driven by an SG&A cost reduction of $161 million or 105 basis points as a percent of revenue partially offset by a 75 basis point decline in gross profit rate.

  • Now excluding the rate pressure from our previously communicated negative impacts including the economics of our new credit card agreement, increased product warranty card and structural investment in pricing, our gross profit rate will have increased for the first time in several quarters due to the execution of our renewable initiatives and more effective management of our promotional initiatives.

  • Let's now turn to the progress of our Renew Blue transformation.

  • On our last call I outlined our 24 months Renew Blue roadmap to address three key business imperatives -- that is improving operational performance, building foundational capabilities to unlock future growth strategies and leveraging our unique assets to create a differentiated value proposition that is meaningful to our customers and our vendors.

  • The roadmap we outlined is built around the following areas -- merchandising, marketing, online, stores, Geek Squad services, supply chain, cost structure and employee engagement.

  • I'm happy to provide today some highlights of our progress in a number of these areas.

  • The first of these areas is merchandising.

  • During the quarter we continued to have compelling and differentiated in-store customer experiences in several key categories including appliances, home theater and mobile.

  • In the appliance category we opened six new Pacific Kitchen & Home stores within the store and expect to add up to 50 more this year.

  • In home theater we opened two new Magnolia Design Center stores within a store and expect to add up to 20 more this year.

  • To date our existing fleet of Pacific Kitchen & Home and Magnolia Design Center stores within a store are outperforming our initial expectations.

  • Also in home theater, based on the success of our existing vendor partnerships we are launching two new partnerships, one with Samsung and one with Sony.

  • By the end of the third quarter we expect to roll out 500 Samsung Entertainment and 350 Sony Experience stores within a store.

  • This will represent the first major merchandising transformation in Best Buy's home theater department in almost 10 years and is intended to make it easier for customers to discover and appreciate the newest rapidly evolving home theater technology.

  • In the mobile category during the quarter we introduced the selling of new installment billing plans with Sprint and Verizon and will begin selling AT&T's late in the second quarter.

  • These rollouts are significant because customer adoption of these plans has been growing and our mobile business has been unable to sell them since they were first introduced in the fall of last year.

  • Furthermore, Best Buy is the first and to date the only national retailer to launch installment billing plans with multiple carriers.

  • The next area where we made progress this quarter is marketing.

  • During the quarter we continued to evolve our marketing to more targeted, personalized and relevant customer communication including continuing to shift away from traditional TV advertising to more targeted and relevant digital marketing.

  • We also began to leverage the early benefits of our new customer database, which we call Athena.

  • These benefits include an increase in marketable email addresses, the ability to target customer segments with specific offers and the ability to send increasingly relevant emails.

  • As Athena has only been recently populated, the additional systems necessary to dynamically utilize the data are still in development and we are only in the very early stages of being able to personalize marketing messages to individual customers.

  • We do believe, however, that with the Athena foundation in place we will see improvements in marketing effectiveness every quarter as our understanding of our customers improves and new personalization capabilities are rolled out.

  • In our online business we continue to leverage our ship-from-store, digital marketing and enhanced site functionality to drive a 29% increase in domestic comparable online sales.

  • We also leveraged ship-from-store to drive improved margins on clearance and end-of-life inventory that has been historically trapped in our stores.

  • Our ship-from-store capability allows us to expose this inventory to our online customers.

  • And with this exposure we are beginning to achieve higher margins.

  • We also enhanced our customer shopping experience around gifting with inspirational gift centers for Valentine's Day, Easter and Mother's Day and continue to raise customer engagement by increasing our product reviews by more than 20% since last quarter.

  • Between now and the holidays we continue to execute on the transformation of our e-commerce platform.

  • We will keep improving the shopping experience by implementing an improved homepage design, a more robust and streamlined wish list, significantly richer visual and editorial content and enhanced search and navigation capabilities.

  • We will also add returned, open box inventory to the online assortments, enhance the online scheduling of home delivery and installation and make it possible for customers to see their historical Geek Squad service plan purchases when they log into My Best Buy.

  • In our retail stores during the quarter we implemented the changes to the field in-store structure that we outlined in our last call.

  • In essence, we did three things.

  • We consolidated and simplified the field organizational structure, we reorganized the field structure around key markets with a goal of having a local strategy for each of those markets and we reduced the number of management level roles within the stores.

  • And so while we have lowered our overall labor costs we have increased the percentage of our retail labor that is customer facing.

  • In our Geek Squad services business during the quarter we continued to reduce our legacy cost structure through operational efficiencies and significantly improved our services Net Promoter score.

  • Our services revenue declined in line with our expectations reflecting the expected negative pressure that we discussed last quarter related to the mobile warranty business as Sharon will discuss later.

  • Looking ahead in services, our team is working on refining our existing service offerings, improving the merchandising of our services and building new offerings that meet the needs of customers in the context of today's rapidly evolving technology environment.

  • In our supply chain we continue to leverage and transform our distribution fulfillment capabilities.

  • As we discussed in our last call, Q1 was the first full quarter that we were able to ship out of all of our 1,400 retail stores.

  • This capability not only significantly contributed to our online growth but also to our online conversion and Net Promoter score by meaningfully reducing our out-of-stock messages.

  • It is also allowing us to increase our speed of delivery to our customers, which we expect to more significantly leverage as we continue to build a more rapid delivery and fulfillment model.

  • In building this model, just this week, we made substantial changes in our distribution operating model to align work schedules with customer demand including expanding our days and hours of operation in both retail replenishment and online fulfillment.

  • This will allow us to get inventory to our customers faster in both channels.

  • In the second quarter we plan to begin exposing returned open box inventory that is currently trapped in an individual store to both our online customers and customers in other Best Buy stores.

  • This exposure is significant because in general individual stores do not have the breadth of traffic necessary to optimize the margin recovery on these products and the majority of open box type consumer electronics is sold online.

  • This exposure is also a critical component of our returns, replacements and damages margin enhancement initiative in the early piloted results are encouraging.

  • Relating to our overall cost reduction initiatives, in the first quarter we eliminated an additional $95 million in annualized costs taking our total Renew Blue cost reductions to $860 million towards a new target of $1 billion.

  • As related to our international segment, we are continuing to execute against our Renew Blue priorities and while we have made considerable progress on our cost reduction initiatives we are increasingly shifting our focus towards our top-line opportunities.

  • So altogether, while we remain mindful of the fact that we still have a lot to do in our Renew Blue transformation, the first-quarter results clearly demonstrate the progress we are making towards improving our operational performance, building foundational capabilities and leveraging our unique assets to create a differentiated value proposition.

  • I would therefore like to express my appreciation and gratitude to our entire team for their commitment to our mission and the impact of their hard work on our results.

  • I will now turn the call over to Sharon to cover more details in our first-quarter financial performance.

  • Sharon McCollam - CAO & CFO

  • Thank you, Hubert, and good morning, everyone.

  • Before I talk about our first-quarter results versus last year I would like to talk about them versus the expectations we shared with you in our fourth-quarter press release.

  • As Hubert said, during the first quarter we continued to make meaningful progress against our Renew Blue priorities which resulted in a better-than-expected non-GAAP operating margin rate of 2.3% and non-GAAP diluted earnings per share of $0.33.

  • These results versus the 70 to 90 basis points of operating margin rate pressure that we previously expected were primarily driven by a significant improvement in the effectiveness of our promotional initiatives as well as a less promotional external environment, a more rapid-than-expected realization of our Renew Blue cost savings and a $0.03 per diluted share nonrecurring financial benefit associated with the transitional economics of our new credit card agreement.

  • I will now talk about our first-quarter financial results versus last year.

  • Enterprise revenue declined 3.3% to just over $9 billion.

  • Enterprise non-GAAP diluted EPS increased $0.01 to $0.33.

  • This increase was primarily driven by the flow through of our Renew Blue cost savings, more effective management of our promotional initiatives and the $0.03 per diluted share nonrecurring benefit associated with the transitional economics of our new credit card agreement.

  • As expected these increases were partially offset by the negative impact of lower volumes, the ongoing economics of our new credit card agreement, our higher mobile warranty costs and structural investments and price competitiveness.

  • Domestic revenue of $7.8 billion declined 2.1% versus last year.

  • This decline was primarily driven by a 1.3% decline in comparable sales and a revenue decline of $63 million, or 80 basis points, due to the less favorable ongoing economics of the new credit card agreement.

  • These declines were partially offset by $16 million, or 20 basis points of nonrecurring financial benefit associated with the transitional economics of the new credit card agreement.

  • Domestic online revenue of $639 million increased 29.2% on a comparable basis due to substantially improved inventory availability made possible by the chain-wide rollout of our ship-from-store capability, a higher average order value, increased traffic driven by greater investment in online digital marketing and a higher number of online orders being placed in our retail stores.

  • As a percentage of total domestic revenue, online revenue increased 190 basis points to 8.2% versus 6.3% last year.

  • From a merchandising perspective growth in computing, gaming and appliances was more than offset by declines in other categories including tablets, services and home theater.

  • Service comparable store sales declined 13.5% reflecting the expected negative pressure that we discussed last quarter relating to the mobile warranty category.

  • Specifically this decline was primarily driven by lower mobile repair revenue due to successfully implementing initiatives to decrease claim severity and higher mobile warranty premium costs which translates into lower commission revenue.

  • International revenue of $1.3 billion declined 10.5% versus last year.

  • This decline was primarily driven by a comparable sales decline of 5.8% driven by Canada, China and Mexico.

  • The negative impact of foreign currency exchange rate fluctuation and the loss of revenue from large-format store closures in China partially offset by revenue from new store openings in Mexico.

  • Turning out to gross profits.

  • The enterprise gross profit rate for the first quarter was 22.4% versus 23.1% last year, a decline of 75 basis points.

  • The domestic gross profit rate declined 70 basis points to 22.7% versus 23.4% last year.

  • This decline was primarily due to a 60 basis point negative impact related to the less favorable ongoing economics of the new credit card agreement, proceeds from legal settlements that occurred in Q1 fiscal 2014 that did not recur in Q1 fiscal 2015, increased product warranty costs primarily relating to the mobile category and structural investments and price competitiveness particularly in accessories.

  • These declines were partially offset by the realization of our Renew Blue cost reduction and other supply chain cost-containment initiatives, more effective of our promotional initiatives and higher inventory shrinkage in Q1 2014 that did not recur in Q1 2015.

  • In addition, the gross profit rate benefited from a 15 basis point impact from the nonrecurring financial benefits associated with the transitional economics of the new credit card agreement.

  • The international gross profit rate was 20.5% versus 21.3% last year.

  • This 80 basis point decline was primarily driven by an increased mix of lower margin gaming and computing products and increased promotional activity in Canada.

  • Now turning to SG&A, enterprise-level non-GAAP SG&A was $1.8 billion, or 20% of revenue versus 21.1% last year, a decline of over $161 million, or 105 basis points.

  • Domestic non-GAAP SG&A was $1.5 billion, or 19.6% of revenue versus 20.5% of revenue last year, a decline of $105 million, or 90 basis points.

  • This rate decline was primarily driven by the realization of Renew Blue cost reduction initiatives and tighter expense management throughout the Company.

  • These impacts were partially offset by Renew Blue investments in online growth.

  • International non-GAAP SG&A was $284 million or 22.6% of revenue versus 24.3% of revenue last year, a decline of $56 million or 170 basis points.

  • This rate decline was primarily driven again by Renew Blue cost reductions and tighter expense management in Canada and China.

  • As we look forward to the second and third quarters we are expecting to see ongoing industry-wide sales decline in many of the consumer electronics categories in which we compete.

  • We are also expecting ongoing softness in the mobile phone category as consumers eagerly await highly anticipated new product launches.

  • Consequently, absent any major product launches we are expecting comparable sales to be negative in the low single digits in both the second and third quarters.

  • From an operating income rate perspective as we outlined last quarter, we are expecting the negative P&L impact that we have been discussing each quarter including ongoing investments in price competitiveness, our Renew Blue SG&A investments and the negative impact of our new credit card agreement to continue but to be significantly offset by our Renew Blue cost reductions.

  • Also, as we discussed last quarter, in the first quarter we reorganized certain foreign legal entities to simplify our overall tax structure which resulted in an accelerated non-cash tax benefit of approximately $1.01.

  • Due to its materiality this benefit was treated as a non-GAAP adjustment in today's first-quarter earnings.

  • This benefit, however, has historically been recognized on a periodic basis and as a result of the acceleration there will be no future earnings benefit for book purposes.

  • Therefore, the Company will have a higher income tax rate going forward on both a GAAP and non-GAAP basis.

  • We estimate that the impact of this and other known discrete income tax items will affect the quarterly fiscal 2015 diluted earnings per share on a year-over-year basis as follows -- flat to a positive $0.01 in Q2, flat to negative $0.01 in Q3 and then negative $0.09 to $0.10 in Q4.

  • For cash tax purposes, though, the benefit from the reorganization will continue to be amortized.

  • With that I will turn the call back over to the operator for Q&A.

  • Operator

  • Thank you.

  • Ladies and gentlemen, we will now begin the question-and-answer session.

  • (Operator Instructions).

  • Chris Horvers, JPMorgan.

  • Chris Horvers - Analyst

  • Thanks, good morning.

  • Wanted to talk about the ship-from-store and what you have seen so far in terms of the benefit to margin.

  • You have the clearance aspect ahead but in terms of the end-of-life inventory, how should we dimensionalize that and how much of the store actually can be -- how much of the product in the store can be shipped out, how much of the assortment is on average on markdown in any particular quarter and what sort of lift are you seeing in terms of net improvement on a mark-down basis?

  • Sharon McCollam - CAO & CFO

  • The answer to all of your questions is, yes, we are seeing benefits.

  • In ship-from-store the amount of inventory that has actually been unlocked represents about two-thirds of our inventory.

  • So where we may be carrying approximately $3 billion of total inventory, about $2 billion of that has been unlocked to the customers.

  • We are just now working on pricing as it relates to clearance inventory.

  • We're working through it category by category.

  • Obviously nothing gets better with age at Best Buy, so a gradual movement into new pricing strategies as it relates to clearance inventory and end-of-life inventory is a thoughtful strategy and of course one that we would implement as we move forward and that's what we are doing.

  • But we have already seen margin benefits which was delivered in today's results through the utilization of ship-from-store and we expect that to continue to grow as we progress through the year and the merchants and the demand planners learn more about how to use ship-from-store as a pricing leverage tool.

  • The big opportunity is from the merchant organization where they are now push, pulling and pushing levers in order to move that inventory through the system faster.

  • And of course it addresses the problem that we've talked about for several quarters where when we get to the point of clearance i.e.

  • end-of-life after clearance, when one store is significantly out of balance we have historically had to take very deep markdowns in order to clear it because we don't have enough foot traffic in order to move that inventory through that store absent a price lever.

  • Now we are going to be able to balance the inventory, theoretically, by opening it up and exposing it to the online customer.

  • So we are seeing positives.

  • You should expect to be seeing more positives and the ship-from-store functionality in the Company is only getting better and there is more to come.

  • Chris Horvers - Analyst

  • Can you talk about the average amount of that inventory that is on markdown at any particular time and what your average markdown is for an end-of-life product?

  • Sharon McCollam - CAO & CFO

  • I think that's highly competitive, so I'm not going to disclose it here on the call today.

  • What I would say is that if you think about our product cycle, the consumer electronics product cycle is built on the premise of obsoleting last year's model and bringing in this year's model.

  • So it is a substantial percentage of our business that we are running through on a clearance or end-of-life basis.

  • Chris Horvers - Analyst

  • Understood.

  • Thanks very much.

  • Operator

  • Greg Melich, ISI Group.

  • Greg Melich - Analyst

  • Thanks.

  • I want to follow up a little bit on the dynamic of Renew Blue versus the margin trends that you discussed in reference to your outlook.

  • Basically as we go forward, Sharon, you mentioned that we expect to significantly offset those pressures with all the good things happening in Renew Blue.

  • Does that mean we can fully offset in the next few quarters like we did in the first quarter, or do you think that there's something to do with the timing in the year-over-year impact that will just make it harder to get the $160 million of cost reductions that you got in the first quarter?

  • Sharon McCollam - CAO & CFO

  • Yes, as you come into Q2 I think we will substantially offset it.

  • When you get into Q3 we will be more than offsetting it at a slight level and then by the time you get to Q4 obviously when you have taken out this much cost it is going to have a significantly bigger benefit in Q4 and that is how it should look.

  • The real message in the outlook today when you look at the first-call estimate is where we see the comp in Q2 and Q3.

  • The consumer electronics industry as defined by NPD, tracked by NPD, in Q2 was again down 2.6%, that's in the press release in one of the footnotes.

  • Obviously we are gaining share in multiple categories.

  • So as we look at what has to happen with the first-call estimates that we have seen out there is that we have to address the consumer electronics softness, which we believe is being greatly driven by a lack of innovation.

  • We need some new excitement in those categories.

  • And we are going to continue to work toward getting back to positive comp store sales and we've got a lot of ideas, and you've got to look at that online growth this quarter.

  • It's just significant.

  • But the real key message that we wanted you guys to take away today is the pressure on the top line.

  • Greg Melich - Analyst

  • And if I could, just remind us when we cycle those things like the credit agreement change in terms of the pressure on gross margin?

  • Sharon McCollam - CAO & CFO

  • I'm sorry, I missed that question.

  • Greg Melich - Analyst

  • So basically the things you talked about, the credit pressure given the new program you have, when do you cycle that change?

  • Sharon McCollam - CAO & CFO

  • Each one of them is slightly different.

  • If you notice in the call by Q4 you have basically cycled all of them.

  • Warranty drops off at the end of Q2 and then the others continue until you get to Q4.

  • Greg Melich - Analyst

  • That's great.

  • Thanks a lot.

  • Operator

  • Anthony Chukumba, BB&T Capital Markets.

  • Anthony Chukumba - Analyst

  • Good morning.

  • I had a question in terms of the installment billing.

  • I know that was a major headwind in Q4 and I guess I am just wondering how much of a headwind was that in Q1 particularly given the fact that you are still not set up with AT&T?

  • Hubert Joly - President & CEO

  • Yes, the installment billing, the fact that we are now starting to sell this is going to be helpful going forward.

  • I would say, though, that in the phone category in this current quarter there will be the impact on the market of new phones and the expectation of customers may be important innovation, important new products coming later in the year.

  • So while we are excited by the ability to delight our customers with the range of options and the fact that we are the only national retailer to offer multiple carriers, we are also aware of potential softness from an overall customer demand in the short term.

  • Anthony Chukumba - Analyst

  • Got it.

  • And just one related follow-up.

  • So would you say looking more at Q1 that not having installment billing set up at all three carriers was more of a headwind than the lack of innovation, or would you say that the lack of innovation was the bigger headwind in the mobile category?

  • Hubert Joly - President & CEO

  • I think sequentially the lack of innovation was quite significant.

  • Remember we already had in Q4 the absence of installment billing, so sequentially the lack of innovation was the major driver.

  • We expect, Anthony, installment billing to gradually pick up as store associates become effective and efficient at selling this and so we are quite excited by this.

  • But again I want to highlight that in the short term we are likely to see some softness.

  • So over time installment billing will be bigger and then we will see what the new products do later in the year.

  • Anthony Chukumba - Analyst

  • Okay.

  • Sharon McCollam - CAO & CFO

  • And Anthony, just adding to Hubert's comments.

  • In the first quarter because of the timing of the rollout of the system for the two carriers, in the first quarter, we did not have a full quarter of the benefit.

  • And to our mobile results in the first quarter it was quite immaterial.

  • Anthony Chukumba - Analyst

  • Got it.

  • That's helpful.

  • Thank you.

  • Operator

  • Gary Balter, Credit Suisse.

  • Gary Balter - Analyst

  • Thank you.

  • I heard conversations, Sharon, you gave us some outlook for second quarter, third quarter but looking at my model and everybody else's, over 50% of your profits are in Q4.

  • Last year you had some serious traffic drivers, or lack of traffic drivers as you discussed and you had gross margins that probably drop more than you would've expected because it seems like everybody was reacting to Target and NPD data.

  • As you look, and I recognize we're a few months away, but as we look out to Q4 can you talk about some of the things that you see as changing year-over-year?

  • Thank you.

  • Sharon McCollam - CAO & CFO

  • Absolutely.

  • I think as we enter Q4 the in-store vendor experiences this year are going to be significant.

  • We have talked about the ones that we have already been working through.

  • We had the Samsung of course and then Microsoft and now with our new partnerships coming into Q4 which is actually a time of year when home theater clearly stands out, we are very optimistic about the opportunity to showcase such an impressive lineup of television and home theater for this holiday.

  • In addition to that, I am very pleased with the progress that we are making on our promotional initiatives.

  • Last fourth quarter we have talked about it, I don't need to reiterate here, that we believe that we could have made some significantly improved decisions around the promotional activity.

  • And we have put systems in place and people in place so the rigor around the promotional investment has been taken, I would call it, to a new level.

  • And by Q4 you know those always grow gradually and incrementally, so I believe by Q4 that we will see that as well.

  • Another area that we are investing in and we are seeing progress in, and again it's gradual and incremental, is in pricing, strategic pricing.

  • Now that does not mean that we will not be continuing to invest in structural pricing which we have already talked about.

  • But offsetting that in the other pricing within the Company that we do, which is every day, every product and timing of changing pricing, we believe that this has not been a capability, a strong capability.

  • Hubert has said that actually since he joined the Company.

  • And we have been progressing in that area as well.

  • So as we come into Q4 I believe that you will see a greater level of sophistication in both pricing and promotion.

  • Additionally, of course, what I just responded to with Greg is that we will be then comping all of our notable negative impacts.

  • And as it relates to the services business, we of course you noticed, or can take note in the prepared remarks this morning about the fact that the work that we have done to reduce severity, while that reduces our revenue because obviously we're not fixing as many things as we subcontract for AID and others, we have made significant progress in our selling process and in our services programs.

  • And I expect again gradually and incrementally to see those be beneficial to us as we get into the really important fourth quarter and it is going to be particularly important.

  • I think we all believe that there is going to be some exciting innovation in several of our categories including mobile sometime this year.

  • And of course that's an opportunity to protect those valuable products for our customers and we expect to continue to remain very focused on our service business.

  • Gary Balter - Analyst

  • Thank you.

  • Thank you very much.

  • Operator

  • Peter Keith, Piper Jaffray.

  • Peter Keith - Analyst

  • Thanks, good morning.

  • When you are talking about the sales outlook for Q2, Q3, if we are looking at the NPD's quantification on the consumer electronics industry the last two quarters, it was down (multiple speakers)

  • Hubert Joly - President & CEO

  • Peter, we're struggling to hear.

  • You seem to be cutting in and out.

  • I'm sorry about that.

  • Peter Keith - Analyst

  • Okay, let me shorten the question.

  • So the consumer electronics industry declines were pretty consistent in Q1 and Q4.

  • Are you expecting those declines to get worse as we go forward here in Q2 and Q3?

  • Sharon McCollam - CAO & CFO

  • I don't believe that we have any reason to necessarily believe that they are going to get worse.

  • There wasn't much innovation in Q4 compared to Q1 so I don't know that we are viewing it as substantially worse.

  • We think that mobile without the newness and the anticipation is going to be affected by something different and remember NPD does not track mobile.

  • You need to focus on those categories and which ones that mobile is actually not in those categories but we think where you are going to see it, the additional pressure, is going to be in Q2 and Q3 in mobile.

  • Peter Keith - Analyst

  • Okay.

  • I want to ask a separate question just on some of the management changes.

  • Hubert, could you address the change of leadership with US stores and then also with Jude Buckley moving out of that co-merchandising role and into a marketing role.

  • I know he has since departed but kind of wondering how you are changing things at the top there?

  • Hubert Joly - President & CEO

  • Again you are cutting in and out, but I think you're asking me about the management changes in our management team?

  • What I would say, Peter, is that I am very proud of our team.

  • We have in our executive team some very strong leaders and we have been able over the last 18 months to significantly not only deliver but strengthen the management team.

  • My colleague on this phone call being a great example of that, of course with Sharon.

  • There is one area where we need to continue to strengthen our capabilities.

  • I would say which is the whole area of developing great customer experiences and marketing and so we will be focused on that.

  • Each individual case, and I'm not going to comment on individual leaders, but again I want to reiterate how proud I am of our team, commitment to our mission, the talent that exists and we'll continue to strengthen it in particular this customer experience and marketing arena.

  • As it relates to the new leader of stores, Shari Ballard, I want to recognize her publicly.

  • Our team is a combination of people who have been at Best Buy for a long time and newcomers.

  • Shari is an amazing leader.

  • I have personally had the opportunity to work closely with her in the last 18 months.

  • She is very strategic, she is performance oriented, she knows retail inside out, she has grown tremendously as a leader, she's one of the most extraordinary leaders that I have had the opportunity to work with.

  • And already in the last few weeks she took the leadership of our retail stores in the US.

  • She started have a very meaningful impact.

  • We are very excited about Shari leading our store organization.

  • Peter Keith - Analyst

  • Okay, thank you very much for the feedback.

  • Operator

  • Matthew Fassler, Goldman Sachs.

  • Matthew Fassler - Analyst

  • Thanks a lot and good morning.

  • So you've already obviously been engaged in an aggressive cost-cutting effort across the enterprise but as we look at the relationship between your overall comps and your growth in online, it seems like the model would dictate some modest persistent sales decline in the stores.

  • If you could just give us a sense over the long run how you are adjusting your model to make it more flexible on cost and how much room there is to sort of move with the migration to omnichannel as you optimize your cost structure.

  • Hubert Joly - President & CEO

  • We are very pleased with the growth of our online business, I think 29% is a good number and Sharon has outlined the key drivers of that.

  • I would note one thing which is increasingly it is going to be hard to distinguish between online and stores and in many ways of course we are moving to be a multichannel retailer.

  • Ship-from-store do you count this in the store results or in online?

  • Of course we know that our store leaders are compensated and incentivized on the whole.

  • Increasingly we want store associates to, if the product is not available in the store, to tell the customer of course I can get it to you.

  • Now be it from a DC, from another store and so forth.

  • So we are very pleased with our multichannel capabilities and how we can leverage that to serve an increasing number of customers.

  • Now, we are seeing, as any other retailer, a phenomenon which is a reduction of in-store traffic as customers spend more time researching online.

  • And many times closing their sale online and some of the times going into the stores.

  • So we have the ability to flex the labor model and we have done some of that in Q1 lowering the overhead in the stores which means that we are increasing the part that is variable and customer facing, of course.

  • And we are one of the areas of focus of Shari is to look at how we can adjust dynamically the staffing to the traffic store by store but also day by day and hour by hour and category by category.

  • Over time we have been very consistent in talking about the fact that we will continue to optimize our store footprint.

  • We know that in the short term our store contributing positively at a great asset.

  • But over time we will see how all of this evolves, how traffic patterns continue to evolve and how we are able to compensate some of them through own growth initiatives.

  • As we develop our personalization capabilities with Athena, we are gaining flexibility in adjusting our store footprint but this is something that will take place over multiple years.

  • And so that's some of the things that we are thinking about as relates to that.

  • Matthew Fassler - Analyst

  • Thank you.

  • Operator

  • Michael Lasser, UBS.

  • Michael Lasser - Analyst

  • Good morning, thanks a lot for taking my question.

  • I wanted to follow-up to two comments made previously in the call.

  • The first was on the prospect of innovation beyond mobile phones.

  • As you alluded to the industry really does need to drive innovation and I was hoping you could expand on where you think that will come from mostly around the holidays and then moving into next year.

  • And then second, Sharon, you alluded to the potential for margin expansion in the third and fourth quarter, could you quantify how much margin expansion you think the enterprise could achieve during that time?

  • Thank you so much.

  • Hubert Joly - President & CEO

  • Yes, thank you Michael.

  • I will take the innovation question and then Sharon can respond on the margin.

  • As it relates to growth drivers, category growth drivers, getting into the next several quarters, holiday and next year, I would list probably a small handful of them.

  • One is in home theater, ultra high-definition TV.

  • Obviously and we do expect some traction there.

  • A) because it's a materially different, from a customer standpoint it's materially different and B) because we will be the destination for ultra high-definition TV with our Samsung and Sony stores in the stores, our Magnolia Design Centers and so forth.

  • Second, we are seeing a good deal of traction in gaming course with the new platform cycle.

  • And while early in the cycle it is mainly hardware driven, of course as the installed base grows and as games developers and publishers would have had more time to bring new products to market we will see the cycle gaining momentum.

  • I think third is appliances.

  • You have seen our continued growth in appliances driven by the housing recovery and expansion of the appliance section, the Pacific Home & Kitchen performance.

  • This may be less technology driven but more underlying economics in our merchandising initiatives.

  • Beyond that, and of course we have seen all there's always good traction around computing, we have seen that with our Windows store and very strong partnership with Microsoft.

  • Beyond that we've talked about the industry as a whole is focused on new categories around health and fitness and connected home.

  • This may take longer to materialize and produce a big impact but there is a ton of innovation going on there.

  • So less impact on Q4 clearly but looking at the next two or three years, areas of intense focus.

  • So these are some of the things we can highlight, but Sharon as it relates to gross profit margin --

  • Sharon McCollam - CAO & CFO

  • When you take my comments and you put them actually into the P&L, the gross profit rate in Q3 will still be down.

  • Remember that it is the Renew Blue cost reductions that are offsetting those pressures and those pressures on a year-over-year basis of course are in Q3.

  • It's not until Q4 we comp them.

  • So I want to be clear about your question was, if it was the gross profit rate I think you said the margin rate and I don't know if you were specific about gross profit or operating margin.

  • What you should see in Q3 is a stabilization of that operating margin.

  • But of course you are going to see the lower revenue and then coming into Q4 where we are very hopeful there is the new innovation comes in as well, you should see an OI margin expansion in Q4 in light of the results of Q4 last year.

  • Michael Lasser - Analyst

  • And the magnitude of the increase will just depend on a variety of factors like the promotional environment, etc.?

  • Sharon McCollam - CAO & CFO

  • It is so clever how you guys do that.

  • Michael Lasser - Analyst

  • We try.

  • Sharon McCollam - CAO & CFO

  • We are not giving guidance.

  • Thank you though.

  • Michael Lasser - Analyst

  • All right.

  • Good luck with the rest of the year.

  • Thanks for all the commentary.

  • Operator

  • Dan Binder, Jefferies & Company.

  • Dan Binder - Analyst

  • Hi, good morning.

  • I was wondering if you could touch a little bit on your price investment activity, specifically accessories that has been an area where you have had price gaps with competitors.

  • I think some still even still exist.

  • So I'm kind of curious what inning you are in on that investment, if you are seeing better growth in the category, better attachments to core purchases?

  • Hubert Joly - President & CEO

  • Yes, thank you for your question.

  • So yes our strategy is to be price competitive and that applies to the entire product line up.

  • We will continue in the next several quarters this year to make targeted investments so that we continue to align.

  • Of course this is a complex field because you have multiple categories, multiple competitors and so forth.

  • But I must say I am very pleased with the progress we are making in this area as well as the customer response in this area.

  • So we will continue in the next several quarters this year to make these investments.

  • Dan Binder - Analyst

  • I'm not sure if I can sneak one more in, but you have had some new leadership in Canada and Geek Squad.

  • I'm just curious if we can get an update on some of the initiatives particularly in light of the negative comps that we are seeing in both areas?

  • Hubert Joly - President & CEO

  • So in Canada we have our President is Ron Wilson.

  • I was with him last week.

  • He is a seasoned veteran of Best Buy.

  • He has done a remarkable job adjusting the cost structure in Canada.

  • Canada is at this point in consumer electronics is a very very soft market.

  • We have seen significant industry decline.

  • We are holding our own very well in comparison to the market.

  • So very good job on the cost side.

  • And the focus is turning, is shifting to driving the top line, of course along the same lines as our Renew Blue initiatives in the US.

  • As it relates to services, Chris Askew who joined us about nine months ago, who is a 20-year industry veteran in the IT services industry has done a very good job in a number of areas so far but in particular to driving efficiencies.

  • There's a lot of process improvements that he has been able to carry, materially improving the service quality around our various service lines.

  • As we celebrate the 20th birthday of Geek Squad this year, the focus there also is shifting to growth.

  • So there is a lot of work he is leading around reviewing the existing service portfolio, the merchandising, the marketing, the selling of the services in partnership with Shari Ballard in particular in the stores as well as innovating.

  • When you think about the needs of the customers in their home, in their connected home, there is a significant opportunity for us to be their technology partner, not just attached the installation of a service but for the management of their entire services.

  • So we have a pipeline of innovation that he is working on in a very disciplined fashion.

  • But of course it takes time to go from ideation to evaluation and then to launching the services.

  • So a lot of work going on in this area.

  • Sharon McCollam - CAO & CFO

  • And I will just add to that that in our prepared remarks this morning we actually added comments about the decline in services revenue.

  • While we are going through this transition on these mobile warranty costs we have referred to them as costs because theoretically they are.

  • But the way that shows up in the P&L, which I talked about, is higher mobile warranty premium costs actually end up in lower commission revenue.

  • That is how the accounting for that plays out.

  • So actually and then on the service where we repair the products under those Geek Squad programs, as we improve the actions we take to reduce severity, it reduces revenue but improves profit.

  • So when we get on our calls, after the call today I would be happy to go into more detail on that for anyone because we could actually have a great performing services business.

  • And as we work on improving our efficiency it could have a negative impact on revenue but a higher improvement on gross profit, so I think it's really important that everybody understand that.

  • Especially as we go through all the operational efficiencies that Chris is introducing for us.

  • Hubert Joly - President & CEO

  • Such a good point there Sharon, thank you for clarifying that.

  • Dan Binder - Analyst

  • Thanks for the color.

  • Operator

  • Ladies and gentlemen, this concludes our conference.

  • Thank you for your participation.

  • You may now disconnect.