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Operator
Ladies and gentlemen, thank you for standing by.
Welcome to the Best Buy First Quarter Fiscal Year 2018 Earnings Call.
(Operator Instructions) As a reminder, this call is being recorded for playback and will be available by approximately 11 a.m.
Eastern Time today.
(Operator Instructions)
I will now turn the conference call over to Mollie O'Brien, Vice President of Investor Relations.
Mollie O'Brien - VP of IR
Good morning, and thank you.
Joining me on the call today are Hubert Joly
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Corie Barry
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This morning's conference call must be
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Today's release and conference call
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GAAP financial
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These non-GAAP financial
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provided to
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not be considered superior to
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GAAP
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Reconciliation of these non-GAAP financial
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directly comparable GAAP financial
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explanation of why these non-GAAP financial
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useful can be found in this morning's earning release as well as in the Investors section of our website at investors.bestbuy.com.
Today's earnings release and conference call also include forward-looking statements within the meaning of the
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private securities
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These statements address the financial conditions, results of operations, business initiatives, growth plans, operational prospects of the company and are subject to risks and uncertainties that could cause actual results to differ
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Please refer to the company's current earnings
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filings, including our most recent 10-K, for more information
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The company undertakes no obligation to update or revise any
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reflect events that may arise after the date
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Please note that beginning Q1 fiscal '18, the company will no longer be excluding non-restructuring property and equipment impairment charges
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To ensure financial results are comparable, we have recast certain financial information for fiscal '16 and '17 by quarter to reflect the previously excluded fixed asset impairments that are now being included in net GAAP SG&A.
The recast forward fiscal '17 non-GAAP operating income
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or 1.5% to $1.73 billion for previously reported
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operating income
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Please see this morning's earnings release
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I will now turn the call over to Hubert.
Hubert Joly - Chairman and CEO
Good morning, everyone, and thank you for joining us.
I'll begin today with a review of our first quarter performance and the progress we made against our fiscal 2018 priorities.
I will then turn the call over to Corie for additional details on our quarterly results and our financial outlook.
We are pleased today to report strong top and bottom line growth for the first quarter of fiscal 2018.
We grew our Enterprise comparable sales by 1.6%, improved our non-GAAP operating income rate by 70 basis points to 3.5% and delivered non-GAAP diluted EPS of $0.60, up 40% compared to $0.43 last year.
Clearly, our revenue was higher than our expectations going into the quarter.
This was due to strong performance in gaming, a better-than-expected result in mobile and the improvement of our overall sales trends within the quarter due to the arrival of delayed federal tax refund checks.
Let me briefly elaborate on these 3 points.
First, we delivered a strong performance in gaming due to robust customer demand and good product allocations for the new hardware that launched during the quarter.
Second, as expected, while mobile was not a growth area due to last year's product recall and the fact that new phones launched later in the quarter than they did last year, sales in the quarter were better than we expected as new unlimited data plan offers from the carriers generated increased demand across devices.
Additionally, our strong multichannel execution of the preorder process for the new phone that launched in April resulted in our highest Android preorder sales ever coupled with strong services sales.
Lastly, in the Domestic business, we saw overall sales trend improve from the initial softness at the beginning of the quarter as consumers began receiving their delayed federal tax refund checks.
Let me now talk about our year-over-year performance, starting with our Domestic business.
We grew our Domestic comparable sales by 1.4% during the quarter, driven by strengths in computing, Connected Home and gaming, partially offset by continued softness in tablets.
We also continued to drive significant growth in the online channel, with Domestic online comparable sales increasing 22.5%, driven by conversion and traffic.
Online revenue was nearly 13% of total Domestic revenue compared to 10.6% in the first quarter of last year.
In the International business, we delivered a 4% comparable sales increase, driven by continued growth of online revenue in Canada and Mexico and positive sales lifts associated with the Canadian store redesigns.
On the profitability side, at the Enterprise level, continued optimization of merchandise margins and good expense management drove the 70 basis point improvement in operating income rate.
So altogether, our Q1 performance reflects the strength of our customer value proposition and continued momentum in the execution of our strategy, and I want to thank all of our associates across the company for their hard work in delivering these results.
Now I'd like to discuss our progress towards Best Buy 2020: Building the New Blue.
As you may recall, last quarter, we introduced this next phase of our transformation, which is focused on shaping our future and creating a company that customers and employees love and that continues to generate a superior return for our shareholders.
In March, we outlined 4 priorities we are pursuing during fiscal 2018.
While it is early in the year, I will share some highlights of our progress thus far.
The first priority is to explore and pursue growth opportunities around maximizing the multichannel retail business and providing services and solutions that solve real customer needs and help us build deeper customer relationships.
We're continuing to expand several of the new concepts we've been testing related to services and solutions.
Earlier this month, we publicly announced our plan to offer a new service, Best Buy Smart Home powered by Vivint, in more than 400 stores by holiday.
Guided by in-store experts, customers select from a suite of leading smart home products, including smart locks, lights, cameras, thermostats and more, and get expert installation, app-based system control and a 24/7 professional monitoring service.
Also in the smart home area, we are curating new product categories across the home.
For example, we launched during the quarter a new smart nursery assortment.
More broadly, we're very focused on the smart home as a key part of our Best Buy 2020 strategy, and we will continue to enhance this category across our website and our stores this year.
We also expanded the test of our new approach to tech support.
Last year in Canada, we began testing a new service offering that provides 24/7 support for all of the technology products a customer owns regardless of whether they were bought at Best Buy.
It also includes other valuable benefits like discounts on installation services and warranty programs.
We expanded that pilot to additional markets in Canada, and we are now piloting a version of the program in a couple of U.S. markets.
In our work to maximize the multichannel retail business, we expanded the pilot of our In-Home Advisor program to another major domestic market.
We are currently operating in Atlanta, Austin, Orlando, San Antonio and Washington, D.C. We are now planning to roll out the program nationwide later this year.
We continue to drive digital innovation, which is, of course, crucial to the success of Best Buy 2020.
In Q1, online revenue reached $1 billion for the first time in a non-holiday quarter.
We are pleased with our progress and believe there are plenty of opportunities to more effectively help our customers in their shopping journey.
We are pursuing growth around key product categories by refining how we sell, including around emerging product categories like Connected Home; appliances, where we believe we can continue to grow share and revenue; and mobile.
As it relates to mobile, we have an initiative focused on improving the multichannel shopping experience for mobile phones.
The smartphone industry has significantly changed over the past few years, especially with installment billing plans, unlimited data plans and the proliferation of prepaid and unlocked devices.
This can make shopping for a smartphone confusing and complicated.
In response to this changing landscape, we are improving the experience on bestbuy.com and revamping the mobile departments in many of our stores to create a better, easier, more seamless shopping experience for customers.
For the new phone launched last month, for example, we simplified the buying experience and provided clarity of carrier offers and ease of phone selection and saw our highest ever Android preorders.
This initiative will include other enhancements such as improvements to the phone activation process, the addition of more specially trained mobile associates and new vendor displays.
This work will impact several hundred of our stores by the end of Q3.
The second priority for this year is to improve our execution in key areas that support our growth strategy.
For example, in our stores, we're very focused on continuing to improve our sales effectiveness.
We're doing this by providing systematic coaching, training and certification; increasing tenure in our store leadership roles; and lowering associate turnover, all of which is resulting in ongoing NPS improvements related to associate knowledge.
We are also investing in large product fulfillments to both support business growth and materially improve the customer experience.
For example, we are collaborating more closely with our vendors to improve inventory availability and in-stock levels, and we are optimizing our supply chain process capabilities through standardization and training.
Additionally, we're selectively adding distribution center capacity to support business growth and get products closer to the customer.
The third area of focus from an execution standpoint is to reduce our exposure to excess and obsolete inventories while improving our recovery rates.
By more proactively planning product transitions and better managing clearance pricing across sales channels, we materially improved our at-risk inventory position in Q1 versus the prior year, allowing us to reinvest those dollars into the new inventories our customers want.
The third priority for this year is to continue to reduce costs and drive efficiencies throughout the business.
We are happy to announce that during the first quarter, we achieved another $50 million in annual cost reductions and gross profit optimization.
We've now reached our $400 million target 3 fiscal quarters ahead of our original deadline.
And so today, we are announcing a new target of $600 million in additional cost reduction and gross profit optimization to be completed by the end of our fiscal 2021.
We continue to have significant opportunities to reduce costs, in particular, through the use of the continuous improvement approach, working cross-functionally to reengineer and pull costs out of complex processes.
Consistent with the $400 million plan we just completed, we expect to use these cost reductions to fund investments and to offset ongoing pressures in our business.
The fourth priority for this year is to build the capabilities necessary to deliver on our -- on the first 3 priorities, which will involve making investments in people and systems to drive growth, execution and efficiencies.
For example, we've been investing in labor expertise across our sales associates and our Geek Squad agents.
We are also in the process of rolling out our new warehouse management system and beginning to improve our customer relationship management capabilities, starting with our In-Home Advisors.
So in summary, we began fiscal 2018 with a strong start, and we are energized about our opportunities and the strategy we're pursuing.
We believe we are uniquely positioned to help our customers in a meaningful way with our combination of multichannel assets, including our online, store and in-home capabilities, and I love -- I love -- how our teams are mobilized to deliver on our mission and Build the New Blue.
And now, I'd like to turn the call over to our CFO, Corie Barry, for more details on our Q1 performance and our Q2 and full year guidance.
Corie Barry - 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 last quarter.
On Enterprise revenue of $8.5 billion, we delivered non-GAAP earnings per share of $0.60, both of which exceeded our expectations.
As Hubert mentioned, top line performance exceeded our expectations due to gaming, mobile and the overall general sales trend improvement throughout the quarter as consumers received delayed federal tax refunds, which primarily benefited the computing and home theater category.
The better-than-expected EPS was primarily driven by better performance in the Domestic business from the flow-through of the higher revenue along with lower SG&A and a higher gross profit rate.
I will now talk about our first quarter results versus last year.
Enterprise revenue increased 1% to $8.5 billion, primarily due to an Enterprise comparable sales increase of 1.6%.
Enterprise non-GAAP diluted EPS increased $0.17, or 40%, to $0.60.
This increase was primarily driven by a higher gross profit rate in the Domestic business, the flow-through of higher Domestic revenue and a $0.02 per share benefit from the net share count change.
In our Domestic segment, revenue increased 1.1% to $7.9 billion.
This increase was primarily driven by a comparable sales increase of 1.4%, partially offset by the loss of revenue from 12 large-format and 40 Best Buy Mobile stores closed during the past year.
From a merchandising perspective, comparable sales growth in computing, Connected Home and gaming was partially offset by declines in tablets and, to a much lesser extent, home theater.
As it relates to the home theater category, we continue to gain material market share.
However, the industry was softer than recent trends, and our sales were down on a year-over-year basis.
In services, the comparable revenue growth of 4.2% was primarily driven by higher warranty sales as we have now lapped the investments in services pricing from last September.
Domestic online revenue of $1.02 billion increased 22.5% on a comparable basis, primarily due to higher conversion rates and increased traffic.
As a percentage of total Domestic revenue, online revenue increased 230 basis points to 12.9% versus 10.6% last year.
In our International segment, revenue increased 0.3% to $616 million due to comparable sales growth of 4%, driven by growth in both Canada and Mexico.
This growth was partially offset by an approximately 215-basis-point negative impact from lapping the $13 million Q1 FY '17 periodic profit-sharing benefit from our services plan portfolio and approximately 150 basis points of negative foreign currency impact.
Turning now to gross profit.
The Enterprise non-GAAP gross profit rate increased 50 basis points to 23.7%.
The Domestic non-GAAP gross profit rate increased 60 basis points to 23.6%, primarily due to improved margin rates across multiple categories, particularly appliances and home theater, and legal settlement proceeds of $8 million or 10 basis points in the services category.
These increases were partially offset by margin pressure in the mobile category and the negative impact of higher sales in the lower-margin gaming category.
The International non-GAAP gross profit rate decreased 140 basis points to 24.5%, driven by a lower year-over-year gross profit rate in Canada due to approximately 160 basis points of negative impact from lapping the $13 million Q1 fiscal '17 periodic profit-sharing benefit from our services plan portfolio.
Now turning to SG&A.
Enterprise non-GAAP SG&A was $1.72 billion or 20.2% of revenue, which was flat on a dollar basis but represented a decline of 20 basis points versus last year.
Domestic non-GAAP SG&A was $1.57 billion or 19.9% of revenue, an increase of $8 million.
This increase was primarily driven by slightly higher incentive compensation expenses.
International non-GAAP SG&A was $149 million or 24.2% of revenue, a decrease of $8 million.
This decrease was primarily driven by slightly lower administrative and payroll and benefits costs.
From a cash flow perspective, we ended the first quarter in line with our expectations, which included our planned increase in the quarterly dividend and the acceleration of our share repurchase plan to $3 billion over 2 years.
I would now like to talk about our Q2 and full year fiscal '18 guidance.
Our second quarter guidance reflects the continuation of much of the positive category momentum we saw in the first quarter as well as the increased level of growth investments included in our initial annual guidance.
For Q2 fiscal '18, we expect Enterprise revenue in the range of $8.6 billion to $8.7 billion and Enterprise comparable sales growth in the range of 1.5% to 2.5%.
On a segment basis, we are estimating Domestic comparable sales growth in the range of 1.5% to 2.5% and International comparable sales in the range of flat to positive 3%.
We expect to deliver non-GAAP diluted EPS from continuing operations in the range of $0.57 to $0.62, assuming a non-GAAP effective income tax rate of 36.5% to 37% and a diluted weighted average share count of approximately 310 million shares.
This guidance range includes lapping approximately $10 million or $0.02 per share of net negative impact from the periodic profit-sharing benefit from our Domestic service plan portfolio that was recorded in Q2 fiscal '17.
For the full year, which, as a reminder, has an extra week in the fourth quarter, we are updating our top line guidance to reflect the better-than-expected first quarter results and our second quarter guidance.
We are now expecting revenue growth of approximately 2.5% versus our original outlook of approximately 1.5%.
We are now expecting full year non-GAAP operating income growth of 3.5% to 8.5% versus our original outlook of 1% to 3% growth.
We recognize it is early in the year, and the first quarter historically has represented approximately 15% of our annual operating income.
As such, this outlook range allows for a level of flexibility as we strategically balance our pace of investments, returns from new initiatives, ongoing cost reductions and efficiencies and ongoing pressures in the business, including approximately $60 million of lower profit share revenue.
As Mollie noted earlier, our updated full year non-GAAP operating income growth guidance is based on the recast fiscal '17 non-GAAP operating income, which is $26 million or 1.5% lower than originally reported.
I will now turn the call over to the operator for questions.
Operator
(Operator Instructions) And our first question comes from Seth Sigman of Crédit Suisse.
Seth Ian Sigman - United States Hardline Retail Equity Research Analyst
I wanted to follow up on the guidance for the second quarter.
The acceleration that you're embedding here, it sounds like part of that is just based on the improvement you saw throughout the first quarter.
But as you think about Q2 versus Q1, can you maybe walk us through some of the incremental drivers that would support that acceleration?
Is that primarily mobile and the launch late in the quarter or other drivers to consider?
Corie Barry - CFO
Seth, thanks for the question.
As we said in the release, most of it is just the continuation of the momentum that we had seen in Q1.
And then, yes, you're right to call out some of the later launch of mobile, which we had said earlier would push some of that into the second quarter.
So it's really continuing -- and remember, we started the first quarter incredibly soft.
If you'll recall, that was part about what was embedded into the Q1 guidance.
So it's really the acceleration we saw at the very end of the quarter pushing into Q2.
Does that help?
Seth Ian Sigman - United States Hardline Retail Equity Research Analyst
That does help.
And then from a flow-through perspective, obviously, very strong flow-through this quarter.
It's a small quarter overall, but does that reflect some of the savings that you discussed?
Or is there a timing dynamic here where you were assuming lower sales initially?
And then as you think about how the year will progress, guidance seems to imply an increase in growth investments, as you talked about.
Are you factoring in any incremental benefits from the cost-reduction efforts that Hubert laid out?
Corie Barry - CFO
So -- okay, I'll try to hit them both.
So as it relates to Q2, it was not as much about cost reductions.
That was really a balance between investments and cost reductions in the quarter.
It was really more what we talked about, some of the profitability that we saw in our categories.
And then, remember, I'd mentioned we had a small legal settlement as well that was not expected.
And so it was really about the profitability of the categories.
And then you're right to call out maintaining that flat SG&A year-over-year, which was a bit of us kind of catching the trend of sales as the quarter went on.
In the back half, you're right to call out that we believe we see potentially more investments.
Really, for us, it's a balancing act.
Hubert talked about a couple of the different initiatives that we're rolling out in the back half.
And we're still working on exactly when do you roll and how do you roll, and this allows us a little bit of flexibility to make sure we do it right, that we invest appropriately and that we feel like we're really putting our best foot forward in some of these key initiatives.
In terms of the cost-reduction plan we laid out, the guidance -- the cost reduction is implied in the guidance that we gave you.
And so we told you, depending on the quarter, sometimes those things would offset nicely, sometimes they wouldn't.
It kind of depends on what the investment profile looks like by quarter.
Operator
And our next question comes from Peter Keith of Piper Jaffray.
Peter Jacob Keith - Principal and Senior Research Analyst
I was wondering, with a competitor of yours that recently liquidated and closed 220 stores, what you're seeing in markets where you may overlap with those closed stores.
And if you'd like to give an estimate on maybe what type of sales lift you'll see going forward from those closings.
Hubert Joly - Chairman and CEO
Yes.
Thanks, Peter.
So yes, a competitor filed last quarter, and I think they're finishing the closing of their stores.
It's always a little bit choppy initially, given promotions, liquidation and so forth, but we believe we're seeing some lift in the sales in the stores, of course, around their locations in appliances and home theater.
To provide some order of magnitude, their appliances and home theater business, that's about $2 billion, and we'll get a share of that.
It's about 200 stores, so about 20% overlap with our stores.
As you can imagine, our teams are very mobilized around maximizing our return from that opportunity, appropriate inventory level position, enhanced marketing investments and, of course, great readiness on the part of our associates to really be helpful to these customers.
So we expect this is going to be moderately helpful as we look forward, and we'll, of course, update you as we move forward.
Corie Barry - CFO
And keep in mind, in the $2 billion number that Hubert cited, not all of that is appliances and home theater.
There are categories in there that we also don't participate in.
So you've got to kind of narrow down exactly what's available to us.
Peter Jacob Keith - Principal and Senior Research Analyst
Okay.
And then on another note, on the gross margin line, particularly in the Domestic segment, you guys have been driving very nice and consistent year-on-year improvement.
I was wondering what the go-forward outlook would be.
Do you think there's some sustainability in that trend?
And I note that you did comment around improved product transitions and maybe some cost take-outs.
And then also, just to pile on, are warranties beginning to have any impact on the gross margin at this point?
Corie Barry - CFO
Yes.
So I would not expect sustainability of this kind of margin expansion.
To your point, we've seen this kind of margin expansion, and on the gross profit line specifically, for a while now.
We're starting to lap some of that expansion from last year.
And so implied in our guidance is that we expect that to actually moderate into Q2 and then even potentially to have some pressure as we head into the back half, which is, of course, a completely different competitive environment.
And a lot of that has to do with, like I said, the lapping.
The other hard part is in Q1, remember, we had a positive legal settlement, and then in Q2, remember, we're lapping the profit shares from the prior year.
So just sequentially between those 2 things, that's 25 basis points of pressure right there.
And so you have to -- and we'll help model out those profit shares throughout the year, but those will continue in Q2, Q3 and Q4, where we lap all of those and they add some pressure to that gross profit line.
In terms of the warranties, EP specifically, we didn't call it out, obviously, as a key driver in our walk.
It certainly is helpful to see the services side of the business grow.
And we like the growth, most importantly, and we like the opportunity to serve our customers and especially, as Hubert said, specifically around mobile, where there's a really good value proposition there for people who want to keep their phones safe.
Operator
And our next question comes from Matt McClintock from Barclays.
Matthew J. McClintock - Senior Analyst
Yes.
Hubert, you just mentioned that you're planning on rolling out the in-home advisory service to the -- nationwide later on this year.
Can you maybe talk about what gives you the confidence to go forward in such a meaningful way with this program?
Specifically because it requires a skill set of actually going into someone's home, and that's something that you maybe haven't necessarily done before in the past.
Hubert Joly - Chairman and CEO
Thank you for your question.
So the -- we are operating in several markets, and we've been operating now -- it started in San Antonio and Austin 1.5 years ago.
And so we have, we feel, after the experience in these various markets, some very good indications.
So first, the customer experience is great.
If the need of the customer is complex, if you're redoing your home theater or if your network is -- needs to be improved, having these conversations in the home unlocks all sorts of discussions with the customers.
There are some needs that people never talk about in the stores.
So we feel the customer response is very, very good.
We also feel, to your point about skills, that we've been able to really hone and refine the skills requirements, the training necessary to do this right.
Initially, and sometimes in these conversations, we -- when people are talking, they say, "Is that the Geek Squad doing this?" No, it's not the Geek Squad.
These are professional, consultative sales consultants and they have broad product knowledge and the ability to really uncover the underlying customer needs.
So great response from a customer standpoint; great results from a sales standpoint, because we're doing this as part of a key growth initiative.
We've also taken the time to look at the tools we need to be able to do this.
So I referenced a customer relationship management system that we'll be implementing for the In-Home Advisors as we move forward.
Now note that we're still pacing ourselves, right?
So we're going to offer this service nationwide sometime in the back half of the year.
And a key variable, of course, is the number of advisers we'll have in each market, and this is something we'll tune.
This is an effort where supply creates demand.
And sometimes, there is lag between the time when you appoint somebody, then they have to be trained, then they have to develop the a book of business.
So we're pacing ourselves.
But the early indications are very positive, and it really highlights how we can leverage our various capabilities, online, the stores and going into people's homes.
So candidly, we're excited, which is why we're doing this, and we'll see how big this can become.
Corie Barry - CFO
And Matt, above and beyond the In-Home Advisor pilot, Hubert hit on it, we've had excellent Geek Squad agents going into people's homes for years.
And I would also highlight our Magnolia teams and our -- particularly in our Magnolia Design Centers have been doing really complex and thorough in-home work for a long time.
So we've also used those learnings to apply to this broader experience that you get from an In-Home Advisor.
Hubert Joly - Chairman and CEO
That's right, yes.
Matthew J. McClintock - Senior Analyst
And if I could ask one follow-up just on the new expense plan.
$600 million, substantially larger than the last one at $400 million.
You talked about a continuous improvement approach.
Can you maybe talk a little bit about how automation plays into that and how the retail industry has a large opportunity in general to automate processes that they've used human resources before in the past for?
Hubert Joly - Chairman and CEO
Corie, would you like to talk about this?
Corie Barry - CFO
I would love to talk about this.
So first of all, just to be clear, it's $600 million but it's over a longer time frame than the $400 million was.
The $400 million was over 3 years.
We're committing to the $600 million by the end of fiscal 2021.
So just to make sure I'm very clear about that.
And I love how you framed the question because you're hitting exactly where we think there is potential over time.
As we invest in things like In-Home Advisor and some of those more complex, interpersonal conversations, we believe there's real opportunity to take waste out of the system through automation.
And there are places like our supply chain, there are places like some of our call centers where we believe we have real opportunities to become more automated, and we've talked about this before.
With the retail landscape evolving so quickly, many times, you're putting in stopgaps as quickly as you can, and you're not thinking about how to streamline it or how to automate it.
You're just thinking about how to get it done and get it implemented.
And now what we're finding is when you take the time to step back, get a really smart group of people together and look at how could we do this better, how could we automate it, that's the place where we're starting to see some real opportunity.
So the essence of your question I think is exactly spot on to where we think there's opportunity over this next period of time.
Operator
And our next question comes from Mike Baker from Deutsche Bank.
Michael Allen Baker - Research Analyst
I wanted to talk about the TV category.
And you said that, that was down, I believe, or at least, home theater.
Was there sort of a temporary impact that you think led to that?
Or is it a case of where we are in the cycle in that business?
Hubert Joly - Chairman and CEO
Maybe I'll start and Corie will augment.
We're continuing to watch this.
We continue to be excited by the TV category.
There's continued innovation that keeps coming back -- or keeps coming online.
OLED is, of course, a very significant one that we are excited about.
Quarter-to-quarter, there will always be fluctuations based on when new products come in, capacity, pricing and so forth.
So I wouldn't draw massive conclusions from the first quarter.
This is something we'll have to watch as we get into the next quarters.
There are some discussions we're not going to get into today as this is highly competitive.
But don't take the trend of the first quarter as an indication of a strategic shift in the category.
It's probably more of a transitionary nature.
Corie Barry - CFO
That being said, I think our guidance would imply a more moderate view on home theater.
And we're -- to Hubert's point, we're watching it closely.
But I think we took a prudent stance in where we think the industry might go on this one.
Hubert Joly - Chairman and CEO
But we are excited that we are continuing to gain market share in that important category.
Michael Allen Baker - Research Analyst
Sure.
That makes sense, and our data shows that as well.
One other unrelated question, the e-commerce business continues to grow well.
Most companies have seen margins go down as e-commerce goes up.
Your margins are doing better.
But as e-commerce continues to grow, do you think that will start to pressure the margins just because of shipping costs and the like on that business?
Corie Barry - CFO
Yes.
I think that as we look to the back half, and we were talking about kind of some of that flexibility around investments, a piece of that certainly for us is continued flexibility around fulfillment in particular.
And as you see the online business grow and you see the customer demands around speed and choice continue to evolve, we do believe that, over time, we need to continue to invest and make sure that we're delivering in the ways that our customers want.
Obviously, when we talk about the cost reductions, we always talk about the inherent pressures in our business as a piece of what we're trying to offset.
That's why we continue to believe the cost reduction is so important.
It's because of the pressures that you can see in the -- not just the channel shift but in how people want to get their products and how we're fulfilling.
And that's, honestly, both large cube and small cube for us.
Operator
And our next question comes from Chris Horvers of JPMorgan.
Christopher Michael Horvers - Senior Analyst
I just wanted to get some early thoughts on the back half.
You've got a number of things breaking in different directions.
You've got what's expected to be a very powerful iPhone cycle that could defer demand, but you also had inventory issues last year that I think in the third quarter was maybe a 160-basis-point headwind for you.
And you're also lapping the Galaxy issue, the battery issue there.
So how are you thinking about that?
And maybe on those categories, what are you baking into the back half from a forecast perspective?
Corie Barry - CFO
Oh, okay.
So first, let's cover -- I think I jotted all this down.
First, on the iPhone, honestly, there's a wide spectrum of belief in terms of how the iPhone will perform, and we know about as much as you do in terms of exactly what this phone is going to be, when it's going to launch.
We said from day 1, we're taking a moderate view on the iPhone launch.
And in general, I -- if you just take step back, I think you have to think about, and Hubert hit on it in his prepared remarks, the changing and evolving landscape of mobile and people moving into installment billing plans, replacement cycles extending slightly as a result.
I think our guidance would imply that continued kind of moderate view, and we'll update it as we know more.
But at this point, that's what we have in there.
You then hit on the inventory issues.
In Q3, when we talked about supply, it was all about the Note and the lack of there being a Note.
And in Q4, that expanded to include some other areas where we were having trouble with supply.
You're absolutely right in that the guidance factors those things in.
We are, at this point, assuming there is some kind of Note launch.
Don't know when, don't know exactly what it is, but we're at least assuming that you can kind of fill up that hole in the bucket in what we gave you.
Christopher Michael Horvers - Senior Analyst
So does that make -- I'm trying to put that all together in my head.
So does that make 4Q -- do you think about the cadence that makes 4Q more weighted given the inventory and perhaps the timing of the release?
Corie Barry - CFO
At this point, we're not going to guide to separate quarters because here's the problem.
It's so dependent on the timing of the releases, and you even saw that in this quarter, right, when we said just pushing out a few weeks given the demand that you see, particularly in that launch period, it can make a huge difference on the quarter.
And so that's why, at this point, we're really just trying to talk about the back half.
Christopher Michael Horvers - Senior Analyst
I understand.
So I want to jump back to a previous question on the gross -- on the second quarter.
You mentioned some pressures on the gross margin or, I guess, abating tailwinds.
Could you run through those again?
If you look back historically, your -- I think the past 3 years, your gross margins rate averages about 100 basis points higher in 2Q than 1Q, and presumably, that's mix driven.
So what makes that not be the case this year and would suggest you should actually have higher earnings in 2Q than the first quarter?
Corie Barry - CFO
Yes.
Well, remember, there's a couple of things.
Remember, first quarter was buoyed at least 10 basis points by a legal settlement that we had.
In Q2, we're going to lap last year's profit sharing.
So between those 2 things sequentially, you've got 25 basis points of pressure just between those 2 things.
Then underneath that, we've said, and we've cited it now for a number of quarters, we've seen some strength in particularly home theater margins, computing margins, and we're starting to lap some of that strength that we saw.
And so we believe we're going to start to see a bit of moderation.
Not that you're going to give it up, but you're just going to see some moderation in our ability to gain at the pace that we've been gaining.
Operator
And our next question comes from Dan Wewer from Raymond James.
Daniel Ray Wewer - Research Analyst
So I wanted to talk about real estate.
It looks like selling space declined another 0.9% year-over-year.
Given the success of shifting revenue to your online channel, do you see an opportunity for the real estate to perhaps close at an even faster rate going forward?
Hubert Joly - Chairman and CEO
Yes.
Dan, thank you for your question.
We -- I think we continue to have the same view, which is ongoing optimization of the store footprint.
Corie, in her prepared remarks, mentioned a number of stores that have been closed in the last year.
This is an ongoing process we are managing very systematically and with great rigor on an ongoing basis.
So no material change here.
The stores continue to be a great asset for us.
They're a great asset from the standpoint of the customer experience on the more complex categories or experiences, and they're a great asset from a shipping and logistics standpoint.
So -- and as you remember, our stores are profitable.
So there's no sea change that we are seeing more gradual continued evolution of our approach to real estate.
Daniel Ray Wewer - Research Analyst
Okay.
Second question, you had noted the benefits of the shift in the income tax refunds.
We've -- most companies have been complaining about this as a headwind.
It looks like we know where those dollars are being spent now.
But just curious, how do you know that the tax refunds shift had a benefit to sales?
Was it based on the timing of the refunds?
And you're looking at week-to-week trends and you saw a benefit?
And also, how long do you think those benefits can continue in 2Q?
Is it maybe for the first half of the period or perhaps longer?
Corie Barry - CFO
So if you remember, when we chatted with you guys what seems like just a little bit ago, we were seeing NPD trends in our business for the first few weeks of the quarter that were down more than 10%.
The quarter ended at down about 3.2% based on NPDs, and so you can kind of read from that.
As the weeks went on, we started to see this gradual shift back.
I don't believe that, that continues on at any pace into Q2.
I think -- we feel like we've seen more of a normalization in our business and that the bump you kind of get when you get that nice refund check, we think we've passed that.
Daniel Ray Wewer - Research Analyst
Last question I have.
Appliance revenue is up 4%.
We've been seeing that growth rate moderate.
Can you discuss what's leading to that?
Presumably, the HHGregg bankruptcy would benefit appliance revenues.
Hubert Joly - Chairman and CEO
Well, there's the market and then there's market share.
There's been, indeed, a moderation of the growth in the market.
It continues to be positive, driven by what's happening in the housing sector.
In the quarter, comps are in the single digits, which has been lower than what we have had historically but continue to be very positive, so we're excited about this.
The HHGregg bankruptcy was more towards the tail end of the quarter, so not necessarily a huge impact in the quarter.
We believe we'll continue to gain market share.
And so we continue -- strategically, we continue to be excited about the sector.
But you're right to underscore that, at the macro level, from a market standpoint, the growth rate has been a bit more moderate.
Operator
And our next question comes from David Schick of Consumer Edge Research.
David Adam Schick - Director of Research, and Retail and Luxury Analyst
I'll ask one question so others can ask.
If you think about the last several years, you worked real hard with vendors and vendors with you to sort of differentiate the store-within-a-store, and that's given you both financial benefits and I would argue merchandising or in-store experience benefits.
We're moving from a hardware to a service period, smart home, et cetera.
Is it fair to say that we'll see the smart home vendors, service providers, et cetera, hardware building out in the store in the same way?
Are you having those conversations?
Should we see another leg of both financial and merchandising or experience differentiation going forward?
Hubert Joly - Chairman and CEO
Yes.
Thank you, David, for highlighting what has been, indeed, a key driver of recovery.
Clearly, being the leading -- in fact, the only national specialty retailer in the sector gives us a great asset and we are able to provide great value to our vendors, and we love the way we are partnering with them from a product development standpoint, marketing and then merchandising and in-store experience.
As we move into this next phase, we'll continue to have similar partnerships.
I think we'll also expand them more into the services and solutions arena.
So clearly, the announcement we made just a few weeks ago around Best Buy Smart Home powered by Vivint is an example, a great example of that, and you'll see that in 400 stores in -- later this year.
The discussions with the vendors can also get into how do we provide a more complete holistic experience to the customers, how do we work together to solve real customer needs and problems so -- and expanding what we can do into the tech support and the solutions arena.
So there's a number of conversations happening in that arena.
So it's going to be an addition.
So we continue to do the product partnerships and expand -- and we're very interested in expanding into the services and solutions, again, with Vivint being the first good illustration of that.
Operator
And our next question comes from Scott Mushkin of Wolfe Research.
Scott Andrew Mushkin - MD, and Senior Retail and Staples Analyst
And so I wanted to -- one of the pushbacks I get when I'm talking to people on Best Buy is just that, historically, the TV cycle has been so important to you guys, whether it be just the TVs themselves or the warranties that go along with them.
As we get into the back half of the year and maybe into next year, as 4K gets a little longer in the tooth, what would be your pushback?
Hubert Joly - Chairman and CEO
Scott, could you repeat your questions?
Because you cut a bit in and out.
So would you please repeat the question?
Scott Andrew Mushkin - MD, and Senior Retail and Staples Analyst
I'm sorry about that.
Yes, I'll repeat it.
So basically, one of the big pushbacks I get regarding your business is that the TV cycle is so meaningful and that as we get longer in the tooth of this 4K cycle, it's going to have a pretty big impact as you get to the back half of the year and into next year because of the profitability of both the TVs and, I guess, especially the warranties.
I was just wondering what your response to that would be.
Hubert Joly - Chairman and CEO
Well, maybe I'll start and Corie will augment.
Guidance for the full year takes into account whatever can be expected from a TV standpoint.
So that's a first response.
And we, both Corie and I, commented on that earlier.
So whatever pressure we are anticipating this year is reflected into this.
So the fact that for the full year, we were able to grow the top line by 1% and grow our operating income rate in that context indicates that there's other factors going on and that we have a range of drivers.
So home theater, we are very proud of our position and capabilities in that sector.
But people have to see Best Buy as also a portfolio of categories and a franchise that rests on continuous innovation across a range of categories and a position with customers and vendors that's actually broader than the TV cycle.
So the last thing I would add to amplify a comment we made earlier is that -- we've said this several times, the TV cycle or where the TV category is these years is different from the previous cycle of moving to HD, which was a more hilly, if I can say it, transition with a deadline by which people had to upgrade.
Here, you see continuous innovation.
The penetration of 4K is still limited.
You have a new cycle around HDR.
You have a new cycle around OLED.
And so there's a series of innovations that are coming in.
So these are the factors -- some of the factors I would highlight on this question.
Corie, anything you would add?
Corie Barry - CFO
No, thank you.
Scott Andrew Mushkin - MD, and Senior Retail and Staples Analyst
So then my second question and I'll yield is just -- you guys are obviously doing some incredible stuff with like Vivint.
And where is that revenue going to come in?
And how is that reflected?
And then, I guess, the same thing, and maybe it's more self-explanatory, when you expand out your services offering to not only the stuff you're selling but to just kind of anyone that wants to call and get someone in there to help them, where does that -- does that go through comp?
Is it going through services?
So just kind of any thoughts both on Vivint and the other initiatives on how you're accounting for it?
Hubert Joly - Chairman and CEO
Again, I'll start and Corie will add.
So this is a key element -- you are highlighting a key element of the strategy from a financial standpoint, right?
During the Q1 call -- the Q4 call, rather, we had highlighted the financial equation we are trying to solve is grow the top line, continue to drive efficiencies and then try to develop more recurring revenue streams and stickier customer relationships to help the financial equation.
If you -- so in the services and solutions space, of course, this offers the opportunity to do this.
Specifically, as it relates to Best Buy Smart Home powered by Vivint, I want to highlight one thing, which is, given the way we are currently approaching the business with Vivint, you should assume that the bulk of the revenue recognition is going to be from the ongoing service revenue stream as opposed to the initial hardware, so which means that the top line impact is going to be very moderate.
And then there is some kind of profit-sharing agreement.
So it's a recurring revenue stream with profitability over multiple years.
And so hopefully, that adds some color.
Clearly, in fiscal '18, the impact on the business is going to be very moderate because we are rolling out really in the middle or the back half of the year.
There's ramp-up costs and so on and so forth.
So this is a case where you have the initial investment and then the in-year impact is really very moderate.
Corie Barry - CFO
On your services question, keep in mind, right now, and we said it, these are pretty small pilots.
In terms of how we think about the revenue there, it will flow as services revenue, and it would be a part of the services comp.
But it's also why -- again, as we think about whether or not we're going to roll these initiatives -- and remember, this one is very much a test in pilot and we're learning.
Not large, so you're not going to see much about it this quarter or likely next, but we will also keep some flexibility in terms of how we think about rolling out and the economics behind it as we head into the back half of this year and into next year and we get that model more refined.
Operator
And our next question comes from David Magee from SunTrust.
David Glenn Magee - MD
Just sort of a follow-up there on that In-House Advisor sort of revenue stream.
What would be the impact you think on the EBIT line relative to your core business over time?
And I know that's not really fair to ask, so maybe if you can just answer directionally.
Corie Barry - CFO
Yes, thank you.
I will answer directionally.
First, let me make sure I clarify kind of a difference here.
On the In-Home Advisor, there is no revenue associated with an In-Home Advisor visit specifically.
Remember, this is a free visit from an In-Home Advisor who's going to come and help you, a consultant for you in your home.
The revenue comes from what you would choose to purchase as a result of that visit, be it hardware or services.
In general, Hubert alluded to the fact that -- and I think there was a really good question around what gives you confidence to roll this out, after now 1.5 years of testing in various markets, we like the overall financial model because, of course, you do have to prove out the investment in this case since there's both people and resources going into people's homes.
But in general, we like what we're seeing when we spend that time and have that marketing folks build a relationship with one of our customers.
So I just wanted to make sure I was really clear.
There isn't service revenue associated with the In-Home Advisor specifically.
It's more what that adviser enables.
David Glenn Magee - MD
Sure.
Secondly, anything on VR that might be meaningful this year?
We're noticing, I guess, the in-stocks seem to be better on that product.
I'm not sure about the demand, though.
Is it something that could be sort of a dark horse later this year?
Or is this more a next year event?
Hubert Joly - Chairman and CEO
Yes.
I would say, David, that we are excited by the fact that there's a set of emerging technologies.
And it's been very interesting to see the inflow and the regular inflow of a variety of technologies, VR being one of them.
You had drones.
You've had a variety of products like this.
The impact of VR specifically is small, but we like the proliferation of innovation across our sectors.
Operator
And our next question comes from Alan Rifkin of BTIG.
Alan Michael Rifkin - MD and Retail Hardlines and Broadlines Research Analyst
So in looking at your first quarter, an incremental $85 million in revenues flowed through very nicely, which transpired into $60 million of operating income, which is really a stepwise improvement in the flow-through.
Incrementally, do you believe that what's driving that, have you hit a threshold either in the warranty business or in e-commerce where -- or on the cost savings program, where you're now seeing a -- what can be expected to be continuous flow-through of magnitude similar to that?
Corie Barry - CFO
Alan, thank you for the question.
I think you can even see implied in our Q2 guidance, we aren't expecting that same kind of flow-through to continue.
And part of that is the rate at which we're investing in some of the things that we've talked about.
Part of that is just flat out moderation in the gross profit rate expectations.
Part of that is we start to lap some of the profit shares that we had last year that we had specifically called out as $60 million of pressure on the year.
And so we -- you can see implied both in Q2 and even in the back half guidance, we would expect that to moderate as we come through the rest of the year.
Alan Michael Rifkin - MD and Retail Hardlines and Broadlines Research Analyst
Okay.
And Corie, just...
Hubert Joly - Chairman and CEO
Very good -- sorry, go ahead.
Alan Michael Rifkin - MD and Retail Hardlines and Broadlines Research Analyst
And Corie, just as a follow-up, as we look at the incremental $600 million in cost reductions, which would take you close to $2 billion since the beginning of the program, would it be reasonable to assume, and granted it's over the long term, that a disproportionately greater amount of that $600 million will flow through to the bottom line?
Corie Barry - CFO
It would not be appropriate to assume that.
And we actually said we are going to need to take that cost out to help fund both the investments that we're making and the pressures we see in our business.
And specifically, when you think about things like improving our fulfillment capabilities and -- I mean, you've seen it.
The rates at -- and pace at which change is happening in retail continues to be amazing, and we believe that cost reduction is necessary for us to reinvest in our business and make sure that we are also moving at that same pace.
Hubert Joly - Chairman and CEO
Very good.
In conclusion, several of you have highlighted the work that goes into delivering these results and you've been kind enough to share some compliments.
Corie and I will make sure to pass these compliments to our teams.
The work that everybody is putting in to continuing to move the company forward is very exciting, and I want everybody at the company to know how much we appreciate and admire the efforts and the quality of the work.
And of course, we appreciate your support and your continued interest.
And as promised, any technology needs, you know where to find us, and we'll find you.
So have a great day.
Thank you.
Operator
And this concludes today's conference.
Thank you for your participation.
You may now disconnect.