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Executives

Jennifer Driscoll - Vice President, Investor Relations

Bradbury H. Anderson - Vice Chairman of the Board, Chief Executive Officer

James L. Muehlbauer - Senior Vice President and Interim Chief Financial Officer

Mike Vitelli - Executive Vice President, Customer Operating Groups

Barry Judge - Senior Vice President, Consumer and Brand Marketing

Brian J. Dunn - President, Chief Operating Officer

Shari L. Ballard - Executive Vice President, Retail Channel Management

Robert A. Willett - Chief Executive Officer Best Buy International

Sean Scully

Andrew Lacko - Investor Relations

Analysts

Gregory Melich - Morgan Stanley

Colin McGranahan - Sanford Bernstein

Matthew Fassler - Goldman Sachs

Brian Nagel - UBS

Jack Murphy - William Blair

Scott Ciccarelli - RBC Capital Markets

Chris Horvers - J.P. Morgan

Kate McShane - Citigroup

Mitchell Kaiser - Piper Jaffray

Anthony Chukumba - FTN Midwest Securities

Best Buy Co., Inc. (BBY) F3Q09 Earnings Call December 16, 2008 10:00 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Best Buy's conference call for the third quarter of fiscal 2009. (Operator Instructions) I would now like to turn the call over to Jennifer Driscoll, Vice President of Investor Relations. Please go ahead.

Jennifer Driscoll

Thank you and good morning, everyone. Thank you for participating in our third quarter conference call. We have two speakers for you today. First, Brad Anderson, our Vice Chairman and CEO, will give an update on how Best Buy is responding to the challenging consumer environment and preparing for the future. Second, Jim Muehlbauer, our Executive Vice President of Finance and CFO, will recap our third quarter performance and add color on our earnings guidance. We will leave more than half of the time on our call for questions and answers.

As usual, we have a broad management group here with me today to answer your questions following our formal remarks.

We would like to request that callers limit themselves to a single question so we can include more people in our Q&A session. Consistent with our approach on prior calls, we will move to the end of the queue those who asked a question on last quarter’s conference call.

We’d like to remind you that comments made by me or by others representing Best Buy may contain forward-looking statements which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management’s expectations.

May we also remind you that as usual, the media are participating in this call in a listen-only mode.

And with that, let’s turn the call over to Brad Anderson, who will begin our prepared remarks.

Bradbury H. Anderson

Thank you, Jennifer and thanks to all of our listeners for participating in our third quarter call. When we updated our earnings guidance in November, we said that rapid changes in consumer behavior had created the most difficult economic climate we had ever seen. The results we are reporting this morning, and even weaker results that we have seen from others in our industry for the same period, show that our statements were accurate. In addition, we believe that the environment for consumer spending is likely to get worse before it gets better. While lower energy costs are an offset, we anticipate that company’s will be laying off more employees, which will exacerbate the decline in consumer confidence, uncertainty, and weakening demand.

In fact, we can foresee a period in which consumers may significantly shift their spending behaviors, which could have a dramatic impact on retailing. To be completely clear, we think it’s fair to let both the investment community and our people know that we are preparing for a wide range of outcomes for the next year, including potentially significant comparable store sales declines.

Part of the reason I enjoy history is because it gives the readers a chance to look at the choices other leaders have made in similar circumstances and the outcomes of those choices. While there’s never a perfect parallel to a single moment in history but if we choose to look at other very difficult macroeconomic challenges in periods like the 1930s in the U.S., as well as globally, and in the 1970s, primarily in England, I believe you can see three patterns emerge in companies that are winners over the long haul in very challenging times.

The first is they survive. Now that sounds obvious but in difficult times, many enterprises do not. In order to survive those companies recognize the new reality and more rapidly than some of their competitors, they adjusted to it.

Second, they focused on their core customers and enhanced the value they provide to them. In order to accomplish this, their organizations had to emerge with greater capabilities, even as they spent less resources.

Third, when growth remerged, these companies saw a significant financial returns and their skills were even more in demand than they had been, and they realized that they were more unique and that they could -- excuse me, and that they would -- than they would have been without the financial crisis. That may sound like common sense and it probably is but the good news is that we at Best Buy believe we are capable of doing what these winners of history did, and we’ve already started preparing the company to do exactly what they did applying the three lessons.

First, lesson one -- we got a lot of reaction in November to our use of the word seismic in describing the significance of the change we were facing. That phrase picked up a lot of attention and we think more people now agree with us that it’s an accurate depiction of the economic climate.

Top of mind for us is ensuring that we remain in a strong financial position no matter what the future brings, so we are peeling back on the level of our investment in the business. We’ve already taken actions to cut our spending, as we reported in this morning’s news release, and after the second quarter, we made reductions in discretionary spending in labor and other areas where we expected reduced volumes. Since that time, we’ve made further cuts in inventory orders and in discretionary projects. And yesterday we announced a voluntary separation program. We offered nearly all of our corporate employees a voluntary separation program because we’ve always believed employees are our most valuable asset and we wanted to reduce the number of involuntary separations.

What we offered was an enriched severance package for those who chose to take this option, including more weeks of pay than we would typically offer in an involuntary program, plus the continuation of the employer subsidy of healthcare and dental coverage for a period of time, among other benefits. We told them that an involuntary severance package could be our next action to supplement the voluntary program.

We will take further actions as well. For example, we plan to cut our capital spending next year by approximately 50%, compared with the projected $1.2 billion in capital expenditures this year. One of the largest components of the reduction will be a significant reduction in the number of new store openings planned, both domestically and internationally.

Notice we are not dropping out our capital expenditures down to a maintenance level per the third lesson we talked about earlier, which is -- which I will get to in a moment. We said on last quarter’s call that we also intend to take out significant levels of legacy costs in our business next year in order to improve our focus and provide further flexibility.

Work is already underway on that front and SG&A dollar spending, including Europe, is targeted to grow by no more than 2% next year. That’s due to fewer stores, the removal of legacy costs and other actions, such as the voluntary and involuntary separation program.

I should add that some of the actions we are considering will likely require restructuring costs later in fiscal 2009 and potentially in fiscal 2010 as well. We intend to update you on those after the final decisions have been made.

Lesson two -- as we work to adjust the realities of today’s changes, we must retain our core strengths and we believe for Best Buy, our core strength is and has been our culture. Our employees will be watching how we make these tough choices and our approach to those choices will place our values on center stage for them. We must proceed in this process the best we can without hurting their loyalty or their commitment to the company. We hope to do that by remaining true to our successful strategy to customer centricity and employee centricity, and that means inviting our employees to participate in determining where we pare back and where we plant seeds for the future, based on what they know about our customers. That means making offers like the voluntary separation program we just announced.

Lesson three, and most importantly, we plan to stay focused on the changing needs of our customers so that we can meet their current and future expectations. We fully expect that opportunities will emerge that would not have emerged in any other time. Consumer electronics offers tremendous engines of productivities and cost savings and we believe that our primary products and services will be even more important in people’s lives in the future than they are today. We must prepare to seize the day as those opportunities emerge and these unfolding opportunities could propel our company to new heights.

If all we do is hunker down and we don’t plant seeds for the future, we won’t get the expected extraordinary outcome on the other side of this cycle and I believe that our future horizon will be much bigger than they are today in retail, in services, in dot.com, and in private label, to give just a few examples. If history is a guide, there may be disproportionate winnings for those who are with us at that time.

To conclude, we face the most challenging consumer environment in our history. We are reducing our spending, we are cutting our costs, and we are being conservative to maintain flexibility and retain our financial strength. In addition, we will use our employees’ insights to provide greater value for our best customers and continue to grow our market share through all of our touch points.

And lastly, we will plant seeds for the future that will allow us to grow when the global economy recovers, using the unique skills we’ll be developing over the next two years.

And with that, I will turn it over to Jim.

James L. Muehlbauer

Thanks, Brad and good morning, everyone. As we are all keenly aware, many things have changed since we last spoke in September. To say that it’s been a very active time at Best Buy would be an understatement and I’m certain the same can be said for you as well. We were pleased with how quickly our teams responded and began to adjust to the rapidly changing environment in the quarter. We believe that their swift actions helped counteract and mitigate a portion of the headwinds we experienced. As Brad noted, it’s of critical importance to adjust our future resource plans based on very realistic expectations for the environment, as these headwinds are likely to continue for some time.

First I would like to recap our fiscal third quarter results and provide some additional color on our performance. And then I will comment on our earnings expectations for the fiscal year.

This morning we reported net earnings of $52 million, or $0.13 per diluted share for the fiscal third quarter. Excluding a non-cash, non-operating impairment charge, we reported net earnings of $145 million, or $0.35 per diluted share. This performance was modestly better than what we had anticipated when we provided our updated guidance in mid-November due to a stronger performance over the Thanksgiving holiday.

Before we jump into the details of the quarter, I want to comment on the impairment charge you saw in the release this morning. We lowered the carrying value of our 2.9% investment in the shares of the Car Phone Warehouse Group PLC that was purchased in the second quarter of last year. To be clear, this charge related exclusively to our investment in the common stock of CPW, which is separate from our operating investment in Best Buy Europe’s retail venture. The driving factor behind this change in valuation was simply the current market price of these shares, coupled with our lack of visibility as to when in the future they will return to their original purchase price. This change in no way reflects our view of the long-term intrinsic value of CPW business, or the strategic operating or financial value of the ventures we have with them both in Europe and the U.S. with the Car Phone team.

Now looking at the quarterly results, our third quarter top line revenue of $11.5 billion was a bit ahead of our revised mid-November expectations. Third quarter comparable store sales for our domestic segment declined 6.3% versus last year. Sequentially, October and November comparable sales were similar. However, if you look at November on a calendar adjusted basis, we essentially saw flat comparable store sales, which reflects our solid Black Friday results.

While we were disappointed in the absolute results for the quarter, as Brad indicated, they were strong relative to most of our peers and we believe we continue to see healthy market share gains. We believe our customer-centric strategy is winning by focusing on customer needs while at the same time offering a wide assortment of great brands at competitive prices. This success was borne out during the quarter by our ability to gain market share in such a volatile consumer environment.

Based on recent data released by MasterCard spending pulse, while total consumer electronic spending declined approximately 25% for the month of November, our domestic revenue declined 3%. This superior relative performance was a direct result of our employees’ strong execution, focus on the customer, and providing complete solutions, which are differentiated in the marketplace.

Looking now at our international portfolio, we were not immune to the global economic conditions in the third quarter. International comparable store sales were slightly weaker than planned. Canada had a comparable store sales decline of 2% for the third quarter against a tough comparison of positive 9% in last year’s third quarter. China’s third quarter had an 8% comparable store sales gain, which showed a recovery versus previous periods. China benefited from pent-up demand after last quarter’s earthquake. As a reminder, our results in China are reported on a 60-day lag basis.

One of the key stories in the third quarter was the gross margin performance for the enterprise. Our gross margin rate increased by 140 basis points, including Best Buy Europe, which accounted for a majority of the improvement. Within our domestic business, gross margins improved by 20 basis points. The effective plans and actions of our teams actually drove rate improvement across nearly all key product categories. Our focus on providing customers with complete solutions and more effective promotions drove a 70-basis point rate improvement in the domestic business.

Key categories leading this improvement included home theater, computing, digital imaging, and gaming. These gains were offset partially by a 50-basis point unfavorable mix impact. The significant growth of our Best Buy mobile business was able to offset a portion of the mix impact from the continued strength in mobile computing.

The domestic performance is especially impressive when we consider that these gains were on top of margin improvements we realized in the third quarter of last year.

The gross profit rate was flat in Canada, which was an improvement versus the second quarter, and we saw another quarter of improvement in our gross profit rate in China.

Overall, we are very pleased by the ability of our employees to deliver this best-in-class performance in a very difficult environment.

Moving now to cost, during the quarter we saw SG&A delever by 250 basis points, which was in line with our revised expectations. After the second quarter, we laid out a plan to lower discretionary SG&A spending for the balance of the year and we are on track with this goal as our SG&A dollar spend in the quarter met expectations. We have taken actions to defer or eliminate non-essential corporate projects and to lower our non-customer facing overhead costs. The SG&A rate also benefited approximately 80 basis points from lower incentive compensation expense throughout the organization due to lower earnings expectations for the year.

While we have made good progress to date, we have many difficult decisions ahead of us. We are prepared to take all necessary actions to ensure we have a cost structure that reflects the ecosystem in which we operate. As noted earlier, we have already set into motion plans to reduce our capital spending by approximately 50% next year, including a significant reduction in the new store openings in the U.S., Canada, and China.

We are also proactively reducing operating expenses as much as possible without negatively impacting our customer-centric strategy. As a result, we are critically evaluating all parts of our cost structure. That’s why we recently announced a voluntary separation program for corporate employees and as necessary, we’ll consider involuntary reductions in staff.

The costs associated with the reduction in force and other potential future actions resulting from this evaluation are not yet finalized and therefore are excluded from the company’s earnings guidance until more information is available.

As we said up-front, this was also the first quarter in which the performance of Best Buy Europe is included in our results. Best Buy Europe’s top line revenue growth was in line with expectations and the company gained market share through strong connections growth and through the exclusive launch of the iPhone 3G in the U.K.

The European business’ gross profit rate, however, was below expectations due to a more promotional environment, a strategy focused on market share investment, and an increase in revenue mix from lower margin categories.

In addition, SG&A costs were modestly higher than we anticipated due to increased subscriber acquisition cost with the German mobile telecom business. As a result of these factors, overall operating results for Best Buy Europe were lower than we initially projected.

Additionally, I would remind you that Best Buy Europe’s results are reported also on a 60-day lag basis.

Turning back to the enterprise, I thought you would find it helpful if I provided a little color on a few balance sheet items. First, we took aggressive actions to adjust our inventory positions during the quarter. Domestic comparable store inventory ended the quarter essentially flat compared to an increase of 10% at the end of the second quarter. That was a slightly better performance than we had expected.

As we saw consumer behavior begin to change in late September, we acted swiftly to manage inventory levels and armed with local insights from our field leaders, were able to direct inventory to areas where traffic was expected to be strongest.

Consistent with the guidance we provided in mid-November, we are well on our way towards further reductions in inventory by the end of the year in our domestic business, provided the fourth quarter plays out as expected.

Over the past few months, many of you have asked us how we think about investments in this new environment. Historically, we’ve prioritized our deployment of capital first to invest in our core business and then to acquire capabilities for customers, and finally in certain economic seasons, return capital to our shareholders. Clearly we are in a new economic season.

In this season, the focus of our entire management team is prioritized on two specific elements of our core business. First, as always, we will act to ensure the financial stability and liquidity of our business. Second, we will look to make investments in the core business which of course includes our domestic and international operations to plant seeds that will position us to capitalize on the many growth opportunities that will emerge when we reach the end of the season.

Moving now to guidance, at this time we are not changing our annual earnings guidance range we provided in the mid-November update of $2.30 to $2.90, excluding the investment impairment and any restructuring charges. Candidly, given the volatility of the current environment and the significance of the month of December to our results, we believe it is prudent to let the business play out for the month and then assess what guidance changes, if any, are appropriate. I can tell you, however, that while post-Thanksgiving revenue trends have slowed further, as expected, we still anticipate that December revenue will be consistent with the guidance we have previously provided. As a part of that annual earnings guidance, we now anticipate an annual comp store sales decline of 1% to 5%.

We expect the enterprise gross profit rate to increase 60 basis points and expect annual SG&A spending excluding Best Buy Europe to grow by approximately 9%. Additionally, given the potential wide range of top line revenue, there is a corresponding wide range of SG&A deleverage outcomes.

And finally, remember this guidance excludes any charges resulting from expense reduction we may undertake in the future.

To close, we were satisfied with our market share gains, margin growth, and inventory actions in the third quarter, a quarter in which the macro environment has undoubtedly been a major deterrent on consumer spending.

Our focus continues to be on serving customers and delivering on the financial expectations we have set out for the balance of the fiscal year. We believe that our customer and employee centric focus is what has differentiated us during these challenging times and will position Best Buy to be an even stronger player in the future with even greater opportunities.

Lastly, we would like to wish you and your family a happy holiday season.

With that, we would like to open up the call to questions from our audience.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Gregory Melich with Morgan Stanley. Please go ahead.

Gregory Melich - Morgan Stanley

Thanks. Jim, could you get a little more deep into the gross margin? It’s impressive to see that improvement, given all that’s going on. You said that it was across all categories -- how do we really execute on that?

James L. Muehlbauer

Greg, thanks for the question. I’ll let Mike Vitelli and team chime in here but one of the key things that we saw in the quarter is that the plans that we began last year after Black Friday armed with the customer insights we derived from our store teams and our merchant teams here at headquarters really set forth a plan this year to lay out a different strategy as to how we wanted to execute the month of November and the Black Friday weekend specifically. And I think what you saw in the margin rates for the quarter reflected the plans the teams have been working on for six months. I think it may be counter-intuitive to some but we honestly made very few changes going into the Black Friday holiday planning weekend as a result of the current environment because we felt that strongly about the plans we had already put forth based on the customer data we had and our ability to really bundle solutions together versus just focusing on individual product prices. I think the team has learned a lot over the last years, looking at our customer segments and specifically that played out in margins across all the categories in the month.

Gregory Melich - Morgan Stanley

And how sustainable -- I mean, a lot of this is the comparison as well versus last year’s promotions. Should we think of that sort of gross margin as a sustainable figure, given that we are worried about the future into ’09?

Mike Vitelli

What I would say is what we found last year and are finding to be successful now is customers are looking for solutions and if you start to look at our insert, our advertising online and how product is positioned in the store, that’s probably the biggest change that you are seeing, both in creating the performance in all of our categories, whether it’s a digital imaging package, whether it’s a home theater package, whether it’s computing solutions -- the individual product at a price point is important but the bundle of this is what I need to make it do what I want it to do in my life is more important, and we’ve been playing that out in all of our advertising and our promotion and in the store as well, and that seems to be what is driving the difference in every category. It’s not as if every SKU is costing us $2 less or we are selling it for $2 more -- it’s the combination of all the things that people want that’s making the difference.

So therefore, I think it’s sustainable.

Gregory Melich - Morgan Stanley

Okay, great and then Brad, just -- you mentioned nicely these two things to succeed in a tough environment -- survive and then focus on the customer. If we think about that, is the CapEx budget, even though it’s down 50%, is it going to be a lot more skewed in a different way, whether it’s --

Bradbury H. Anderson

Yeah, it’s skewed pretty significantly differently than I would say the year before, which is if it’s a discretionary item, we’re not spending it so we are taking some risk by not spending on some discretionary choices we spent pretty freely on last year. We also -- last year the percentage was mainly leveraging on things we knew, so we opened a lot of stores in a number of different environments to lever off successful past models. This one what it is primarily protecting is initiatives that look at new opportunities that will be created over the long haul, which have been protected. So you’ve got -- we’ll still be planting seeds in Europe and elsewhere with new stores in other configurations that we think will bear long-term fruit and that’s protected but there’s less leverage spending than there was this past year. And we are taking some risks with some places where we are not doing sort of systemic spending.

James L. Muehlbauer

Greg, I think one of the advantages that we have, and we’ve chatted about this in the past, is really over the last three years, we’ve made major investments in our stores in most of the major categories in our business, including redefining the home theater space, the appliance space, the computing space, most recently the GPS and Best Buy Mobile space, along with the gaming in the past. So the significant investments we’ve made over the last three years has really put our stores in a good position to leverage the current environment without a significant investment next year in new operating models, other than as Brad mentioned, places that we want to experiment from an innovation standpoint from the future.

Jennifer Driscoll

Thanks, Jim and Brad. Next question, please.

Operator

Thank you. Our next question comes from the line of Colin McGranahan with Bernstein. Please go ahead.

Colin McGranahan - Sanford Bernstein

Good morning. Just on the SG&A line first, and then a quick follow-up to Greg’s question on gross margin, of the 80 basis points of favorable incentive comp in the current quarter, how much of that was an accrual reversal from the first half of the year?

James L. Muehlbauer

Thanks for the question, Colin. A portion of that was from the first half of the year but as we flow our expenses for the year, we accrue a majority of our bonus expense in Q3 and Q4, just given how our profitability skews.

Colin McGranahan - Sanford Bernstein

Okay.

James L. Muehlbauer

So most of it was driven by what we saw in Q3 and what we are projecting going forward.

Colin McGranahan - Sanford Bernstein

Okay, and then the 2% SG&A dollar growth for next year in total, I think you said that’s including Best Buy Europe, is that on a like-for-like basis or is that in total? Because Car Phone under Best Buy Europe was only in there for half a year.

James L. Muehlbauer

Colin, thanks so much for asking the question. Let me put some clarity around that -- I think Brad misspoke during his script. That 2% increase is excluding Car Phone Warehouse. It’s meant to be just on the core Best Buy and international business and to Brad’s point, we are planning a dramatic reduction in SG&A spending next year. That comparable number for this year is more like 9% and it’s been about 9% growth for the last few years. So we are looking at 2% growth and in this environment, we are going to continue to look for ways to hopefully find opportunities to even spend less than that, if we can keep focused on the growth options that we have in front of us and deliver the customer-centric experience in our stores.

Colin McGranahan - Sanford Bernstein

Okay, and then just a quick follow-up on Greg’s question on gross margin, clearly very impressive improvement in the rate, 70 basis points. Can you give us any sense of breaking that down between how much -- and I understand the bundled solution selling was the biggest part of it but benefit from markdowns, a more favorable promotional year-over-year impact, and then specifically was there any benefit from the private label credit card, more effective or I guess a better relationship with HSBC and that contract?

James L. Muehlbauer

Yeah, so [inaudible] few pieces -- I’ll take the private label credit card piece and maybe Mike, you can follow-up on the markdown and promotion environment. The private label credit card piece, we have not experienced a material change in our margin structure quarter over quarter as a result of that. So we are still seeing similar ongoing benefits from that relationship and that was not a material new driver in the change over the margin rate in the quarter.

Mike Vitelli

And on the margin, I would still say the point is the mix within categories and the products that we are selling together is part of the change. And the other aspect is we tried to be a lot more surgical about our promotions, promoting to reward zone silver customers and some of our best customers, which is some of the insights we got from last year of begin able to track who those customers are and what they buy, so I think a slightly more surgical approach to our promotions that allows some of the benefit as well.

Colin McGranahan - Sanford Bernstein

Okay. Thank you.

Jennifer Driscoll

Thank you, Mike and Jim, for your responses. Next question, please.

Operator

Thank you. Our next question comes from the line of Matthew Fassler with Goldman Sachs. Please go ahead.

Matthew Fassler - Goldman Sachs

Thanks a lot. Good morning to you. The first question I would like to ask relates to your sales performance in the U.S. You quantified your aggregate market share, given that the sales by category or so vary, can you try to give us a sense of what your market share trends were you think in some of your bigger categories, most notably in home office and entertainment and then electronics?

Jennifer Driscoll

Barry Judge, would you like to take a shot at that?

Barry Judge

Our market share gains were pretty much across the board in what we tracked. Jim talked about how we outperformed the industry in November in terms of the market, MasterCard market pulse data. But in October, we had significant gains in home theater. Within that, televisions drove a lot of our home theater gain. As we have had for the last 24 months, strong gains in computing, especially in notebook computers and desktops, as well as good market share gains in MP3. So pretty much across the board, our entertainment business was closer to flat, the entertainment meaning music, CDs, and DVDs. But in the electronics part of our business, very strong across the board.

Matthew Fassler - Goldman Sachs

And my second question, as you think about U.S. store growth, I know you are cutting CapEx enterprise wide by roughly half. What’s your first cut at what you think that means for domestic store growth in the fiscal 2010 year?

Brian J. Dunn

Last year we opened -- this fiscal year we are just wrapping up in February, we opened 100 stores. We are pulling back on our CapEx by approximately -- by 50%. I don’t think there will be a linear relationship there. I think what’s important, where there are places where we still see a number of places that are in need of Best Buy stores and we will continue to have a strong store growth program but it will be significantly reduced year over year.

Matthew Fassler - Goldman Sachs

And will there be a skew to the 20s, the 30s, or the 45s in terms of the kinds of formats you think you will move to?

Brian J. Dunn

I think that you will find us opening a similar mix to the one we opened this year. Markets that require a 45 will get a 45. Markets that can support a 30 will have a 30 and so on.

Matthew Fassler - Goldman Sachs

Thank you so much.

Brian J. Dunn

You bet, Matt.

Jennifer Driscoll

Thanks, Matt and thanks, Brian, for the answer. Next question, please.

Operator

Thank you. Our next question comes from the line of Brian Nagel with UBS. Please go ahead.

Brian Nagel - UBS

Good morning. I’ve got a couple of questions, if I could but first with respect to the competitive environment, your primary competitor is now bankrupt and closing stores. I just wonder if we can maybe get a comment on what we have seen as far as promotional cadence of that chain and anything you’ve noticed where the stores are actually closing, if there’s anything different there.

And then the second question I have with gift card sales, and we’ve been running a proprietary survey here at UBS and one of the findings is that gift card sales are definitely weaker this holiday season. So the question would be if you are seeing any changes in your gift card sales year over year. Thanks.

Jennifer Driscoll

We’ll have Shari Ballard talk about Circuit and Barry talk about gift cards.

Shari L. Ballard

Good morning. On the Circuit front, let me start by telling you how the team is approaching it and then I will give you what we are seeing in the data so far. The store teams are approaching it from the perspective of the customers who are shopping at the Circuits in their neighborhoods are doing so because they are choosing Circuit, not because they are unaware of Best Buy, which means that we’ve got to do a much better job locally if those customers decide to give us another chance of actually winning their business. So it’s not an approach that says because we’ve got a competitor that’s struggling, we assume we’ll get a bunch of that market share. So the teams are working very hard and converting the customers who come in and are choosing to give us a second chance.

So far what we have seen has been generally positive. Our traffic, our close rate, and our comps in the impacted stores, so those would be the stores that have circuits that are going out of business near them are outperforming the balance of the chain. So they’ve got better comps, they’ve got better close rates, and they’ve got better traffic and we’ve seen no material change relative to the balance of the chain in margin and/or things that we can control from a margin rate locally. So so far, I think the teams are doing a great job and it’s early.

Jennifer Driscoll

And gift cards?

Barry Judge

On the gift card question, so kind of tacking back through the entire year, our gift card sales were strong through October, so we were outperforming our prior year. They have slowed down in November and December for two reasons -- first, per your comment about demand, demand has slowed. Secondly, our promotional strategy versus last year is less reliant on gift cards, so that’s another reason that our sales have slowed. However, because of the sales growth that we had prior to November, our gift card liability outstanding is relatively close to what we saw last year. So as we think about moving into next year, we are offsetting some of the weakness because of our strength earlier in the year.

Brian Nagel - UBS

If I could follow-up, just one question on the gift cards, just remind us, what impact do gift card redemptions have upon sales in January and February?

James L. Muehlbauer

We haven’t quoted the exact impact but what we have said in the past, a vast majority of those gift cards historically are redeemed before the end of our fiscal quarter so we would expect an impact of whatever the final gift card sales are to be felt primarily in January and February.

Bradbury H. Anderson

And just to put a little more context, the core gift card season is the next 10 days so we will know much more in 10 days.

Brian Nagel - UBS

Thanks a lot.

Jennifer Driscoll

Thank you, Brian and earlier, that was Jim [inaudible]. Next question, please.

Operator

Thank you. Our next question comes from the line of Jack Murphy with William Blair. Please go ahead.

Jack Murphy - William Blair

Good morning. A couple of quick questions -- one, if you could talk about what you view as the level of maintenance CapEx for the next fiscal year, it looks like $600 million would be -- it looks like below D&A so if you could just give us a sense of that. And then with the resetting of the next fiscal year CapEx, could you talk about getting a year or two beyond that and what if you have done any reset of your view of long-term square footage growth?

James L. Muehlbauer

So let me break that into two pieces -- first off, I think Brad also touched on this in his section, when we think about cutting our capital spending by 50% next year, there’s a couple of key factors that will impact us. One is we have talked historically about the capital that we are spending this year, roughly $1.2 billion, was going to be at a kind of an all-time high level. And first and foremost, we had not anticipated that we would be repeating that next year, even under a normal environment. The investments that we have been making in our information systems technology, our POS systems, both domestically and internationally, were scheduled to peak in the current fiscal year, so part of that is just we knew we reached a peak.

Secondly, and we are very purposefully, we are not reducing our capital next year to just absolute maintenance levels. We are going to continue to keep the stores looking great, looking fresh to serve customers. We know that that is a -- pulling into that part of the portfolio has long-term negative consequences and we are very confident that maintaining our core business requires to maintaining those maintenance type investments.

We are going to invest that roughly $600 million in areas to maintain our core business, open up fewer stores, and continue on with some of the growth options that we see going forward based on those investments. So we are purposefully not taking it all the way down just to maintenance capital levels. We are going to be north of that to make sure that we maintain a balance of pragmatism and flexibility but also make sure that we are investing in our seeds for growth.

Jennifer Driscoll

Bob wanted to add a comment on that and Brian, why don’t you talk about new store runway?

Robert A. Willett

As Jim said, this year that we are in currently was the peak year for putting our infrastructure in place from an international perspective and we are sticking true to that so our investment in point of sales systems and in our multi-channel systems are past their peak, and we will still continue to invest but entries into countries now will be at minimal cost, as opposed to the big investment we made this year. And that was, as Jim rightly pointed out, was going to be our peak year anyway. And from here on forward, we will definitely be opening some 50% and less stores internationally this year on a very selective trial basis, just as we’ve continued to do. So this was never going to be a race, never a race to spend lots of capital.

Brian J. Dunn

I just want to add a comment about the new store runway -- people should not hear this as us retrenching on the long-term outlook for new store growth runway. We are still very, very confident about our new store growth runway. You should expect us to use this time to retool the stores we have and to get sharper around the value propositions within those stores because as Shari talked about earlier relative to the Circuit opportunity, we are extremely focused on -- we will focus on customer acquisition this year. We know there’s a good number of customers at play in this marketplace and we have every intention of earning that business back through the experiences we provide online, in our call centers, and right in our heartland in our stores.

Jennifer Driscoll

Thank you, Brian. Next question, please.

Operator

Thank you. Our next question comes from the line of Scott Ciccarelli with RBC Capital Markets.

Scott Ciccarelli - RBC Capital Markets

I guess my question also relates to the competitive environment and Circuit City. Obviously there are significant changes going on in the competitive environment. I guess what I was looking for is any color you might be able to give us regarding negotiations with your vendor base at this point. I would assume any benefits that would accrue to you as you kind of go back to your vendor base would largely be incremental to what we have already seen. So A, I’m looking for confirmation of that and then B, any kind of color around what’s going on with the vendors and your increased -- their need of you in the distribution model. Thanks.

Brian J. Dunn

I’ll comment on the front-end and then I’ll turn it over to Mike for a little clarification of what it is I say. This is a global issue. This is -- if there was ever any doubt anyone had about a global economy, it is here, it is upon us and this thread runs across the entire globe.

One of the things I am most pleased with is the way our vendors have responded and worked with us relative to how do we manage this challenge for the ecosystem that we all participate in, and we have been quite pleased with how our vendors have cooperated with us, shared information, and talked and worked with us on strategic plans for next year and the years beyond.

Mike, beyond that, I don’t know what kind of color you want to give.

Mike Vitelli

No, I think that’s a great comment. We are in a very rapidly changing environment and the collaborative planning and forecasting work that we do with our vendors weekly I think has been integral to our mutual success over the last several weeks. Because had that not been in place, it’s just something we put in place over the last couple of years, neither Best Buy nor our vendors would have been able to respond as quickly as we both have been, and I think it makes us all healthier for that.

And as we go forward into the future, as the retail environment changes, I think Best Buy does become valuable because it still becomes one of those places that people can come and see the latest and greatest and what the -- our suppliers are bringing to the marketplace. And there’s unfortunately fewer places where they can do that.

Scott Ciccarelli - RBC Capital Markets

Maybe rephrasing the question a little bit -- would you guys look for better terms, would you look for lower prices, working with the vendors, more co-op money? I guess what I am trying to figure out is as you guys increase in importance to them as the distribution partner, where would you guys kind of focus your efforts in terms of having it benefit Best Buy?

Brian J. Dunn

I think the one thing that you would look at on the long-term mark is that there’s a fundamental change in the nature of what this business has been over the last few years, whereas the supplier -- if you’re Samsung, you were figuring out how you were supporting maybe in a market like the U.S. hundreds of varied retail formats and presentations that would make up the market share. As it gets smaller, and as it gets more focused on fewer accounts and there are often accounts like us and Walmart that have similar needs, it makes it easier for vendors to do things that help us figure out how to turn our inventory faster, improve the profitability on each transaction because you are not trying to market to as many variety of different things. And I think over time, we will benefit -- I think you are seeing some of that right now in how fast, as Mike alluded to, how fast we and our suppliers have adapted to a rapidly changing ecosystem.

If you deploy that on a longer term basis and look at what you could potentially do with big suppliers to reduce operating expenses for both of us that shows up in gross margin, and increased inventory and cash flow, there’s lots of options over the long-term that are available.

When I was talking about that they are all -- if you survive, there are all sorts of benefits on the other side. This was one of the really obvious places where a supplier who might not have considered sort of sharing its distribution costs would consider it now.

Jennifer Driscoll

Bob, did you want to add to that? I’m sorry, Scott, did you have a --

Scott Ciccarelli - RBC Capital Markets

No, I just said thanks, guys.

Jennifer Driscoll

Okay. Next question, please.

Operator

Thank you. Our next question comes from the line of Chris Horvers with J.P. Morgan.

Chris Horvers - J.P. Morgan

Thanks and good morning. A follow-up question on the inventory and then a second question. First on the inventory, you guys did a great job of managing it down. How is the supply chain looking from a days of inventory perspective, and if Best Buy is not taking the inventory in, where do you think it is going and how does that impact pricing in the environment.

And then related to that, if normally you face let’s say 15% ASP or price deflation every year, how should we think about what that might look like for the next three quarters if prices have come down substantially since September?

Mike Vitelli

Okay, so looking at two difference pieces, inventory overall when we look at the supply chain in total, it’s better than we would have anticipated and I think that’s in fact in part to, as I was describing earlier, the suppliers and us have been working together. The minute that we see a change, it’s literally on a SKU level, that’s something that can adjust on a worldwide basis, given the weekly relationships that we have. And I don’t -- and I think the scenario that we are seeing, a lot of our suppliers were seeing earlier, so you actually read earlier in the season where people were adjusting their worldwide production of certain products, so that the chain wasn’t as full. So I think that’s a positive right now.

And as far as price changes are concerned, in the 25-plus years I’ve been in the industry, prices go down every year. Consumer electronics is the only place I’ve ever seen that prices go down every single year. They will do that again. It’s a matter of degree and it will be different by category.

Bradbury H. Anderson

But we don’t really see it being driven by -- what would have happened five years ago, which was the delayed reaction to what we saw in the marketplace, it was tons of inventory that would have been had to be liquidated, so there’s less [inaudible] than there would have been historically.

Mike Vitelli

I agree.

Robert A. Willett

Just to reinforce Mike’s point, we are much better now at forecast accuracy than we probably have ever been and we are still not as accurate as we can be, to be absolutely candid. Our inventory I think is in really good shape. We are working much closer with vendors now. We are also sharing supply chain information in the way we’ve never been able to do it before and that’s actually enabling us to take out costs but also be a bit sharper than we have been.

And the other thing to remember is that we have also increased our SKUs, number of SKUs this year -- not in every store but across the business. We have significantly more SKUs because this is just what customer-centricity was about, and that is about tailoring the assortment on a fact basis to those stores that sell stuff, as opposed to putting everything everywhere. So we’ve moved away from a push model to a much more of a pull model and candidly, we’re still not there yet but we are much smarter, which is one of the reasons why the teams have done such a great job with their field customers, to make sure that we have responded very quickly to this position.

It’s actually a very good thing for us, to be candid, because one of the nice things about a difficult situation like this is you concentrate much more on cash flow than probably you do at other times, to be absolutely candid, so working capital becomes much, much more important and that’s where we are today. So I think you can see us staying on top of this and being much more prudent about the amount of inventory we have put in relevant to forward sales as opposed to filling space.

Chris Horvers - J.P. Morgan

Mike, just as a follow-up maybe then, if -- I mean, order of magnitude, is it normally 15% declines and you could maybe look at 25% declines, or any key categories where the supply chain is more full or less full versus others?

Mike Vitelli

I don’t think we are seeing anything out of the ordinary. Which categories decline at which rates, they are all very different and new products come in at different price points, larger screen sizes, faster CPU computers, every category has got such dynamics in it, I don’t think you can say okay, next year it’s going to be 9% across the board or in any individual category.

Chris Horvers - J.P. Morgan

Thank you.

Jennifer Driscoll

Okay, and that was Mike, Brad, Bob, and then Mike at the end, for those keeping score at home. Next question, please.

Operator

Thank you. Our next question comes from the line of Kate McShane with Citigroup. Please go ahead.

Kate McShane - Citigroup

Good morning. You highlight in your press release that the Geek Squad [black tag] protection helps with your comp store sales and warranties, so I was wondering if you could talk a little bit about what consumer behavior has been like towards warranty purchases over the last few months, and do you think any of the reduction in your seasonal staff at your stores could impact some of the attachment rates for things like warranties?

Jennifer Driscoll

We’ll have [Sean Scully] address that question. Sean.

Sean Scully

Thanks for the question. I think first and foremost, the traditional warranties was kind of a one-trick for all. It was just set a price versus the value of the product and you sold it and we really worked aggressively in the last year to create multiple offers for our customers. So while we saw attachment be relatively flat to slightly down, we actually saw our ASP lift about 10% because we had a much broader assortment and could offer much more broad solutions to our customers. And we think that’s leveraging the assets that we really built in the last three to four years. So I think that will continue, even in this economic challenges. As a matter of fact, consumers may make choices to prolong the life of their products, which I think puts us in a perfect position with that customer. Regardless of the product that they need or the solution that they need, we have a lot of assets to help them in their needs.

Kate McShane - Citigroup

Okay. Thank you.

Jennifer Driscoll

You’re welcome, Kate. Next question, please.

Operator

Thank you. Our next question comes from the line of Mitch Kaiser with Piper Jaffray.

Mitchell Kaiser - Piper Jaffray

Thanks, guys. Good morning. I was hoping you could give some insight into the importance of reward zone. I know you mentioned that you had changed some of your marketing initiatives, particularly over the Black Friday weekend and the importance of the program going forward.

Jennifer Driscoll

Barry.

Barry Judge

So Reward Zone, right now we have about 34 million Reward Zone customers. That’s broken down by 32 million in our base, about a million in our silver program, which is our -- when we talk about best customers a lot but essentially they are our premiere customers, as well as a number of customers in our Reward Zone MasterCard program. And really what we are starting to do, and Mike mentioned it when he talked about margin, we are starting to differentiate the benefits that we accrue to different customers based upon our understanding [about it] through Reward Zone. So as an example, Reward Zone Silver customers have to spend $2500 or more to get in the program and by getting in the program, they get benefits, additional benefits to shopping at Best Buy -- so benefits like free shipping on Best Buy.com, a longer return policy, points banking, a slightly better certificate rate -- essentially we are looking for ways that we can go -- you know, we have good prices but ways to go beyond price with consumers that are looking for those benefits.

As we move into next year, we are going to be looking for additional ways to spend money, spend our promotional dollars against customers that are most interested in shopping with us and make our program then we think more valuable to them and getting more of their wallet share.

And what we are seeing in our business, some of this is working, as we look at our wallet share, as an example, as a way to understand whether we are successful, silver members have a significantly higher wallet share with us than base members, or people that are not in the program. So we know that we are shifting. We think that we are shifting business from where it could go in the marketplace to us through this. And as I said, as we get into next year, we are going to be looking for more opportunities to do that.

Mitchell Kaiser - Piper Jaffray

Okay, thank you. And just --

Bradbury H. Anderson

Just to mention one point -- this is an example of a seed planted almost six years ago that now works for us as a huge differentiator in the marketplace, so that’s the kind of thing when we are looking at investments going forward, if we perceive that the seed has that kind of potential, especially as the markets grow, those are the places we are not going to not invest as we look into the horizon.

Mitchell Kaiser - Piper Jaffray

Okay, that’s helpful. And then just a follow-up for Jim, I think it’s important to point out here because I think people are excited about the SG&A opportunity, and I recognize there’s a wide range of outcomes for Q4 but what number should we be anchoring that 2% SG&A growth ex-Europe off of, Jim, if you don’t mind?

James L. Muehlbauer

Well, we haven’t given specific dollar guidance for the balance of this year. Once again, I went back to -- I’ll go back to the comments we had in the release. We expect it’s going to be up 9% year over year for this year, excluding Europe. I think the key thing, Mitch, as we look into next year, is that the level of changes we are looking across the entire operating model are going to be very dramatic. We’ve talked a lot about what’s going to happen in the capital space. Obviously to get that type of reduction in SG&A, we’re going to be pulling other levers across the business model. So as we see how the business plays out for the balance of December and into the balance of this year, we’ll get a better sense of what consumer behavior is going to look like after the holidays, where there’s going to be interest going forward, and how to plan our business appropriately. So obviously we’re out a little bit in front of what we typically do from a guidance standpoint from next year but we felt it was very important to give you a sense of the order of magnitude of the changes that we are talking about in our business model.

Brian J. Dunn

I just want to add one piece of context as I think about this, and I think you’ve heard it in all the answers, or a good number of the answers today -- we’re going to take this moment, this season, this economic storm, and we are going to look at every dollar we deploy, every bit of human capital we deploy, and we are going to look at all the seeds that Brad referred to that we’ve planted over the last five, six, seven years, and we are going to look to leverage them in the spirit of connecting with our customers, customer acquisition, in the most efficient way we can.

I thought Barry’s example around Reward Zone was a great one. Based on what we have learned there, we know we can repurpose some of our broad-based advertising dollars to very specific targeted customer groups and we have a high degree of understanding of what the sensitivity of their responses to us are and we think that’s enormously valuable to our vendors, we know it’s enormously valuable to our store teams, and we think it provides a great service to our customers. So the theme here, I hope you don’t hear hunker down, duck and cover. I hope you hear sweat the assets, harvest some seeds we’ve grown, and deploy them in service of growing our enterprise. That really is how this management team is looking at this.

Robert A. Willett

And just to reemphasize Brian’s point, all of the things that have been talked about have all been shipped to other countries. The excellent work down here with Best Buy mobile and the [inaudible] work that has been so successful is now in Canada and producing massive comps. We’ve now got SAS stores up there as well -- on a pilot basis, but we’ve still got those. And --

Brian J. Dunn

Bob, I don’t think anybody knows what a SAS store is.

Robert A. Willett

Sorry, beg your pardon --

Unidentified Participant

That will be next quarter’s call.

Robert A. Willett

Stand-alone stores for Best Buy Mobile -- we have 40 in the U.S. and we have three in Canada. And so these -- we’re agnostic as to where good ideas come from. The reality is that we are going to nurture those little acorns to grow into great oak trees and then take them elsewhere, and they are all flowing into Canada and that’s why I think we are going to see some great improvements in the operating profit over time in Canada based upon the good tools that we’ve developed here.

Mitchell Kaiser - Piper Jaffray

Okay, thanks, guys. Good luck and I appreciate the answers.

Jennifer Driscoll

Thanks, Mitch. Time for one last question, please.

Operator

Thank you. Our last question comes from the line of Anthony Chukumba with FTN Midwest Securities.

Anthony Chukumba - FTN Midwest Securities

Thank you. Just had a question related to your expansion plans for next summer in the U.K. -- I mean, given the fact that you are going to be cutting back on CapEx and just being more selective with your spending, I guess I was just wondering if A, you are still planning on opening those stores in the U.K. next summer, and B, even if you are, if it changes your thinking in terms of hurdle rates or in terms of milestones to hit to then roll out additional stores. So I guess I’m just wondering if your thinking is changing at all on that.

Robert A. Willett

Great question, and a great opportunity just to sort of reemphasize the fact that going into Europe was never a race. We were never going to open lots of stores next year. It was always going to be two to three. And that’s where we sit. The reality is it’s probably more like two. And the opening is probably going to be early Autumn, around about October time.

It took us 19 months to open our second store in China and that was very deliberate to really understand the market. We are taking that careful approach. We’ve since opened another two stores in China. We have four and we’ll open another two Best Buys by the end of the year, so we’ll have six. So we’re not going fast and we’re not going fast in the U.K. We’re going very deliberate. We’ve identified our first location. It will probably be October and we will sit and we will trial this and we will learn and listen and then we will go forward but we are not rushing into this in any way, shape, or form.

But in terms of lessons learned, yes, we are learning lessons around the mix and we are getting -- we opened our first store in Mexico last week and again, you are only going to see a couple of stores, a couple of investments to really learn, first of all, and the other thing to remember is we do have 2,500 Car Phone Warehouse stores across nine countries in Europe. And one of the first things we promised our board that we would do was that we will also sweat those assets before we do other things. So we are actively working on an integration program at the moment around the addition of games, PCs, we’ve just opened three small, 3,000 square foot stores, wireless world stores, where we’ve got a big mix of PCs, games, and accessories, and I’ve got to tell you in the first few weeks, one swallow doesn’t make a spring, so to speak, but they are actually doing pretty damn nicely, thank you.

But we are going to go very carefully and very cautiously and as I say, we’ll open 50% less stores internationally this coming year than we’ve opened this last year. We’re going to be extremely deliberate. And in Canada, we are going to focus on really getting behind the 100-plus stores we have of Futureshop and modernizing as opposed to opening masses of new stores. The new store opening program in Canada is cut dramatically as well.

I hope that helps.

Anthony Chukumba - FTN Midwest Securities

That’s helpful. Thank you.

Andrew Lacko

Thank you, everybody. That concludes our call. Thanks to the audience for participating today in our third quarter earnings conference call. As a reminder, a replay will be available in the United States by dialing 1-800-405-2236, or 303-590-3000 internationally. The personal identification number is 11122732. The replay will be available from 11:00 a.m. Central Standard Time today until noon Central Standard Time next Tuesday, December 23rd. You can also hear the replay on our website under For Our Investors. If you have any additional questions, please call Wade Bronson, at 612-291-5693, Jennifer Driscoll at 612-291-6110, or me, Andrew [Lacko], at 612-291-6992. For the reporters on the call, we would ask that you contact Sue Busch at 612-291-6114. Again, thank you, everyone, for your participation today and that does conclude our call.

Operator

Thank you, ladies and gentlemen. At this time, you may disconnect and have a nice day.

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