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Best Buy Co., Inc. (NYSE:BBY)

F1Q10 Earnings Call

June 16, 2009 10:00 am ET

Executives

Andrew Lacko - Senior Director of Investor Relations

Brian J. Dunn - President, Chief Operating Officer

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

Mike Vitelli - Executive Vice President, Customer Operating Groups

Robert A. Willett - Chief Executive Officer Best Buy International

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

Analysts

Gary Balter - Credit Suisse

Gregory Melich - Morgan Stanley

Matthew Fassler - Goldman Sachs

Colin McGranahan - Sanford Bernstein

Jack Murphy - William Blair

Scot Ciccarelli - RBC Capital Markets

Chris Horvers - JPMorgan

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Best Buy conference call for the first quarter of fiscal 2010. (Operator Instructions) I would now like to turn the conference call over to Andrew Lacko, Senior Director of Investor Relations.

Andrew Lacko

Thank you, Richard. Good morning, everyone. Thanks for participating in our fiscal 2010 first quarter earnings conference call. We have two speakers for you today. First, Brian Dunn, our President and COO, who will become CEO next week, will share his thoughts on the results we reported this morning and provide you an update as to how we are performing versus our priorities for fiscal 2010. Second, Jim Muehlbauer, EVP of Finance and CFO, will recap our first quarter financial performance and comment on our fiscal 2010 guidance for the remainder of the year.

After our prepared remarks, we’ll leave ample time for your questions. As usual, we also have a broad management group here in the room with me today to answer your questions after we make our formal remarks.

We would like to request that callers limit themselves to a single question so that 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 also 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.

Before we jump into the details of the quarter, I would like to take care of a couple of housekeeping items. First, as you likely noticed this morning, we launched a new format for our quarterly earnings news release. We believe this better matches the length and content of the quarterly release with the needs of our investors. We anticipate that the revised format will be well-received but as always, we welcome any feedback, both positive and constructive, that you may have.

Secondly, I want to comment briefly on the restructuring charges you saw in this morning’s news release. Our first quarter fiscal 2010 results included restructuring charges which impacted our net earnings by $25 million, or $0.06 per diluted share. These restructuring charges were related to the store operating model changes in the domestic segment and corporate restructuring costs in Best Buy Europe. The balance of our discussion on this morning’s call about the quarter will exclude these charges. That means the comparisons we make will be on an adjusted non-GAAP basis. For a comprehensive GAAP to non-GAAP reconciliation of our reported to adjusted results, please refer to the supplemental schedule on page 10 of this morning’s news release.

With those housekeeping items aside, I would like to turn the call over to Brian Dunn. Brian.

Brian J. Dunn

Good morning, everyone. Thanks, Andrew and thanks to all of our listeners for joining us on our first quarter earnings conference call. This morning we were pleased to report adjusted quarterly net earnings of $0.42 per diluted share, which were essentially flat versus last year and better than our expectations for the quarter.

Before I dig a little deeper into our performance, I want to take a moment to thank our employees worldwide who once again delivered results well ahead of the market in the face of an extremely challenging environment. We’ve introduced some necessary changes to our business model during the past couple of quarters, which is never an easy task. But the performance we are seeing from our teams shows that they have embraced the work with the kind of energy and optimism that we have come to expect from them and maybe even take for granted. Our people are the heart of Best Buy and performance like we’ve seen thus far this year is due entirely to them.

Perhaps even more important than the financial results we are seeing are the encouraging strategic results we see. First and foremost, we continued to grow our market share. Our share gains accelerated during the quarter since a major competitor closed its doors, something we’ve been very purposeful in planning for and to be blunt, taking advantage of. We saw significant share gains in each of the three screens -- in TVs, computing, and mobile phones. More on that in a moment when I give a short overview of our progress and our four strategic priorities but the headline for us is this -- we are confident that our value proposition is working.

Second, despite the fact that our people around the world are dealing with some very difficult changes, our voluntary employee turnover improved once again to 41%. In fact, for the past five quarters, we’ve seen a turnover ratio below 50%, a level rarely seen in the world of retail. Our strategy is predicated on our ability to build relationships with customers and that begins and ends with experience and engaged employees, and that’s why we’ll continue to work to drive our turnover down and our employee engagement up.

Finally, and not coincidentally, our customer satisfaction scores hit a record high during the quarter. Despite the many challenges our employees face on a daily basis, they continue to connect meaningfully with customers as evidenced by our CSI score, which is a measure of overall customer satisfaction. We consider anything above 80 as best in class, and our first quarter score came in at 82.

We’ve talked a lot over the past nine months about the current economic environment. It’s the most challenging we’ve ever faced as an enterprise. But to me, the real question is what are we learning? And beyond that, how are we applying those learnings to create value for customers, employees, and shareholders? I think we’re seeing that the current climate is forcing companies to focus like never before, to become very clear and very articulate about why they exist and what differentiates them from the others.

While we would never wish for a situation like this one, in many respects we have embraced the opportunity to bring additional rigor to our company strategies and how we help you understand them. That’s why last quarter I provided an outline of the four strategic priorities we plan to use as our compass for the next several years.

Our core strategy remains unchanged and these priorities will provide the framework to prioritize our investments and maintain our innovative culture. So today, I would like to provide you an update on the progress we’ve made and some of the opportunities still ahead of us for each of these priorities

The first is growing our local market share. Contrary to what some macro industry data points may have suggested, we saw significant market share gains during the quarter and in fact, we believe those gains built as the quarter progressed. For the three-month period ended April, we estimate that our overall domestic market share climbed nearly 200 basis points. In March alone, our market share increased 240 basis points, the single largest monthly increase I have ever seen at the company.

The strong gains were driven by improved product assortments, the efforts of the team to grow the businesses through a local lens, our employees’ strong execution at the store level, and a tailwind from the recent exit of Circuit City.

We get asked daily what impact each of these drivers has had on our market share position, especially the liquidation of Circuit. Candidly, while we have performed our internal estimates in a manner similar to many of your models, it is difficult if not impossible to peel back the onion and precisely quantify the relative contribution of each.

However, regardless of the source of the gains, we are encouraged by the fact that we saw significant gains across a broad range of product categories during the three months ending in April, including a more than 400 basis point increase in computing, a more than 350 basis point increase in digital imaging, and a more than 250 basis point increase in home theater.

I want to talk for just a minute about how I think our market share gains -- about how I think about our market share gains and why I think you will continue to see us take share. Simply put, we believe that if we combine the assets of our entire enterprise with the insights of local leaders and service of customers, we will grow our business around the world. We believe that now more than ever, we have a unique opportunity to present a compelling and unmatched experience for the customer who has never shopped with us before. And in a market with diminishing traditional options for customers, we have a new opportunity to win the loyalty of the customer who might have shopped us in the past and found the experience lacking.

The quality of that experience directly shaped by the insights and energy of our employees will determine if these customers continue to shop with us.

Let me take notebooks as an example. As I just said, our market share was up more than 400 basis points in notebooks and I think it’s due in large part to the fact that we have a buffet of products and services, if you will -- literally every major computing brand and the Geek Squad under one roof. But that’s only half the equation. The other half is this -- our employees can leverage that buffet of offerings and tailor it to the different wants and needs of customers in a certain market and its going to be different from San Antonio to Vancouver and from London to the Bronx. But because we have a full buffet in those cities, and engaged local teams whose business it is to know and understand the wants and needs of their customers, we can win.

I don’t mean to diminish this remarkable market share performance or take it for granted. We are very, very pleased with the results. But as impressive as the results are, they really just reinforce what we fundamentally believe -- our growth is the sum of millions of individual customers interacting with our 155,000 employees around the world in stores, on the phone, and online.

Connected digital solutions is the next strategic priority I will discuss. I just talked about the power of a full buffet of options in the physical world of computing. We are building a similar buffet of options of connected solutions in the digital world. We are just getting started in this work and we are admittedly behind where our customers need us to be, which is exactly why we are calling out as a company strategic priority. That’s why we are honing our value proposition for Napster; that’s why we are aggressively developing Geek Squad’s ability to provide connected solutions; and that’s why we are investing more in the growth engine that is Best Buy Mobile.

We know the third screen is an area of tremendous growth for our industry and our company and we believe Best Buy Mobile is positioned to take full advantage of that growth. We are especially excited by our customers’ growing appetite for smartphones and we are eagerly anticipating the impact of new products like the new iPhone and the Palm [Pre] on our business.

In short, the success of Best Buy Mobile and our mutually beneficial venture with Carphone Warehouse gives us great confidence that we will develop a buffet of digital options for customers just as robust as the physical one, and that Best Buy will be an enabler of connectivity for customers around the world.

Our next strategic priority is international growth. You’ve heard us say this before -- we believe our core hypothesis is universal. We believe that people just about everywhere want to realize the full promise of technology to solve problems in their lives and to connect them to the people they love and the content they want and need.

Furthermore, we believe that we can find and develop local leaders in each community who can tailor the buffet of assets I referred to earlier to serve the unique needs of that community. But of course, the differences between communities and between sets of customers are not limited to how they might use technology -- they extend to how fast they are adopting technology in the first place and every country certainly presents a unique set of challenges, whether they are cultural, economic, or political. For example, we are very enthusiastic about our investment in Europe. Optimistic about the prospects for the Best Buy, Geek Squad, and Carphone brands when the market bounces back but also very pleased with the strategic opportunities our relationship with the Carphone Warehouse brings to the enterprise. Each country in our international portfolio is at a different place on the journey but you can rest assured that we will continue to look with a candid eye at where we choose to deploy our assets, human and capital, and we will look with equal candor at the returns we earn for every investment we make, financial and strategic.

Finally, our fourth priority is driving an efficient and effective enterprise. As Jim will cover in a moment, our spending was essentially on plan during the quarter. What is most important to focus on is not where we have reduced spending but on what we are continuing to invest in. In the past 12 months, we have opened 185 stores in the U.S., Canada, China, Europe, and Mexico and we continue to plant seeds around the world that we believe will provide options for future growth. We will preserve our investments in growth opportunities.

The articulation of this priority is not just a reaction to the seismic changes we’ve seen in the economic climate over the past nine months; rather, it is the fuel for everything we are doing as an organization and the process we will use to manage our investments and maintain our innovative culture.

In closing, I’d like to make two final observations -- first of all, I would like to revisit our market share performance one more time. We have a proven track record as a company of buying share, not renting it, and we believe that this is the case here. When customer demand accelerates, I am confident that we will see growth in accordance with our share gains.

Finally, as you know, I start a new job next week. Since I spoke with you last quarter, I have been traveling a lot, meeting with customers, shareholders, and members of the media, and especially employees. We live in a time of great pessimism and it is certainly not en vogue to project an air of hope and optimism about the future. But when I talked to our employees from Vancouver to New York to Shanghai, that’s exactly what I hear and feel. What I hear from our people is an expression of deep-seeded belief in the power of technology to help people, and an equally powerful belief in Best Buy to unlock that promise. We’re proud that in a time when so many storefronts are closing, we are opening new stores and new channels and creating new jobs around the world. And along the way, providing a platform for thousands of new employees and millions of new customers to solve problems and pursue their own brand of happiness together. As I assume the responsibilities of CEO next week, that is my north star.

With that, I will turn it over to Jim Muehlbauer for his thoughts on our quarterly results. Jim.

James L. Muehlbauer

Thanks, Brian and good morning, everyone. This morning I am pleased to provide you with an overview of our first quarter financial results and how they compared with our plans for the period. Secondly, I will review the thinking behind our continued guidance for fiscal 2010.

As Brian mentioned up front, our adjusted quarterly net earnings for the first quarter of $0.42 per diluted share was essentially flat versus last year. This performance was a bit ahead of our expectations when we provided FY10 guidance earlier in the year. While it’s very early in the fiscal year and there’s much in front of us, we are clearly encouraged by this beginning, especially in the very challenging environment for consumer spending.

Looking at the quarter’s financial results, total revenue for the enterprise rose 12% to $10.1 billion. The revenue increase was driven primarily by the inclusion of Best Buy Europe and the net addition of 185 net new stores over the past 12 months. These new store gains were offset by a first quarter comparable store sales decline of 6.2%. As a reminder, last year’s results were positively impacted by government stimulus checks that began in May of last year and continued through the second quarter.

Domestically, first quarter revenues increased nearly 1% from last year. The quarter saw a comparable store sales decline of 4.9%, which was offset by the addition of 115 net new stores over the past 12 months. As you might imagine, most categories showed declines in this environment, such as the low double-digit increases in gaming, appliances, and cameras we experienced. Additionally, flat panel TVs saw a comparable store sales that were essentially flat versus the prior year, as unit increases offset declines in the average selling price.

Partially offsetting these declines we saw in the quarter were computing and mobile phones, categories that continued to be in demand for our customers and a bright spot for us as evidenced by their low double-digit and mid-double-digit growth respectively.

In fact, in computing this is the 26th consecutive quarter with double-digit comparable store gains.

While the comparable store sales trends begin to show signs of stabilizing during the quarter, it is important to point out that the domestic comparable store sales declines were the highest during the month of May, as we faced difficult comparisons versus the government stimulus activity last year.

On a positive note, traffic declines for the -- on a positive note, traffic declines in the first quarter were the lowest we had witnessed in a year and speak to the market share gains we experienced as customers accelerated their migration to our model.

Additionally for the quarter, we saw slight growth in ASP as notebooks, computers, mobile phones, and televisions increased in the revenue mix, offset by a slight decline in units per transaction. The net result was essentially flat average ticket for the quarter.

Most significantly, revenue in the domestic business reflected strong market share gains in many of our major categories, as Brian mentioned earlier. In total, these share gains were slightly higher than we originally expected and helped to offset a somewhat softer consumer demand in the CE industry.

Revenue in our international segment was $2.6 billion, or a 67% increase over last year, which was consistent with our expectations. European operations accounted for most of the increase.

We also faced an 11% FX headwind in the quarter.

Canada and China experienced comparable store sales declines of 13% and 16% respectively as difficult macro conditions continued to adversely impact those regions of the world.

In Canada, we held market share flat despite our comparable store sales decline, so that gives you a sense of the overall macro environment in Canada. In China, our performance was in line with our other peers.

The gross profit performance of the company once again continues to stand out in the industry despite the difficult environment. Gross margin performance of 25.3% reflected a 160-basis point year-over-year improvement and was driven by the inclusion of Best Buy Europe and the continued strength in our domestic business.

For the first quarter, the domestic gross profit rate was 25.1%. The almost 70 basis point year-over-year increase reflects our third consecutive quarter of domestic gross profit expansion. Strong rate performance across product categories such as digital imaging, services, computing, and home theater contributed nearly 100 basis points of margin improvement. Partially offsetting the rate improvements, however, were the net 30 basis point unfavorable revenue mix impact driven by the strength of notebook computers, offset by mobile phones and slower growth in lower margin gaming.

When one peels back the layers of the quarter, we can attribute the strong rate performance to three main drivers, some of which we expect to sustain and some that were more event driven or timing in nature.

First, promotional effectiveness in the impacts and timing of model transitions drove approximately 30 to 40 basis points of the growth. While we anticipate that we will continue to utilize effective promotions through the remainder of the year, the model transition benefits are not likely to continue as the year progresses.

Secondly, lower spending on distribution costs, in part due to lower energy costs, drove 20 to 30 basis points of the rate improvement. As the year progresses, we anticipate less favorable year-over-year energy comparisons will mitigate this benefit.

And lastly, increased productivity in our services business helped improve our margins by approximately 20 to 30 basis points.

So when one helicopters up, we believe that roughly 40 to 50 basis points of the first quarter rate strength is sustainable as we look out to the balance of the year. However, we expect the headwinds from computing in the mix to continue as notebooks drive growth and provide opportunities to leverage our connected digital solutions strategy with customers.

All in, consistent with our prior guidance, we still expect domestic margin for the year to be essentially flat.

Now turning to the enterprise cost performance, we have more good news. SG&A expense totaled $2.2 billion, or 21.9% of revenue for the quarter. The inclusion of Best Buy Europe’s higher operating cost model contributed to the majority of the rate increase. In fact, SG&A deleverage for the quarter across the enterprise was better than we expected, due to tight cost controls and slightly better-than-expected top line performance.

When looking at our SG&A dollar spend, excluding FY09 acquisitions, we are pleased to report that year-over-year SG&A spending was essentially flat, which was also better than our expectations for the quarter. As a reminder, the full-year guidance we provided called for a 1% increase in absolute SG&A spend for the year excluding FY09 acquisitions. As you may recall, since mid-last year, we have told you that we plan to prudently plant seeds for future growth while evaluating our non-critical SG&A, and that’s exactly what we are doing as evidenced by our ability to hold SG&A costs flat, despite the incremental cost of operating 140 more stores than last year.

So when you add it all up, it results in adjusted operating income of $348 million, a 26% increase versus last year. This strong result -- this was a strong result when you consider that it was delivered in a negative comparable store sales environment and against a challenging year-over-year comparison period due to the positive impact stimulus checks had in the first quarter of fiscal 2009.

Best Buy's domestic segment reported first quarter adjusted operating income of $328 million, an increase of $51 million, or 18% compared to the prior year’s fiscal first quarter. The resulting 70 basis point improvement of the domestic segment’s adjusted operating income rate reflected improvement in the gross profit rate and strong cost controls.

The company’s international segment generated $20 million in adjusted operating profit for the fiscal first quarter, which was a $20 million improvement versus last year. Gains from the addition of Europe operations were partially offset by a decline in the balance of international, which primarily reflects the challenging conditions in Canada. That said, the results of the international operations were still slightly better than our plan for the first quarter.

I also wanted to comment briefly on our tax rate. As you likely noticed, our effective tax rate of 45% reflects a significant increase and is higher than our previous run-rate. The primary driver of this increase is simply the timing impact of losses on certain international operations which place upward pressure on our overall effective tax rate in the first half.

At this time, we still expect that our annual tax rate will fall within our original guidance range of 38% to 38.5% for the full year and probably trends toward the upper end of this range. Overall, the timing impact of the tax rate in Q1 reduced EPS by approximately $0.04 to $0.05.

This brings me to our earnings outlook -- as I said up-front, we are off to a good start with the first quarter performance. We remain on track to deliver diluted earnings per share of $2.50 to $2.90 for the fiscal year. While the first quarter EPS was ahead of our initial expectations, there are clearly a number of unknowns around consumer spending that could impact our performance for the back half of the year, where we generate a substantial portion of our earnings.

Given the limited visibility in the environment, it is prudent to maintain our original earnings guidance at this point in the year and we hope that this proves out to be conservative.

As I mentioned on our last call, we continue to monitor opportunities and risk in the environment that could have a material impact on our performance. Key items on our radar screen continue to include changes in consumer spending behaviors as the duration of the economic downturn progress; reaction by competitors and vendors to the current climate; the availability and cost of consumer credit, resulting from increased charge-offs in the industry and legislative changes; and impacts of stimulus activities and other material legislative changes.

So to summarize, the year is off to a good start and we delivered strong share gains, gross margin expansion, and disciplined expense control in the first quarter. We know it will continue to be a choppy macro environment for our customers but we are confident in our strategy and the growth drivers it presents for the future that are within our control. We will continue to invest where we see customer opportunities and where our employees can drive growth and profits for our shareholders.

With that, I would like to turn the call back to Brian for a couple of closing comments. Brian.

Brian J. Dunn

Thanks, Jim. We’ll take your questions in a minute but first I want to make a note for the record -- today marks that last time we will engage in this quarterly discussion with Brad Anderson as our CEO. Seven years ago, Best Buy was riding high, coming off our best year ever by traditional measures. We were winning in the marketplace but those of us in what Brad would call the established orthodoxy of Best Buy didn’t realize is that we were winning a game that was rapidly coming to a close and we were not ready for the new game.

It took someone with tremendous vision and the courage of his convictions to remove our blinders and I can tell you it was not easy for him or for us, but he did it. He led Best Buy from the shifting sands of the product centric world and insisted that we rebuild our foundation on solid ground, on what we have come to call customer centricity. It’s on that timeless foundation that we move forward, confident that we can change with customers into a world of unimagined mobility and connectivity. We believe we are well-positioned to thrive in this new world and we owe a huge debt of gratitude to one man for the vantage point we enjoy -- Brad Anderson.

On behalf of all of us at Best Buy across the world, 155,000 strong, thank you, Brad.

With that, I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Gary Balter from Credit Suisse.

Gary Balter - Credit Suisse

Thank you. First of all, Brad, congratulations on retiring and Brian, congratulations on taking over in three days. The question -- I was going to ask a longer term kind of where the Geek Squad fits in but I think more the focus on people is on the short term, so I am going to stick to the short-term -- you know, do you talk -- and this is more for Jim -- you talked about 70 basis point improvement in domestic margins first quarter but you also said you expect it to be flat for the year, even though you laid out 40 to 50 basis points of sustainable gross margin.

Did you kind of reconcile that? And with that, you made some comments that you are watching consumer credits, you’re watching vendors, you’re watching changes in consumer spending behavior. I would love your thoughts and the company’s thoughts about what you think of the new credit bill and the impact that could have? And also, what have you seen in your trends -- you mentioned May was weaker because of stimulus but were there other things that may have bothered you? Thank you.

James L. Muehlbauer

Thanks, Gary. So on the gross profit rate, as we look forward to the balance of the year, one of the things that has been in our model for certainly the past four or five quarters is the growth in our computing business has been certainly putting a drag on our gross margin rate. As we mentioned up-front, we are very happy with the sales in that space in that consumers are choosing the options that Best Buy have and we are happy to sell those products to consumers to connect them to the digital world. It does put pressure on the gross profit rate so that’s been a drag that we welcome. We expect that that is going to continue for this year.

The two new elements that we will also see this year on the mix side of the business is as we lap and anniversary our Best Buy mobile launch. Some of the benefit we’ve been seeing in the mix this year will start to mitigate as we lap that launch, which principally starts in Q2 and Q3 of next year.

So the 40 to 50 basis points of rate improvement that we expect to continue is going to be mitigated by the mix impact of growth in our computing business in the balance of the year.

Gary Balter - Credit Suisse

But you shouldn’t be giving up the 70 you got already, or are you saying it’s going to turn negative on a margin basis for the next three quarters?

James L. Muehlbauer

We’ll have to see where the actual mix goes. I mean, once again, in that 70, there were items in there that I tried to call out that were related to lack of transitions in some key product categories. One of the reverse benefits of being low on inventory coming out of the first quarter is that we have less product to transition and we called that out on the last quarter call as well. So that 70 basis points we didn’t view as sustaining in the first place. The balance of the 40 to 50 is going to be mitigated once again by the mix impact, and we’ll see how things mix out for the balance of the year. That’s our best view now but clearly as we learned last year, there’s a long way to go in the year and it will be a very interesting environment for consumer spending.

Your second question, Gary, really had to deal with some of the opportunities and risk factors that we talked about both on last quarter’s call and on our call just now, and certainly as we look at how the recovery period either starts to engage or doesn’t engage for the back half of the year, pressures that we see in the environment around both our vendor community and certainly from a competitive standpoint, we’re playing a different game this year with the mix of competitors that we have and certainly the offerings that we are putting in the marketplace. So as we sit here in the end of the first quarter, it’s difficult to predict exactly how that game is going to be different with companies like Circuit City out of the mix. So part of the upside that we have and certainly part of the thing that we are monitoring is what does consumer behavior look like with the lack of Circuit City and certainly as the unemployment continues to move up and the recession period extends out, how do we see any changes in consumer behavior overall from a spending perspective.

I think part of that is also contributed by the same headlines we all read around what’s going on in the banking industry around credit. Certainly there are a number of institutions, including our business partner, that have been looking at their credit activity and making adjustments both in response to the significant level of charge-offs they are seeing in their portfolios and quite honestly in reaction to some of the legislative changes that have been handed down. And we continue to work with our banking partners as we have over the last few years to adjust and monitor the performance of our portfolio Best Buy light of those changes.

Gary Balter - Credit Suisse

Thank you.

Operator

Thank you. The next question comes from Gregory Melich.

Gregory Melich - Morgan Stanley

Thanks, guys. Two questions -- one, Jim, could you just give us what the domestic inventories were, either in total or on a comp-store basis? Both, if you have them. And then I had a follow-up on the SG&A.

James L. Muehlbauer

So domestic comparable store inventories were basically flat for the quarter. If you’ll recall at the end of last quarter, comparable store inventories for our domestic business were down 15%, which was lower than we wanted it to be. We have taken the time since the last quarter to get better in-stock positions in some of the primary categories that we were short on in Q1 and saw that inventory position build through the quarter to get to a flat comparable store inventory level. So we feel good that we have great in-stock levels for customers as we sit here today. You know, there certainly is going to be opportunities and challenges as we look what consumer demand looks like going forward with specific SKUs, but we made a good recovery and making sure that we are in good in-stock positions by the end of the quarter.

Gregory Melich - Morgan Stanley

So right now, we feel inventory is good, you’ve got enough to make the sales and -- but not too much?

Mike Vitelli

That’s a great characterization, Greg. That’s just how we feel. We believe we’ve got ourselves in a good in-stock position on the new SKUs and the new services and products that are in our different departments, and we feel pretty balanced and our days of supply given our forward outlook are right where we would want them to be.

Gregory Melich - Morgan Stanley

Okay, great. And on the SG&A side, I think in the release you guys called out that advertising expense was down but that was something you didn’t expect to continue going forward. Could you quantify that or give us some more color there?

Brian J. Dunn

So the color on that, really two pieces -- we did some advertising last year really related to gift card promotions around high definition DVD players that we gave to customers, so that was an item that we are benefiting from lapping. And secondly as we just looked at the re-phasing of our advertising for the year, we expect that some of the favorability that we originally planned in Q1, we’re going to push out to later periods.

Gregory Melich - Morgan Stanley

So was there a basis point number that helped you in SG&A in the quarter?

James L. Muehlbauer

Yeah, we haven’t quoted that publicly but it was meaningful, obviously, otherwise we wouldn’t have called it out specifically.

Gregory Melich - Morgan Stanley

But in terms of holistically for the year, you still think SG&A dollars could be flattish?

James L. Muehlbauer

Yeah, I think it’s going to be flattish. I mean, I am very encouraged that we are tracking better than plan right now but we’ll have to see how the year plans out. The thing that we are being very purposeful on and I know there may be some questions around why not raise guidance at this point in time and specifically, it’s just in light of what might happen in the consumer environment. We’re not trying to provide some cushion to spend more SG&A in the back half of the year. It’s clearly recognizing, especially after last year’s, that there’s a lot of unknowns in the environment yet. We are going to continue our cost control and to the specific point on advertising, we think now is a great time to be out there with the effective promotions that we have, as evidenced by what we are doing from a share standpoint. And we’re going to see more opportunities to build our share, so that advertising is an integral element of bringing customers into the Best Buy story. So it’s not something that we are looking at peeling back from our budget at this point in time.

Gregory Melich - Morgan Stanley

Great, thanks.

Operator

Thank you. The next question comes from Matthew Fassler from Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot. Good morning. I would like to talk to you briefly -- excuse me, about your market share trends and to think about the numbers that you have quoted over the past several quarters. You spoke about a 200 basis point share gain in the April quarter, during most of which Circuit City was gone, or essentially gone. As I look back at the past couple of quarters, for the prior quarter you had talked about 120; the quarter before that, 170. So as you think where the Circuit share would be visible in the context of the share trends that you quote, it would seem like to the extent they were a 6% or 8% market share player, the share pick-up might be a little bit bigger so if you could give us some insight as to how we should think about that in terms of what we know about Circuit’s size.

Mike Vitelli

The period that we are looking at and we’re discussing today is March, April and May. March was a period where we, as we described earlier, we’re still getting back into inventory, so our share gains in March were probably more depressed than we would have liked them to be at that point in time. We’re starting to see those share gains start to accelerate as both we’re in-stock and inventory and the fact that we’re completely out of that period.

So we’re seeing the acceleration start to grow and we’re seeing the share gains in categories where we’d expect to see them, where there’s different types of competition. What do I mean by that? So if you look in the entertainment area, music, movies, and games, that’s a place where products are ubiquitously available almost everywhere and we’re getting a kind of a storefront proportionate share. But in areas where we are uniquely competitive, in car stereo, for example, where we are one of the few national players, in higher end home theater, in computing, and cell phones -- these are areas where we are seeing the most significant share gains. Digital imaging is another one.

Matthew Fassler - Goldman Sachs

Got it. And then just Mike, by way of follow-up since I’ve got you, you talk about the consumer environment. Can you give us a sense as to where consumers are migrating on the ticket scale? Do you see them taking lower price to more value-oriented options in some of the bigger ticket categories like TV or digital imaging? And if that was already the case, have you seen that at all?

Mike Vitelli

It hasn’t materially changed. I would say the one thing that we are doing differently now than we did a couple of years ago is we are not advocating lower end price points. So we used to be able to say okay, we’re going to focus a lot of our attention on the higher end and kind of let the lower end go where it’s going to go. We’re being more aggressive there, particularly in flat panel TVs. So we’re seeing as much growth in the smaller screen sizes as we are in the larger screen sizes, which we think is good overall because in a sense, it’s a traffic driver to the whole home theater and entertainment department. But I wouldn’t say that there’s a massive shift to where people are saying okay, I’m stepping out of high-end television and going to the low-end. In fact, the opposite. We are seeing some strong growth in the LED televisions which are some of the highest priced ones that are in the market today.

Matthew Fassler - Goldman Sachs

Got it. Thank you so much.

James L. Muehlbauer

Matt, maybe just to follow-up on Mike’s response around your market share, what we are excluding today as far as our market share is the three months ended April, so in that you do have a little bit of a Circuit activity that is still going on from a liquidation standpoint. And remember also we talked last quarter about being out of stock in some key categories, so as we look at the -- certainly the share performance in March, April, May and June, we’re expecting that trend to continue to build, which I believe was Brian’s point.

Brian J. Dunn

And the last piece on market share is when you dig into the categories, as Mike mentioned, dig into the categories in which Circuit City had decent mid-single-digit share in, that’s where you will see big share pick-up in our categories. So you have to go underneath the big number and look at the specific categories in which we’re gaining.

Matthew Fassler - Goldman Sachs

Understood. Thank you very much.

Operator

Thank you. The next question comes from Colin McGranahan.

Colin McGranahan - Sanford Bernstein

Thank you. I guess firstly, Brad, good luck on your next journey. It’s been a pleasure working with you. Secondly, just following up on Matt’s question a little bit on the share gains, just to clarify first -- so you said nearly 200 basis points for the quarter ending May or 200 basis points for the quarter you were quoting ending April?

James L. Muehlbauer

April.

Colin McGranahan - Sanford Bernstein

Okay, and when -- with the 240 in March, was it that April was better than March and it was just February when Circuit was still in business it was much worse, and with the steeper negative comp in May, was that all then just underlying weakness in the environment and you don’t think the share gain will be bigger than March at 240?

Mike Vitelli

Again, we quoted through the end of April, our share gains were strong throughout the quarter. We don’t have May’s share data yet but we know the industry, because it was down low-single, low double-digits, 13% or so, and our trends were quite a bit better than that, as May turned out. So yes, we think May will be good.

Colin McGranahan - Sanford Bernstein

Okay, and then would you assume that the 200 basis points, that the vast majority of that is coming from former Circuit customers? And I know it’s very different by product category but that would suggest then you are getting somewhere between 20% and 30% of Circuit’s business? Does that jive with your math?

Mike Vitelli

I don’t think it’s that precise of math. The one thing that is in there is that 200 basis points is an all-category three-month average. The number on a monthly basis is accelerating. February is when they were liquidating, March we were less in-stock than we would have liked to be and the market was a little more depressed. April is accelerating and we think May is going to continue to do that. And again, as I said, it’s very different by category so I think we are getting the share that we would expect to get in the categories where we would like to get it and the more commodity type categories like music and movies are much more spread.

Colin McGranahan - Sanford Bernstein

Okay, thank you, Mike and then just finally to follow-up, and this is much more theoretically, as you think about this environment where clearly there’s accelerating underlying demand weakness but your share is great but you are putting up great gross margins and it seems like you are obviously in the seat to drive the level of promotional activity and right now you are being I would say relatively benign -- how do you think about that trade-off in this kind of a decelerating environment between gross margins, the promotional, a leadership position you want to take, and your traffic and share going forward?

Mike Vitelli

Well, I’ll start. I would not characterize our promotional activity as benign. I think we’ve put some great values in the marketplace as new products came out and we put them front cover, front and center. Our master promotion, albeit an early start for a new category for us is trying to be competitive in an area where we actually haven’t played before. We’ve been front and center with all of the new cell phones as they come into the marketplace, so I think we’ve been as competitive as we have always been. There are less people with a national ad but the competition in the marketplace is very, very strong.

So I don’t think it’s a scenario where we are going to sit back and be able to say we are going to get an extra 10% higher on every unit that we are selling. I don’t think that’s the marketplace we’re in. In fact, I think it’s quite the opposite, as everybody is trying to aggressively bring consumers into their store. You don’t see it as much because there may be less print that we are all able to get our hands on and compare but there are so many other places where the consumer is able to get and look at value for dollar that we are being as aggressive as we need to be at all times.

Colin McGranahan - Sanford Bernstein

Great. Thank you, Mike. That was very helpful, thank you.

Operator

The next question comes from Jack Murphy from William Blair. Please go ahead, sir.

Jack Murphy - William Blair

Yes, congratulations to Brad and best of luck, Brian. Just a couple of things -- again on the market share, could you talk about the sustainability of the transitioning to new products faster than the competition as a source of market share? Does that have to do with improved vendor relationships and just as it relates to the sustainability of that? And then a follow-up on promotional effectiveness -- as the demand environment eventually gets better at some point, do you think that you are going to see materially better promotional effectiveness and a better demand environment, or sort of the benefits of Circuit going to dissipate more quickly than that?

Mike Vitelli

Well, to answer your first question on getting the products in-stock faster, I think that’s a function of the supply chain work and the collaborative planning and forecasting that we do with our vendors regularly. And we sit there and actually plan with them ahead of time when are the products going to come in and how we can bring them into the market faster. Because that’s actually good for us and it’s good for our suppliers. They get into their newer products, which is where they have their cost-downs and manufacturing, et cetera, so it’s good for them and it’s good for us. The fact that we can do it and execute with them is a positive I think for the industry as a whole and we believe that’s sustainable over a period of -- over multiple years. It doesn’t happen more than once a year, generally, except in an area like PCs, but for the most part we think that’s a sustainable advantage for us going forward.

As far as the promotional effectiveness, I’m not sure what the underlying theme of that phrase but I think in the first quarter, what that was for us related to going from one set of product line-up to another year, the transition period, we were able to be effective in that we didn’t have to -- we didn’t have excess inventory that we had to mark down excessively to move it and get into the new product line. I think that’s where the promotional effectiveness comment comes from in the first quarter.

Jack Murphy - William Blair

I guess I was referring more to the lack of Circuit City’s circular in the marketplace and your ability to predict the return on your promotional spending.

Mike Vitelli

As I said to Colin, I think the lack of the Circuit City circular isn’t -- it does not change the competitive environment one bit. I think there are regionals that are continuing to grow with their aggressiveness. The online channel grows with theirs, the mass channel grows with theirs. Yes, there is one less competitor in the marketplace but it’s no less a competitive market.

Brian J. Dunn

If I could just add one thing to Mike’s answer, I think the sustainability of these new technologies, these new products come onto our sales floor, I think what really drives the sustainability for us over the mid- and long-term is the fact that we have these men and women in our stores who are connecting with customers and understanding, helping customers understand what these new, these advancements can do for them. That really matters and from my view, that is sort of what is sustainable about our model relative to the new technologies that come our way.

Andrew Lacko

Great. Thanks, Richard. Next question, please.

Operator

Thank you. The next question comes from Scot Ciccarelli from RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets

Given the growth that you guys have seen in notebooks, how important has it -- and how important has it become for your business, can you talk about the potential impact of netbooks on your business and how you might think about a subscription model within that space?

Mike Vitelli

We think netbooks is a positive. We’re starting to see it grow. It brings more people into the marketplace. In many cases, it becomes a second device, is what we are seeing, where this is my travel unit that to your point can be connected to the Internet every place that I go and in that sense can become a subscription model in that it is tied to a mobile broadband service, and we think that is a big area of growth in the industry overall over this year and the next couple. And to Brian’s earlier point, this is one thing we are going to be able to show to customers we believe better than anybody else is, and to be able to connect them to the service and have them walk out working with their netbook as they leave the store.

Scot Ciccarelli - RBC Capital Markets

What about the potential for cannibalization or do you think a lot of that will wind up being incremental, Mike?

Mike Vitelli

Cannibalization of notebook sales?

Scot Ciccarelli - RBC Capital Markets

Yeah.

Mike Vitelli

I think we’re still seeing massive growth in the overall portable PC industry as this becomes basically an indispensable device, whereas before it was a -- it was something that gee, I’d like to have -- it’s become a must-have, and not only for -- you know, you’d have one per family. Now you’re having one per person and netbook gets you to multiples per person. So I think we are actually starting to see an acceleration of a category that we have taken for granted for a couple of years.

Brian J. Dunn

Scot, one of the things we’ve seen since the world changed a bit in September is a continued strength and material growth in notebooks, smartphones, and these items have really moved from the world of discretionary, we believe, to -- these have really become utilities. This sort of notion of ubiquitous connectivity has become critical to people’s lives and I think we are seeing that in how customers are choosing to spend their dollars right now.

Robert A. Willett

Just to sort of follow-up a little bit on what Brian was saying, one of the things that we’ve learnt from CPW and its annuity consumer approach, subscription approach is that these are the sort of products that we are actually experimenting with in a number of stores in the U.K., in order to test both the model, the annuity model, as well as the acceptability of this type of product. And it starts to give us, as Mike said, completely new things to think about in a way that we’ve not thought about them previously. So it’s one of the strengths and one of the other things I just want to add as well, to save Mike’s blushes, somewhat, Jim talked about our sort of -- our sales decline in Canada from a comp perspective. But having said that, we did hold our market share -- in fact, we marginally improved it by Circuit two little bps. But the real key thing is in there, if you take TVs, the TV sector in Canada, which declined by 22%, our market share grew by 300 bps, thanks to the real aggressive promotional work that’s going on. So it says Best Buy over the door and that’s exactly what we are ensuring happens. That’s not something that we are letting go. And we are seeing all sorts of different trends across the world.

In China, for example, where a year ago we were very, very heavily swayed towards international brands, now we are seeing massive movement towards local brands. We’re seeing 30% and 40% improvements locally in Shanghai in local brands. International brands -- Sony, Samsung, declining by nearly 50% and 60% in Shanghai alone. So we are seeing huge shifts which we are learning about and some of those shifts will translate to other parts of our business and what this is doing is providing us with tools and learnings that we can use elsewhere.

Scot Ciccarelli - RBC Capital Markets

Okay, great. Thanks a lot, guys.

Operator

Thank you. The next question comes from Chris Horvers from JPMorgan.

Chris Horvers - JPMorgan

Thanks. Good morning and congratulations. I would love to hear your thoughts about the sequential comps domestically in the first quarter versus the fourth quarter. Clearly 4Q was an awful period for the consumer and you clearly took Circuit’s share as they went out of business -- why don’t you think you saw a sequential improvement domestically and how do you think the timing of Circuit’s closure, in-stock levels, and the DTV transition impacted those sequential comps?

James L. Muehlbauer

If we look at the sequential comps in the quarter, you’re absolutely right. We started to build share certainly through Q3 and Q4 last year, as Circuit was winding down operations. One of the things we knew was going to happen towards the end of the year, the first part of this fiscal year, is that as they went out of business and did their liquidation sales, we knew that would take revenue out of the marketplace for us, so we knew that was going to put pressure on our comps overall. So what we saw in Q1 from a progression standpoint is honestly exactly what we thought would happen. We knew that the pressure on comps would be greater towards the end of Q1 as we lapped the stimulus activity.

As a matter of fact, from a comparable store sales standpoint, on a monthly basis May is our most difficult comparison period for the year. On a quarterly basis, Q2 will be our most difficult comparison for the year within domestic. So looking at the comp sales progression in the quarter for our domestic business, going up as the quarter went along, absolutely anticipated. I think we made the comment on the call this morning as well, we saw a little bit more softness in the CE industry than we thought but we also grew more share than we planned. So the combination of those two events actually allowed us to deliver a comp store sales performance that was actually above our plan expectations for the quarter.

Mike Vitelli

Right, and just factually on a comparison basis, although Q4 and Q1 were weak, the last three months actually are the weakest in the industry, partially because of how strong last year was. So the industry is weaker than we expected. The comparisons are more difficult on an industry basis.

Shari L. Ballard

Just to add to what you were saying, I think from a one-year view of domestic comp performance, that’s exactly right. The kind of deceleration of the comps through the quarter. If you look at it on a two-year basis though, it’s the exact opposite. So when you are -- if you kind of try to normalize it two-year, it actually -- our comp performance accelerated through the quarter and it definitely accelerated in May.

Chris Horvers - JPMorgan

That’s very helpful. And maybe could you talk about how the consumer behavior was around the DTV transition? Were the stragglers, the last in line more looking to buy the box or did you see people actually coming in and buying the TVs?

Mike Vitelli

We saw a lot of activity overall. Of course you had the expected late last minute activity and we sold over 175,000 boxes the week right of the transition.

Brian J. Dunn

And is that about 7X, Mike, a normal week?

Mike Vitelli

That’s right. It was just an amazing number, and it was a great testament I think to what our Geek Squad and our employees in our store were doing to help our customers get this done across the country. But we saw all levels of activity, both people coming in to get a box and that’s a great opportunity for us to have people see all the new televisions, so we think that’s going to be -- that was a little bit of a stimulus in the sense of people coming into the store and seeing some products for the first time.

Brian J. Dunn

-- a high number of Geek roles as well around that transition.

Mike Vitelli

Yeah, it was interesting because we actually got -- the FCC actually gave us some grants to actually let us do that for customers around the country that needed help to actually set the product up, which was great for those people that were able to help out because it wasn’t your average person like, hopefully like us that could do that ourselves but people that needed the help.

Chris Horvers - JPMorgan

And Mike, maybe if I can just squeeze on in as long as I have you, can you talk about how you think about ASPs on TV in the back half with LED versus how unit growth might play out? Thank you.

Mike Vitelli

As I said in prior calls, I try desperately not to predict where ASPs are going, as it becomes a self-fulfilling prophecy of Best Buy is going to see the ASPs going this way, therefore we need to be more aggressive than that.

Brian J. Dunn

Can I suggest ASPs are going up then, Mike?

Mike Vitelli

But suffice it to say, the actual activity that we saw in the first quarter, the first quarter versus the fourth quarter, there was not a drop in costs per inch of television, so there wasn’t a material change and I think given some of the results that the manufacturing world saw in the fourth quarter, based upon losses in the flat panel business on a total supply chain basis, I think there’s a deep desire to make that a more profitable business across the entire world.

Andrew Lacko

Mike, I don’t know if you answered the question about LEDs though and how that fits in with that.

Mike Vitelli

Well, LEDs are clearly a higher cost technology and as they mix in, and they are mixing in well with us and they are an exciting product in the industry, it’s one of the -- since high definition and flat panel came to market, it’s one of the more demonstrable and noticeable changes in technology that’s visible to the average consumer without explanation.

Andrew Lacko

Great. Thanks, Chris and Richard, I think that’s all the time we have for calls, so I would like to thank everyone for participating in our first quarter earnings conference call this morning. As a reminder, a replay will be available in the United States by dialing 1-800-406-7325, or internationally at 303-590-3030. The personal identification number is 4089334. The replay will be available from 11:00 Central Time today through next Tuesday, June 23rd. You can also hear the replay on our website under “For Our Investors”.

If you have any additional questions, please feel free to contact Wade Bronson at 612-291-5693, or you can contact me, Andrew Lacko, at 612-291-6992. We ask that reporters listening in should contact Sue Bush at 612-291-6114.

Thank you, everyone, for your attention this morning and that now concludes our call.

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