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Best Buy Company Inc. (NYSE:BBY)

Q3 2011 Earnings Call

December 14, 2010 10:00 am ET

Executives

Brian Dunn – Chief Executive Officer

James Muehlbauer – Chief Financial Officer

Michael Vitelli – Executive Vice President, President-Americas

Bill Seymour – Vice President, Investor Relations

Analysts

Gary Balter – Credit Suisse

Christopher Horvers – JPMorgan

Mitchell Kaiser – Piper Jaffray

Matthew Fassler – Goldman Sachs

David Strasser – Janney Montgomery Scott

Bradley Thomas – Keybanc Capital Markets

Greg Melich – ISI Group

Mike Baker – Deutsche Bank

Anthony Chukumba – BB&T Capital Markets

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to Best Buy’s Third Quarter FY11 Earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. If you have a question, please press the star followed by the one on your touchtone phone. If you would like to withdraw your question, please press the star followed by the two; and if you are using speaker equipment, please lift the handset before making your selection. This conference is being recorded today, Tuesday, December 14, 2010.

I would now like to turn the conference over to Bill Seymour, Vice President of Investor Relations. Please go ahead.

Bill Seymour

Thank you, Alicia. Good morning everyone and thank you for participating in our fiscal 2011 third quarter earnings conference call. We have two speakers for you today. First, Brian Dunn, our CEO will share his thoughts on the quarter and the rest of the year. Second, Jim Muehlbauer, our CFO will recap the financial performance, then provide you with our perspective on how the balance of the year will play out. And after our prepared remarks, I anticipate we will have ample time for questions.

Before I pass the call over to Brian, I’d like to take care of a few housekeeping items. First, we would like to request that callers limit themselves to a single question during the Q&A portion of the call so we can get to as many questions as possible during the next hour. Second, I’d like to remind you that the 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. Third, as usual, the media are participating in this call in a listen-only mode. And lastly, I’d like to remind you that our fiscal 2010 first quarter results last year included restructuring charges which impacted our net earnings by $25 million or $0.06 per diluted share. The balance of our discussion on this morning’s call will exclude these charges. That means that 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 in this morning’s news release.

With that, I’d like to turn the call over to Brian Dunn.

Brian Dunn

Good morning everyone and thanks for joining us on our third quarter earnings conference call. First I want to take this opportunity to thank our employees for their tremendous effort this quarter and during the Black Friday weekend, and I want to extend our sincere appreciation to our customers for shopping at Best Buy. I’d also like to wish everyone a Merry Christmas and happy holidays.

Our third quarter results fell short of our expectations in some respects, and I want to address that in detail; but I’d like to begin by emphasizing the many positive trends we’ve identified this year. These trends, which provide further validation of our strategic direction, gained powerful momentum in the third quarter.

Our growth in connections during the quarter led to continued gross margin strength. Margins were up 90 basis points in our domestic business driven primarily by the growth of Best Buy Mobile. Gross margin expansion is a key indicator of our progress in our Connected World strategy, and I’m pleased with the continued gross margin progress this year.

Central to our Connected World strategy is driving gross margin outside of our traditional hardware categories. As a proof point, we had strong connections revenue growth in Best Buy Mobile, computing and TV. Solutions as a percentage of our sales mix increased year-over-year driven by the strength in connections as well as services, accessories, and Black Tie Protection. Going forward, I expect that the growth of Best Buy Mobile as well as the continued momentum of our other Connected World initiatives will continue to drive our margin expansion.

Our expense control was tight in the quarter. Total Company SG&A was up only 1% year-on-year, which is good considering the lower sales than expected. Our in-store execution continues to be solid. Our international business maintained its momentum this year with performance to plan in the third quarter, and we continued to return cash to our shareholders, buying back more than $1.1 billion of stock this year.

Our sales in the U.S., however, were lower than we expected for the quarter, and as a result earnings were less than we anticipated. I’ll walk you through the reasons for this as we see them, starting with a few thoughts on Black Friday weekend.

Our employees in the field and our merchant and supply chain teams all performed at a high level of efficiency. For the weekend, our teams improved close rate, increased units per transaction, delivered a higher average ticket, and increased solutions as a percent of our sales, driven by connectivity. All of these year-on-year metrics were better for the weekend than they were for the whole quarter, which testifies to the razor-sharp focus of our associates.

Another bright spot was our online channel which had more than 40 million site visits from Thanksgiving through Cyber Monday and delivered low double-digit comp sales growth for the period.

Here are the facts: our forecasts and the forecasts of the vendor community were looking for an improvement in the TV industry in the third quarter supported by a more promotional environment and pent-up consumer demand for new technologies. While we did see sequential month to month improvement in our TV business, the quarterly results fell below our expectations. In fact, estimates are the TV market was down double digits in value terms in the third quarter. We think this was driven by a weaker overall demand environment for TV along with slower adoption of new technologies.

Current products have proliferated this year, in part due to a significant increase in channels of distribution. Much of the industry’s promotional activity on TVs this quarter was centered on third tier brands as loss leaders. Our value proposition is based on the best selection of the world’s greatest brands with leading-edge technology and great prices. The newer technologies like 3D and IPTV, which we assort more broadly than anyone, have been slower to take hold. We’re confident that these exciting new technologies will take off, and when they do, we expect to benefit from being the leader.

A good indicator of this is Magnolia Home Theater, our premium home theater business. The growth of Magnolia has been very strong recently and we consider than an encouraging bell weather of future consumer adoption of new home theater technology.

Next I’d like to talk about mobile computing. The notebook market was weaker than we expected, and we estimate the notebook market declined year-on-year. There were a number of factors driving this. The Windows 7 launch last year was more significant than we and the industry forecasted, and we saw two main shifts occur in the tablet space: more overall customers migrating to tablets, and customers waiting as they considered their purchase decisions on tablets versus netbooks and notebooks.

While we’re pleased with our market share in tablets thus far, we believe we’re positioned to become the primary destination for this category as our vendors partners bring an array of exciting new tablets to market in the first half of next year.

The gaming sector lagged our expectations. We did not perform as well on some of the new game titles as we had expected, especially coming off a 20-month high in market share a year ago driven by Wii and PS3 hardware and title sales. We believe we are well positioned to grow this product segment because of our relationship with so many gaming enthusiasts. In the short term, we feel very good about the launch of the new gaming peripherals, Kinect and Move. We estimate that we have a number one market share in Kinect and Move, which already have had a positive impact in November.

We also continue to be excited our opportunities in used gaming, which is a lucrative market that we have just recently entered.

In general, the combination of technology innovations and improvements in our own value proposition leaves us optimistic that we’re positioned to grow our share in the gaming business.

In summary, we need to remember that we had difficult comparisons for many of our core businesses comparing market share and comps last year. The lower than expected sales performance in the third quarter that I talked about and our current visibility to the rest of the year has resulted in us lowering our view for the full year. Jim will provide more color on that in a few minutes.

I’ll turn now to our other businesses and comment on the trends we’re seeing there. Our mobile phone business had another great quarter with almost 30% comps and the highest gross profit dollar growth of any of our businesses. We introduced many new products including four new tablets and five smartphones that are exclusive to Best Buy. As I said, Black Friday was strong for mobile. During that weekend, connections were up significantly.

We also grew our accessory sales, our Geek Squad Black Tie Protection sales, and the number of upgrade checks. Upgrade checks are a primary driver of our Best Buy mobile business because so many customers have no idea that they can upgrade to a great new phone for little or no out-of-pocket expense for the hardware. We believe that Best Buy Mobile continues as a huge growth opportunity for us and will continue to contribute positively to our future earnings. We estimate that we have only about 5% market share and we plan to more than double that share over time.

We also saw very high demand for e-readers. This is a growing category for us. We sell all three major e-reader brands and sales were very strong. This is noteworthy because it illustrates customers’ appetite to be connected and to engage in new technology. We’re the only store where the customer can compare all brands, models and features side by side with expert help for any questions they may have.

Our U.S. online business grew 7% in revenue in the quarter. About 40% of the products we sold online were picked up in-store. This trend continues to be a key advantage for us, and we believe will be increasingly important to consumers as we get deeper into December. We plan to accelerate the use of this channel as an important way to deliver great value and shopping convenience to our customers.

We’ve talked to you about how we’re bringing the Connected World to life for our customers and our investors. Best Buy Mobile is the tip of the spear for the Connected World and we’ve shown the positive impact mobile has had on our margins. When we look outside of mobile, we’re making good progress in other areas that we expect to translate into incremental margin as well. A few examples – in computing, we’ve seen good growth and attachment of mobile broadband onto laptops and netbooks. AirCards and MyFi cards grew significantly in the quarter. In TV, we continue to see very strong growth in connections. Connections revenue grew triple digits.

As I mentioned earlier, a very important theme for this quarter and during Black Friday weekend was the strong store execution in the U.S. We are proud of the great work of our blue shirts and agents with their commitment to providing a great experience for our customers. Let me share with you a few metrics that continue to provide encouraging news about our store execution.

In the third quarter, our retail satisfaction scores were up to over 80%. Our customers’ likelihood to recommend across all channels was up to over 85%. Customer complaints per transaction were down 17%, and our close rate improved year-on-year. Therefore, while we’re not satisfied with our sales at this early juncture of the holiday season, we’re very pleased with the experiences our employees are providing.

Shifting gears now to our international business – our strategy continues to be to grow the profitable businesses and invest in the others only when they have a proven operating model. We see encouraging signs on several fronts. Our international operating margin was up significantly year-on-year, and our year-to-date operating profit was the highest in several years.

There are two parts to our international business: established businesses and new Best Buy emerging ventures. In our established international businesses, the performance of our Five Star chain in China once again stands out. I’m very pleased with the continued growth and the profitability of that business. Five Star had comps approaching 30% and significantly improved operating margins.

And looking forward to the fourth quarter, the continued margin development in our store execution are very encouraging; but the sales performance has been challenging and it colors our view for the balance of the year. We have our biggest quarter ahead of us and will do our very best to make sure we capture more than our fair share of the holiday.

Here are just a few examples of some of the actions we’re taking to drive the business forward in the fourth quarter. To compliment the availability of iPad in all of our 1,100 big box stores and in all of the Best Buy Mobile standalone stores, we just started selling the iPad on BestBuy.com for home delivery. Starting last week, we extended the opening times of our stores to make it even more convenient for customers to do their holiday shopping. To help customers buy and give the items they really want this season, we’ve lowered the minimum purchase requirements for some of our financing offers.

The holidays will be big for Best Buy Mobile. We have lots of new products, including several new smartphones and tablets; and we’re very excited to be the exclusive retailer of the Nexus S, which we’ll start selling this Thursday. And based on the overwhelming success and customer feedback from the Free Phone Fridays campaign in October, we will offer free smartphones every day during the remainder of the holiday shopping season.

To wrap up, I believe that this holiday season will again demonstrate the power of Best Buy’s model. We add value because we stay closest to our customers to get them great name-brand products at great prices, packaged with great service. We offer them a place where they can talk to knowledgeable, unbiased and engaged salespeople who demonstrate the art of what’s possible, the full array of what this amazing industry has to offer, and put together solutions for them based on what they truly need. We believe this makes Best Buy the best place to shop for the holidays.

With that, I’ll turn it over to Jim for some additional color on our third quarter results and the financial outlook. Jim?

James Muehlbauer

Thanks, Brian, and good morning everyone. My comments today will cover our third quarter results and how they compared with our plans. I will also provide you an update on how we are thinking about our annual guidance based on these results and potential outcomes in the fourth quarter.

The net earnings of $0.54 per share we reported in the third quarter was below our expectation and Street estimates. While we are clearly not satisfied with the sales outcomes which drove the earnings shortfall this quarter, there were several key items embedded in these results that continue to be encouraging trends on the progress we are making in the operating model. These items include the strong continued expansion of gross margins driven by sales of connections, solid controls over variable expenses, and share buyback activity, all of which are core elements of our plans to improve shareholder returns.

As you noticed in our release this morning, the single largest driver of our softer than expected performance in the quarter was the comparable store sales decline in the domestic segment; so let’s turn straight to the domestic sales story in the quarter. Domestically, third quarter revenues decreased 3% from last year to $8.7 billion. The quarter saw a comparable store sales decline of 5% versus our expectation of flat to modest growth.

In setting our plans for the quarter, we knew that we would be up against very strong comparisons from the prior year. If you recall, unlike many retailers, our domestic segment comps last year in the third quarter were up approximately 5%, and November was up even a stronger 8%. Looking at this year’s actual sales performance in the third quarter, Brian has summarized the key drivers of what was different versus our expectations, including a softer industry environment in key categories and changes in our share in TVs, mobile computers and gaming.

While these trends resulted in declines in store traffic, strong coordinated execution by our store and corporate teams during the quarter drove increases in key metrics such as close rate and attach rates. These gains helped to partially offset the traffic declines and average ticket was down only slightly for the quarter.

Rounding off the impact in our domestic segment from the softer sales performance, inventory levels naturally ended higher at quarter-end. Comparable domestic inventory levels finished up approximately 8%. The increase was largely driven by the revenue softness versus our expectations for categories such as TVs, notebook computers and gaming.

Looking ahead to the fourth quarter, we do not expect a significant risk from actions required to rebalance our inventory positions. We have a significant volume of business still ahead of us in the largest quarter and have the ability to moderate future purchases. In addition, the items currently on hand are of good quality.

Turning now to sales in the international segment, third quarter revenues increased approximately 3% from last year to $3.2 billion. In the quarter, we saw a comparable store sales gain of 2.3% which was in-line with our expectations. The revenue growth was led by comparable store sales gains in our established international businesses such as the 27% gain in Five Star and a 2% gain in Best Buy Europe. These gains were partially offset by a 4% comparable store sales decline in Canada which had many of the same top line headwinds that were experienced in the domestic segment. In aggregate, total revenue for the Company declined 1% to $11.9 billion during the fiscal third quarter.

We continue to be very pleased with the progress we are making on improving gross profit rate performance. The third quarter’s gross profit rate of 25.1% reflected a 60 basis point year-over-year improvement. The domestic gross profit rate increased 90 basis points year-over-year. This performance was modestly better than we had expected and was driven by several familiar themes which served to more than offset softness in TV category margins.

First, as mentioned earlier, we delivered strong growth in our Best Buy Mobile business as customers continued to respond positively to this value proposition and our exciting exclusives and compelling offers such as Free Phone Friday. Second, we continued to improve our promotional effectiveness and drove gains from lower financing costs and improved pricing strategies in categories such as appliances. Finally, similar to the first half of the year, the gross margin rate improved slightly as a larger portion of our vendor programs were orientated towards purchase incentives instead of advertising support, which is recorded as a reduction in SG&A.

Within the international segment, the gross profit rate declined 20 basis points year-over-year, which was driven primarily by growth in our lower margin Five Star business. Partially offsetting this mix impact was strong margin growth in our Canadian business as strength in mobile computing and solid store execution increased gross margins.

Turning to SG&A, we were pleased to report that third quarter expenses only grew by 1% to $2.5 billion. The SG&A dollar growth was limited due to tight cost controls on variable spending items like labor, project costs, and outside services. SG&A also benefited from lower management incentive compensation when compared to the prior year, given our expected performance for fiscal ’11.

While we spent less in SG&A than we planned in the quarter, on a rate basis SG&A delevered 50 basis points versus last year. This deleverage was in line with what we would expect given the lower revenue in the quarter.

So when you bring it all together, the net result is that third quarter operating income increased 2% versus last year to $385 million, which represents a 10 basis point rate improvement.

Domestic operating income decreased 13 million and the operating income rate decreased 10 basis points. International operating income doubled to 45 million and the rate improved 70 basis points.

During the quarter, we also continued our share repurchase activity, acquiring $420 million or 11 million shares. This brings our year-to-date total to more than $1.1 billion, or roughly 31 million shares, which is nearly 7% of the Company. We estimate that repurchase activity had a $0.03 favorable impact to our third quarter EPS.

Given the share repurchased year-to-date, this fiscal year will be the second largest year of repurchase activity in the history of the Company. We continue to see share repurchases as an important element of improving our returns for shareholders over time.

With that overview of the third quarter complete, I would like to turn the discussion to our expectations for the balance of the fiscal year. One of the inherent challenges of having a fiscal quarter that ends right after the Thanksgiving holiday is that we are right in the middle of the holiday selling season and only have partial visibility to customer behaviors. Based on the shortfall to sales and earnings experienced in the third quarter combined with the current visibility we have to potential outcomes in the fourth quarter, we now expect annual diluted EPS in the range of $3.20 to $3.40 for fiscal 2011. This amount includes a roughly $0.12 impact of share repurchases made year-to-date through the end of the third fiscal quarter.

I want to be clear that this reduction in our guidance is primarily driven by lower expectations of comparable store sales in the domestic segment. We continue to expect to see improved gross margin rates and strong control over variable expenses in the fourth quarter.

So in closing, while we have seen a softer start in the top line than we had hoped, there is much holiday business that remains ahead. As always, we will continue to drive to the finish line for the year and we remain very encouraged by the positive elements from the first nine months of fiscal 2011, including strong margin expansion and SG&A management, and improved returns for shareholders via share repurchases.

From all of us at Best Buy, we wish you and your families a wonderful holiday season and a very Merry Christmas.

With that, Alicia, we are ready to take questions from the callers.

Question and Answer Session

Operator

Thank you, sir. As a reminder, ladies and gentlemen, if you have a question please press the star followed by the one on your touchtone phone. If you would like to withdraw your question, you can press star, two; and also if you are using speaker equipment, please lift the handset before making your selection.

And our first question is from the line of Gary Balter with Credit Suisse. Please go ahead.

Gary Balter – Credit Suisse

Thank you. Just a question on—you mentioned in the press release about the loss of market share. Could you discuss who you believe you lost that share to, and what you’re doing to regain it?

Brian Dunn

Sure, Gary. Good morning. Happy to take a run at that. As we discussed in our commentary around—or in my prepared remarks, there was an awful lot of activity at opening price points, particularly in home theater, and this was primarily at some of the large discounters. And this was a space, as you well know—our strategy is really focused on great name brands, the big sort of tier one, tier two name brands, at great prices. There was an awful lot of activity at the sort of tier three brands at opening price points, and (inaudible) that was a place we elected not to chase.

Gary Balter – Credit Suisse

So it was mostly in TVs, is what you’re saying? Or all in TVs?

Brian Dunn

Mike, do you want to add a little color to that?

Michael Vitelli

Yes, hi Gary. This is Mike Vitelli. I think it’s a little bit in television and a little bit in computing; and I think when we calculate our share—one point for everybody listening is there are categories like smartphones where our greatest growth is that is not in the calculation. It’s mainly the traditional CEIT, so that’s why it’s TV and computing is the big story—or the big difference. But let’s talk about what we’re comparing to.

You know, Best Buy is about latest and greatest; and last year that really played to that strength as we had the digital TV transition. We had the launch of LED, LCD televisions. We had the launch of Windows 7. We had record high shares in all of those areas, so we knew that we were going to get some of that decline coming off, and we saw a little bit there. And as Brian said, a little bit in entry level televisions and in entry level computing in November, where we have that promotion going on more actively in December. So in 32-inch televisions, we did that a lot last year around the Black Friday time period. This year, we didn’t do it then. We’re doing our—a lot of our 32-inch television promotions right now.

Gary Balter – Credit Suisse

And just following up on that market share question – you talked about how the TV sales, the high end isn’t really catching on right now. What does that imply for you in terms of your outlook for this month and for, I guess, January and February, a bit into next year. But what do you think is holding back that consumer from buying either the LED TV or the 3D TV? Is it pricing? Is it just not enough differentiation from what they could get on a cheaper LCD, and how are you adapting to that?

Michael Vitelli

Let’s break those two things apart. I think LED TV is actually selling quite well. It’s distribution has broadened and that’s part of our share going from, really, record high early adopter launch shares last year to a slightly more normalized but still well above our average TV—we’re well above our average TV share in LED TVs, so that’s going well.

The other thing I would say is going well is plasma is very, very strong. The growth in units in plasma was offset by their ASP decline. Your biggest ASP declines in the quarter and year-over-year are in plasma TV and large screen. In that case, we see growth in both of those places – growth in units of greater than 43-inch LCD TV and growth in units of plasma TVs. Their ASP declines are offsetting it, though, so we’re not seeing the growth there.

The place where you’re mentioning that we’re not seeing both the industry and our expectations in growth right now are 3D television and Internet-connected television. They’re a little bit slower than I think the industry wanted it to be. LED, I think, is just one of those that has to ramp up. There needs to be more content for it and we’ll be able to see a little bit more of that over time as their retail prices start to change.

Brian Dunn

3D, not LED.

Michael Vitelli

3D.

Brian Dunn

Gary, can I just add one thing? In my remarks, I mentioned Magnolia. We’re actually doing—we’re quite pleased in the high end. It is an adoption in the middle which we see as a next-year sort of value proposition for the consumers in the middle around 3D and IPTV.

Thanks for the question, Gary.

Gary Balter – Credit Suisse

Okay, thank you.

Bill Seymour

Next question, please.

Operator

The next question is from the line of Christopher Horvers with JPMorgan. Please go ahead.

Christopher Horvers – JPMorgan

Thanks and good morning. I want to step back and try to focus big picture. There’s been a constant back and forth with the Street, just people saying the product cycle’s weak and you’ve consistently countered that point. As you think about retail sales here and very strong sales in nearly every other category, as you think about those market share comparisons ahead, can you talk about your ability to really drive sales and margins simultaneously, and perhaps as you think about your top line outlook, is it really a function of labor markets getting better and driving a replacement cycle of what’s a relatively young stock of electronics in people’s homes, particularly TV and notebooks?

James Muehlbauer

Yeah Chris, it’s Jim. Why don’t I just take the first part of that and pull it apart a little bit? I think your commentary on the overall performance in retail so far this holiday season, you know, appearing to be relatively solid certainly is valid as we look across other retailers. I think part of that from our perspective is that we also had an anomaly last year in the performance in our business during Q3 in November, and specifically in December. We posted very strong comparable store sales gains. Most of the folks that are comping up against those numbers are comping up against much weaker comparisons, maybe even negative comparisons from last year. So as I look on a two-year basis, we’re not that far off of what most of retail is doing, maybe a little bit behind at this point in the holiday season.

Clearly like a lot of retail but in the CE space, there we’ve talked about headwinds from a macro standpoint around employment and housing and jobs for quite a period of time, so I don’t think there’s any new news in that phenomenon. What we have been focused don is all year long where we’ve seen products that have strong customer appeal, that are the latest and greatest, we’ve seen people opening up their pocketbooks; so whether it’s been the launch of new smartphones, the launch of the early changes to the gaming platforms we’ve seen, what we’ve seen in the tablet space overall – consumers are out spending in those categories. It’s just that the weight of those new things right now during the current year hasn’t been able to overcome the size of the core growth in our televisions and core notebook business overall.

So as Brian mentioned, our business is beyond just selling the hardware. You know, the reason we have the shares we do in the hardware business is because we’ve been able to find a way to make money around those transactions, and that’s certainly the evolution we’ve been making further into the Connected World and the strong gross margin performance we’ve driven as a result of that. But I think as we get into what the balance of this year looks like, we certainly expect to see the trends we started to see in Q3. How they will actually play out in Q4 – I mean, there’s a lot of business yet to come. But I think as we get into next year, I think what’s exciting from our standpoint is there’s interest there from consumers on the latest and greatest, but really they’re making trade-offs in their discretionary spending not only across CE but within CE categories where there are periods of time we may have historically seen them buying multiple large products in a year. They’re being more choosy at this point in time.

Christopher Horvers – JPMorgan

But as you think about that—I mean, your business mix is your business mix as it stands, and part of that comparison is you drew margin share so much kind of in the absence of Circuit City, so now you sit here—you know, the easy Circuit compares are behind you. You have other smaller growth electronics retailers starting to pick up space. So can you—you know, at the end of the day, can you really drive top line? As you think about the next three quarters, can you really drive—have sales expanding at the same time that you’re expanding your gross margin; or is the promotions on the 32-inch TVs and Free Phones every Friday right now really a reaction to a sales miss that surprised you?

Brian Dunn

Yeah, Mike, go ahead.

Michael Vitelli

The point on phones is the way the phone business is and the way that phones are sold as subsidized—like, free phone is a not a new phenomenon. What it is, is we’re being aggressive in the smartphone category, which is the fastest growing one. That is still a—while it doesn’t address the top line, the way it flows in, it’s very significant to our margins and you’re seeing that happening, and we believe that category is going to continue to grow and continue to grow aggressively, and we’re going to be a significant part of that. I think the smartphone and our Best Buy Mobile business in general is a significant trend that’s going to continue in the quarters that you described.

The other thing I think that we’re optimistic about is it’s clear that the tablet concept is very hot in consumers’ minds. It’s extracted a lot of early adopter dollars right now. A lot of those dollars are going outside of Best Buy at this minute because there’s a very limited number of manufacturers and products in that space. But that’s going to rapidly change as we head into next year, for the four quarters of next year, and that gives us a strong opportunity as when there’s a broad array of products and suppliers in this area, we do great.

Brian Dunn

And as far as television, I’ll just add – as we get into next year - you asked about the next three quarters – certainly over the next year you’re going to see the second and third generation of IPTV which we think will come out more appropriately featured and be more and more interesting to consumers.

Thanks for the questions.

Bill Seymour

Next question, please.

Operator

The next question is from the line of Mitch Kaiser with Piper Jaffray. Please go ahead.

Mitchell Kaiser – Piper Jaffray

Thanks, guys. Good morning.

Brian Dunn

Good morning, Mitch.

Mitchell Kaiser – Piper Jaffray

I was hoping you could talk a little bit just on your philosophy around opening price point products. I think last year you really chose to participate on the computing and TV category. Sounds like you’ve pulled back a little bit this year relative to last. And then if we stay kind of in this—you know, where the advance featured products are still going to be somewhat challenged, would you step on the accelerator on the opening price point, do you think?

Brian Dunn

I’ll—let me start with a frame here and then I’ll ask Mike to give a little detail. I mentioned in our remarks, my prepared remarks, that we were not focused on that opening price point. We certainly have the opening price point represented in our store and will continue to have that kind of value represented in our store. We chose not to lead with it, Mitch, because we have a—I have a strong view that where we really add value is with those great name brands and that sort of latest and greatest technology at a great price that our people can help you put together better than anyone. And Mike, perhaps you want to speak a little bit on how we’re thinking about future promotions?

Michael Vitelli

I think in TV—I’d mentioned it earlier but it’s worth repeating. We did our entry level 32-inch promotion in November. This year we’re doing it in December. We’re aggressive with that right now. On the computing side, we’ve made price adjustments in the third quarter and into the fourth quarter to be more aggressive because the consumer is definitely showing a propensity at the low end. We look at it as our share, if there was any loss in computing, it was in the below $400 range where we’re trying to make sure we have more competitive offers there.

Brian Dunn

Yes. And Mitch, if I could just—you asked about our philosophy. We’re absolutely interested in increasing our presence in lower price points. We’re always going to be mindful of profitability. You’ll see us leverage our presence online to do some of that sort of hot price points; and you’re going to see us do what we do very well. We’re going to implement promotions to drive traffic to our stores, to our online channel, to our phone channel.

Mitchell Kaiser – Piper Jaffray

And then just as you think about—you mentioned the weakness in IPTV and 3D. Is it more a pricing issue or is it a customer perception issue, or is it a combination of both? How should we think about that? Thanks.

Brian Dunn

I think—I’ll take a stab at this, Mike. I think there’s a couple of things. I think there was confusion about 3D early. It was a little short on content. I think as this fall now, we’ve had some big gaming titles that have come out with 3D. More and more cinematic releases are coming out in 3D. I think 3D will become top of mind as an important feature for television as we get into next year. And as far as IPTV, I think it’s still really new and I think the idea and the notion of it is still new, and I don’t know if it is enough by itself to get people off the couch to go buy a new TV as we sit today.

Michael Vitelli

I think that’s right. I think it’s both of those areas; and I also think the reality is, again, the strength of the tablet category has captured mind share and wallet share of early adopters of new technologies this year. I think that’s—it’s hard to suggest that a tablet is taking TV share. It’s not because it’s doing the same thing. It’s a mind and dollar placement.

Brian Dunn

This isn’t a year where people are going to come out and buy a new television and a new computer or tablet.

Thanks, Mitch.

Bill Seymour

Next question, please. Thanks.

Operator

The next question is from the line of Matthew Fassler with Goldman Sachs. Please go ahead.

Matthew Fassler – Goldman Sachs

Thanks a lot, and good morning. If we could just get a little more clarity on how you see some of the moving pieces playing out during the fourth quarter. You often give us sales guidance as well as earnings guidance. I didn’t see that here. What I hear from you is perhaps a little more of a promotional stance on television as you talked about moving the lower price promotions into December. Presumably some of the sales weakness as well is baked into that guidance; but any color you could give us on the contours of those expectations would be terrific.

James Muehlbauer

Yeah Matt, it’s Jim. Thanks for the question. Given where we’re at in the quarter and given the predominance that the month of December has in the quarter, we decided it would be more useful that—we’ll wait to get through December sales and we’ll do our December sales release, and then we’ll give color and context around what we actually see. But as we look at what the potential range of outcomes could be through Q4, there are multiple scenarios that are playing out in that new guidance range. What I would tell you is that the primary driver in the range is really what does comparable store sales look like through the holiday season. There are some variables we have in that, both plus and minus, on the margin standpoint; but the key lever I’m looking at in that sales range—I’m sorry, in that EPS range, is what’s the top line look like overall.

Matthew Fassler – Goldman Sachs

And if I could just ask as a very quick follow-up to that – as TV pricing has started to come down, there’s been some discussion of how elastic this category is. Can you give us your updated thoughts on that? It sounds like it might be elastic to some degree, but perhaps in some price points that you chose not to play in in the third quarter. But as you take a high level look at the impact of vendors lowering prices, what do you think it’s doing for the market?

Michael Vitelli

What we’re seeing is plasma televisions had pretty significant price declines year-over-year, probably in the 15% range, and dramatically changed their unit take rate slightly higher than that, so it offset gave us some positives. So there is some elasticity at the high end. We see that. I will tell you, though, at the highest end there’s been less than we’ve seen in the past, and I think that’s a comment on the consumer in general – is that we’ve seen at the high end, a price change doesn’t have the same impact as it would have had a year or two years ago.

Matthew Fassler – Goldman Sachs

Thank you so much, guys.

Brian Dunn

Thanks, Matt.

Bill Seymour

Next question, please.

Operator

The next question is from the line of David Strasser with Janney Montgomery Scott. Please go ahead.

David Strasser – Janney Montgomery Scott

Thank you very much. Going back a little bit more to the market share, and I guess it’s somewhat related—it’s been touched on a bit already on the call, but when you look at the market share, do you worry that maybe that the promotional calendar, or your promotional strategy, was too focused around wireless, particularly at this time of year? Like walking through the stores particularly around Black Friday weekend, it’s a relatively tough sell; yet it seemed that on TV and circulars, it tends to be highly focused on that category. And do you think you lost message elsewhere? And just as a follow-up to that, too, does it make you think a little bit about the wireless strategy, about rolling out the Best Buy Mobiles quicker to try and maybe differentiate those offerings a little bit?

James Muehlbauer

Yeah, David, we certainly look at the wireless activity—at the way customers have been responding to that for a period of time. And we have been, obviously, moving very quickly in that space, both within our store-within-a-stores within Best Buy, whether it’s expanding square footage that we dedicate to the wireless space, and as you know we’ve ramped up the number of standalone stores we have in that space. And as tablets come on, that category from a mobility and connectivity standpoint even gets more interesting going forward. So we have been accelerating that space, and as Brian mentioned in his comments, we’ve got a long way to go from a market share standpoint. So that business is going to continue to be very exciting for us.

As far as to your question around how do we look at the promotional activity in Q3, specifically in November, wireless versus other categories, I think customers who shop with the Best Buy experience are accustomed to seeing a wide variety of things featured during that period of time, and customers obviously come in with different needs today. So from our lens, I don’t think we overemphasized the wireless category at the expense of our television and our computing business. To Brian’s point, we felt actually very good about the offers we had out there in both of those categories overall based on who our customer is and how they shop us.

One of the great benefits that we have given the reward zone database is that we’ve been able to track customer behaviors on Black Fridays for years and understand which customers just shop us that day to cherry-pick and actually don’t come back into the model overall. So what we’ve spent more of our time doing is putting our promotional dollars against customers and against experiences where we add the most value, so whether that is inviting our reward zone silver customers to promotional events in advance of Black Friday and using that energy around better experiences for those best customers, or partnering with our vendors to come up with offers on Black Friday that really demonstrate what the best of we do together versus, I would say, driving a higher top line with actually less profitability. So we know that top line—in some cases when they’re in third tier type products, does not translate into more customer loyalty, does not translate into more profitability for our business. So it’s always about balancing where we put the promotional effort versus the long-term strategy of the Company.

Brian Dunn

And that balance, David – this is Brian – is the tightrope we always walk. And you’re asking what is a very good question when we’re right in the middle of the game. We’ll have a much better understanding as we get through December and into January, and I think we’ll be able to provide a little color then.

David Strasser – Janney Montgomery Scott

Fair enough. Thank you.

Bill Seymour

Next question, please. Thanks.

Operator

Our next question is from the line of Brad Thomas with Keybanc Capital Markets. Please go ahead.

Bradley Thomas – Keybanc Capital Markets

Thanks. Good morning. I wanted to follow up on the SG&A. Very well controlled during the quarter. As you as a company evolve from being more of a growth company several years ago to being more expense and return focused now and more margin focused, how should we think about SG&A growth as we look ahead to 2011 in light of perhaps some of these more challenged top line trends?

Brian Dunn

I have to jump in. We sort of reject the notion that we’re not a growth company as well. You’re absolutely right that we’re focused on expanding our margin rate and extracting value for what we’re able to do for customers and actively pursuing businesses where we can make a difference and are margin-rich. But we absolutely see ourselves as a growth company.

James Muehlbauer

And certainly the investments that we’ve made, Brad, have focused on areas where we can drive profitable growth, so we’ve been spending more money in categories like mobile phones, whether it’s in-store or outside of the store. We’re going to continue to spend money where the customer is going in those spaces. The good news is from an SG&A standpoint, we spend on average a little bit more in transacting that business with customers, but the returns we get from a margin standpoint are also much greater, so that’s a great trade-off overall.

As we look at the portfolio certainly going forward, we’re always making adjustments to the operating model; and when I look at the expense profile for this year with expenses being up—you know, planned for the year 5ish, a little over 5% versus the trajectory we’ve been on historically, it’s a much, much lower run rate that we have experienced overall. So as we plan expenses in the environment, you know, we’re looking at the levers around where is the customer going, what type of support do we need to provide from an in-store experience and labor model around that; and then if we see parts of the portfolio that aren’t performing at the same level we anticipated, we have the ability to dial back those investments in-store as we go forward.

So we’re not getting into guidance for next year yet, but certainly every year when we set expenses, we’re mindful of the environment that we’re moving into, and I think you saw us take a big step down over the last year. To Brian’s point, we are going to continue to invest expenses in places that are good for our shareholders, and we’re not bashful about doing that at all; at the same time, harvesting expenses from areas that aren’t delivering the same levels of returns that they historically did.

Brian Dunn

That’s right. You’ll also see us, Brad—while I sort of emphatically state that we’re a growth company, you’re also going to see us—we have an awful lot of investment deployed that we should be able to leverage and will leverage benefit from over the quarters and years ahead, and you will see us continue to be focused on returning excess cash to our shareholders.

Thank you.

Bradley Thomas – Keybanc Capital Markets

Okay, thank you Brian and Jim. If I could just ask one follow-up question on the inventory commentary that you had earlier, Jim – could you maybe just talk a little bit more about the leverage that you’re able to pull above and beyond just getting a bit more promotional with the slightly elevated inventory levels that you have going into the holiday season?

James Muehlbauer

Yeah I mean, Brad, we’re focused on inventory at a moment in time here in Q3 with the enormous amount of volume we have in Q4. So we run a very high velocity business during this time of year, and even if you go back two years ago when the environment changed dramatically, we actually—we were at peak inventory levels before the holiday season when the environment changed. We were able to manage and navigate through that successfully with our vendor partners and our customers, so looking at what inventory trends are sitting there today, more specifically what the specific inventory is, we feel that we’re in a good position to move that inventory through the balance of Q4 and actually moderate purchases of future inventory. A lot of that stuff that’s on our balance sheet today, 30 days from now it will be gone. So we’re really talking about what’s our reorder pattern going forward.

Bradley Thomas – Keybanc Capital Markets

Great. Thanks Brian. Thanks Jim. Best of luck here for these next couple of weeks.

James Muehlbauer

Thank you very much.

Bill Seymour

Thank you. Next question, please.

Operator

The next question is from the line of Greg Melich with ISI. Please go ahead.

Greg Melich – ISI Group

Thanks. I want to talk about the traffic side of it. I think you’d mentioned that ASPs were down a little bit or transaction size, so traffic may be running down 4%. How is that trending and what do you think is driving that, and how do you actually get that to improve? And one thing that did look better was service – I’m just curious, what was driving services in the quarter to at least do better than the Company?

Brian Dunn

Greg, you got garbled there at the back end. Can you restate the question for me, please?

Greg Melich – ISI Group

On the services side, what helped services do better than the rest of the Company? What area was strong?

Michael Vitelli

Greg, this is Mike Vitelli again. On the traffic side, I would say the biggest portion of the traffic declines are consistent with the story we’ve been telling for several years now. Packaged media sales have declined in units and that’s a significant part of the overall traffic and has declined. And a little bit was in the television and computing area that we just discussed, so that wasn’t a new or big story from what we described earlier. Our close rates are improving, which is improving our overall transaction count, which is better than the traffic move. And I think to your point, what’s happening in that close rate in addition to the individual units themselves is the complete solution. So we’re seeing, whether it’s computing or home theater, increased attachment rates at every price band of television and every price band of computing in Geek Squad Black Tie Protection. And that has been a significant part of the service growth as our close rate and our complete solution, the two biggest categories have improved.

Brian Dunn

I’d also just add—reiterate, the terrific—on top of everything Mike just said, the terrific job our sales associates are doing in presenting the value that those plans represent to our consumers.

Bill Seymour

Thank you. Next question please.

Operator

Our next question is from the line of Mike Baker with Deutsche Bank. Please go ahead.

Mike Baker – Deutsche Bank

Thanks. Two questions – one, on your fourth quarter outlook, wondering how you’re balancing what sounds like being more promotional with, as I look at it, you have a more difficult comparison. So I just want to understand how those play into your range of outcomes for the fourth quarter. And then following up, Brian, on your point of stating you’re a growth company, is that a square footage growth company? I guess what I’m getting at is what do you see as your square footage expansion over time, domestically but perhaps more importantly overseas? Or is that growth more of growing the existing assets, growing margins, growing earnings perhaps even through buybacks, et cetera?

Brian Dunn

I’ll answer that. First, I’m going to go to the first part of the question. It is about profitable growth. It is about growth in connections, and if you want to sort of back up and look at us historically, for many, many years we were a strong product-centric company. Then we moved into an area of customer-centricity, very focused on our customer. You should think about us taking the best elements of both and moving them into this Connected World. Best Buy Mobile is the example we cite most frequently because it’s the most developed. You should think of it as profitable growth around connections and geography, but primarily driven by profitable growth with connections.

James Muehlbauer

Yeah and Mike, just to round that off, talking about square footage. We’ve talked for a long time about the level of square footage growth during the next five years in our traditional big box model being way different than it was the previous 10 years. So that’s not a surprise. Where you will see us continue to invest in square footage is where it makes sense in our connectivity businesses, like our Best Buy Mobile standalone stores. So when you pull apart that square footage story, it’s not the big box retailer continuing a run rate of new stores expansions like we’ve done historically. It’s leveraging the installed base of stores that we have; to Brian’s point, investing in the growth that we can drive in those stores through connections, and then building our square footage where appropriate to meet customer needs in other spaces where those big box stores don’t fit.

Brian Dunn

And as we get to year-end, we’ll be updating you on how we’re thinking about that.

James Muehlbauer

Second part of your question around the outlook for the quarter, as I mentioned, fourth quarter—as I mentioned earlier, we’ve got a variety of scenarios that play out. One thing you shouldn’t take away from that is that we’ve seen the results in the third quarter and now we’ve pulled the massive promotional lever and are going to drive the top line at the sole expense of margin. That’s not what we’re talking about here. What we’re doing, as we always do in every holiday season – we’re playing out our plans and adjusting to the market as we see it. The promotional activity that Mike predominantly talked about earlier was stuff that we already had planned in the mix for the most part for Q4, versus how we want to spread the TV promotions between Q3 and Q4.

When you helicopter back all the way up and kind of set context for the year, we set out this year to expand our margins through changes in the operating model and to grow our top line with a little bit of market share growth. What we’re learning now as we’ve seen the customer play out is that our top line growth assumptions earlier in the year turned out to be too aggressive based on the environment that we see for demand, specifically in the TV industry and the computing industry overall; and we’re getting the activity that we wanted to get out of the margin expansion overall. So as we look structurally going forward, given where our model adds the most value per customers in representing those new launches of technology and those top tier brands, we feel great about the position that we’ve built around that and our ability to drive even more profit out of that. We find ourselves just more challenged in the top line from an industry standpoint than we set out, especially when a lot of that growth that did happen in the computing space is happening in a form factor that we don’t participate in proportionally as we do in the rest of the CE business.

Thank you for your questions, Mike.

Bill Seymour

Yeah, thanks Mike. This will be our last question, Operator. Thank you.

One more question, please.

Operator

Okay. The next question is from the line of Anthony Chukumba with BB&T Capital Markets. Please go ahead.

Anthony Chukumba – BB&T Capital Markets

Good morning. I just had a question related to the markets—the tough market share in video gaming. I mean, I certainly understand some of the market share losses in the TV category, some of the slowness in the TV category in the way of position there; also in PCs where not really chasing that opening price point. I guess I’m just a little confused in terms of video games because that doesn’t really seem—I mean, was there a lot of promotional activity? What do you attribute that to, because it seemed like you had the right product, you’re now in the used video game business, you reset a number of your stores to emphasize that category more and I’m just sort of wondering, kind of post mortem, why didn’t you get the market share that you thought you were going to in video games?

Michael Vitelli

This is Mike Vitelli again, Anthony. The second part of your question is we’ve just started what we’re doing with trade-in and used games. We’re very pleased with the reaction that we’re getting in the about 800 stores that it’s in. And the stores where we actually have trade-in counters inside the gaming department, which is a few hundred, the exchange rate is much, much higher than the stores that don’t have it, so that’s something we’re going to continue to expand. So we’re pleased with that and getting us into that part of the business that we virtually have zero in today.

As far as gaming in the third quarter, our hardware was good; our software was softer than we would have liked, and that’s basically because of the titles that were launched in that time. Last year at this time we were into a lot of Wii business and that kind of family category where we did strong in. We were lapping that against titles that were much more core gamer, which is the share and the business that we’re trying to go after with the trade-in and used. So that’s what happened in it, but we’re optimistic and very aggressive in what we’re doing in that space going forward.

Brian Dunn

We also know, just to add, how important the trade-in value proposition to that core gamer, and that is an area and an opportunity for us that we’re very enthusiastic about for next year.

Thank you for the question.

Anthony Chukumba – BB&T Capital Markets

Thank you.

Bill Seymour

Okay, that was the last question, Operator.

Operator

Okay ladies and gentlemen, that’s all the time we have for the question and answer session. I will turn it back over to Mr. Seymour for any closing remarks.

Bill Seymour

Thank you Alicia, and thanks to our audience for participating in our third quarter earnings conference call. As a reminder, a replay will be available in the U.S. by dialing 800-406-7325 or 303-590-3030 internationally. The personal I.D. number is 4387850. The replay will be available from 11:30 a.m. Central time today through December 21. You can also hear the replay on our website at For Our Investors.

Thank you for your attention. That concludes our call.

Operator

Ladies and gentlemen, this concludes the Best Buy Third Quarter FY11 Earnings conference call. You may now disconnect. Thank you for using AT&T Conferencing.

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