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Best Buy Co (NYSE:BBY)

Q2 2015 Earnings Conference Call

August 26, 2014 08:00 ET

Executives

Mollie O'Brien - VP, IR

Hubert Joly - President & CEO

Sharon McCollam - CAO & CFO

Analysts

Simeon Gutman - Morgan Stanley

David Schick - Stifel Nicolaus

Alan Rifkin - Barclays Capital

Aram Rubinson - Wolfe Research

David Magee - SunTrust Robinson Humphrey

Mike Baker - Deutsche Bank

Brian Nagel - Oppenheimer

Operator

Welcome to Best Buy’s Second Quarter Fiscal Year 2015 Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to Mollie O'Brien, Vice President, Investor Relations.

Mollie O'Brien

Good morning and thank you. Joining me on the call today are Hubert Joly, our President and CEO; and Sharon McCollam, our CAO and CFO. As usual, the media will be participating in this call in a listen-only mode.

This morning's conference call must be considered in conjunction with the earnings release that we issued earlier today. They both contain non-GAAP financial measures that exclude the impact of certain business events. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons, but should not be considered superior to as a substitute for and should be read in conjunction with the GAAP financial measures for the period. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning's earnings release.

Today's earnings release and conference call also include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, growth plans, operational investments and prospects of the company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and SEC filings for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

In today's earnings release and conference call, we refer to consumer electronics or CE industry trends. The CE industry, as defined by the NPD Group, includes TVs, desktop and notebook computers, tablets not including Kindle, digital imaging, and other categories. Sales of these products represent approximately 65% of our domestic revenue. It does not include mobile phones, gaming, movies, music, appliances or services.

I will now turn the call over to Hubert.

Hubert Joly

Good morning everyone and thank you for joining us. I will begin today with an overview of our second quarter results and then update you on the progress we’re making against our Renew Blue priorities. Then I will turn the call over to Sharon for additional details on our quarterly results and commentary on our financial outlook. So first, our financial results. In the second quarter we delivered $8.9 billion in revenue and $0.44 in non-GAAP diluted earnings per share versus $0.32 last year. The ongoing benefits of our Renew Blue cost reduction and other SG&A cost containment initiatives drove these better than expected results.

On the top line as expected sales in the NPD track consumer electronics category declined 2.5% in-line with our domestic comparable sales decline of 2.0%. Like other retailers and as reflected in this quarter’s performance we continue to see a shift in consumer behavior. Consumers are increasingly researching and buying online. As a result traffic to our brick and mortar stores continue to decline and yet our in-store conversion and online traffic continue to increase due to the execution of our Renew Blue strategy which is in direct alignment with this shift. Our Renew Blue strategy is designed to grow our online business, enhance our in-store customer experience and leverage out multi-channel capabilities or deliver to our customers great advice, service and convenience at competitive prices in the channel they want to be served. Each of these initiatives contributed to our second quarter results.

And so I’m pleased to update you today on the progress we’re making against our renewable transformation road-map which is built around following areas. Merchandising, marketing, online, stores, Geek Squad services, supply chain, cost structure and employee engagement. So first of these areas is merchandising. We believe we’re raising the bar in our retail channel by continuing to roll out compelling and differentiated customer experiences across major categories such as appliances, home theater and mobile. In the appliance category we opened 18 new Pacific Kitchen & Home stores within a store on our on track to end the year with approximately 115 stores versus 67 last year.

In the Home Theater category we opened seven new Magnolia design center stores within the store and our on track to the end the year with approximately 50 stores versus 33 last year. Both of these premium stores within the store concepts continue to outperform our expectations. We also rolled out over 800 Samsung and Sony Home Theater stores within a store during the quarter. This represents the first major merchandising transformation in Best Buy’s home theater department in almost 10 years. We believe that home theater transformation further solidifies our position as the destination for customers to discover and interact with industry leading home theater technology particularly ultra-high definition or 4k TVs and we’re encouraged by the early consumer response to our expanded ultra-high definition assortments.

We’re excited about the future of this technology even though we believe that the impact to our business this year will be limited.

In the mobile category in the second quarter we began offering customers the option to purchase installment billing plans with the Top 3 U.S. carriers. While mobile phone demand in the second quarter including year-over-year trading volume declined as customers wait for highly anticipated new product launches the penetration of installment billing progressively increased during the quarter and we believe we’re well-positioned to capitalize on the new products when they are introduced.

In the area of marketing, we made progress in our evolution from analog in mass to digital and targeted communications with our customers. During the quarter we continued to shift our marketing investment dollars towards digital media campaigns and away from print and television advertising.

We’re also leveraging our Athena customer database to pilot new targeted email campaigns, we’re in the early stages of being able to personalize marketing messages to individual customers which we view as a 2 or 3 year journey. We do however expect to see gradual and incremental improvements in marketing effectiveness every quarter our customer insights improve and our new personalization capabilities are rolled out.

In our online business in the second quarter we continue to leverage our ship from store, digital marketing and enhanced website functionality to drive a 22% increase in domestic comparable online sales. Similar to the first quarter ship from store represented over half of the online sales growth. We’re also using ship from store to drive gross profit improvements on our clearance and end-of-life inventory by exposing it not only to our retail customers but also to our online customers. We also launched several customer facing improvements on the website to drive increased engagements in a more seamless online shopping experience including number one a new global homepage that is easier for customers to navigate, number two significantly richer visual and editorial content for the ultra-high definition, digital imaging in the health and wearables category.

Number three, new text messaging options for order confirmation and delivery that are garnering significant customer adoption and number four visibility to customers Geek Squad purchases instead of their My Best Buy accounts on bestbuy.com.

As we head into the back half of the year we will continue to launch online shopping experience improvements, such as additional product category we designed, expanded wish list capabilities and improved checkout process in an expanded and more inspirational holiday gift center.

Of course we will also be continuing a significant behind the scenes work on the transformation of our e-commerce platform. In our retail stores the field and store structure changes we implemented last quarter are to-date generating results in-line with our expectations. We have consolidated and simplified the field organization, we organized to help drive local strategies and reduce the number of management level roles.

In total what our year-over-year retail labor cost are now lower, other investment in customer facing labor including vendor funded labor has increased. While we still have much to do in reinvigorating the customer experience, we are making progress and are pleased to see our in-store experience contribute significantly to the 400 basis point improvements in our overall NPS or Net Promoter Score that we saw in the second quarter.

In our Geek Squad Services business we continue to increase our net promoter scores and drive down cost to operational efficiencies. We also continue to focus on refining our existing service offerings, improving the merchandising of our services, and building new offerings that meet the needs of customers in the context of today’s rapidly evolving technology environment.

In our supply chain we continue to leverage and transform our distribution and fulfillment capabilities. In May, we implemented significant changes to our distribution operating model that aligned work schedules with customer demand including expanding our days and hours of operation. This implementation was seamless and we’re now able to replenish inventory to our stores and deliver to our online customers faster which is both a competitive top line and improved customer service opportunity particularly in advance of the holiday season. We also continue to leverage our ship from store capability. Not only does it continue to be a significant contributor to our online sales growth, it has also been expanded to drive increased sales out of our retail stores.

Let me explain. In the past when blue shirts were looking for a product that was out stock in a store the system they used could only see a variable inventory in the individual store and a distribution centers. Today using the exact same system the Blue Shirts can now see all available inventory in our distribution centers and our 1400 stores. As a result our Blue Shirts are gaining increased confidence in being able to serve their customer and drive incremental sales.

In the area of returns, replacements and damages we continue to make progress in the second quarter including launching a company-wide awareness program for our Blue Shirts, our Geek Squad agents and our corporate support teams. This program is focused on raising awareness of the operational behaviors that are contributing to the over $400 million in annual losses that we have historically been incurring. The program is also rolling out new operating procedures to reduce these losses. These procedures include number one setting the right product the first time, number two, enforcing the company’s return policy and increasing the frequency of exchanges. Number three inspecting return inventory, number four, culturally resetting in-store perception of the value of return inventory and number five exposing this inventory to our online shoppers.

As we have consistently said this online exposure is critical to optimize margin recovery because the majority of open box inventory is searched for and purchased online. And in the second quarter we began offering Geek Squad certified open box inventory online primarily in the computing and tablet categories. In the fourth quarter as new systems are implemented we will begin offering additional open box inventory that is in excellent conditions which represents the majority of our open box returns.

We’re seeing early sales in margin improvements from the roll out of these new procedures. We expect to see stronger results as the program matures and we improve the online searchability and overall multichannel customer experience over the next several quarters. Relating to our overall cost reduction initiatives in the second quarter, we eliminated an additional $40 million in annualized cost taking a total renewable cost reductions to $900 million towards our target of $1 billion.

Now as it relates to our international segment while we have made considerable progress in our Renew Blue cost reduction initiatives we have substantial work to do on top line stabilization. To address this we’re following the same kind of Renew Blue transformation roadmap that we’re pursuing in the U.S. So to recap, while the other consumer electronics environment continued to be soft, the second quarter ended better than expected primarily due to strong expense control.

In addition we made significant progress against our Renew Blue priorities and clearly demonstrated our increasing ability to tightly manage what we can control. And looking ahead our goal is to continue to create a significantly differentiated multi-channel customer experience such that every interaction customers have with us regardless of channel makes them a promoter of the Best Buy brands.

In support of this we will be intensifying our investments in customer facing initiatives across both channels in the back half of the year and Sharon will elaborate on this later in the call. In fact I will now turn the call over to Sharon to cover more details on our second quarter financial performance and our financial outlook.

Sharon McCollam

Thank you Hubert and good morning everyone. Before I talk about our second quarter earnings results versus last year I would like to talk about them versus our expectation. As Hubert said during the quarter we continued to make meaningful progress against our Renew Blue priorities which resulted in a better than expected non-GAAP operating margin rate of 2.9% and non-GAAP diluted earnings per share of $0.44. These results versus our expectations were primarily driven by stronger SG&A cost containment initiatives, greater promotional effectiveness and better performance of our new credit card agreement.

I will now talk about the second quarter results versus last year. Enterprise revenue declined 4% to 8.9 billion. Enterprise non-GAAP diluted EPS increased 38% to $0.44 primarily driven by the flow-through of our Renew Blue cost savings and other cost containment initiatives. As expected the positive impact of these cost savings were partially offset by the negative impact of lower volume, higher year-over-year sales in the lower margin gaming and computing categories and the previously communicated negative impacts from our credit card agreement and structural price investments.

Domestic revenue of 7.6 billion declined 2.4% versus last year. This decline was primarily driven by a comparable sales decline of 2% and a revenue decline of 20 million or 25 basis points due to the less favorable economics of the new credit card agreement. Domestic, comparable online revenue however increased 22% to 581 million due to substantially improved inventory availability made possible by the chain wide roll-out of shipped from store last January. A higher average order value and increased traffic driven by greater investment in online digital marketing.

As a percentage of total domestic revenue, online revenue increased a 160 basis points to 7.7% versus 6.1% last year. From a merchandising perspective growth in gaming, computing appliances and televisions was more than offset by declines in other categories including mobile phones, tablets and services. Services comparable sales declined 8.9% primarily driven by lower mobile repair revenue due to our success in decrease claim severity and frequency. Lower attach rates and higher mobile warranty premium costs which translate into lower commission revenue. These were partially offset by a factory warranty recovery related impact that occurred in Q2, fiscal ’14 that did not recur this year.

International revenue of 1.3 billion declined 12% versus last year. This decline was primarily driven by a comparable sales decline of 6.7%. The negative impact of foreign currency exchange rate fluctuations and the loss of revenue from store closures in China.

Turning now to the gross profit, the enterprise non-GAAP gross profit rate for the second quarter was 23.1% versus 23.7% last year, an expected decline of 60 basis points. The domestic non-GAAP gross profit rate declined 50 basis points to 23.4% versus 23.9% last year. This decline was primarily due to a mix shift into the lower margin gaming and computing categories, structural investments and price competitiveness particularly in accessories a 20 basis point negative impact related to the less favorable economics as a new credit card agreement.

These declines were partially offset by an increased mix of higher margin large screen television and the realization of our Renew Blue cost reductions and other supply chain cost containment initiatives. The international gross profit rate was 21.1% versus 22.3% last year. This 120 basis point decline was primarily driven by our Canadian business due to increased promotional activity and an increased mix into the lower margin gaming category.

Now turning to SG&A, enterprise level non-GAAP SG&A was 1.8 billion or 20.2% of revenue versus 21.5% last year, a decline of a 189 million or a 130 basis points. Domestic non-GAAP SG&A was 1.5 billion or 19.9% of revenue versus 21.3% last year a decline of a 147 million or a 140 basis points. This rate decline was primarily driven by the realization of our Renew Blue cost reduction initiatives and tighter expense management throughout the company.

International non-GAAP SG&A was 290 million or 22.1% of revenue versus 22.3% last year, a decline of 42 million or 20 basis points. This rate decline was primarily driven by Renew Blue cost reductions and tighter expense management in Canada and to a lesser extent China.

Merchandize inventories increased a 146 million or 2.7% to 5.6 billion primarily due to deliberate investments in high demand back to school computing inventory and inventory to support our over 800 Samsung and Sony Home Theater stores within a store. As we enter the back-half we expect this increased level of inventory to continue in order to support our ultra-high definition TV and Pacific Kitchen & Home expansions as well as our initiatives to reduce retail out of stocks.

In our consumer surveys one of the top reasons customers say that they do not buy when they are in a Best Buy store is that the product they are looking for is not in stock in that store at that time.

Now looking forward to the back half, as Hubert remarked earlier, industry wide sales are continuing to decline in many of the consumer electronics categories in which we compete. We’re also seeing ongoing softness in the mobile phone category ahead of highly anticipated new product launches. Therefore absent any changes in these declining industry trends and with limited visibility to new product launch quantities. We continue to expect comparable sales to decline in the low single digits in both the third and fourth quarter.

From an operating income rate perspective in the back half we’re expecting the following business drivers versus last year. One, a similar promotional competitive environment but with better promotional effectiveness internally. Two, a greater mix of online revenue that will put pressure on the overall operating income rate, three, continued industry softness and higher promotionality in Canada and China; and four, a net positive impact from our Renew Blue cost reductions as they will more than offset our investments in structural pricing, the new credit card agreement and the new incremental investments we’re making in the back half of the year totaling 40 million to 50 million or $0.07 to $0.09 per diluted share to support the customer facing initiatives that Hubert referenced earlier.

This 40 million to 50 million will breakdown by quarter as follows, 10 million to 15 million in Q3 and 30 million to 35 million in Q4. As a result of all of these business drivers and particularly in-light of the fixed cost deleverage that will accompany an expected low single digit comparable sales decline, we’re expecting the non-GAAP operating income rate in Q3 and Q4 to increase in-line with the year-over-year improvement that we saw in the first half.

Additionally in the back half the estimated diluted earnings per share impact of the discreet tax items that we discussed last quarter will continue to be in the ranges of flat to negative one in Q3, and negative $0.09 to $0.10 in Q4.

With that I will now turn the call back over to the operator for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Simeon Gutman with Morgan Stanley.

Simeon Gutman - Morgan Stanley

Just a couple of questions. First on the top line I think you called out TVs both in the printed release and in the script and then there should be product launches on the mobile side and those are two pretty important categories between TVs and mobiles. And so we appreciate the status quo view on the top line but shouldn't one look at I guess some of these trends and have a little bit more of a constructive outlook in the back half of the year?

Hubert Joly

I think anyone can have their view on the future. I think we have shared ours this morning. We have a backdrop of a consumer environment that’s a bit fragile. We see the trends, of course in our space you always have ups and you always have downs so the net effect is what you’ve to look at. Specifically as it relates to TV while we’re excited by the new technology and the customer response I think we all have to appreciate the fact that the actual impact this year will still be relatively limited before we ramp up into next year. So that’s something take into consideration. Of course as it relates to mobile. The uncertainties around the quantities you get at this point in time and frankly we have little visibility, a limited visibility at this point in time. So I think you can develop the view that there is upside but we want to highlight that there is some factors that limits the potential top line in the back half of the year. But again Simeon, forecasting is difficult so we shared our view and we respect yours.

Simeon Gutman - Morgan Stanley

And then my follow-up is regarding the intensifying of investments. Can you hash out whether that is how you are reacting to some to some opportunity that you see or is something changing that is unfavorable? Because I think the topline outlook or picture that we see doesn't seem so different from the way that it was laid out or forecast by you and so what is prompting the change?

Hubert Joly

I think what’s prompting change is from a strategic direction standpoint there is no chance. Meaning that our moves completely consistent with the roadmap that we have outlined over the last couple of years and certainly this year. I think the investments are a combination of us seeing the potential of some of the initiatives we’re working on as well as the need to be in the game for some of these initiatives. So no dramatic change but increasing confidence and sense of reality around these opportunities. I don’t whether Sharon McCollam you want to add any color to this but that’s what I would say.

Sharon McCollam

Absolutely, I will follow-up on what Hubert said. There are areas where as you guys know we’re seeing substantial improvements in the way our business is operating that we believe that we can accelerate faster. This is really about intensifying and accelerating our efforts into this year. They surround things that you would completely expect like improved shipping times to our customers, better fulfillment, customer facing initiatives in our stores. Some online investments that are highly competitive that we would like to not go into great detail here today. But they are all surrounding the customer and things that actually are facing the customer which we think is going to be very important and to your point, Simeon about the possibilities for Q3 and Q4 we think these will competitively position us much stronger as we go into the back half especially Q4.

Operator

And we will move on to our next question from David Schick with Stifel.

David Schick - Stifel Nicolaus

Could you give us any sense of what these capabilities like ship from store to the customer at home or that inventory lookup that you talked about with associates in stores and we have certainly experienced that when we are in stores, the frustration in the past with the associate's ability to say yes right now. As you look at turning that on, how much do you think you gave up an opportunity over time and in particular last year's fourth quarter?

Sharon McCollam

Sure. David, I’ve to believe that it is an important number. First let’s just ground ourselves on ship from store, that aspect of our business right now which was over half of our online growth this quarter. In the store what we’re seeing with that number is we launched it late April and the stores are just now starting to use it. We’re seeing the numbers increase each day and we’re looking again in these customer facing initiatives I was talking about, we’re looking at some opportunities there to make that even a more efficient process once they found the inventory and getting it to the customer faster.

So I think that last year we didn’t have it at all. Similar to ship from store, you’re seeing you know what’s doing for us obviously. In the store side of it, they did not have this capability and then in ship from store when you think about the back half of last year, if you recall in Q2 and Q3 we really only had 50 stores that were shipping, October last year we went to 400 stores shipping and then in January of ’14 this year we went to -- our all 1400 stores. So in the back half we also expect the ship from store capability to benefit us in three ways. One of course is serving the customer where, when and how they wanted, they want that inventory and we have opened up that 2 billion of inventory to give to them.

The second is the margin improvement that we’re seeing because particularly on our clearance end of life inventories, it is creating a much more efficient clearing method because we have so many viewers online to supplement the retail traffic thus driving a better outcome on the markdowns.

Another benefit that we have seen from ship from store is that when we’re allocating the inventory to all the stores we used to send a lot of that inventory back for reallocation when we’re out of balance. We have significant, more than half of the inventory returned a year ago, we didn’t have to return this year. Thus the cost and complexity that goes along with that. So those are what we’re seeing now. The back half of course is a very different time of year and there is nothing in what I just shared with you that would say to us here that we’re not going to see the types of benefits at a much higher rate occurring in the back half for us particularly again this is so big around Q4 when I’ve to have it I need that gift, those kinds of demands from our customers and we will be shipping faster and that will be important.

David Schick - Stifel Nicolaus

And as a follow-up, the original Renew Blue take on the business was -- or the outline was the long term 5% to 6% operating margin. Now there has been a lot of puts and takes to the industry and you guys have worked on initiatives, there has been incremental pressures, there is opportunities all over the last 18 months. But do you think all those things together still boil down to a 5% to 6% operating margin opportunity long term for the business?

Sharon McCollam

Yes, I think that it's important though to recall that when we gave that we said we need very low single-digit but single digit positive comp sales. When you think about the revenue leverage that you see especially in quarters like Q4, on the fixed cost which I called out earlier in my business drivers for Q4, it's so significant and with our categories, these NPD categories tracking at this negative 2.5% rate I know it makes it hard to see but that 5 to 6 is predicated on that. What we’re particularly pleased with right now well not excited about negative comps, don’t get me wrong is that with the things that are within our control operationally and executionally we’re continuing to improve in those areas. What that says is that when we get to that point, where we see the cycle comeback into CE that we’re going to have the operational infrastructure and the cost structure that will highly leverage those sales and that’s the part that we’re greatly looking forward to and I know as investors you guys are too. But that’s how we see getting to that number is going to be through some top line growth and then in addition to that continuing to make progress against these kinds of initiatives that we spoke of today.

David Schick - Stifel Nicolaus

I guess we will have to see if anybody ever makes a new phone or anybody wants a nicer TV again in the future. Thanks.

Hubert Joly

Thank you, David.

Operator

And we will move on to our next question from Alan Rifkin with Barclays.

Alan Rifkin - Barclays Capital

So first question surrounds the Renew Blue program. You had targeted $1 billion in cuts but for the last few quarters the expense savings have been declining sequentially with only $40 million realized in this quarter. As you look further out over the next couple of years, do you think $1 billion in totality is still the number? And in breaking it down between SG&A and cost of goods, where do you see the greatest incremental savings going forward coming from?

Sharon McCollam

Yes, in the spirit on the SG&A side of the Renew Blue cost reductions. We have obviously taken substantial cost out of the company and of course they have slowed I mean the 40 million is less than it was in the previous quarter. The place that as you know we have not included in that billion a large percentage is of the returns replacements and damages, we within the numbers we’re reporting on our achievement of Renew Blue has an amount associated with returns, replacements and damages but it's actually very slow to-date. And off that as you recall let’s just all get grounded. We said we’re losing over -- approximately 450 million and we expect to lose a 100. So we see a 300 million to 350 million opportunity there.

It's very structural and how we go after it, we’re going in the fourth quarter you will start seeing a lot of that online inventory show up and then Hubert in his prepared remarks to help give you guys more visibility to some of the other things that are happening in the company because while showing the inventory online is very important and quite frankly getting those viewers and getting that population when the majority of this inventory is sold online anyway is critical but there are other operating things happening internally right now and plan is being put into place and changes in operating procedures happening that we think are going to accelerate that for us as we -- this would be a 2016 opportunity for us as well. So that’s where I see it coming from Alan going forward. We will continue, however there are areas operationally in the company, I would speak to our services areas and some of our other what I would call tasking related activities in our stores and some of our replenishment processes where I think that there is higher efficiency to be garnered but again many of these requires structural system changes, so are slower in coming.

Alan Rifkin - Barclays Capital

Okay. One more question if I may. Sharon, this is really the first time you have given definitive guidance on your comp outlook for the all-important fourth quarter and you are now saying it will be down low single digits. Where does this number really compare to where your plan was at the beginning of the year and what really has changed if anything in terms of your guidance on the comp for Q4 specifically?

Sharon McCollam

Yes Alan, we certainly believed that early in the year that we would see less softness in those NPD categories. We also were more optimistic about the innovation in mobile and after last year having the Samsung Galaxy other things came out we don’t want to go vendor by vendor, we had a few exciting things last year but the fact that the innovation in mobile has been pretty soft this year was different than we hoped. Now the good news is that we have remained very conservative and you know us. We don’t live on our wishes and hopes here; we live on what the data says.

So, based on the industry data around these categories it still does not paint a positive picture. If you look at the people who write about this industry even with a highly anticipated phone, not speaking to any one vendor but one of the highly anticipated phone launch. The saturation in the mobile phone category makes this complicated to forecast. We think it's exciting and we think the installment billing programs which by the way Hubert also called out. We’re seeing an acceleration in that and it's very fast, the disruption of the carriers could be a dynamic that we did not anticipate. What’s happening with the carrier plans right now what you’re observing I’m sure we did not anticipate.

Now again until we see what that means we’re not going to put that into a forecast. We’re looking at economic data just like you, our consumer trending data and this is what it's showing. Now that is the same data I might add that told us to tell you last quarter that Q2 would be negative low single digit comps which is exactly where we ended up and we still in those NPD categories gained share.

So that is what we’re using Alan. So could it be better? Yes. Is the acceleration of Ultra-High Definition TV happening? There is no question about it. I saw an analyst report out this morning on the topic. So if that happens, you know when you read what I wrote this is predicated. What I explained and laid out is predicated on a low single-digit negative comp and the environment we’re in now with only slight excitement and not any other offsets to this phone and UHD opportunity. Clearly I don’t know if anyone is out there, that is better positioned than Best Buy with our new 800 Samsung and Sony Home Theater stores within the stores. I don’t know how you could be better positioned to go after this new opportunity not to mention and I have to call this out is the blue shirts that are supporting that in our stores but knowledge of UHD in Best Buy, I’ve to say we would put it up against anything in the industry right now and we’re very product of that.

So those are the possibilities Alan, that is not something I’m telling you that the data does not support it and then there also you need to get -- you would also have to have an excessive amount of inventory as well. So we will see what happens but right now we see the data says that we could see similar NPD performance, track the categories performance.

Operator

And we will take our next question from Aram Rubinson with Wolfe Research.

Aram Rubinson - Wolfe Research

Thanks, good morning and we can feel just how hard you guys are working to achieve these results so appreciate you sharing the time with us. A couple of things. If you looked at the NPD categories that you referenced, can you give us a sense of what the e-commerce penetration is of those categories and maybe kind of how you compare against that? Also how the profitability shift to e-commerce is affecting the margins, SG&A, et cetera? I'm just not sure we have gotten any quantification around that.

Hubert Joly

So e-commerce penetration in our categories is higher than in retail in general. We’re one of the most highly penetrated sector from an e-commerce standpoint and it continues to shift, that’s one of the things I said earlier. We’re seeing continued and rapid shift in consumer behavior in researching and then buying online but if not buying online, studying the research process online before going to the stores which we do see is the for a given purchase, it reduces the number of trips to the store because you come to the store very well equipped and you completed.

This is not new but this is continuing and very significant this has been the premise of the entire Renew Blue strategy and transformation. Now we’re very encouraged by the growth of our online business, 22% this quarter. The reason why we’re excited about this is that, as we said before, is to achieve the same kind of market share online as we’re experiencing in the stores and we have much to do. So all of this is happening in a context where we’re able to improve our operating income rate year-over-year which is something that we’re very excited about.

Now as it relates to your question pertaining to the profitability online versus the stores, I would first preface it by saying that trying to construct a meaningful P&L by channel is actually a fairly futile exercise because it is so inter-dependent. How should I count and allocate the marketing expenses? How should I count and allocate the investment that I make online for which a lot of the conversion is actually happening in the stores. So this is an exercise with limited practicality. This being said, in general online today the mix of products we sell, so let me say that profitability for given product is not materially different online versus in the stores. What we do see today is that from a mix standpoint not surprisingly the kinds of products that we tend to sell more online would be lower cube, lower touch, more commodity type products simple to buy, convenient and so forth. Whereas in the stores you’re going to buy higher cube, higher touch products. You’re going to have online -- still today despite our great progress lower attachments of accessories and services.

And I don’t think that this is necessarily something that we will continue. In fact we’re determined to change that by helping customers buy the entire solution online and so down the road we would expect the profitability to the extent that we can calculate profitability to converge between the two channels but today as we shift more towards the online channel, this is having a slightly negative impact on the overall gross profit rates because of these lower attachments.

Aram Rubinson - Wolfe Research

Just a clarification and then a follow-up. Of your business which is 7.7% penetrated online, what is your guys best guess as to where the industry is on that same penetration?

Hubert Joly

In the Renew Blue presentation back in November of 2012 we had tried to estimate that and from memory we had estimated that the market share or the penetration of online in our industry was in the high-teens and so clearly we have room to grow here. The mindset of the company as we see no reason why our online market share, or market share online should be lower than in the stores and we are determined to be agnostic from a channel standpoint and a profitability standpoint so as to be able to serve the customers the way they want to buy it.

Aram Rubinson - Wolfe Research

And if you can just help by telling us in your fourth-quarter guidance or your back-half guidance what you have contemplated for the promotional environment in Q4 specifically as you compare it against last year's kind of free for all?

Sharon McCollam

In our prepared remarks or in my prepared remarks I said and was very clear, and this is for both Q3 and Q4 that we expected a similar promotional competitive environment. I left out irrational but okay, that was your adjective. But what we said is that we’re going to have better promotional effectiveness internally. After Q4 last year you will recall Hubert made many comments about what we would be doing differently this year and has really done that each quarter and we have seen it work each quarter. So going into Q4, the rational disciplines that we have implemented and some of this additionally is also very operating procedure and systematic internal or systematic internally.

We did not have the capabilities, pricing capabilities and promotional tracking capabilities a year ago that prepared us well for that kind of an environment. This year we have made investments in those areas. We have talked about those in previous calls and our teams are getting stronger obviously every quarter. So we anticipate our ability to do better but honestly we just believe that our competition will continue with similar behaviors to previous years.

Operator

And we will move on to our next question from David Magee with SunTrust Robinson Humphrey.

David Magee - SunTrust Robinson Humphrey

On that last question, I was curious it seemed like last year the sector business sort of softened late in the year and people were culling too much inventory in the channel and then panic ensued. Are you seeing a similar build up this year or do you think you will see a build-up this year of the same level of inventory throughout the sector going into the fourth quarter?

Sharon McCollam

David you might be on the cell phone and we got a cut out on about every third or fourth word, could you just repeat your question for us please?

David Magee - SunTrust Robinson Humphrey

Last year I recall it seemed like that the business for the sector softened late in the year and inventory levels were too high across the retail sector and there was panic afterwards. I’m curious as you sort of think about this year being similar, are you seeing inventory levels growing at the same rate as they did last year?

Hubert Joly

I think that’s, we don’t know of course the inventory levels of our competitors. What I would say is if you rewind to last year the market environment, the demand in our space in Q2 and Q3 as well as our own comps trended relatively positively in Q2 and Q3 I think we were -- in Q3 we were positive in the low-single digits and while we were probably getting market share, this was also represented of a more supportive business environment including in the very important mobile category and whereas this year to repeat when we look at the market in Q1 and Q2 including in mobile you’ve a very different picture. Sharon talked about in mobile, everybody is talking and accepting new products in the back half but the penetration of smartphones in the country has really reached very high level. So how big of an impact is it going to have above and beyond the question of the availability of the inventory. So you’ve I think a very different environment. Forecasting into Q4 is really hard; we’re giving you our best shot. I think that after Q3 we all maybe able to get a better perspective. There will be more information but certainly the sentiment going into the back half of the year is very different from what it is today.

Now we’re not sitting here thinking and hoping that everybody there will be say, okay so we won't compete in consumer electronics we’re not counting on that. What we’re highlight is that we ourselves are approaching holiday this year with a different set of tools than last year. Sharon talked about the better enhanced effectiveness around promotions and of course we have a whole list of things that we have been working on during the year that I mentioned including our gifting strategy and wish list which are being deployed. The better in store experience with the additional stores within the stores and expert labor in particular around Ultra-High definition TV but also appliances and what not. The more targeted marketing communication, the ship from store of course which will be in all of the stores was not in other stores last year. It was deployed in all other stores in January.

And then the increased effectiveness as a result of the organizational changes was made in the stores. So as you can see we’re very focused on what we can control in executing everything in our control and then we will take the environment as it is.

David Magee - SunTrust Robinson Humphrey

Just a quick follow-up. Some people think that back-to-school is a harbinger of what is to come with holiday sales. Are you seeing anything with back-to-school that gives you reason for hope or cautiousness?

Hubert Joly

I would say that back-to-school so far is in-line with our expectations. There is potentially I think in retail in general, a more positive environment but we’re not just going to take a couple or three weeks as a source of excitement. This is an economy in general in a sector where there is lot of volatility week to week and month to month depending on this, this and that. So but yes in general there is a sense that the retail environment in the last few weeks have been better and certainly the beginning of the quarter has been in-line with our expectations.

Sharon McCollam

And David I will just add we’re very focused on the calendar at Best Buy and the things that go all around the calendar. One thing to consider which I’m sure you’re all considering. I have seen several reports, is that because of the weather last year many school districts are going back to school early and we are also very focused on how much of this is lift versus shift because of the timing of earlier back-to-school dates than a year ago to cover up for snow days. So that is just an add for you on some things that we’re looking at internally just to make sure we don’t get over -- get ahead of our lights in this.

Operator

Thank you. And we will move along to our next question from Mike Baker with Deutsche Bank.

Mike Baker - Deutsche Bank

A couple of questions. First, on phones, you have talked a few times about not sure what the volumes you guys are going to get or the inventory. How has that played out in the past iPhone launches? Can you remind us what kind of allocations you have gotten and has it actually been a positive to your business when it launches or is it maybe perhaps can be a negative because people are going to go to the Apple stores because you guys won't have the allocations?

Hubert Joly

Yes, I mean what I would say without getting into excessive details. We have a very good relationship with all of our key vendors in that space. I think we’re mutually important to each other and we value their relationship. I think they value the channel. So in general that would be true in our business. Anytime there is significant innovation from a product standpoint that is far from being a negative if I can put it this way. So we look forward to the launch, I think our comments pertaining to the fact that every time in the initial weeks there is limited inventory and now I think we are being treated by our vendors very, very fairly. There is no doubt about this and I think in phones in the U.S. we have to keep in mind that while in the last five years you’ve seen a rapid increase of the penetration of smartphone you will reach a point of penetration which is about 70% which is quite high and it's about 90% plus of the new phones that are being sold being smartphones but there is a point where there is a cap to the penetration of phone. So we’re expecting a huge lift, is not something that we would contemplate.

Mike Baker - Deutsche Bank

When did you expect that to launch by the way? Is that a third quarter or a fourth quarter event?

Hubert Joly

I can give you a phone number in California to call for further details.

Sharon McCollam

We have some more visibility to these things than you do.

Mike Baker - Deutsche Bank

Understood. One more question if I could on a different topic and just looking at the expenses that you referenced the November 2012 Analyst Day documented a few times. In that presentation I think at the time you had said that your North American corporate G&A was about $4.2 billion which I think was 10% of your North American sales at that time. Can you update us on where that number is 18 months later?

Sharon McCollam

We have not been continuing to publish that number, we actually because of the investments we have made in the stores and other things, we feel that it's little more competitive than it used to be. So we have made a decision to not continue to report on segments of our G&A.

Operator

And we will move along to our next question from Brian Nagel with Oppenheimer.

Brian Nagel - Oppenheimer

My first question, you have mentioned the Ultra HD TV quite a bit and others have as well. As we look at that product category, what do you see -- maybe more from a qualitative standpoint, the consumer response right now? And are there certain things that need to change whether it be content and such to make Ultra HD maybe a bigger driver of better topline results at Best Buy?

Hubert Joly

What’s very exciting about Ultra-High Definition TV compared to 3D a few years ago is that the customer benefits is immediately tangible and meaningful in the form of improved image quality which of course is a huge driver of demand in particular when you get to these very large screens, the number of pixels become critically important and what’s very positive today is that even without new content you’ve the upscaling and so with the current content the customers see a material difference and when they go to our stores we can show them the difference between high-definition and ultra-high definition TV and I encourage everyone on the call as well as the rest of the country to pay a visit to one of our stores where you’ve the Samsung and Sony customer experience.

When you walk into the store you don’t know that you need an Ultra-High Definition TV. After 10 minutes seeing the product and talking with Wesley [ph] blue shirt was hyper trained in Ultra-High Definition TV. You will know that you needed, the only question you will have is when and which one it will be. Now beyond that of course, there are various media companies that are working on 4k content. I think you can hear Netflix, you can hear Amazon, you can hear a variety of sources but again we don’t need to wait for that to have that. The TV, Samsung and Sony also have storage devices that allow you to have access to.

So what’s going to drive the penetration is the price decline. Now prices have started to go down and probably for many of you on the phone it's going to be highly affordable this holiday but for the vast majority of the public they may want to wait until next year and the following year. There is price points that are significant from that standpoint. So, we think it's essentially a price discussion but the product itself is very ready and exciting. So which is why we said this morning we are excited by the potential but do realize that the impact this year will still be rather limited.

Brian Nagel - Oppenheimer

A second question is a follow-up if I may. I think someone else asked about back-to-school. In recognizing back-to-school period has shifted a little bit this year and it is obviously not nearly as big as the holiday season but the question I have is we talked about some of these better internal promotional effectiveness. Are you seeing -- is there a way to say that here in back-to-school we have seen these efforts on the part of Best Buy to drive better results and maybe that is a harbinger of how we should think about your promotional effectiveness come the holiday selling season?

Sharon McCollam

Yes I think that obviously every day we’re practicing better promotional effectiveness and when we look at our performance as it relates to all periods but back-to-school as well we have been using that rigor, that promotional rigor around all that that we’re doing and obviously we’re seeing outcome similar to outcomes that we saw in the second quarter. So yes, I believe that what you’re seeing from us today as it relates to pricing and promotional rigor is going to be no different than what you see -- I actually believe in Q4 it will be better because you guys got to remember there were something’s in Q4 last year that of course were above and beyond exceptional target breaches and other things which I don’t even want to raise here. So I believe that all the disciplines we put in around and then those things that will not recur may put us in a very strong position thus the reason that in the prepared remarks today we talked about the fact that despite all of these things we’re still expecting operating margin expansion in the back half equal to what we have seen in the first half of this year.

So despite some of these negative things that we’re talking about despite the fact that we’re going to -- we have guided to you slightly negative single digit comps we’re still saying we’re going to expand our operating margin even though -- versus some of the first call estimates we could have 300 million or so less revenues. So it is that promotional effectiveness and of course then there is the G&A side of it as well that’s driving that but we’re expecting to see benefit in Q4 on both.

Hubert Joly

Thank you Sharon and I think we’re going to wrap this at this point and in closing obviously I want to thank our teams across the business for their outstanding commitment and hard work serving our customers every day and driving the transformation of our company and of course I would like to thank all of you on this call for your participation this morning and your ongoing support. So thank you and have a terrific day.

Operator

That concludes today’s conference. We thank you for your participation.

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Source: Best Buy's (BBY) CEO Hubert Joly on Q2 2015 Results - Earnings Call Transcript

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