Best Buy's (BBY) CEO Hubert Joly on Q3 2017 Results - Earnings Call Transcript

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Best Buy Co. (NYSE:BBY)

Q3 2017 Earnings Conference Call

November 17, 2016 8:00 AM ET

Executives

Mollie O’Brien – Vice President, Investor Relations

Hubert Joly – Chairman and Chief Executive Officer

Corie Barry – Chief Financial Officer

Analysts

Matthew McClintock – Barclays

Scott Mushkin – Wolfe Research

Mike Baker – Deutsche Bank Securities

Chris Horvers – JPMorgan

Simeon Gutman – Morgan Stanley

Greg Melich – ISI Group

David Schick – Consumer Edge

Peter Keith – Piper Jaffray

Brian Nagel – Oppenheimer

Scot Ciccarelli – RBC Capital

David Magee – SunTrust Robinson Humphrey

Dan Wewer – Raymond James

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Best Buy’s Third Quarter Fiscal 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded for playback and will be available by approximately 11:00 AM Eastern Time today. [Operator Instructions]

I would now like to turn the conference over to Mollie O’Brien, Vice President of Investor Relations.

Mollie O’Brien

Good morning and thank you. Joining me on the call today are Hubert Joly, our Chairman and CEO; and Corie Barry, our CFO. This morning’s conference call must be considered in conjunction with the earnings release we issued this morning. Today’s release and conference call 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, which 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, which is available on our website, investors.bestbuy.com.

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 conditions, 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, including our most recent 10-K 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 NPD-tracked categories. The categories tracked by the NPD Group, includes TVs, desktop and notebook computers, tablets, digital imaging and other categories. Sales of these products represent approximately 63% of our domestic revenue. It does not include mobile phones, appliances, services, gaming, Apple Watch, movies, music or Amazon branded products.

I will now turn the call over to Hubert.

Hubert Joly

Good morning, everyone and thank you for joining us. I’ll begin today with a review of our third quarter performance and then provide an overview of the progress we are making against our fiscal 2017 priorities before turning the call over to Corie for additional details on our quarterly results and our financial outlook.

We’re pleased to report, today, growth on both our top and bottom lines with enterprise revenue of $8.95 billion, an increase of 1.4% and non-GAAP EPS increasing 51% from $0.41 last year to $0.62 this year. These results were due to the strong performance in both our domestic and international segments. In our domestic business, we delivered comparable sales growth of 1.8%. This was on top of comparable sales growth of 0.8% last year.

We saw continued positive momentum in our online channel, delivering their third straight quarter of 24% revenue growth. From an overall merchandising perspective, we saw year-over-year sales growth in home theatre, mobile, and emerging categories like wearables and connected home. This was offset by continued softness in gaming. We also continued to drive considerable year-over-year improvement in our net promoter score, which increased approximately 400 basis points over Q3 last year.

In our international business, revenue grew 4% on a constant currency basis. On a reported basis, international revenue increased 3.3%. Altogether, we have delivered another strong quarter, which reflects the strength of our value proposition and our execution. And I want to thank all of our associates for their dedication and hard work in achieving these results. I am and I hope they are proud of what they’ve accomplished.

Now before I go into more details on our third quarter performance, I would like to address the recent highly publicized product recalls in mobile phones and appliances. As you would expect, it did have a negative impact on the third quarter, particularly during October. We expect the magnitude of the impact to be more material in the fourth quarter, as the impact will be on the entire quarter in Q4 versus only a part of the quarter in Q3.

As we looked at our revenue guidance, we had to incorporate the fact that certain products will simply not be available for sale during our fourth quarter as originally planned. The expected impact of these recalls in our fourth-quarter domestic revenue is approximately $200 million. With that incorporated, we’re planning to deliver comparable sales in the range of minus 1% to plus 1%. Still, we expect our non-GAAP diluted EPS to increase by 6% to 9% versus last year.

Now, I’d like to update you on the third quarter progress against our fiscal 2017 priorities. The first priority is to build on our industry position and multi-channel capabilities to drive the existing business. We’re pleased with our progress here as we’re driving growth across multiple areas of our business. In home theatre, we continued to grow sales and market share due to the strength of our Magnolia design centers, continued success of our vendor experiences and strong performance online.

We believe we have built a market-leading customer experience around home theatre and large screen TVs, based on our assortment, our merchandising, our online experience, the expertise of our in-store sales associate and of course, ability to help customers in the home. The combination of new technology and declining ASPs has been driving growth and interest in the TV category. We offer a unique experience in assortment to our customers including 4K ultra Hi-Definition televisions with high dynamic range, OLED televisions and a variety of other emerging technologies.

Also, our strategy at Best Buy is not just about selling TVs. It is about helping customers with their entertainment needs, driving growth in audio, streaming devices and other accessories, as well as delivery and installation. We are excited about the continued television product innovation being introduced to the market. And we believe advances in picture quality, content availability and smart home integration will continue to drive excitement and demand in the industry. This plays to our strengths as the technology and service leader in the category.

We also delivered revenue growth during the quarter in the mobile category. As expected, new product launches stimulated demand during the quarter. This growth was partially offset by the well publicized issues with the Samsung Note 7, which has been recalled and is no longer being produced or sold. As a result, the mobile category performed better than last year but not as strong as our expectations heading into the quarter.

Our strategy to win in this category is, in part, focus on our ability to be an advocated for every phone owner. Our Blue Shirts have the tools and training to analyze customers’ current phone plans and their actual needs and then recommend the right plan at the right cost. We can also recommend hardware upgrades, add family members to existing plans, and create entirely new family plans. Using these tools, we have found that at least 50% of customers are able to save money on their monthly mobile plan.

Also we’ve increased our AT&T and Verizon stores within the store to 426 from 247 at the end of last year. In support of our strategy, these vendor experiences feature highly trained specialists who provide access to the carrier’s products, services and detailed customer information, and the ability to learn about a wide set of connected or smart devices. We also drove growth in several emerging product categories. We are as excited as ever about the role that technology can play in people’s lives, and the opportunity this creates for us.

Emerging categories are gaining traction in part due to our ability to physically showcase products and offer expert help to customers. In connected home, we’re seeing strengths in home automation including security, lighting, and video monitoring. Drones are also becoming a more meaningful part of the business and virtual reality products hit all of our stores during the third quarter with new, dedicated virtual reality departments in more than 700 stores.

These new departments will offer demonstrations, virtual reality products, PC gaming devices and accessories. Since we first began offering install demos, customers have experienced approximately 300,000 virtual reality demos at Best Buy.

In appliances, we leverage our 203 specific kitchen and home stores within the store and ongoing market share gains to deliver our 24th consecutive quarter of comparable sales growth. We reported 3% comparable sales growth this quarter on top of 16.4% in Q3 of last year. Our growth decelerated late in the quarter due in part to product recalls and shipping delays that resulted in constrained inventory with key vendors.

In services as expected, our comparable sales trend improved significantly in the third quarter as we began to lap the pricing investments made last year and we are seeing higher attach rates and revenue growth from new products we introduced. In addition, we continue to drive improvements in our service quality and increased our net promoter score. We expect comparable sales in our services business to be slightly positive in the fourth quarter.

Turning to our digital channel. We delivered our third consecutive quarter of 24% domestic online sales growth. This growth was driven by increased traffic and the cumulative benefit of our investments over the past few years in the digital customer experience and enhanced dot-com capabilities. We continue to refine our search, research, and checkout capabilities with a focus on streamlining the customer experience across all channels.

For example, a new feature that can filter product search results by local store availability is resonating with customers as it makes their shopping journey a little easier. In addition to help customers after their purchase, we’re piloting product support pages, which provide customers information about the products they’ve purchased including transaction details, product specs, Geek Squad plans and quick access to expert help.

We also launched a pilot in the Best Buy mobile app that allows customers to book 30 minute in-person appointments to consult with Blue Shirt experts. In our physical stores, we’ve continued the momentum from the investments we’ve made in training and coaching from the reduced employee turnover that we discussed last quarter. Heading into the holiday season and the fourth quarter, we have armed an increasing number of associates with tablets that allow them to look at product and customer information and transact. Also, we invested additional labor around key holiday product categories where customers need more help and in the fast growing in-store pick up area.

In our international business, we recorded strong top and bottom line results in both Canada and Mexico. In Canada, we are seeing positive early results from the new store redesigns we have developed in partnership with key vendors. And we are also pleased with the growth of our services business there and excited by the lessons we are learning as a result.

I’ll now turn to our second fiscal 2017 priority, which is to reduce cost and drive efficiencies throughout the business. As it relates to our Renew Blue Phase 2 target of $400 million by the end of fiscal 2018, we achieved another $50 million in the third quarter. This brings our current total to $300 million in annualized cost reductions and gross profit optimization. As a result of our successful focus on driving out cost, we are able this year to improve the customer experience while maintaining flat SG&A.

Our third fiscal 2017 priority is to advance key initiatives to drive future growth and differentiation. We intend to be the company that makes it easy for customers to learn about and enjoy the latest technology as they pursue their passions and take care of what is important to them in their lives. With our combination of digital, store, and in-home assets, we believe we have a great opportunity to address key customer pin points, build stronger ongoing relationships with our customers, and unleash growth opportunities.

As we’ve stated before, fiscal 2017 is a year of exploration and experimentation. And we are testing several concepts across – around the country that have the potential to be compelling customer experiences. Based on early results, we’ve expanded both the in-home advisor program and the Geek Squad on-demand pilots to additional markets. The in-home advisor program pilot involves a free in-home consultation with an experienced technology advisor who can identify our customers’ needs, design a personalized solution and become a personal resource over time. Our Geek Squad on-demand pilots provide services to customers who need immediate technology help or advice including same day.

We also recently launched a new program called Magnolia Care to provide ongoing support and troubleshooting for the comprehensive custom home theatre solutions we provide to our Magnolia Design Center clients. Also in Canada, we’re testing a new service called Geek Squad Home Membership that provides support for all of the technology products that customer may own regardless of whether they were bought at Best Buy. On the connected home front, we are testing different merchandising concepts like creating displays with actual front door experiences to demonstrate front door security solutions.

So in summary, we are excited by the continued industry product innovation we’re seeing, the role we play for customers, the growth opportunities in front of us, the quality of our execution, and the strengths of our financial performance. Looking ahead, our teams are ready to execute our plan for the holiday season. As our marketing tagline, Holiday Gifting Made Easy, states, our goal is to make holiday shopping effortless for customers. To win holiday and deliver on this promise, we have created an exciting assortment of great and competitively priced products, and we have mobilized our assets, including our leading-edge digital capabilities, fast and free shipping across the entire site during holiday, and of course our knowledgeable Blue Shirts and Geek Squad agents who are here to provide compelling in-store experiences and in-home services.

And so in closing, I’d like to thank all of our associates and their families for everything they will do this holiday to delight our customers. I say to our associates, you are Best Buy, and I appreciate you very, very much.

And now, I’d like to turn the call over to our CFO, Corie Barry.

Corie Barry

Thank you, Hubert, and good morning, everyone. Before I talk about third quarter results versus last year, I would like to talk about them versus the expectations we shared with you last quarter. Enterprise revenue of $8.95 billion exceeded our expectations, driven by out-performance in the domestic and international businesses. Non-GAAP earnings per share of $0.62 also exceeded our expectations, primarily due to higher gross profit rates in both businesses and lower than expected SG&A in the domestic business.

I will now talk about our third quarter results versus last year. On a constant currency basis, enterprise revenue increased 1.5% to $8.95 billion, primarily due to comparable sales growth in the domestic business and the continuation of the strong performance we’ve seen in international throughout this year. On a reported basis, enterprise revenue increased 1.4%, reflecting approximately 10 basis points of negative foreign currency impact. Enterprise non-GAAP diluted EPS increased $0.21 or 51% to $0.62. This increase was primarily driven by one, a higher gross profit rate and the flow through of higher revenue in the domestic business; two, a $0.05 per share benefit from the net share count change; and three, Canada, which as of the end of Q3 has now lapped the disruptive impact from the brand consolidation last year.

In our domestic segment, revenue increased a greater than expected 1.3% to $8.2 billion. This increase was primarily driven by comparable sales growth of 1.8%, which was partially offset by the loss of revenue from 14 large formats and 23 Best Buy mobile store closures. Industry sales in the NPD-tracked categories, which don’t include categories such as mobile phones and appliances, declined 3.1%.

From a merchandising perspective, comparable sales growth in home theatre, mobile phone, wearables, and connected home was partially offset by declines in gaming. In services, the comparable revenue decline of 1.8% moderated as expected as we have now lapped the investments in services pricing from last September. This decline in services revenue during the quarter was entirely due to the ongoing reduction of repair revenue driven primarily by lower frequency of claims on extended warranties. Domestic online revenue of $881 million increased 24.1% on a comparable basis primarily due to increased traffic, higher average order values, and higher conversion rates.

As a percentage of total domestic revenue, online revenue increased 200 basis points to 10.8% versus 8.8% last year. In our international segment on a constant currency basis, revenue increased 4% to $753 million driven by growth in both Canada and Mexico. On a reported basis, international revenue increased 3.3% reflecting approximately 70 basis points of negative foreign currency impact.

Turning now to gross profit. The enterprise non-GAAP gross profit rate increased 70 basis points to 24.6%. The domestic non-GAAP gross profit rate increased 60 basis points due to improved margin rates in the computing and home theatre categories, which were partially offset by the mobile category.

Unlike Q2 of this year, we did not see year-over-year pressure on our gross profit rate from the investments in services pricing or a periodic profit-sharing benefit from our services plan portfolio. The international non-GAAP gross profit rate increased 190 basis points to 24.3% driven by a higher year-over-year gross profit rate in Canada due to a more favorable product mix and lapping the disruption and corresponding increased promotional activity last year related to the brand consolidation.

Now turning to SG&A, enterprise level non-GAAP SG&A was $1.88 billion or 21% of revenue, an increase of $18 million; however, the enterprise revenue increase resulted in leverage of 10 basis points. Domestic non-GAAP SG&A was $1.71 billion or 20.9% of revenue, an increase of $20 million. This increase was primarily driven by the timing of previously outlined investments.

International non-GAAP SG&A was $169 million or 22.4% of revenue, a decline of $2 million driven by the positive impact of foreign exchange rates. The 110 basis points of SG&A rate decline were driven by sales leverage. In the third quarter, we returned $290 million in cash to our shareholders, $201 million through share repurchases and $89 million in regular dividends. This brings our year-to-date total cash return to over $931 million.

I would now like to talk about our fourth quarter guidance. For the fourth quarter, as we execute our holiday plans, which includes a disciplined promotional strategy, we expected to deliver non-GAAP diluted earnings per share in the range of $1.62 to $1.67 compared to $1.53 last year. This outlook assumes a diluted weighted average share count of approximately 315 million and a non-GAAP effective income tax rate in the range of 35% to 35.5%.

Note that our revenue and EPS expectations include approximately $30 million or $0.06 of net negative impact from the lapping of the periodic profit-sharing benefit from our services plan portfolio that we received in the fourth quarter of last year. From a revenue standpoint, we are excited by the rate of technology innovation, the quality of our assortment, and our ability to execute.

As Hubert said earlier, we also need to factor in our projections the impact of recent product recalls that happened in the last few months, and that certain products will simply not be available for sale during our fourth quarter as originally expected. The impact of the recalls on Q4 is expected to be approximately $200 million.

With this incorporated, our enterprise revenue expectation is $13.4 billion to $13.6 billion. Underlying our enterprise performance is domestic comparable sales in the range of negative 1% to positive 1% and international comparable sales in the range of negative 2% to positive 2%.

Lastly, I want to take one final opportunity to remind everyone that as we announced earlier this year, we will no longer be doing a holiday sales release in early January due to the growing importance of that month to our Q4 financial results. We look forward to talking to you in February on our Q4 call.

I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Matthew McClintock. Please go ahead.

Matthew McClintock

Hi, yes. Great quarter, everyone. Congratulations.

Hubert Joly

Thank you.

Matthew McClintock

I was [indiscernible] be for a second. Home theatre outstanding results during the quarter, seems like there’s been a proliferation of 4K TV skews and maybe lower demographic channels or lower price point channels, the value channel. And I was just wondering, how do you see the competitive dynamics of 4K TVs playing out especially as we enter the peak holiday season this year, thank you.

Hubert Joly

Thank you for your question, Matt. So the TV category is playing out pretty much as we expected. There is indeed a reduction of ASPs and the combination of reduced ASPs and great product is stimulating unit demand and in that context, I don’t want to talk so much about the competitors, but I can talk about us. The customer experience we provide combination of assortment, merchandising, the online experience and experience in the stores, our service capabilities is allowing us to continue to gain market share. These market share gains have slightly moderated, because it doesn’t continue forever but we’ve built a capability that’s quite unique.

The other thing that we want to highlight and we’ve talked about it on previous calls, the cycle of this time is different from the time where TVs went to digital and it was a much more contained cycle. We see continued product innovation today and coming in the future and this continued product innovation allows us to appeal to the type of customers that we appeal to which are in part the leading edge and early adopters, provide this great experience and allows us to stay ahead of the game.

So we aren’t surrendering by any stretch of the imagination. I think there’s been some words around us we’re – in the game to win and we’re very proud of the capabilities we have.

Corie Barry

And Matt, I would just add as you can hear in our prepared remarks, it’s not just about the 4K cycle but because we supply solutions and the more full experience particularly in some of the vendor experience shops, we also see a very nice halo to the accessories like streaming devices like audio, within the category as well.

Operator

And we will take our next question from Scott Mushkin. Please go ahead. Mr. Mushkin, please check the mute function on your phone.

Scott Mushkin

Hey guys, sorry about that. The mute button on. And thanks for taking my questions. So I guess first kind of housekeeping item. The loss of $200 million in revenues is that about a nickel to EPS as we look at the fourth quarter is that a good approximation?

Corie Barry

Yes. We are not going to translate it all the way down into profit at this point. So…

Scott Mushkin

Okay. And then the second question not housekeeping is just because what Corie was talking about a little bit in the efforts in 2017. You guys are now starting to see comp accelerate a little bit. Are we – are you going to be able to outside of what you think like TV cycles and other things maintain a better comp stance given I’m talking over multi-quarter year type of look given some of the changes you’re bringing to the business? Is that kind of the goal here as you look out 2017 and 2018?

Hubert Joly

Yes. Thank you, Scott. Clearly today we aren’t providing any guidance for next year or the following year. But as you have heard us talk about, one of our key priorities this year is to find ways to accelerate our growth. We believe that from the standpoint of all of the stakeholders including our shareholders, if we are able to accelerate our growth in a profitable way, this creates a different outcome. And we believe that we are in an opportunity rich environment by focusing on the underlying needs of our customers and creating this better customer experiences and providing solutions and services to them, we do believe we have opportunities.

We’re taking the time to explore and experiment this year, we’ve shared with you a few of the things we are exploring but I have no doubt, a key area of focus for our Management team and all of our associates every day is to grow the Company. So without providing any guidance I can share with you that we’re very focused on that while continuing to drive efficiencies to drive the investments in the future. So no guidance but a very clear focus as we look ahead, as we discussed, as we are beginning this year.

Operator

And we will take our next question from Mike Baker. Please go ahead.

Mike Baker

Thanks. Just a couple on the mobile category. First, so as it relates to the recall, what you typically – what have you seen this quarter and what do you think you’ll see? Do people just hold off on buying if they were interested Samsung, do they just hold off and buying a phone or do they replace it with another phone and then related to that it seems like you got a bump from the iPhone 7 launch. Typically how long does the bump from a new successful iPhone launch last? Is that a couple quarters? Is that into next year until you lap it? Thanks.

Hubert Joly

Yes, thank you for your question. So on the Note 7, it’s early to say. We do see a fair bit of brands and Operating Systems and size loyalty and so the customers are not rushing to buy something else at this point in time so we’ll see how it evolves during the quarter but this is a pretty much hold your breath kind of a situation for many of these customers, you want to take the iPhone 7, Corie?

Corie Barry

Yes, on the iPhone, we are actually seeing a pretty much just in line with what our expectations were. If you recall we kind of said we didn’t think it would be quite the bang of an iPhone 6 nor quite the slowness that we saw last year somewhere in between and that’s a little bit of what we are seeing. To your question about how long does the trend last it’s a little tricky, remember we talked a bit about single skew and the ability to buy the phone across multiple carriers that means we add a better supply of inventory, add more inventory that is available for customers, so that means quicker sell through early on.

And so we’re watching it now to look at the trends that implies going out. We like where the trends are holding up right now and typically as we watch the cycle it obviously tails as you go through the year, but it usually when people want the phone it’s a cycle that continues. So again, we are not going to quite provide guidance into next year, but it tends to be a cycle that continues over time as people replace their phones.

Operator

And we’ll take our next question from Chris Horvers. Please go ahead.

Chris Horvers

Thanks. Good morning, everybody. I wanted to follow-up on the product recall and availability issues that you mentioned. Can you frame out what you thought the revenue impact was to the third quarter? Is it all Samsung and is it all mobile and appliances and then following up on the earlier question, it sounds like you’re saying there’s very little substitution across brands, which if something breaks particularly on the appliance side, the rule of thumb is that two-thirds of demand is sort of failure or repair driven. So just trying to frame out the components how much it impact third quarter, what’s your estimate between mobile and appliances and then thinking about the substitution aspect.

Corie Barry

Yes. So in the third quarter like we said the impact was a little bit less materially less than what we’re seeing in Q4. We thought the total amount of the impact was probably around $60 million that was heavily weighted toward mobile, much lighter on the appliance side of things. To your question about you kind of elaborate on the replacement cycle, Hubert had started on it. The truth is yes, there is definitely a repair aspect, but the phone still can be repaired. And if you are quite loyal to both the Operating System and the size of your phone, which we are seeing people be loyal to then you might be more willing to go through some of the repair work and wait for whatever else might be coming.

So we actually are seeing a ton of people move into other devises. It seems like people are pretty loyal to that combination of Operating System and size that’s offered and was offered by the Note.

Hubert Joly

In case to elaborate, as Corie said the vast majority is on sounds to your question about appliances, people replacing the product after a failure, you are absolutely right on that front that the percentage of the missed sales is quite, is relatively small in appliances. Okay.

Chris Horvers

Understood. And then so maybe just following up on the appliances comp in the third quarter, the growth rate has decelerated pretty sharply and listening to Home Depot and Lowe’s this week they both had very good quarters in appliances. So are you more heavily weighted to brands that were dislocated because the shipping issues or is there pressure coming in from J.C. Penney, how would we think about your market share trends there? Thank you.

Hubert Joly

Yes, thank you. The latest data we have from a market share standpoint go to September. So we don’t have October. As of September based on the data we have – we continue to gain market share materially. And yes, we are more weighted towards the Korean brands in appliances.

Chris Horvers

Thank you.

Operator

And we’ll take our next question from Simeon Gutman. Please go ahead.

Simeon Gutman

Thanks, good morning. Hubert, going back to I think it was the first question on the TVs, can you share with us what you are anything directional on your premium versus non-premium business, because I think the battle is being waged maybe on the non-premium side. So if you can give us context of where your business sits and how is that evolving? Is the business mix evolving more towards or less from premium? And then just as part of that can you also talk about computers? I don’t think it was called out maybe I missed it in the remarks, but there was a resurgence. I’m curious how that’s going, it’s a pretty big category and curious how you think about it into the fourth quarter?

Hubert Joly

Yes. Thank you, Simeon. So on TVs, if you breakdown the industry in our business by TV size, you’ll see a very different picture and this is an important point to highlight because it’s not just about 4K’s and OLED TVs it’s very much about large screen TVs. And the customer demand is gravitating of course towards the larger screen TVs and the competitive landscape is different by TV size. So our customers and the experience we provide allows us to gravitate towards the higher – the larger screens and more fully featured TVs and not just 4K’s, again this new innovation with HDR and OLED, so that is playing to our strength, so that dynamic is helping us, okay.

And in a sense we also create – helping to create the dynamics is our merchandising efforts, our online efforts, our in-store efforts is allowing us to create that excitement about this more fully featured larger screen TVs. I think computing remains very important strength for us and this is another case where the industry is now doing great frankly from a top line standpoint. And combination of the assortments the creation of a premium more fully featured exclusive assortment on the Windows side and our strong presence with Apple, the great experience in the stores in partnership with our key vendors has really made us a great destination, great customer experience, great market share and evolution of the market.

So this is a case where in partnership with our vendors and everything we can do we are helping to drive the market and a better outcome. So these are exciting categories. And looking at Q4, from a demand standpoint, there’s potential excitement with both existing categories and then of course these new emerging categories because of course there’s ways of growth and there is indeed this year quite a bit of innovation.

Operator

And we’ll take our next question from Greg Melich. Please go ahead.

Greg Melich

Hi, thanks. Congrats on a great quarter.

Hubert Joly

Thank you, Greg.

Greg Melich

I guess I had two questions. One I would just start with, the last few questions were all about how you guys are really winning with more premium product and the whole experience and offering. And so I guess I’d ask the question from a different way, which is if you were to look at the whole store in that 1.8 comp, if you could help us get a sense of how much of that is transaction count growth versus an ability to expand the basket or the ticket with customers by selling them a whole home theatre as opposed to just a TV and then I had a follow-up.

Corie Barry

Yes, so on that one, I think when we look at the store what we’re most pleased with is our ability to offer the more premium products and the bigger solutions and the other products that go with it. Obviously from a traffic perspective, we’ve continued to see consistent performance in the stores with obviously a traffic pick up online. And so where we are seeing a lot of the benefit in the store side is definitely around that ability to provide the more premium product and then that product surrounded by a much more fulsome experience that’s really supported by some of that expertise that we’ve been talking about in our stores.

Greg Melich

So I don’t want to put words in your mouth, but it sounds like traffic trends to the store are unchanged, but the improvement has been once you get someone there you’re selling them a fuller package and then online growth as well helping that?

Hubert Joly

And of course Greg, online we do have a traffic growth 24% is very robust. And yes, the trends you’re highlighting are very much in line with our strategy and focus of our teams. We have such a rich set of opportunities to provide solutions to our customers, once they are in a stores, we need to take care of their needs and it’s both the basket that’s an opportunity, but also the share of wallet I think that’s building these relationship with their customers helping them over time and becoming a resourceful is another set of opportunities. So these are very exciting opportunities ahead of us.

Greg Melich

Yes. Maybe Corie, you mentioned something how the markets changed, now you saw more people getting streaming and audio systems attached. Are there any metrics you can provide of that versus like five years ago, where I don’t know a third of TVs have a surround sound and it used to be 20% or anything?

Corie Barry

I’m probably not going to provide metrics at this point. But suffice it to say, I mean, obviously when you think about five years ago streaming was a little baby and it’s come a long ways since then and obviously as the TV has gotten thinner you have absolutely zero sound quality associated with those TV is not there but it’s difficult for you to get any sound out of a very, very beautiful thin, lightly bazel panel. And so I think it’s the evolution of technologies naturally lended itself to adding in some of these other experiences.

I mean, obviously we don’t want anyone to go home and not love their home theatre system. And so we’re trying to find ways to make sure they understand up front, look you may not feel like you’re getting the full experience when you get home without something to help you on the audio side. So I think that it’s not only what we are doing, it also, you kind of are watching technology trends that lend themselves [indiscernible] this continued evolution that lends itself to a more complete experience.

Greg Melich

And then just on the guidance, just to make sure I’m backing it right, gross margins are expected to be down just a little bit in the fourth quarter, if I’ve put in everything?

Corie Barry

No, actually I’d say probably something that looks more like flattish to up maybe to fittest.

Greg Melich

Okay. Thanks a lot. Good luck.

Hubert Joly

Thank you, Greg.

Operator

And we will take our next question from David Schick. Please go ahead.

David Schick

Hi. Add my congratulations, not only on the results but on the engagement level in stores, the energy level, I know we’ve talked about it before, but in the retail industry it’s exciting to see it in the stores.

Hubert Joly

Thank you so much David. Goes to our heart, thank you.

Corie Barry

Thank you.

David Schick

My question is this, so the share gains have continued and compounded. And as you say, at some point they can’t keep accelerating but they can stay there to some extent. I guess, how does the compounding really of the conversation or the work with the vendors go? So I’m sure you won’t talk specifics, but as you’ve become more and more important in the way that they develop new products, that they introduce new products, that they talk to customers, I mean, how is the conversation different with the vendors than maybe broadly than 18 months ago or 36 months ago? I think that would be helpful to think about the evolution of the sector.

Hubert Joly

Yes. Thank you, David. Clearly these vendor partnerships partnering with our key vendors has been a big part of the story of Best Buy forever, but certainly in the last four years. If anything we’re deepening these partnerships, as we focus on solving problems for customers and providing solutions, we are adding a services dimension to these discussions. So that we can provide an end-to-end seamless experience and support to customers. So that’s an area we are exploring this, I can talk about specifics here because we’re – it’s an infomercial opportunity and we are a service provider – authorized service provider and we have a pilot with Samsung on in store repair for the phones and the tablets.

And so again providing – if you have a Samsung product we’re the only place where you can actually go to get this and of course Apple has go their own stores, but we have a very significant footprint. Also collaboration upstream in product design is something that is a great capability that we have and we are able to work with some key vendors upstream together create a winning strategy for our coming customers. And so being a player, in the North American market is such an important market for these vendors and Best Buy being a leading edge player in that creates a unique opportunity to create something very compelling for customers so these are some of the developments and as you can see they are pretty exciting.

Corie Barry

I think one just last piece I’d add is you continue to see especially in the emerging categories our ability to showcase experiences. We talked about VR and the 300,000 visits to experience VR. We’ve talked about kind of our working on creating some of those Connected Home Solutions you can actually experience what those things do for you. I think that’s where you continue to see our vendor partners interested and what we provide uniquely in our stores.

David Schick

Thank you, so much.

Corie Barry

Thank you.

Operator

And we will take our next question from Peter Keith. Please go ahead.

Peter Keith

Hey, thanks a lot and great quarter.

Corie Barry

Thank you.

Peter Keith

Corie, hoping you could comment a little bit on the gross margin drivers for Q3? With better margins in home theatre and computing, I’m guessing some of that is better attach. But could you maybe give us little more specifics? And is that a dynamic that you think can carry forward into the next couple of quarters?

Corie Barry

Yes, so let’s talk about gross profit a little bit. So what we saw in both home theatre and computing is really reflective of a little bit of what Hubert hit on, which is around kind of our mix, our assortment, our merchandising strategies and then absolutely to the last part of your question, some of that ability to have the basket due to the sales expertise that we have in our stores.

Additionally, we talked about our ability to take out cost especially around some of our reverse logistics and we’re also seeing some of that benefit our profit rates there. That however, was also offset by a little bit of a decline in the mobile category where we also have some mix challenges there.

The other thing that I would note is as you compare to the second quarter and you think sequentially about what’s happened in profit, we did not see material pressure from the investments in services pricing or the periodic profit share benefit. And so you kind of took those pressures away and then saw this bit better results around some of that mix and assortment. And it was very helpful to our overall margin rate.

And then in terms of your question about do we see some of this going forward. That obviously, we have confidence in our expertise and our strategies and merchandising elements. I always, I’m thoughtful around Q4 which is such a very different competitive quarter than the rest of the year. And so the guidance that we are giving you incorporates where we think we’re positioned to provide the very best value and very best experiences to our customers. And then also obviously Q4 you have to take into account what I hit on before which is the 25 basis points of pressure from that periodic profit share lapping from last year.

Peter Keith

Okay. Thank you very much and good luck with the holiday.

Corie Barry

Thank you.

Hubert Joly

Thank you.

Operator

And we will take our next question from Brian Nagel. Please go ahead.

Brian Nagel

Hi, good morning.

Hubert Joly

Good morning.

Brian Nagel

Very nice quarter, congratulations.

Hubert Joly

Thank you, Brian.

Corie Barry

Thank you.

Brian Nagel

So the question I wanted to ask just on the holiday. In your comments here, I think it’s fair to say you sound pretty constructive as we head into this holiday season. The questions I have and I’ll lump them together, to what extent – as you look at either your promotional plans or maybe what you’ve seen from competitors, does that seem more subdued or rational than prior years?

And then to what extent does maybe the spreading out, the de-emphasizing of Black Friday help to give you confidence that we lower the risk of maybe some irrational behavior out there? Then the final question with that, is there a product – I know we talked a lot about TVs and other categories, but is there a product that you think will really help to drive the holiday season this year? Thanks.

Hubert Joly

Thank you, Brian for the question so is the promotional environment this year likely to be more subdued, short answer is no. I think it’s always promotional and our category as we all know is used by certain player as a way to attract traffic. So there sometimes it will be aggressive promotions – often times limited quantities, but it creates, so no – we cannot see any chance from that standpoint.

Black Friday I think what until the game is played it’s hard to know but we do see a combination of a bit of spreading out but also peaks and valleys being higher and steeper as the consumer has been trained to shop when the prices are more promotional, so I don’t think that there is a material chance here.

From a product standpoint, I think what’s exciting this year is that there’s a broad range of exciting categories across what I would characterize as some of our more traditional product categories like for example, TVs and computing the new TVs are just extraordinary and computing our teams have done a great job as well as these emerging categories, so around connected home, around wearable, around drones, around virtual reality, there’s many reasons to come and check our products.

Portable audio, there’s also headphones. There’s some really cool new headphones. I’m personally so excited about my personal holiday shopping. I have to disclose I’m going to buy a new drone. I bought one last year but I’m going to buy a new one. This is exciting.

Brian Nagel

Well thank you and congrats again.

Hubert Joly

Thank you.

Operator

And we will take our next question from Scot Ciccarelli. Please go ahead.

Scot Ciccarelli

Good morning, guys. Hopefully a quick housekeeping item here. Corie, did you guys see an improvement in merchandise margins? And then secondly, can you guys talk about the In-Home Advisor test a little bit more? How far has that been rolled out in your testing? And is there any color that you can potentially provide us regarding kind of take a perspective in terms of the performance there. Thanks.

Corie Barry

So from that – what you refer to as merchandising margins perspective, obviously I think you can tell based on my comments around some of the assortment in the mix and driving in computing and home theatre. Yes, that is part of where we saw some of the improvement. To your question about in-home advisor, I’ll give a little color and if Hubert would like to add any, he’s more than welcome. So obviously we noted that we’re at least rolling out to one more market. It’s still very early and a test like this obviously it takes time not just from an understanding results perspective, but also just from a learning for us expertise training and ensuring we have seamless hand off between our stores and the in-home experience.

And so we are really working hard to ensure that we understand all those operational components. We like the experiences we’re learning about in the home. It reinforces I think for us this idea that there’s a lot of technology. It continues to evolve very rapidly, but there is confusion once people have it in their homes in terms of not just how to use it, this isn’t just about broken, it’s also about how do I do the most with it and actually understand how to take it to the next level and then when I’m comfortable doing the most with it, I’m often more likely to investigate and play with more things in my home.

So we like the things that we’re learning. You can tell we’re taking a very measured approach to making sure that if we’re going to do this we do it right and we have a lot of confidence in the value prop. That being said at this point, the teams are incredibly focused on delivering holiday and all of the intricacies that go with that. And so we’ll continue to learn and then we’ll obviously update you as we head into next year.

Scot Ciccarelli

Thank you.

Operator

And we’ll take our next question from David Magee. Please go ahead.

David Magee

Yes, hi, good morning and great quarter.

Corie Barry

Thank you.

David Magee

Actually a related question to Scot’s, on the Geek Squad with all of the moving parts there lapping the price cuts and these new programs, anything you see there that changes your opinion about the ultimate potential of that business over the next several years?

Hubert Joly

Yes. Thank you, David. We continue to be excited about the opportunities for a couple of reasons. One is there’s a need of customers for support and again it’s evolving towards maybe less break fix and more support and more help. And two, traditionally, we’ve been focused on selling services at the point of sale as an attach and we see the opportunity to help customers at their point of need. So that’s where Geek Squad on-demand is an opportunity. And if you do the math given our product market share and our percentage of attach, the bulk of the market is something that historically we had not addressed and we’re seeing some exciting green shoots, and experiments. We talked a bit on the call about Canada. We are talking about Magnolia Care.

So this is hard work because it’s building a new business in a sense of reinventing an existing business, but we continue to be excited by the opportunity and very focused on doing what it takes creating the right products, service offerings, also the processes to deliver, the capabilities, and then the go to market. So this is going to be, this is going to take time, but we continue to be excited about this.

David Magee

Thank you, Hubert. And then just a real quick, on the appliance side, are you seeing your customers embrace connected appliances at this point?

Hubert Joly

Yes. This is very early days around that. So it’s good that there’s innovation and people learn from that and so forth. It is not a primary driver of purchase decision for the bulk of the market at this point.

David Magee

Thank you.

Hubert Joly

Thank you.

Operator

And we’ll take our last question from Dan Wewer. Please go ahead.

Dan Wewer

Thanks. You noted that we have anniversaried the disruption from future shops, restructuring. I wanted to follow-up on that. Where do we stand on rolling out the major appliance departments into the Best Buy stores in Canada? And do you anticipate that once you add a major appliance department, it can grow to 9% of store revenues as it does in the U.S.?

Hubert Joly

Okay. So thank you, Dan. So in international, you’ve seen the numbers. There’s quite a bit of momentum there. In Canada specifically, we’ve mentioned in the prepared remarks that the new prototype stores that we’ve developed in partnership with the vendors are performing very promising and so there will be more on that. Appliances is the other opportunity. So when we deploy these new prototype stores, it does include an appliance department and then we also in the process of we’ve begun the process of deploying appliances in the other store.

We don’t have a forecast at this point in terms of the percentage of the business. It’s well represented and of course bear in mind that whatever space we allocate to appliance will cannibalize other product categories, but there’s no doubt that this is an opportunity – a significant opportunity for us, the same view that we have in the U.S. about the opportunity for us exists in Canada. So it’s going to take time to roll this out and we’ll take some investments, but we’re quite excited about it and so more to come on that.

Dan Wewer

If I could just follow-up, once you complete these investments in Canada, can the operating margin rate be equivalent to that in the U.S.?

Hubert Joly

Again, no specific guidance but conceptually and bear in mind that international is not just about Canada. So don’t directly apply this to your model. But conceptually, certainly is President of Canada is on the phone and listening, Ron Wilson, there’s no reason for Ron not to be able to perform to that same level all the time and it’s going to take time. And I have to congratulate our Canadian team they have done a remarkable job going through that brand consolidation. And then using that as a springboard to move forward, I was with all of their store general managers last month and there is definite momentum here. We have a great team. And so it’s very exciting and we’ll see how quickly they can go through higher levels of margin. So if he’s not on the call, I’ll certainly relay your question to him.

Dan Wewer

Okay.

Hubert Joly

Thank you.

Dan Wewer

Thank you.

Hubert Joly

Thank you. In closing, I’d like to do three things. One is, wish every one of you and your family on the call a wonderful holiday season. Number two, I would say that I hope you will give us the opportunity to help you with your holiday shopping this season. And we look forward to serving you either online or in the stores or in your home. And then number three, I’d like to really thank you for your attention and your support throughout the year and hopefully going forward. So thank you. Have a great holiday season. Thank you so much.

Operator

This does conclude today’s call. You may disconnect at any time and have a wonderful day.

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