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Best Buy Co., Inc. (BBY)
F2Q08 Earnings Call
September 18, 2007 10:00 am ET

Executives

Jennifer Driscoll - Investor Relations
Brian J. Dunn - President, Chief Operating Officer
Robert A. Willett - Chief Executive Officer, Best Buy International
David Morrish - Senior Vice-President, PC Mobility Group
Sean Scully - Senior Vice President, Services
James L. Muehlbauer - Senior Vice President and Chief Financial Officer, Best Buy U.S.
Mike Vitelli - Senior Vice President, Consumer Electronics
Bradbury H. Anderson - Vice Chairman of the Board, Chief Executive Officer
Darren R. Jackson - Chief Financial Officer, Executive Vice President - Finance
Ryan Robinson - Senior Vice President, Finance and Treasurer
Julie Owen - Senior Vice President, Entertainment Group
Carla Haugen - Investor Relations

Analysts

Mitchell Kaiser - Piper Jaffray
Bill Sims - Citigroup
Gary Balter - Credit Suisse
Brian Nagel - UBS Equities
Matt Fassler - Goldman Sachs
Mike Voss - Alex Brown Investment Management
Scott Ciccarelli - RBC Capital Markets
Danielle Fox - Merrill Lynch
Jonathan Cramer - Cowen and Company
Carly Whitter - Marisko Capital Management

Presentation

Operator

Thank you for standing by and welcome to Best Buy's conference call for the second quarter of fiscal 2008. (Operator Instructions) I would now like to turn the conference call over to Jennifer Driscoll, Vice President of Investor Relations. Please go ahead, Ms. Driscoll.

Jennifer Driscoll

Thank you, Eric. Good morning, everyone. Thanks for participating in our second quarter conference call. We have five speakers for you today; first, Brian Dunn, our President and COO; second up is Bob Willett, CEO of International and Chief Information Officer; third we have Dave Morrish, Senior Vice President of our PC Mobility Group; fourth, Sean Scully, Senior Vice President of Services; and finally Jim Muehlbauer, CFO of Best Buy U.S.

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

As usual, we would like to request that callers limit themselves to a single question so that we can include more people in our Q&A session, especially with five speakers. Consistent with our approach on prior calls, we will move to the end of the queue those who asked a question on last quarter’s call, and I guess we still have 100 or so dialing in.

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

As usual, the media are participating in this call in a listen-only mode. With that, I’ll turn the call over to Brian Dunn, who will begin our prepared remarks.

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Brian J. Dunn

Thank you, Jen and good morning, everyone. In our last conference call, we talked about two sets of results from our first quarter; our financial results, which were disappointing, and what we called our strategic results -- customer satisfaction, loyalty, and market share. These strategic results, which we believe are more indicative of our real progress over the long haul, were very encouraging in the first quarter.

The good news from our second quarter is that those strategic results continued to move in the right direction. Our market share once again increased over last year. So did our customer satisfaction scores and our memberships in Reward Zone, the loyalty program for our best U.S. customers, increased to almost 25 million members.

We are also obviously pleased with the financial results we are sharing with you today, which we see as being more in line with our strategic progress.

The strategy we’ve chosen to [get to] the unmet needs of customers -- excuse me, and works back from there to create solutions for them. This strategy does not lend itself to a linear path and the results won’t be linear, either.

We are following a compass, not a detailed map, and that’s why we plan our business on an annual and not a quarterly basis.

We are also pleased with our financial performance because we believe it demonstrates our ability to learn and to adapt better and faster to our customers’ needs in the demands of an extremely challenging marketplace.

We learned from what we were seeing and hearing in the first quarter before it was even over and adapted the maps we are creating and working from across the Best Buy enterprise on a global scale and in the fabric of each of our businesses, reacting to what our customers and the marketplace in general were telling us. And that’s a theme you’ll hear repeated throughout our remarks today.

In a minute, my colleague, Bob Willett, will share some of the details behind the tremendous news we bring you from Canada and China, the results we’re enjoying there and more importantly, the lessons learned along the way will benefit the entire enterprise because we are applying what we learn across borders and oceans, even while we continue to adjust an improve upon that as we go.

What we learn also forms and guides our expansion plans in other countries, because each market is unique with unique sets of customers and their unmet needs. No company, or country, for that matter, has a monopoly on good ideas. We are not concerned about where a good idea comes from and we are very clear it’s not our plan to force Best Buy on the world but to bring the best of the world to Best Buy, and then to continuously share what we learn back and forth in pursuit of offering the best possible experience no matter where you are.

You’ll also hear this morning from Dave Morrish and Sean Scully, who will illustrate the importance of offering a large assortment of products in differentiated experiences, supported by services to help our customers. To drive the point home, they’ll also illustrate where our market share might have been without this powerful combination.

And speaking of services, one of the specifics Sean will discuss is the new services disclosure. The timing is ironic in some respects because we are separating out the revenue from our services business just as we are learning to fully embrace the fact that services are not a separate line item, but are in fact the lifeblood of all of our business.

Be that as it may, we hope providing this information will increase the level of transparency and expand the dialog on this critical piece of strategy.

Finally, Jim Muehlbauer will run the anchor leg for our team today and give you some additional context around the numbers. In short, we are raising the bottom of our annual guidance range because of our second quarter results and our expectations for the back half of the year.

And now, I want to close my remarks by giving credit where credit is due; to our people. The men and women of Best Buy Enterprise came through again and I want to thank them and congratulate them, not only for their hard work but for their leadership in a challenging environment, which gives us optimism as we look ahead to the holiday shopping season.

I know I speak for this entire management team when I say that we are proud to represent them here today.

With that, I’ll turn it over to Bob Willett.

Robert A. Willett

Thanks, Brian. My comments this morning will begin with an update on our growing business in China, since we get a lot of investor questions about that. Then I’ll share my thoughts on the adaptations that drove Canada’s performance. I’ll wrap up with an update on our work with the Carphone Warehouse, our strategic partner in the U.K.

I too would like to start with congratulations to our team in Canada and China, as well as our global sourcing team. Collectively, these teams delivered revenue growth of 54%. It’s very hard to produce double-digit comparable store sales gains on top of a 9.3% gain for the previous year. For the second quarter, we reported a 16.3% comparable store sales gain for international, which at the moment includes exclusively our Canadian stores.

Our global sourcing teams are also creating great outcomes through our private label brands, delivering a unique point of difference for our customers in each country.

Our international revenue growth reflected the gains in Canada, which I’ll explain later, as well as the acquisition last summer of Five Star, which continues to grow its top line at rapid pace.

Our Five Star stores continue to be on plan for revenue as we focus on meeting the needs of the Chinese consumer. We are making good progress with tests underway related to a new operating model for our Five Star stores, taking the best ideas from what we see throughout the world and yet expressing them in a way that serves the Five Star customer segments and brand.

These stores will look very different to the customers compared to the in market Best Buy stores, yet they will be consistent with our overall strategy, including more local autonomy for the staff, inventory and the merchandising.

Our Best Buy store in Shanghai also continues to perform, giving us confidence as we move forward with preparations for the next two Best Buy stores in Shanghai. We’ve also attracted high caliber talent in China and Turkey, and are in the process of hiring leaders and finding real estate in Mexico. We remain on track to open a handful of stores in both countries within the next 12 to 18 months. We are in the middle of assessing the customer segments in these markets as we speak. Entering the Turkey marketplace also offers us the opportunity to expand our global sourcing capabilities.

As our news release indicates, one of the key drivers of Best Buy's out-performance this quarter was the result we garnered in international. We experienced double-digit comps at both Futureshop and Best Buy stores in Canada this quarter. These gains came primarily from an increase in the average ticket without sacrificing margins.

Our gross profit rate for Canada improved by 50 basis points. With the help of good execution and teamwork, we also improved SG&A in Canada by a full 220 basis points, due to the expense leverage on higher volumes, coupled with more disciplined spending.

Operating profits in Canada improved by more than $30 million year over year. Altogether, our operating profit in Canada, which was 0.5% five years ago, now is on track to approach 4% for this fiscal year and on its way to 5%.

My colleague Brian commented that we create value for shareholders when we are fast to project and adapt to changes in consumer needs and wants. Those adaptations can create structural barriers for competitors. In smaller, fast-growing economies, this phenomena is even more pronounced. Not only do these economies diversify our company’s revenue streams and give us opportunities for faster growth, but they afford us very useful benefits. Oftentimes we have the opportunity to apply a successful adaptation in one market to boost results in other markets where we operate.

One of our strengths at Best Buy is scaling new ideas. We go at breakneck speed once we crystallize our thinking around a successful innovation, like Geek Squad. That’s a U.S. example, but the point is we love new ideas and are agnostic about their country of origin. It’s all a part of our philosophy of bringing the world to Best Buy as opposed to taking Best Buy to the world.

And it’s also consistent with our overall approach to running our business in an integrated way, supported by a common platform throughout. It may be helpful to provide a specific example of sharing adaptations between countries. Here are three striking examples where we’ve shared good ideas with Canada from our supply chain program in the States; global sourcing, price optimization, and private label goods. These adaptations are providing benefits to Canada this year.

We’ve also had successful adaptations flow in the reverse direction, such as when we took good ideas from our international segment back to the core. As an example, there’s the success we’ve had in Canada in anticipating how certain customer segments look to purchase TVs differently from other customer segments. This change lifted our market share and our financial results. Today, we are implementing a variation of this concept in the States.

Dual branding is another such instance. What we’ve seen so far with dual branding in China and in Canada makes us biased in favor of using dual brands in any new country we enter in the future. Likewise, as we look around the globe for the best adaptations to customer needs, we have realized that in areas where we may be weak, the best way to improve our effectiveness quickly is by working with outside partners and sharing insights with each other. Accordingly, we sought out partners with unique strengths, like HSBC, Virgin Mobile and, of course, Carphone Warehouse.

So last but not least, I would like to give you an update of our relationship with the Carphone Warehouse. As you read in this morning’s news release, we have acquired a minority shareholder position in Europe’s largest mobile communications retailer, which is, in my opinion, highly respected. CPW shares our passion and culture around customer excellence. This partnership with Carphone Warehouse is very exciting because of the potential to bring together our individual competencies in order to create a vastly superior customer experience. It’s one of the many growth options that hold particular excitement for our people.

Our minority ownership stake in CPW reaffirms our commitment to our strategic partnership. Working with this best-in-class company gives us capabilities and expertise that complement our own assets, assets such as the 500 million visitors into our U.S. stores annually and the successful Geek Squad operating model.

We’ve previously announced our partnership with respect to rolling out Best Buy Mobile in the United States and eventually in other countries where we operate. This work continues to proceed. We now operate 41 Best Buy Mobile stores within a store, as well as the original five standalone locations in the States.

Knowing how important services are to customers, we recently have reached agreements on launching home computing support services in the United Kingdom. We began offering Geek Squad in London in March. We are pleased with the initial results and hope that we’ll see the results we need in order to offer Geek Squad services eventually in other locations where CPW operates.

Thank you for listening. I would now like to pass you over to Dave Morrish who will give an update on how adaptation has helped us drive our success in computing. Dave.

David Morrish

Great. Thanks, Bob and good morning. Bob gave us very good examples of adaptation in our international business. I would like to build on those examples in the context of adapting our computer business to support customers’ changing needs, which we have accomplished in a challenging industry environment.

As many of you know, Best Buy has enjoyed a leading market share position in computing for the past several years. We believe that having a differentiated experience in computing is critical to the success of our overall strategy as an electronics retailer, particularly as the world gets more connected and as our products get more integrated.

Computing’s lower margins tend to get negative ink. Yet in the first half, our operating profits in home office increased. The drivers included higher volumes, lower cost, and a better understanding of our customers needs. We also had solid double-digit comparable store sale gain in sales of notebooks to consumers. Our performance in desktop computers were more modest, yet were still industry leading. We believe that the story here, like other areas of our business, is around successfully adopting our model to allow us to grow.

Vista provided a new way to utilize computers and we adapted our business to take advantage of that occurrence. At the same time, the launch of Vista operating system created new learning challenges for our customers. This transition was made easier because of the support provided by our Geek Squad agents. Specifically, our Geek Squad agents personalized the screens for our Vista customers so they would better understand its features and benefits.

Over the past few years, we have been able to mine our customer database and gain a much better understanding of how consumers want to utilize their computing products. We now understand that for sum, the computer is becoming a tool of self expression or creativity. For others, it’s a tool that increasingly help them stay connected and share their lives with loved ones. And for others, it’s simply a tool to help them manage their lives.

We have used these insights to boost our results. Specifically, we have worked with our manufacturers to create unique PCs, PCs that support the pursuits of personal experiences. We recognize that our customers have changing preferences, including greater interest in variations of size, style, design and color.

A customer insight about the power of the Apple brand prompted other adaptations for us. We had tested Apple computers four times in recent years and never really cracked the code. However, last year, supported by Geek Squad, Apple labor and customer insights, we landed on a new successful model. So we expanded the test of 50 stores and today, approximately 200 Best Buy stores carry Apple computers. By the end of October, we’ll have approximately 270 Apple locations. We’ll monitor the results through the holidays and consider more Apple locations after year-end. So far, it appears that this business is largely incremental for us and it is definitely generating customer traffic.

Another way we use customer insights is to create unique product bundles that bring the whole experience to life. Look for new bundles this fall in our print ads and our end caps and online. We are utilizing Canada’s approach with a unified, multi-channel story, another example supporting Bob’s point.

Now, assume for a moment that we had the right products, price points, designs, brands, and bundles, plus the availability of services, even after all that we are still not done meeting the unique needs of our customers. We complete this task only after we train our employees to demonstrate how these can help our customers fulfill their dreams and ambitions. That’s actually more important than giving them the technical details.

If we can do all of these things better than our competition does, it shows up in revenue, profits, and customer satisfaction scores. All of these indicators have been pointing north. It also should show up in market share. In the last quarter for which we have data, we believe our share of consumer market for notebooks rose over three points. That’s a large bump for one year and it’s been growing steadily, actually, since the national launch of Geek Squad. In fact, since that national launch, we believe that our market share in computing has actually doubled.

Likewise, my colleague, Mike Vitelli, tells me that the market share in flat panel TVs has grown materially as well. When we compare our flat panel share today to what we had prior to having robust home theater installation capability, the different is striking. We have garnered over a 50% increase.

Now, there were other factors, of course, such as improved assortment in bundles, yet we believe that our market share increases in computing and home theater wouldn’t be as high as they are today without our services capability.

So as we look at the success of the second quarter, our discussion would be incomplete without talking about services. I know Sean agrees. With that, we give you Sean Scully, the senior VP who heads up our services group. Sean.

Sean Scully

Thanks, Dave. Well, we certainly have learned over the last few years how integral services are to customer centricity. As you’ll remember, we accelerated Geek Squad in 2004 because we realized we couldn’t be customer centric without it. Not that it is a silver bullet, but it does enable us to serve our customers business.

We disclosed our service revenue for the first time this quarter, so I want to take the opportunity to frame up the business. I view our role as a service organization as two-fold. First, we support the customer experience and deliver our brand promise; second, we drive revenue and profit through the sales of services.

Our role in delivering the right customer experience shows up in a lot of different ways. Let me talk about two. A tangible way for us to measure and track customer dissatisfaction is through returns. Not only do returns represent customers that haven’t been fully satisfied but they also add cost to our supply chain. That is an opportunity for us on both a customer front and a financial front.

We know when home theater transactions involve a service component, our returns drop over 10%. We also know when a computing transaction involves Geek Squad, it lowers returns nearly half. So we see evidence that providing services results in a substantially better customer experience and clearly helps our bottom line.

That brings me to the second way we track whether we are enabling a better customer experience. As you know, this year our total company on the America Customer Satisfaction Index, jumped from 71 to 76. We are very proud that our total company customer satisfaction scores are moving up and our scores in services have been some of the strongest movers.

We feel a big responsibility to help deliver the brand promise to our customers and I think you are seeing that play out in our market share and customer satisfaction customers.

The second role for services, as I mentioned, is to drive revenue and profit growth for the enterprise. That speaks in part to the numbers that we’ve disclosed in this news release.

As you saw, services represent 6% of the revenue in the second quarter and grew at 5.3% on a comparable store basis. I think that number understates the actual value and role that services plays in bringing all of the products together for our customers, but you have to draw a box around the business and break it out separately.

I think Dave made the point really well. We wouldn’t have our current market share in computing without Geek Squad, and that works both ways; we wouldn’t be nearly as successful with Geek Squad if it weren’t for our dominance in computing and TV.

Now I’ll give you some context on the pieces of the services revenue and the moving parts in the growth rate. The largest in the service categories is the commissions we earn through the sales of extended warranties. The second largest bucket in the consumer services, which include services in computing, home theater and mobile installation, largely performed by the Geek Squad. Revenues from product repairs is the third bucket, appliance installation, delivery and other items make up the balance.

For annual context, the global service business was approximately $1.9 billion in fiscal 2007.

Finally, here’s what we’ve seen in the growth rate; the Geek Squad computing and home theater business delivered a double-digit comp gains; our product repair revenue comped up modestly. These gains were partially offset by a single digit decline in the sale of warranties.

I mentioned the inclusion of home theater and mobile installation in the Geek Squad brand earlier. We are very proud of the brand and the capabilities we have built and the fantastic customer response. We are bringing the strength of the Geek Squad brand to all of our installation service offerings. The benefit that we deliver for consumers is in making the technology work for them when and where they need it.

Our customers already thought that Geek Squad did more than servicing computers and now we do, which I think speaks directly to the strength of the brand and the confidence we are inspiring.

Looking forward, we truly believe we have just scratched the service in responding to this customer need. Our focus is obviously to grow our business but not as a standalone P&L. Frankly, operating services in a standalone fashion would limit our potential. We see a huge market opportunity by enabling all the other parts of the company to deliver full solutions to our customers. And at the end of the day, our customers just want to enjoy their stuff and we will be there for the entire experience. That is our value; that’s our true value.

Now I would like to turn it over to Jim Muehlbauer.

James L. Muehlbauer

Thank you, Sean and good morning, everyone. As Brian mentioned up front, our strategic resolve remains unchanged from the first quarter and we were able to achieve better financial results in an environment that showed more signs of economic unrest.

Overall, the quarter played out better than we originally expected with a few things driving upside in our performance. Fiscal year-to-date, total revenue rose 15% and operating income now stands flat with last year. While we certainly have a ways to go to complete the year, we are pleased with the results in the quarter and remain confident in our ability to deliver solid performance for the year.

Two key areas exceeded our expectations for the quarter. First, the gross profit rate in the U.S., particularly in the home theater business, was better than we expected. Second, the continued strong results from Canada that Bob detailed earlier. Those were the top financial stories for the quarter.

With those as headlines, I want to walk you through the highlights of our performance in the quarter, update you on the progress we have made in evolving our capital structure, and review our guidance for fiscal 2008.

First, total revenue of $8.8 billion was slightly ahead of expectations, based on better-than-expected top line growth in Canada. Revenue growth in Canada was fueled by a 16% comparable store sales gain, positive foreign exchange impact, and new stores.

The U.S. business remained largely unchanged from the first quarter and delivered a 1.7% comparable store sales gain, which was in line with our expectations. We continue to see strong growth in computing and gaming, as well as strength in our online channel. The U.S. online channel delivered over a 20% comp in the period.

Home theater sales for the quarter also finished in line with our expectations but continued to be constrained by softer consumer demand in the industry. We continue to press our advantage in this space by expanding our high definition advantage solutions to include audio, advanced DVD, and gaming, which provide customers with the complete experience they want for entertaining their friends and family.

We firmly believe that the combination of these customer-focused solutions and strong execution by our retail and services team provided the platform for our profitable market share in this important business.

The overall gross profit rate decline of 60 basis points improved significantly over our performance in the first quarter, when margins declined approximately 150 basis points. Let me break down the key drivers of the year-over-year change.

First, the addition of the China business drove 30 basis points of the decline in the second quarter, as expected. We will begin to fully lap the inclusion of the China business in the third quarter. The balance of the decline was driven by the anticipated mix effect of growth in computing and gaming hardware, which was partially offset by improvements in home theater.

The home theater margin improvements were driven by sharper pricing, excellent retail execution, and more efficient promotional spending.

Our company wide SG&A rate improved 80 basis points. International business accounted for over 50 basis points of the year-over-year improvement. First, strong revenue and solid expense performance in Canada contributed 20 basis points of the improvement to the enterprise; second, the addition of the China business, which carries a lower SG&A rate, contributed 30 basis points to the enterprise reduction.

SG&A spending in our U.S. business, which drove 30 basis points of improvement, was once again in line with our plans, as we appropriately edited and managed costs in the softer comp environment we saw in the first half.

Our field teams continue to refine their operating model and drive productivity gains. We were pleased with this level of SG&A leverage in the U.S., especially given the revenue environment.

Net, it adds up to roughly a 25 basis point improvement in the operating income rate and more importantly, a 21% increase in operating income dollars. Bottom line, we grew our EPS 17%.

All in all, we’re pleased with the momentum we started to build in the second quarter, especially in an environment that continues to have mixed signals.

Next, I want to give you a status update on our use of capital to drive growth and shareholder returns. Fiscal year-to-date, we have opened up 67 new stores globally, including 51 in the U.S. We are on track for our plans to open up 130 to 135 new stores globally this year, a record for the enterprise, and continue to see this as a high return investment.

We are also very pleased with our progress on the accelerated share repurchase program. Our confidence in our people, our business strategy, and growth options makes this a great investment in our view, especially at our current stock price.

Given the significant changes to our total shares outstanding, I thought it would be helpful to provide context on our share count expectations for the balance of the year. Under the ASR, we have repurchased 55.7 million shares thus far. On a weighted average basis, that reduced our share count for the second quarter by 29 million shares. The third and fourth quarters will reflect the full weighted benefit of that reduction and for guidance purposes, we are projecting a diluted share count of approximately $433 million shares for each of those quarters.

We assumed in our guidance that the final tranche of approximately 7 million to 12 million shares will be retired on the last day of the ASR period, which is at the end of the fiscal year. As such, those shares do not impact the weighted average share count for the fourth quarter or the year, but we’ll be starting next fiscal year with a diluted share count of approximately 425 million shares, which will be 15% lower than last year.

Which brings me to my final point before we open it up for Q&A; our outlook for the year. Given our better-than-expected results and outlook for the remainder of the year, we have raised the bottom end of our annual guidance range. Our current momentum and expectations for the second half indicate that our earnings will finish in the upper half of our new $3.00 to $3.15 guidance range.

While we are pleased with the progress and improved financial performance in the second quarter, our optimism is balanced by the fact that 70% of our earnings are still ahead of us for the year in a volatile macroeconomic environment.

Given the 3.3% comps year-to-date and what we see ahead in both the product cycles and in the environment, we are projecting annual comp sales near the midpoint of our 3% to 5% range. We continue to expect more modest declines in the gross profit rate in the back half as we have now lapped China and will be lapping an intensely promotional period last year.

Additionally, we are forecasting continuing SG&A rate gains in the back half to more than offset the gross profit rate decline. We still expect a nominal improvement in our operating income rate for the fiscal year.

We watch the same mixed signals in the environment that you do and know that we cannot control their impact on the consumer. But the things that we can control give us great confidence in the back half. Record market share, rising customer satisfaction, 25 million reward zone members, and more new and exciting products and solutions, just to name a few. More important, we have nearly 140,000 engaged employees that are focused on our customers and ready for this holiday shopping season.

To recap our remarks, we continue to see positive signs in our key strategy measures, like market share, customer satisfaction and customer loyalty. We are pleased with our financial momentum in Q2 and our optimism for the year has not changed.

Longer term, we are confident that our ability to adapt and meet rapidly changing customer needs will allow us to close the gap between who we are today and who we know we can be in the future.

With that, I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mitchell Kaiser with Piper Jaffray. Please go ahead.

Mitchell Kaiser - Piper Jaffray

Thanks, guys. Good morning. Very nice quarter. I was hoping you could comment -- I think it was a big surprise, at least from our perspective and I think other investors that we talk to, is the margin rate improvement in home theater, and I know you mentioned execution and promotion and some other things, but is that inclusive of services as well?

And then, on the services side, I think Sean mentioned that if you break down the biggest components on the services side that you’ve disclosed, and thank you for that, that warranties was the biggest part of that. But if we go back to the filing last year, I think warranties were about 2.2% of sales, and you are saying this is 6%. I was wondering if you could just reconcile the differences there. Thank you.

Mike Vitelli

Mitch, good morning. Thank you. The answer to your first question about home theater margins, it is yes and yes. Home theater margins are up, as Jim mentioned, with our high definition advantage program, where we are bringing installation, so services are a piece of it, audio, high definition sources, such as DIRECTV and now including next generation DVD and gaming, and as well as audio.

So our home theater margins would be up without services, but that is a part of it as well. So when we look at the entire package, it’s up and it’s really offering those, if you will, those variable solutions to customers. The promotion is not a fixed package. It lets customers make those decisions for themselves and they’ve been opting into it very well.

James L. Muehlbauer

I’ll take the second part of that question. We’ll glad you like the services disclosure. The services business really, as we’ve disclosed, includes a number of different things. The 6% of sales that Sean outlined really includes our warranty business, our computer services business, our home theater business, our mobile installation business, and some of the other service elements we have, which are referred to in our previous filings around the warranty business, the 2.2% of sales. That is just one component of that services bucket, Mitch, and it happens to be the biggest component.

Mitchell Kaiser - Piper Jaffray

Right, but I think that -- I think last year warranties were 2.2% of sales, right?

James L. Muehlbauer

That’s correct.

Mitchell Kaiser - Piper Jaffray

Okay, but I guess -- does services mix up as a percent of sales in the second quarter then, given that it’s 6%? Or would you expect services to be 6% inclusive of warranties for the whole year?

James L. Muehlbauer

It moves a little bit during the quarter, so it’s roughly about 6% for the entire year.

Mitchell Kaiser - Piper Jaffray

Okay. I guess I’m not following how the -- well, okay. I got you. It’s not the majority, it’s the biggest piece.

James L. Muehlbauer

That is correct.

Mitchell Kaiser - Piper Jaffray

Okay, understood. Thank you, guys.

Jennifer Driscoll

Thanks, Jim, and we list them generally in order of magnitude, not just for that but for everything we usually -- and thanks Mike and Jim for that answer. Next question, please.

Operator

Our next question comes from Bill Sims with Citigroup. Please go ahead.

Bill Sims - Citigroup

Thank you very much and good morning. My question is on the computer business. It appears you did a phenomenal job growing the notebook computer business and continuing to gain market share. However, according to NPD, it appears the industry saw a slight sequential softening from July to August this year versus years past. Did you see -- did you as well see that take place in the industry, and can you comment about what we are seeing in the notebook computer business? Has it softened a little bit in August, relative to what you’ve seen in previous August, August going into the back to school selling season? Thank you.

David Morrish

I guess I would like to comment in this way; we continue to see strong growth in terms of our computing notebook share, and as I mentioned as well, desktops are moving along nicely in that same environment and customers really responded to our offerings during that timeframe. think the biggest thing as well is we continue to see that growth that Sean outline in our geek services as well.

So all combined, when we look at how Best Buy performed, we are really pleased in terms of how customers reacted to our offerings and that’s how we saw --

Bradbury H. Anderson

-- though, Dave, between July and August?

David Morrish

We did not see a significant pattern shift at all, Brad. I mean really, for us, it pretty well stayed the same. There were some indications in the industry that a few players saw some softening but for the most part, it seemed to remain robust.

Bill Sims - Citigroup

Thanks, Dave.

Jennifer Driscoll

Okay, next question, and that was Dave and then Brad.

Operator

Your next question comes from Gary Balter with Credit Suisse. Please go ahead.

Gary Balter - Credit Suisse

Thank you. First, I just wanted to point out an irony or inconsistency in your comments. Brian, you mentioned that we discovered service is not a separate line item and yet this is the first quarter you broke it out.

In terms of the question, and I could ask the dual brands, et cetera, but the thing I think that as investors we are trying to balance is you put up another good quarter and you keep on putting up good quarters, you put some cautious comments at the end -- how should we be thinking about your thoughts on the macro outlook and what impact that can have? And now even for this year but also into ’08? And as part of that, we’re in the markets that housing is getting hit -- you know, Florida, California, Michigan -- are you seeing big differences in those markets versus your other markets right now?

Darren R. Jackson

Gary, why don’t I frame that and you know what? I’ll point to something that you just highlighted in your comments. When we look across our business, I think as we did last quarter, and then Brian kicked off this quarter, is we look at the strategic drivers of the business, our loyalty, our customer satisfaction, our reward zone, and I’d say it’s on purpose you heard many times in the call today adaptability. And maybe a frame to think about; when we look across the U.S., and I’ll just pick Detroit; Detroit in the quarter was up over 5%, and Detroit shouldn’t be up over 5% but it’s also one of our leading CSI markets.

So what we are learning is that when we actually get it right with the customer, you can navigate an environment if you keep your head up and adapt. And so when I look at the results, and this is what you heard from us last quarter, is that we weren’t thrilled with the financial results but we were, we had a sense of satisfaction with the strategic results and that’s what we saw play through. It just so happened that this quarter, that the strategic results, the financial results in places like Detroit, Michigan made a difference.

Unidentified Participant

And CSI is customer satisfaction.

Darren R. Jackson

Yes, customer satisfaction index, and so we are learning every day and we are teaching every day as we pay more attention to metrics beyond the financial metrics and make the [adaptation]. It’s showing up in the financial results that we are seeing in the business.

Jennifer Driscoll

Thank you, Darren and Barry, for that clarification. Next question, please.

Operator

Our next question comes from Brian Nagel with UBS. Please go ahead.

Brian Nagel - UBS Equities

Good morning. A couple of questions; in your press release and in your comments, you talk about market share gains. If you could just talk a little bit further about the rate at which you think you gained market share here in Q2 versus Q1. Then, maybe more specifically, some of the product categories where you think you had particularly strong gains. Thanks.

Unidentified Participant

Well, as we’ve talked about in the calls prior, we’ve been picking up market share over the last 12 months in a pretty significant way across most of our categories. And really, it’s been since we’ve really combined our strength in hardware with our services, as we talked about earlier. So with the HD advantage program last September through Super Bowl and up until this year, we’ve seen significant gains across the portfolio of products in home theater. And then, beginning in February with our overt effort to connect Geek Squad services and hardware, we’ve seen an acceleration in the PC business as well. Again, across all the components of what we consider to be the PC business -- desktops, notebooks, peripherals, software, et cetera. And on top of that, because we’re combining it, our services business is picking up market share as well.

So it’s across the board and it’s more significant than we had seen prior to about 12 months ago. And we are always opening up new stores, so that’s always contributing. Our percent of new stores to our total though is less than it has been historically, so it really is more of the core business that is gaining market share than it is new store related.

Robert A. Willett

In addition to what you’ve heard Dave and company talk about in terms of computing, we’ve also done incredibly well in gaming and also in digital imaging. Those areas we are investing heavily in them and they are really working very well for us, and so the across-the-board picture is absolutely the right one.

Jennifer Driscoll

Thanks, Brian, for the question, and Barry and Bob for the answers. Next question, please.

Operator

Our next question comes from Matt Fassler with Goldman Sachs. Please go ahead.

Matt Fassler - Goldman Sachs

Thanks a lot. Good morning. I would like to dig a little bit deeper into the home theater margin dynamic. Can you think about where the supply chain is and your interaction with the supply chain at this point of the year versus where it was a year ago, which I believe was the time that the supply chain started to see some negative fallout? And if you can kind of put the second quarter home theater gross margin performance in context of how that should help us think about the second half.

Mike Vitelli

Thanks, Matthew. When I look at last year, there was one thing that was definitely evident was a growing increase in flat panel availability and we all started to notice that in the industry, that the opposite is actually true now, particularly in smaller screen sizes.

As my colleague Dave had tremendous success in notebooks, a lot of the manufacturers shifted some of their small screen size production to notebook and monitor panels, so that now 32-inch and below are actually in tight supply, which is a positive in the sense of as far as pricing is concerned.

Larger screens sizes are coming into the marketplace and I think that’s where we are seeing the biggest increase in availability and in price declines right now, as those categories are starting to become more affordable.

So as I look out into the second half, I see a little more stability in the availability versus the demand and hopefully that will translate itself into a more positive third quarter activity.

Jennifer Driscoll

Thank you. Next question, please.

Bradbury H. Anderson

That would third quarter, our third quarter, which would correlate with part of the --

Mike Vitelli

With November.

Bradbury H. Anderson

Right, calendar fourth quarter.

Jennifer Driscoll

Next question, please.

Operator

Our next question comes from Mike Voss with Alex Brown Investment Management. Please go ahead.

Mike Voss - Alex Brown Investment Management

Hi, guys, I just have a question on how much cash was actually used to buy back stock in the quarter. Was it the full $3 billion or something less than that?

James L. Muehlbauer

The full $3 billion.

Mike Voss - Alex Brown Investment Management

And so if I did the basic math, it looks like you paid around $52, $53 a share. If that’s accurate, how do you juxtapose that -- I guess it was an agreement you had with Goldman Sachs, but how do you juxtapose that relative to the stock that never really traded at that level in the entire quarter?

Ryan Robinson

Good morning. The way that the math works on that is we only received a partial delivery of the shares underneath that agreement, so it is inaccurate just to take the number of shares divided by the dollar amount because there will be a supplemental delivery at the back end of the contract.

The number of shares under that supplemental delivery is in the range that we talked about. It would depend on the market price but we would estimate it somewhere between 7 million and 12 million shares.

Mike Voss - Alex Brown Investment Management

So when all is said and done, what do you think the average cost that you would have paid for the shares to be?

Ryan Robinson

It would approximate the volume weighted average price during the contract period, which runs from mid July through the end of the fiscal year.

Mike Voss - Alex Brown Investment Management

So it should be somewhere let’s say in the low to mid 40s, given that the preponderance of the shares have already been purchased?

Ryan Robinson

Certainly. What we don’t know is what the price is going to be between now and the end of February.

Mike Voss - Alex Brown Investment Management

Right. Okay, thanks.

Jennifer Driscoll

Thanks for the question, Mike. Next question, please.

Operator

Our next question comes from Scott Ciccarelli with RBC Capital Markets. Please go ahead.

Scott Ciccarelli - RBC Capital Markets

I had a question just on the spending side. I mean, you guys have spent a lot of money and you use the term investment, of course, but you know, invested a lot of money in different parts of your business. But with the SG&A performance that we had in this quarter, should we read anything into that regarding future spending plans or expectations? I know there tends to be some lumpiness in it, but just in general in terms of what the outlook is on investment spending. Are we starting to reap some of the fruits of the previous spending? Just give us a framework, if you would. Thanks.

James L. Muehlbauer

I hope two things are true; one is that we never stop investment spending in our growth options, and two, we are clearly gaining some of the benefits in our business and our expense model from previous expenditures, most notably the comments that we talked about this morning. The performance in our Canadian business after initial years of infrastructure investment, to see that type of leverage in that business is truly impressive.

Sean also talked about how our services business has grown after a number of years of investment spending behind that, so those are two real life examples showing up in our numbers today of leverage we are getting from previous investments.

When we saw the results in our first quarter, conventional wisdom may have said to start to dial back in our investment. We absolutely did not do that. As a matter of fact, we pushed forward. We opened up more new stores in the first half of this year, almost 70% more than we did last year. We continue to see that as a strong growth vehicle and we certainly look for options to continue to improve our expense structure going forward.

So we are not moderating the expense lever based on just the current environment we’re in. We are really continuing to push forward on our growth options because we think that’s the longer term answer that makes our business model work and will deliver those consistent shareholder returns going forward.

Jennifer Driscoll

Thank you, Jim. Next question, please.

Operator

Our next question comes from Danielle Fox with Merrill Lynch. Please go ahead.

Danielle Fox - Merrill Lynch

Thank you. Could you talk a little bit more about what you expect to be different this year versus last in the promotional environment for Christmas? It sounds like you are expecting a more benign environment and I’m wondering why that is? And if you could also just comment on the costs associated with some of your credit promotions and how those have maybe changed. Thank you.

James L. Muehlbauer

As we look at the back half of this year, consistent with what we said on the last call, we know that we are lapping a dramatically more promotional environment that we experienced last year, and our confidence in that around the performance for this year is really predicated on what we’ve heard in the marketplace from the different constituents, being our vendors and our customers, around the experience they had in the back half of last year.

Our intelligence tells us that we are going to have a more rational promotional environment. I think that is played out in our numbers to date. Certainly in our margins within the second quarter demonstrate that. And we have a long way to go yet in the back half of the year but it is really that collective intelligence we have in the external marketplace that’s given us that view.

The other things that we look at is the competitive environment from the store fronts that are out in the back half of the year has changed year over year. We have fewer competitors like CompUSA, we have Tweeter who’s got obviously fewer stores than they had last year, so there’s less retail square footage in the space that we were selling products that allows us to really accelerate for the customer.

I think we also spoke on the call about our continued relationship and expansion of our strategic relationship with HSBC and that we are really using that relationship to improve our loyalty programs internally, which is having a positive impact on our ability to provide customers with attractive financial offers to buy some of the larger ticket items in our portfolio.

So we continue to be very, very happy with that relationship and really believe that that’s bringing a competitive advantage in the marketplace for us.

David Morrish

I would also add that in the PC business last year in the back half, there was a fair amount of angst around the transition of the XP operating system, and so a number of products were cleared out early by some competitors. That led to a rush at the end of the cycle. This year, it is a much more rational cycle in the PC business and Vista has also provided some level of stability in terms of, with its features and benefits, more customers are trading up in that space to enjoy those features and benefits. So again, slightly higher prices in terms of PCs overall compared to last year, and particularly with regard to the transition costs that were experienced last year.

Jennifer Driscoll

Thank you. That was Jim and Dave Morrish. Next question, please.

Operator

Our next question comes from Jonathan Cramer with Cowen & Company. Please go ahead.

Jonathan Cramer - Cowen & Company

Good morning. Given your out-performance in the international group this quarter, just your expectations for where the growth is going to come for the remainder of the year between domestic and international and what are some of the key drivers in the Canadian business.

James L. Muehlbauer

Bob, I’ll be happy to talk about the balance of the domestic business if you wanted to frame the Canadian performance for the back half of the year.

Robert A. Willett

First of all, I would like to say it’s more of the same. We are on a track. We’ve been on a track now for a good 12, 18 months and the focus is not changing. We’ve made some great in-roads but there is still a long way to go. We are still early into the journey and as we said, we look to 5% next year and beyond that, I’m not going to say anymore otherwise --

Darren R. Jackson

Five percent margins.

Robert A. Willett

Five percent operating margins, so I think it is more of the same in Canada and more of the same in China. We are starting to really learn now what works and what doesn’t work in China. We’ve learned a great deal from the consumer research. We’ve seen some success. We’ve also seen what doesn’t work and we are now starting to turn those things into a model store in Five Star and we are also looking to open more Best Buy stores in the first half of next year, now that we’ve really understood. But it’s more of the same. I don’t want to say it’s different because it isn’t.

James L. Muehlbauer

Jonathan, I’ll maybe just round out the enterprise view. I would tell you that as we looked at our estimates for the second quarter, I don’t think we -- I know we didn’t write down a 16 comp for Canada in the second quarter based on the even more difficult comparisons they had in the second quarter, so to Bob’s point, we continue to look for robust growth there but we’ll be lapping some more difficult comps in the back half of the year in Canada.

In the U.S. business, we’ve actually got a number of very exciting product cycles that are different than last year. We have a gaming cycle that essentially launched in Q3 of last year with very limited availability of product. Our employees are telling us that there is strong customer demand in those spaces and we are looking forward to having much more product available to meet those needs for our customers.

We are also looking at, as Dave mentioned on the call, just a large number of computer solutions, including Apple in the assortment that we didn’t have last year in that portfolio, which will be to strengthen our product mix.

Also, with the Apple announcement around the new iPods and the new solutions they brought to the music space generates another level of customer excitement. And not to be forgotten in the mix, certainly as we believe we have a much stronger new release schedule in the DVD business based on the strength of the box office performers early in the year.

So if I couple all that with the great progress we are making in services and Mike Vitelli’s comments around the availability of product and the new improvements we’ve made in the high definition advantage solution, we really feel good about the things that we control in the product cycle and solutions for the back half of the year. The $64,000 question that you know is how is the macro environment going to either plus that up or actually detract from that in the consumer’s mind in the back half of the year.

Darren R. Jackson

I think, Jonathan, the frame we absolutely want to leave you with long term though is that you should not miss the point about making our international investments. So we didn’t talk about China. Longer term, we see a $100 billion market. Services, we see a $60 billion market, and Best Buy for Business, we see an $80 billion market. And you know what? In Detroit, we saw a five comp.

So what you should take away from that is that we see growth throughout all parts of our enterprise and the one I would focus us on again is I am wowed we did a five comp in Detroit. I think that is a microcosm of the opportunity that we have, and we have to continue to push out into these other places to diversify our portfolio, and so longer term I think it is going to be the combination of the diversity of the portfolio and the growth that we are seeing inherent in our core business by getting back in and figuring out in difficult times how you can do a five comp in Detroit.

Jennifer Driscoll

All right. Thank you, Darren. We’ll take our last question, please.

Operator

Our final question comes from [Carly Whitter] with [Marisko] Capital Management. Please go ahead.

Carly Whitter - Marisko Capital Management

Thank you. I have two questions. The first question is on Apple. Can you elaborate a little bit more why you are starting to see some success right now? Is it really due to the presence of Apple employees in the stores? And can you talk about the mix of products that are being sold? And the second question I’ll follow up with is on appliances.

David Morrish

To begin with, I guess there’s a number of different reasons you could look at the success we’re enjoying. First of all, I think we’ve established a very good brand presence for Apple in our store. We work very closely with Apple to make sure that we lived up to their brand expectations, but at the same time you asked a question around having their employees in our store and our employees in our store.

I think we are very pleasantly surprised that there’s joint learning going on between our employees and their employees, and I think the overall level that we are able to generate in terms of customer satisfaction with the Apple brand between both sets of employees has improved significantly, and the spillover into even regular Microsoft PCs has been exciting, and so we are enjoying growth on both sides of that.

Carly Whitter - Marisko Capital Management

And are you seeing a lot of the strength on the Apple side in the Mac side or on the music side?

David Morrish

I’ll let Julie Owen comment on the iPod side, but with regard to iMac, we’re seeing significant improvement in terms of sales levels, even in many stores above what’s being experienced in the Apple stores, so I’m really, really happy with the number of products we’re putting out the door and as well, it’s been all incremental in those particular stores, so pretty exciting results.

Julie Owen

On the Apple side, in the music -- and I’d actually call it music and video space, Apple continues to introduce some exciting products that really make people get access to bring in their music and now, with the new Nano video screen, the ability to take your video everywhere. So we are seeing a ton of excitement from consumers around those products and they love coming to Best Buy to see the full solution of how they might bring those things together. We’ve got some nice inventory of that and see a huge upside for consumers in that space.

Robert A. Willett

This is also working well for us in Canada and in China. And looking at things through the lens of the customer and applying the customer segmentation data in Shanghai, we’ve actually got a very large Apple store inside our store and we’ve seen spectacular results. I don’t want to disclose the share that we’ve got of Apple’s business in Shanghai but let’s just say it’s pretty big.

In Canada, Apple is also accounting for a large proportion of our business. It’s looking at what it is that customers really want as opposed to what we think they want. It’s taking the data, the customer analytics and really applying it to space allocation and the way in which we create the shopping experience. And there’s no question it’s working well for us and if the Canadian team were here, they would tell you how well it has really worked for us. And as a result of that, we are getting great investment and cooperation with Apple to build it out.

David Morrish

I would add one thing, sorry, Jen. I would add just one thing; Apple’s a very vivid example. We have a number of our vendor partners making some really good moves around working with us on being customer focused and delivering value propositions that matter to our customers. Apple’s just a particularly vivid example at this moment.

Carly Whitter - Marisko Capital Management

Okay, that’s helpful. Thanks. The second question I had was on appliances, which the whole market is down and your comps are down, seven on top of down two last year. Can you talk about how promotional that category is, what the trends were like intra-quarter, and the competitive environment?

Mike Vitelli

Thanks for asking about appliances because we think that’s one of the spaces where we’ve made some really positive progress, even in this down market. It’s one of the spaces where our customer satisfaction index with the employees in that department is the highest in the company. We’ve gained share in the down market. Part of the decline was also a pretty significant decline versus last year in air conditioning, so we actually saw some positive signs in other areas.

But I think we are in a great position, both because we have a relatively modest share in the space. We’ve made some significant improvements in the products that we have and the customers we have that when that market starts to come back on a macro level, we’ll continue to gain share there.

Competitively, I think everybody is looking at the space and saying you are not going to be able to buy share in a time like this because it’s -- and people are I think acting accordingly.

Carla Haugen

Thanks, Mike. With that, we are going to conclude our call. On the previous question, just so all know, it was Dave Morrish, Julie Own, Senior Vice President of Entertainment, and Bob Willett.

Thanks to our audience for participating in our second quarter earnings conference call. As a reminder, a replay will be available by dialing in the U.S. 800-405-2236, or internationally 303-590-3000, and entering the personal identification number of 11096979. The replay will be available from about 12:00 p.m. today until 1:00 a.m. Eastern Time next Tuesday, September 25th. You can also hear the replay on www.bestbuy.com. Just click on “For Our Investors”.

If you have additional questions, please call Jennifer Driscoll at 612-291-6110; Charles Marentette at 612-291-6184; or me, Carla Haugen, at 612-291-6146. Reporters, on the other hand, should contact Sue Busch, Director of Corporate Public Relations, at 612-291-6114. And that concludes our call.

Operator

Ladies and gentlemen, this does conclude the Best Buy conference call for the second quarter of fiscal 2008. You may now disconnect and we thank you for using AT&T teleconferencing.

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