Full Transcript of Best Buy’s F3Q06 (Qtr Ending Nov 26, 2005) Conference Call - Prepared Remarks (BBY)

| About: Best Buy (BBY)

Here’s the entire text of the prepared remarks from Best Buy’s (ticker: BBY) fiscal Q3 2006 conference call. The Q&A is here.

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Jennifer Driscoll, Vice President of Investor Relations

Brad Anderson, Vice Chairman, Chief Executive Officer

Brian Dunn, President

Ron Boire, EVP, General Merchandise Manager

Darren Jackson, EVP-Finance, Chief Financial Officer

John Walden, EVP, Customer Business Groups

Kevin Layden, Chief Operating Officer

Charles Marentette, Senior Director of Investor Relations


Alan Rifkin, Lehman Brothers, Analyst

Mark Rowen, Prudential, Analyst

Scot Ciccarelli, RBC Capital Markets, Analyst

Bill Sims, Citigroup, Analyst

Matthew Fassler, Goldman Sachs, Analyst

Colin McGranahan, Bernstein, Analyst

Steve Chick, JP Morgan, Analyst


Welcome to Best Buy's conference call for the Third Quarter of Fiscal 2006. Operator Instructions As a reminder, this call is being recorded for playback and will be available by 1:00 p.m. Eastern time today. I would now like to turn the conference call over to Jennifer Driscoll, Vice President of Investor Relations.

Jennifer Driscoll, Vice President of Investor Relations

Thank you. Good morning, everyone. Thank you for participating in our investor conference call for the fiscal third quarter. With me here in Richfield this morning are Brad Anderson, our Vice Chairman and CEO who will give you the third quarter highlights; Brian Dunn, President Retail North America who will update you on our domestic and international segment; and Darren Jackson, Executive Vice President Finance, and CFO who will cover today's results as well as our earnings guidance for the fiscal year. Joining us by telephone is Ron Boire, Executive Vice President and General Merchandise Manager who will discuss our competitive position in the third quarter. With me here today and available for our Q&A session are Mike Linton, Executive Vice President and Chief Marketing Officer; Kal Patel, Executive Vice President of Strategy and International Development; John Walden, Executive Vice President of our Customer Business Group; Bob Willett, Executive Vice President of Operations and CIO; Kevin Layden, President of Best Buy Canada by phone; Susan Hoff, Senior Vice President and Chief Communications Officer; Shawn Score, Senior VP of Sales Development; and Charles Marentette, Senior Director of Investor Relations.

I'd like to remind our listening audience 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 results to differ from management's expectations. As usual, the media are participating in this call in a listen-only mode. Also, the call is available for replay. In case you missed a portion of the call or wish to hear it twice. Let me give you the replay instructions. Simply dial 973-341-3080, and then enter the personal identification number which is 6777800. The replay will be available from approximately 1:00 p.m. Eastern Time today until midnight on Monday, December 19. I'd like to remind callers that we plan to take your questions after we conclude our prepared remarks which should run 20, 25 minutes. Please limit yourself to one question so that we can include more callers in our Q&A session.

Consistent with our approach in the last quarter we will move to the end of the Q those who had their question answered in last quarter's call. We had positive feedback from this change last quarter so we're pressing forward. With that, I'll turn the call over to Brad Anderson, Vice Chairman and CEO, who will begin our prepared remarks. Brad.

Brad Anderson, Vice Chairman, Chief Executive Officer

Thank you, Jennifer and good morning, everyone. My agenda for the call today includes three items. First, I'll briefly discuss our third quarter financial results. Second, I'll put our results in the context of our transformation. And third, I'll give you highlights on the third quarter. As we announced this morning, our third quarter earnings totaled $0.28 per diluted share on $7.3 billion in revenue. We also reported a comparable store sales gain of 3.3%. The good news was that we had a strong start to the holiday season and we believe, we've continued to grow our market share. We generated a respectable comp store sales in environment with a great deal of ups and downs, and we also continued to see significant improvement in our gross profit rate. These variables we consider very encouraging.

We had very ambitious plans for the quarter with strong growth goals and transformation goals going side by side. Specifically, we made progress on our sourcing, our supply chain, and IT work. We also opened or converted a record number of stores to customer centricity. We increased the number of Geek Squad agents by 25% in the quarter, and we opened our first seven stores in Quebec. In short we made a tremendous number of investments in our portfolio of capabilities. Some of these investments are paying off, such as our sourcing, supply chain, and IT work, yet others did not perform as expected during the quarter, such as our Canadian expansion and our organic growth drivers which include new store openings, converted stores and services. As a result our SG&A spending was higher than we expected. Frankly, our spending rose to what we feel is an unsustainable level. This is a risk we accepted when we embarked on this journey at such a rapid pace. And looking forward we realize we must scrutinize our investments and manage the pace of our transformational activities while we rationalize our operating model.

As we transform our stores, the primary investment in change is in the labor model and at all of our stores we've been adding specialized positions. These include Geek Squad agents, home theater installers. At our segmented stores, on top of that we've been adding business pros and personal shopping assistants and other positions. These specialized positions came in addition to our existing labor model, and if the truth be told we have not optimized what was already available in our stores. I view the decline in productivity as a sign of growing pains in our transformational work. Looking forward, we're going to find the right balance in our expense structure, including labor.

Identifying the best practices at the most profitable stores and making those standard procedures at all stores, which is something we call gap management, traditionally has been a strong suit at Best Buy. This approach helped us attain our current position as the number one consumer electronics retailer and we're going to call on these skills once again as we evaluate our entire enterprise and work to optimize our operating model. Looking back at the third quarter we have many reasons to be excited from the transformational standpoint and an operations standpoint. In particular I'd like to highlight four points.

First, we significantly expanded our service capability during the third quarter. If we go back to the early stages of customer centricity we quickly learned that services must be integral to our transformation. The fact is today's products are more complex than ever and customers want and need more service. In the third quarter we added 2500 U.S. Geek Squad agents bringing our total at the quarter's end to 11,900 agents. We are well prepared for the uptick in demand for services that seasonally occurs in January. Additionally, we employ nearly 1300 home theater installers, so that we can offer a better customer experience around digital TV in time for Super Bowl XL.

Second, we converted 116 more stores to the customer centric operating model in the quarter and opened 38 new segmented stores. These stores top line results continued to outperform the balance of the chain. As a whole, however, we are not seeing the return that we expected, and I think our transformational activities, if you think about our transformational activities as an investment in a portfolio of capabilities and growth opportunities, our job as a company is to manage that process, and manage the team and focus our energy on those initiatives that are yielding the best results, and rationalize or slow down the ones that are not. We fully intend to do that.

Third, I was very pleased with our revenue results during the week of Thanksgiving, and I'm confident that a competitive offering, excuse me. I'm confident that a competitive offering and the relationships that we've built with our customers during the year drove our strong performance. Our results from that week give me optimism for the fourth quarter and I'd like to thank our employees for their teamwork, their extra effort, and their solid execution overall. Finally, we believe we continue to gain market share in the United States and in Canada due to the new store openings and comparable store sales gains. Moreover, our market share gains were not limited to one or two product categories but were broadly based.

So in conclusion, we're encouraged by our progress with the transformation. We said in the first quarter call the transformations are not linear. In that quarter we enjoyed the amazing upside results when everything works together, this quarter was on the other end of the range. Yet this quarter also creates a better opportunity for us to drive change in our operating model. When I take a step back, what I see is we're getting better at understanding our customers, and we are expanding our capabilities to serve them more profitably over the long term. With that I will give you Brian Dunn, President of our stores. Brian.

Brian Dunn, President

Thank you, Brad, and good morning, everyone. I would like to reiterate Brad's congratulations to the team for its solid finish the week of Thanksgiving. We stayed focused through a choppy environment early in the quarter and our holiday plan was both well executed and well received by our customers. I want to walk through a couple of items from the quarter. First, as Brad mentioned we had ambitious plans for the quarter. In the United States we opened or converted 154 segmented stores during the quarter. We also conducted training on customer centricity at hundreds of other stores. In Canada, we adjusted our labor model and opened 16 new stores including 7 in Quebec, a new market for us. Then we asked our teams in both countries to ramp up and execute the first phase of our holiday plan. In short, we asked a lot of our employees, and they still delivered a 3.3% comparable store sales gain in an environment that started out somewhat more challenging than we had anticipated.

Our merchant team improved in-stock levels year-over-year particularly in high-margin goods and accessories which are so critical to completing the total solution sale. That investment better positioned our retail team to win with our customers, and they ran with it. In the end, it was a combination of competitive offers, a broad product offering, and a great store experience that got our holiday season off to a very solid start and helped drive the increase in the gross profit rate. Suffice it to say we have a lot of things working well. I like our competitive position as we approach the final stretch before the holiday and the quarter that generates roughly half of our annual earnings.

Efforts from across the company are improving the experience for customers in our stores. For example, we installed a new point of sale systems at more than 200 stores prior to Thanksgiving. We can process transactions much faster with shortens customers' wait times particularly on high-volume days. We will install these POS systems in every U.S. Best Buy store by the middle of next year. This quarter we also offered consumers more instant rebates, which saved time at checkout as well. Consumers have told us through their purchases and on-line surveys that they have strongly approved of that decision.

Overall, our customer centric stores' top line performance continues to be performing significantly better than the balance of the chain. Collectively stores converted for at least one full quarter had a comparable store sales gain of 5.4%. Frankly, this performance was short of our expectations. The stores opened six months or longer continue to perform on both the top line and bottom line but we have to work to do, but we have work to do on the later waves before they meet our expectations.

We also continue to grow in our understanding of our customer segments and their needs and behaviors. For example, busy moms shopped our stores earlier in the season. We also learned a lot about our more affluent customers. We saw exciting top-line results from the segmented stores outfitted with the Magnolia home theater experience. Customers appreciate the combination of premium brands, specialized labor, and the physical feel of the store. These stores within a store not only are boosting our home theater business, but they are driving improved results in multiple other product categories at those locations.

As Brad noted, we took a risk in moving as fast as we are. So it is not a complete surprise that we are experiencing growing pains. In addition, as we approach the midpoint of our transformation, this is the time when we would naturally begin optimizing the new model. While this work is complex, Best Buy has a strong track record of scaling new ideas, and I am highly confident that we will strike the right balance in this equation.

Switching gears, I want to touch on our results from Best Buy Canada. Our challenge in the quarter was a shortfall in our revenue results amid heightened competition and a challenging economy in Canada. Our operating income results were also below our expectations. At Future Shop stores we completed the rollout of a new labor model. The conversion now is behind us and trends improved as the quarter progressed. What the numbers don't show is that we continued to grow our combined market share in Canada. Our share rose more than 200 basis points despite these challenges. Even more encouraging, we have not yet seen the full impact of the seven Montreal grand openings in late October. Lastly, the critical selling days for Canada are still ahead, particularly Boxing Day, December 26, our biggest revenue day of the year in Canada. Now that we have built the necessary scale in Canada, and have established our two brands with consumers, our focus will turn to optimizing our operating model in Canada in order to drive improved profitability.

Back to the U.S. Magnolia stand-alone stores reported very strong comparable store sales up 19%. It was the highest quarterly gain since we acquired the chain five years ago. Moreover, the gain came not only from video, which posted strong results for sometime, but also from audio, which marks a complete turn around. This business appears to have hit a sweet spot for us. We are also, we also are applying what we are learning to the Magnolia home theater stores located in Best Buy stores.

In summary, we have many positive indicators across our business. Today, three-quarters of the way through the year we are proud of what we have accomplished. Year to date we have grown revenue by $2 billion or 11%. Increased the gross profit rate by 130 basis points, and grown earnings per share by 41%. Our attention is now turned to the most important quarter of the year, when our retail execution will continue to make the difference. With that, let me turn the call over to Ron.

Ron Boire, EVP, General Merchandise Manager

Thank you, Brian. Good morning, everyone. I am certainly pleased by the continued improvement in our gross profit rate as it directly reflects many of the structural changes we are making to our business. The capabilities we are building in strategic pricing, supply chain, global sourcing, and tailored market assortments continue to drive the year-over-year improvements. Our private label product continues to play its role very effectively. It fills in our assortment and gives us cost-effective products while adding to our gross profit rate. As an indication of the category's strength we easily exceeded our volume expectations for the promoted products during our holiday kickoff. Our quality, value oriented brand names, such as Geek Squad, Insignia, Dynex, and Init complemented the highly respected brand names of our vendor partners which comprise the majority of our business.

We have now started to lap the launch of these structural changes. So the year-over-year impact of private label products on the gross profit rate will remain important but will slow in future quarters. We continue to see benefits from pricing strategies, tailored market assortments, and supply chain work as we expand our capabilities and utilization of these tools, but going forward they become part of the base for comparison, and incremental improvements are harder to achieve. On a related note, many of you have asked questions about the promotional environment. The environment in the third quarter was only slightly more promotional than prior year. I don't expect the promotional environment will materially change during the balance of this selling season.

Others of you have asked about our competitive landscape which increasingly includes the discount channel. That's not a surprise to us. We've predicted this sometime ago. Today we compete based on our authority in categories, our in-store experience, and our ability to deliver the total solution to customers. Even as we invest in our transformation to further differentiate ourselves, we have remained competitive in the marketplace, as evidenced by how we looked on Black Friday. We will continue to provide compelling competitive offers to our customers. We are confident that we are well positioned to win with customers this holiday.

Now I'd like to touch on a few key categories. First, we are extremely pleased with our third quarter flat-panel TV performance. It actually exceeded our expectations, which says a lot. The average selling price decline was in-line with expectations and we continue to see customers trade up to larger screen sizes and better technology. There are, of course, spotty availability issues, as there always are in such a hot category, but I do not expect these to have a material impact on revenue performance in the fourth quarter.

Second, I want to briefly mention the gaming space. We were pleased with our Xbox 360 position in the market, and the customer response was obviously overwhelming. This product is a perfect example of technologies converging and how our retail expertise in gaming, computing, digital televisions, content, and networking is a competitive advantage. As consumers change how they will enjoy products and services we provide. This trend plays to our strengths, and it's one of the many reasons we are excited about the beginning of this new gaming cycle. That said, the total gaming category put modest pressure on the comp gain for the quarter as we saw a slowdown in existing platform hardware and software sales leading up to the launch of Xbox 360. Additional strong categories included MP3 players with an expanded assortment of products and accessories year-over-year. We also saw strength in notebook computers, satellite radios, and appliances.

As Brad said earlier we are pleased that we are seeing results across many areas of our business. It's not just one hot product category driving our results. With that I'd like to turn it over to Darren who will walk you through the quarter and discuss our outlook.

Darren Jackson, EVP-Finance, Chief Financial Officer

Good morning, everyone. I'll start by trying to provide some insights into how the quarter unfolded and SG&A trends. At times the quarter was volatile. We endured a combination of hurricanes, high gas prices, plummeting consumer confidence. Yet we finished with robust revenue growth the week of Thanksgiving, which included the launch of Xbox 360. Candidly, we are pleased with our 3.3% comp gain given how the quarter started. With that as context, let me walk you through our results.

First, total revenue grew 10% from last year's third quarter to 7.3 billion. The increase in our average ticket and units per transaction offset modestly the lower customer traffic during the quarter. That said, I am pleased to add that customer traffic was positive as we closed November for the first time in more than a year. Next, from a structural perspective, we enjoyed strong double-digit growth in revenue from services. In addition, comps of the segmented stores outpaced the balance of the chain. I applaud the team as they managed a lot of operational change and still were able to deliver for our customers. I continue to believe that the scale of our transformation efforts is causing growing pains, which may be constraining the sales somewhat.

Now turning to our gross profit rate, we saw an improvement of 120 basis points during the quarter which was more than we expected. Our stores competed in a modestly more promotional environment than last year as Ron mentioned, but this factor was more than offset by further incremental benefits from structural changes in the business. We benefited from more profitable product mix including more services and an increase in consumer electronics. We also realized an accounting benefit in the quarter. This benefit related to gift card breakage and was worth approximately 30 basis points. This change will add $0.04 to $0.05 of EPS this fiscal year and we expect $0.02 of that to be recurring each year. Excluding that benefit the gain in our gross profit rate still was above our expectation.

That brings me to our expense rate. For the quarter the SG&A rate of 21.8% rose 150 basis points. My comparison versus last year's rate of 20.3% when adjusted to include stock compensation expense. The increase was higher than expected, so let me highlight the material drivers in that change. One, the transformation to customer centricity including services added 70 to 80 basis points to our expense rate. Two, hurricane Katrina and Rita, coupled with the absence of positive one-time events in last year's numbers, added 30 basis points to our expense rate. Three, deleverage associated with the flat comparable store sales and the new store growth in Canada added approximately 30 basis points. The balance was principally driven by the sales deleverage in the balance of the United States stores.

Now our move to the new model brings with it a higher level of fixed costs. Historically we had a simpler model that frankly was easier to adjust in a mixed environment. As we stand today, we have a more complex and differentiated model, and we have to evolve the capability to make adjustments. We now have 284 stores operating under this model, and a year under our belt. Our focus is now on refining the model so that we can better match incremental costs with incremental revenues.

Turning to the operating line, the SG&A rate increase offset the gain in the gross profit rate. We deleveraged the operating income rate by 30 basis points. We gained in interest income and taxes consistent with the first six months of the year, our tax rate is benefiting from more efficient tax strategies and we continued to assess additional ways to further make progress on this line. Our current trend suggests that our income tax rate will be 33 to 34% for the fiscal year.

Taking a step back and looking at the quarter, I'm very encouraged by continued gains in our gross profit rate. That is the result of many structural changes we are making to our business model. And while the SG&A rate is concerning, it is within our control. We are focusing our efforts on building capabilities to adopt the operating model to the environmental and economic changes. We continue to be optimistic for the remainder of the year. I still expect we will finish the year in line with our previous guidance.

For the remainder of the year, we reiterate our comparable store sales gain of 3 to 5%. That is driven by an extra day of holiday shopping, and the gaining importance of the post-holiday selling season. We expect that the gross margin rate will increase modestly from last year, and that the increases in SG&A rate will offset these gains, resulting in a modest reduction in our fourth quarter operating income rate, versus Q4 of last year. For the fiscal year, however, we expect an improvement in the operating income rate. In terms of EPS for Q4, we anticipate $1.06 to $1.16, up from $1.04 last year on a comparable basis. The IR team has posted on the website a summary that we hope you have already seen. The summary reconciles last year's reported GAAP Q4 number to the $1.04 number that we're using for comparison purposes. As you recall last year's fourth quarter had several accounting changes like lease accounting and we've tried to provide what we think is the best comparative number from last year.

Moving to the fiscal year, our outlook would put us at a $2.05 to $2.15 in diluted EPS. This is the same guidance we gave last quarter, updated to include the direct costs I mentioned from hurricane Katrina and Rita. This range calculates to an earnings increase of approximately 20% for the year on a comparable basis. This year's growth rate is consistent with our track record over the past decade as well. Year to date, as we've said, our earnings are up over 40%, which is gratifying. There are signs that we must take action to closely evaluate our portfolio of transformation activities. This senior management team chose the investments, and this team will make the adjustments to deliver the results we all expect.

In summary, we are proud of our employees and their contributions they continue to make. This is especially true given the amount of constant challenge and change throughout our system. We have confidence in our ability to implement the strategy because of the hard work and the engagement of our employees. With that, we would wish all of you a blessed holiday, and thank you for participating on our call today. Now, I'd like to open the phone lines up for questions.

Question-and-Answer Session



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