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Best Buy Co., Inc. (NYSE:BBY)

F3Q08 Earnings Call

December 18, 2007 10:00 am ET


Jennifer Driscoll - Vice President, Investor Relations

Brian J. Dunn - President, Chief Operating Officer

Shari L. Ballard - Executive Vice President, Retail Channel Management

Robert A. Willett - Chief Executive Officer Best Buy International

James L. Muehlbauer - Senior Vice President and Interim Chief Financial Officer

Bradbury H. Anderson - Vice Chairman of the Board, Chief Executive Officer

Julie Owen - Senior Vice President, Entertainment Group

David Morrish - Senior Vice President, Computer Merchandising

Mike Vitelli - Senior Vice President, Consumer Electronics

David Ashan

Barry Judge - Senior Vice President, Consumer and Brand Marketing

Charles Marentette - Senior Director, Investor Relations


Colin McGranahan - Bernstein

Anthony Chukumba - FTN Midwest Securities

Gregory Miller - Morgan Stanley

David Strasser - Banc of America

Gerald Feldman - Telsey Advisory Group

Chris Horvers - Bear Stearns

Michael Baker - Deutsche Bank

Gary Balter - Credit Suisse


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

Jennifer Driscoll

Thank you, Eric. Good morning, everyone. Happy holidays. Thank you for participating in our fiscal third quarter conference call. We have four speakers for you today. First up is Brian Dunn, our President and COO; second, Shari Ballard, Executive Vice President of Retail Channel Management; third we have Bob Willett, CEO of International and Chief Information Officer; and fourth we have Jim Muehlbauer, Senior VP of Finance and Interim CFO.

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

We’d like to request that callers limit themselves to a single one-part question so that we can include more people in our Q&A session. 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.

I’d 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 actual results to differ from management’s expectations.

As usual, the media are participating in this call in a listen-only mode.

And with that, I’ll turn the call over to Brian Dunn who will begin our prepared remarks.

Brian J. Dunn

Thank you, Jennifer and good morning and happy holidays, everyone, and thank you for joining us today. We are very pleased to deliver the news we bring you today because we believe it spells growth -- growth that comes from our continued progress in building relationships with our customers. In a minute, I’d like to talk a little bit about why we believe that.

But first, I’d like to put the third quarter’s results in context. If you go back to the first quarter, we talked about financial results and strategic results and how they don’t always match up in a three-month window of time. The confidence that we expressed then, even in a tough financial quarter, was anchored in what we were seeing with our customers and our employees. We delivered very different financial results in Q2 but with no change in our focus on driving the customer experience because that is how we are transforming this company.

Let’s face it -- Best Buy was built as a distribution channel, a vibrant, independent distribution channel but a distribution channel nonetheless. The business model initially had more to do with supply, what we can sell, than demand, what customers want to buy.

When margins began to drop and it became more about efficiency and speed, we knew we had to reinvent ourselves. That’s where customer centricity began. We have to reach people, employees and customers, and win with them. That’s where the profit pools in growth are. Our solid second quarter results were possible only because of the investments in cultural changes we have been undertaking to move our company in this new direction.

The third quarter was another transformational quarter and one where the strategic results and the financial results were once again aligned.

First, the financial results; today we reported EPS of $0.53 for the third quarter, an increase of 71%, with revenue growth of 17% and a comparable store sales gain of 6.7%, and once again the strategic results, which are really a measure of how well we are building our relationships with customers, are very encouraging.

Our customer satisfaction was up again this quarter, as was our market share, and so was reward zone membership. We now have nearly 28 million reward zone members. In addition, just 14 months after launching our reward zone MasterCard, we have surpassed 1 million members. It’s one of the country’s fastest growing retail credit cards.

We continue to look for ways to build upon the relationships we have with our most loyal customers, like offering exclusive sales events and other special promotions, and our customers love it.

The number of customers we consider most loyal was up this quarter too. Those customers spend more with us and come back to shop more often, offering us an opportunity to do more for these customers. We have built a solid, credible relationship with our best customers and so they trust us to move into new spaces with them. In fact, they are asking us to do more for them. We are going to determine these new spaces by what our customers are demanding and not what our vendors are promoting.

I want to give you one good example of a new space -- our musical instruments business. A couple of years ago, we started testing a 2,500 square foot store-within-a-store musical instruments concept in California. The project was heavily based on customer research. As you can see on YouTube, Facebook, and MySpace, music is converging with technology and Best Buy is seen as a partner they can trust in both areas. In addition, many of our employees are musicians themselves and are thrilled to help others create, play, perform and share music. It is early but the results of this test so far indicate that we’ve found and are serving a customer need. We now have four of these stores with plans to add more next year.

I’d like to give you three more examples of tangible indicators that we’re improving the customer experience.

First, in September we began offering our reward zone members the opportunity to redeem their certificates online. In and of itself, that isn’t terribly exciting but the customer response is powerful in what it tells us. In the first month, the percentage of certificates redeemed online was double that redeemed in our stores. It proved what we already knew -- customers love the flexibility to shop with us in different ways. When we listen to our customers and provide the right multi-channel offerings, they also spend more money with us. In fact, when they shop us using different channels, they often double the number of transactions with us in a year and remain loyal customers. That’s an important piece of profitable growth.

Second, the experience that we offer our customers during the Thanksgiving week is always, in my opinion, best in class but we still find a way to make it better every year. The truth is that the customer experience increasingly starts before Black Friday and because of this trend, we are better utilizing the online channel to communicate with customers about what to expect, like how the ticketing process will work.

On Black Friday, we were very encouraged by a couple of statistics. Despite record holiday volumes in our stores, customer wait times were shorter than ever and the stores I visited recovered from that morning rush very, very well. That set us up for a very good afternoon with our blue shirts engaging with customers and completing more complex transactions with them.

And finally, my third example, two weeks ago we announced the addition of Dell to our computer assortment. We are certainly pleased to be offering Dell products to our customers because we now have the complete lineup of every major brand for our customers, all backed by the service and support of the Geek Squad. We know that our customers wanted this brand because Dell was one of the most heavily searched words on our website and now we can meet that need.

As these three examples show, we are striving to build relationships by offering more to our customers wherever they interact with Best Buy, putting together powerful offers led by customer insights and delivered by our employees is a recipe that’s working.

And speaking of our employees, I’d like to conclude my remarks with a few comments about them. A quarter like the one we just completed, with 71% earnings growth, can only come when every part of the company is pulling in the same direction. From the U.S. to Canada to China, it was uniformly spectacular performance and I want to pause here to say thank you to our people. I hope you are proud of that performance and proud of what you are building at Best Buy.

We know that our focus on customers means nothing without our people to complete the relationship with them and I’m pleased to report that we are making progress in some key indicators on the employee side of that relationship equation. We continue to reduce our U.S. retail employee turnover and are on track to reduce it by five percentage points this year. Our general manager turnover continues to improve as well, trending at an impressive 13%, a significant decrease from last year.

As we look to the future, our confidence is grounded in our employees and the progress they are making with our customers. Our employees work for a growth company and we see a ton of untapped opportunities for growth next year and for the next 10 years.

We already mentioned musical instruments. We can explore other new offerings as well. Even as we look with new eyes at existing areas, such as financial services, cellular, private label, our high-end business, and even warranties. We have a growing number of loyal, enthusiastic customers and so it is up to us working on their behalf to decide where the brand can go with them next.

We believe in our employees and have faith in what they can do for customers, especially if we give them the right tools. When we put our faith in our people and their insights on customers’ needs, they reward us with quarters like the one we are reporting today.

To talk more specifically about how we make that happen, next up is Shari Ballard, who heads up our stores, call centers, and dot-com capability for the U.S. Shari.

Shari L. Ballard

Thanks, Brian. Good morning, everyone. I would like to spend my time with you today discussing the growth premise underlying Brian’s comments and providing examples of the opportunity we have available to us when we operationalize that premise to our full capability.

Our point of view is this -- there are opportunities for growth that can only be seen by employees who talk to the customers directly in the places where the customer interacts with the brand. For us, that means in our stores, on the phones, online, and in customer homes. By providing these employees with the data and tools they need to understand their community, the various customer segments in that community, the needs specific to those segments, and placing them in an environment where they are invited and expected to try out their ideas for better serving those customers, we can grow Best Buy at exciting rates.

Additionally, we believe that running our business with a lens focused on who we serve in addition to what we sell them will unlock even more opportunities for growth. We are seeing evidence that using these different lenses to drive the business does work and I’d like to share some specific examples of that with you today. While I don’t want to overly generalize a single day out of the entire quarter, I am going to comment on Black Friday because it offers some compelling evidence for us.

First, Black Friday and the following weekend was a success. From a financial perspective, we had solid revenue growth and our margins were up on a year-over-year basis. Our dot-com channel significantly exceeded our revenue expectations and it was also a success from the customer perspective.

Our customer satisfaction scores were up three points year over year Black Friday and our customer complaints were down 25%. Additionally, the majority of our growth came from our most loyal customers and from our opportunity customers. Opportunity customers are those who love our categories but are not loyal to the Best Buy brand exclusively.

While we are pleased with these results, we are even happier with the way we are starting to get these results and with what we are learning about our customers in the process. We are using customer data to design value propositions within and across the channels, measuring how the customers respond and adapting based on what we are learning.

The first example I’ll use comes from advertising. In our Thanksgiving insert, we advertised a number of bundles. We learned that all bundles are not created equally. One of those bundles included a laptop, noise canceling headphones, and HD DVDs. In the past, we would have just looked at how many of those we sold. Now, we have the capability to look at how actually bought them. That bundle in particular skewed heavily to our most loyal customers by nearly 500 basis points, while other bundles in the ad under-performed relative to our best customers.

We knew that information fairly quickly and are using that knowledge to guide how we serve those customers in the future. For instance, we now know that offers that include an entertainment component skew heavily to our most loyal customers.

In the same vein, we’re learning that many of our most loyal customers want to have alternatives for how they shop with us. For example, many of them would prefer to avoid the fray of Black Friday so this year, we offered them a private shopping event the weekend before Thanksgiving and had outstanding customer response and very good business results.

Now, we add local insight on top of that macro visibility and we can literally see countless opportunities for better serving the customer. We’ve got some specific examples of that from Thanksgiving week, too.

The first example is store 48 in Topeka, Kansas -- a little shout-out to the Kansas team this morning -- with industry insight coming from our PC mobility operating group here at the corporate office, the local team knew that GPS was going to be on fire this holiday. They also knew that one of the biggest reasons customers leave our stores without buying is because they can’t find what they are looking for. It’s not that we are out of stock; they can’t find it. Store 48 tested the idea of relocating GPS to a more intuitive location in their store. Their GPS category growth versus their peers increased by 20 percentage points.

Still working from the insight that customers want an easier experience with us, another store made changes to its notebook display to make it easier for the customers. They literally took the cabinet doors off their display and had grab-and-go notebooks in a box with the handle, easily accessible for the customers. The first day with their new approach showed a triple-digit comp in their notebook business.

The final example comes from the North Scottsdale area, where a handful of stores used their best asset, their people, more strategically on Black Friday. They knew from past experience that customer shopping patterns change dramatically as the day unfolds, so they scheduled some of their most experienced associates later in the morning and in the afternoon in an attempt to better match experienced selling labor with the way the customers wanted to shop.

Not only did we see this in Phoenix but we saw application of this in many other markets and it’s an example of us learning within the day how to respond to local customer needs. We believe this contributed to the three point improvement in customer satisfaction that I referenced earlier.

We have more examples and they are all variations on a theme. That theme is that when we get away from looking at the business solely by what and where we sell and pay attention to the combination of powerful customer focused solutions matched with the insights of our local teams, we can unlock extraordinary results. That’s why we are confident in our growth runway.

We believe we can materially grow market share in our current categories this way and that in these dialogs with customers, we’ll discover new, adjacent spaces where they want us to participate, like musical instruments that Brian referenced a minute ago.

I also think this lens will take us into new spaces, as we identify customers and we identify where customers are massively disappointed with their technology solutions. Our work with Carphone Warehouse and the customer value propositions we are building together in the mobility space is an example of the possibilities.

As we get better and better at operationalizing our core premise, we expect to see the results show up in market share gains, comp growth, and overall earnings growth. There is no reason a 10-year old store can’t be generating growth like a new store based on what we are seeing.

As I close, I too want to thank the employees in all of our channels and here at our corporate office for working together to deliver a great quarter. Team, the work you are doing is defining a very bright future for Best Buy.

With that, I will turn it over to my colleague, Bob.

Robert A. Willett

Thanks, Shari. I’d like to take you through an overview of the results in the international segment, then I’ll comment a wee bit on each country’s performance as we take our domestic growth engine to international markets and continue to invest in our enterprise infrastructure.

Collectively, our international segment produced operating income of $22 million, a material increase compared with the $7 million for the prior year’s third quarter. Our earnings gain was supported by revenue growth of 32% to $1.7 billion, or more than a sixth of the total revenue for the enterprise, including comparable store sales gain that clocked in at 9.3%.

We were very impressed with the work that the teams did in serving customers. We are benefiting from the opportunity to achieve faster growth in markets outside the United States.

As you’ve seen in the news release, our international operating income rate improved by approximately 80 basis points. This gain was largely due to the focused execution in Canada, which drove 130 basis points of SG&A expense improvement, as well as an operating model shift in China.

These improvements offset a modest 40 basis point decline in our international gross profit rate which reflected unfavorable mix changes and pricing pressure in Canada. All together, our operating profit income rate for our international segment was 1.3% of revenue. We delivered these results while continuing our work through the Geek Squad partnership with Carphone Warehouse, as well as preparing to enter Turkey and Mexico.

I’ve already begun down the road commenting on the individual brands so let me complete that thought. First and foremost, congratulations to the Five Star team on its 13% comparable store sales gain, a brilliant debut to the company comp figure.

Because of the very different business model typically employed by retailers in China, which focuses on devoting space in stores for each of the vendors, this metric historically wasn’t a focus area for the team in China but they are fast learners. We believe that comps are a critical way of gauging how customers are responding to what we are doing in our stores and other channels. It’s also terrific feedback and the Five Star stores are using the data to drive actions. Sales per square meter are also rising, another good indicator and contrary to other retailers in China. In addition, both customers and employees are responding well to the new layouts we are testing in 20 Five Star stores.

Customer centricity is very much the centerpiece of our strategy internationally. In fact, sometimes we are able to move more nimbly when we enter new countries because there are no legacy issues with which to contend. Specifically, it’s much easier to create a culture from scratch where employees are encouraged to gather customer insights, develop ideas for serving them better, and measure the results.

For example, at our Best Buy store in Shanghai, we’ve seen a real cultural shift compared to how other retailers operate in China. Our focus is not on vendor funding or rapid real estate growth but on the employee experience, the customer experience, and the overall store performance.

Employees are responding to our culture, as evidenced by the very low 15% staff turnover we’ve had in the store’s first 11 months of operations. Customers are responding to the opportunity to touch and try our products, which are arranged by category, not by vendor.

Ninety-one percent of customers surveyed said they like the in-store experience and 76% are likely to recommend Best Buy. Given that the customers and employee metrics look good, it’s no surprise that financially our performance in China is on track with our plans year-to-date. Yet it’s still early days and we continue to go carefully with our organic store growth plans.

As expected, Canada, where we have a very focused leadership team, also reported a strong comp. Our comparable store sales in Canada rose 8.7% on top of a gain of 13.7% in the last year’s third quarter, including both store and online performance. Well done, team.

We recently launched reward zone at Best Buy stores in Canada and we are anticipating as many as 550,000 reward zone members by fiscal year-end. We believe this investment will be repaid in customer loyalty, spending, and shopping frequency.

Another change we made in Canada was the launch of home theater services last summer, which is showing up in our international services growth. Last, we have a small but quickly growing private label business which gives us huge differentiation and growth potential.

Before moving on, let me take a moment to give an example that illustrates how private label can differentiate us and provide growth. One of the many things our private label team does well is to talk to our store employees about what customers need but can’t currently buy from us.

In our Canadian stores, we found out that there is an increased need for both a 25- and 50-foot HDMI cable to connect their home theater system components, but none of our vendors offered anything that long. In less than two months, the private label team launched a 25-foot rocket fish HDMI cable. The 50-foot will follow in February and the 25-foot is selling very well.

Through our partnership with Carphone Warehouse, we continue to add the Best Buy mobile experience at our stores and currently operate 181 such locations. The early results are really promising from a top line perspective. We’ve previously indicated plans to offer this experience at all U.S. Best Buy stores within the next two years.

Likewise, we continue to progress with offering Geek Squad services at Carphone’s U.K. locations. While the in-home channel is still in the pilot phase, the online and over-the-phone channels are right on plan. More important, the customer reaction is just terrific. We need to get the message out because the business model clearly offers value for customers.

We also continued to move forward into new markets, recently welcoming to Best Buy an experienced new leader for Mexico with a passion for our values, including unleashing the power of our people. We also currently expect our first stores in Turkey and in Mexico next fiscal year, and we are pleased with the initial response from our vendor community.

We’re not daft enough to believe we are good at everything and we can go everywhere with our current store formats, but we do think we will have less risk in expanding internationally than any other retailer because we have a good business model and a clear sense of the employee behavior we need and the culture we want to create to serve our customers.

We’re also learning from others who have gone before us. We cannot be effective offshore unless we are good at what we do at the core and can translate it to other markets.

To facilitate this effectiveness, we are continuing to make major investments to complete our supply chain program and technology infrastructure build-out. These investments will enable us to implement new capabilities that will accelerate our differentiation.

Our core is very strong. That’s why we are a growth company and we plan to keep acting accordingly. We’re also very optimistic about what the future holds for us.

Thanks for your attention this morning. We’ll put a full stop there and turn the call over to Jim, but before closing, I’d like to wish all of our employees and their families a very happy Christmas, a happy holiday. Jim, over to you.

James L. Muehlbauer

Thank you, Bob and good morning, everyone. In short, we are pleased with the 71% EPS growth in the quarter. We saw relatively consistent underlying strength throughout the quarter and enjoyed a very solid November. Consumer electronics appears to be once again the holiday gift of choice and, as Brian said, our employee planning and execution on behalf of our customers was second to none.

Both our strategic results and our financial results are telling us that we offer the products people want but more importantly, we are offering the experience that people want. While we love great financial results, we are most excited about the positive traction we are gaining as evidenced by our latest customer satisfaction and market share data, which shows us continuing to build share in key categories profitably.

Our 17% revenue growth in the quarter was driven by strength in both our domestic and international segments. We reported a 6.1% comp in the domestic business, or roughly 3% when adjusted for the calendar shift. That was double the first half run-rate of 1.7%.

The acceleration in comp performance from the previous quarter was a function of both better industry growth and share gains in product categories such as gaming, notebooks, and GPS.

We’re also doing a better job of developing bundled up solutions that make sense for our customers and that leverage the benefit of a world-class retail team. Additionally, we saw a greater revenue contribution from new stores because we accelerated the timing of new store openings this year. We opened up 72% more U.S. Best Buy stores in the first half of this year versus last year. As expected, U.S. consumer interest for the quarter centered on gaming, computing, and GPS.

As Bob mentioned, our international growth segment posted strong revenue growth as well, with 32% growth on top of 51% growth last year. Total revenue growth was aided by the impact of positive foreign currency exchange rates, the 9.3% comp sales gain, and new store openings.

The gross profit rate was flat year over year. Sometimes flat feels like a success. The gross profit rate actually increased in the domestic business by 20 basis points. I know that you have not heard the words gross profit and increase used in the same sentence for a while but let me give you some color behind these results.

As you all know, we’re lapping a pretty promotional November, particularly in home theater and notebooks. Consistent with our hypothesis at the beginning of the year, these two spaces were more rational this time around and we actually grew home theater margins for the second quarter in a row. Part of the way we accomplished that was through lower cost promotional programs.

We have also lapped the inclusion of the China business. While we’ve added new stores in China, it no longer puts pressure on the year-over-year gross profit rate comparison.

These gains were essentially offset by the impact of continued strong growth in lower margin categories, such as gaming hardware and notebook computers, which we saw both domestically and internationally.

A continued bright spot for the year was the level of SG&A improvement. Our 120 basis points of SG&A leverage reflected strong revenue growth and efficient spending. Our domestic leverage accelerated from Q2, fueled by higher revenue growth and changes we’ve made to our store labor model. As you can appreciate, we generate significant leverage on a 17% revenue growth.

In addition, we had fewer changes in the stores this year than last year when we were rolling out 136 Magnolia home theater rooms. The absence of start-up expenses and a more efficient labor model enabled our stores to better focus on serving customers.

Finally, internationally the SG&A rate also improved by over 100 basis points, supported by strong revenue growth and expense control, including advertising leverage.

Net, it adds up to roughly a 120 basis point improvement in operating income rate and more importantly, a 79% increase in operating income dollars. The calendar shift contributed to that growth but we are very pleased with the underlying growth we see on an apples-to-apples basis. At the end of the day, this was one of our best third quarter operating performances in recent memory.

Bottom line, we grew our diluted EPS by 71%. These results bring us to 19% earnings growth year-to-date after being flat through the first half of the year.

All in all, it was a very solid performance. Our employees deserve all the credit for maintaining focus on executing their operational plans which drove this rewarding quarter. We are consistently working on new and better value propositions for our customers and not that everything always works, but seeing how well customers are responding gives us a ton of energy for the future.

Before shifting to our outlook for the balance of the year, it might be helpful to touch on a few balance sheet items. First, our U.S. comparable store inventory was up approximately 8%, which was higher than previous quarters. This inventory increase was a function of purposeful investments in high growth product categories such as flat-panel TVs, gaming, and notebooks. Furthermore, almost half of this increase was due to the calendar shift as we ended the quarter one week deeper into the holiday season. Overall, we are comfortable with the status of our inventory positions.

Second, our diluted share count for the quarter finished about where we thought, at 431 million shares. We still expect an average diluted share count of 454 million shares for the fiscal year. As previously stated, the accelerated share repurchase program is planned to conclude at the end of our fiscal year.

Looking forward, we are raising our earnings guidance for the fiscal year due to our solid performance in the third quarter. For the year, our earnings outlook is $3.10 to $3.20, an increase of 11% to 15% year over year. We still expect an enterprise comp of roughly 4%, driving close to $40 billion in revenue.

Our annual outlook assumes SG&A leverage will offset gross margin declines, yielding nominal growth in the operating income rate for the year.

Specific to the fourth quarter, earnings will be constrained by the loss of the 53rd week from last year and the shift of the holiday shopping week into Q3 of this year. Conversely, the ASR will provide a tailwind for EPS growth in the fourth quarter.

While we will continue to make progress in improving our promotional programs, we expect the Q4 gross profit rate to be down modestly from the prior year, in part due to mix shift changes and the gift card breakage that benefited the prior fourth quarter. We also expect significantly lower SG&A leverage in Q4 versus Q3 as a function of lower revenue growth driven by the absence of the 53rd week and the calendar shift.

Reaching $40 billion in sales is an exciting milestone for everyone in the company. For context, it took us 33 years to hit the first $10 billion mark. We added $10 billion in the last two years alone. We’ve come a long way and we aren’t done accelerating the growth.

We have said many times that our results won’t be linear because we are pursuing a growth strategy that’s dependent on really engaging our people to generate ideas that meet customer needs which won’t be linear. We’re humble enough to remember that both when financial results exceed our expectations and when they don’t meet our expectations.

To be clear, while we are pleased with the progress we made this quarter with comparable store sales, as a growth company we are not yet satisfied that we have truly unlocked the best solutions for our customers, or that we fully embrace the ideas generated by our employees to grow the business faster. We see that as the biggest opportunity that’s still out there in front of us.

And when we do these two things successfully, we believe we will set the organization on even a higher growth trajectory for the future.

In closing, I want to reiterate our appreciation to all of our employees for the great quarter they produced. We are confident that our diligence in maintaining our customer focus will continue to lead us to outsized growth opportunities.

Thank you and we wish you and your family and friends a wonderful holiday season.

And with that, Operator, we’d like to turn it over to questions and answers, please.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Colin McGranahan with Bernstein. Please go ahead.

Colin McGranahan - Bernstein

Good morning. Thank you. I guess my first question is for Bob Willett; who needs a 50-foot HDMI cable in Canada?

Robert A. Willett

Name and address to follow.

Colin McGranahan - Bernstein

I do have a serious question. Looking at obviously November, Best Buy I think led the way in a less intense promotional environment, or a more favorable promotional environment. What do you see so far in December in the context of the overall holiday shopping trend, which looks like it started well on Black Friday but has decelerated since? And how are you thinking about the promotional strategy through the fourth quarter, given your current inventory position?

James L. Muehlbauer

I’ll try to take that apart a little bit and maybe let some of my colleagues add some color. First off, you are right -- we did execute our plans in the third quarter on Black Friday consistent with the environment that we had actually anticipated through most of the year. Our teams were much sharper on our promotional offers and the execution of our store teams were phenomenal. We were very, very pleased with our top line results and more importantly, our margin results when we compared them to the previous year.

As we look at the fourth quarter so far, the promotional environment continued to be about what we thought. From a sales standpoint, early in December -- you know, importantly we’re trending within the range of our predicted outcomes for the quarter and historically we know that our customers are shopping later and later each year. Accordingly, we are planning and we are prepared for a strong finish for the holiday season, after what is somewhat a slower overall retail environment in early December.

As you know, December is our largest earnings month of the year and we look forward to giving you an earnings update during our December sales release.

Colin McGranahan - Bernstein

Thanks, Jim and just to be clear on that, so trending within your predicted outcomes, so that would be for the fourth quarter kind of $1.70-ish implied in your full year guidance?

James L. Muehlbauer

Roughly a -- we don’t give quarterly guidance, as you know, Colin, but I think if you looked at the fourth quarter, it would imply something like $1.70 to $1.80.

Colin McGranahan - Bernstein

Perfect. Thank you.


Our next question comes from Anthony Chukumba with FTN Midwest Securities. Please go ahead.

Anthony Chukumba - FTN Midwest Securities

Thanks. Congratulations on a great quarter. I just had a question in terms of I guess what you are expecting for this upcoming weekend. It looks like the promotional environment, as you said, has been fairly rational through the first few weeks after Black Friday. What are your expectations for this upcoming weekend and then just after Christmas?

James L. Muehlbauer

As I mentioned earlier, our teams have been preparing for the rush of the close of the holiday season all year long and this is the time of the year where our teams certainly have a lot of energy around meeting customer needs as they finish their shopping lists. So we don’t comment specifically on expectations for the last week or so other than the fact that we’ve purposefully made investments in inventory to have great in-stock positions. We’ve got store labor planned to meet the needs that we see of our customers and we believe that we are going to have a strong finish to the holiday season.

Brian J. Dunn

I would just add that we are very confident about the position our employees in the stores are in to not only execute the plan but this year we really asked them to innovate around the plan and to make good, smart decisions in each of their localities and we are very confident about what that means.

Bradbury H. Anderson

After watching the holiday seasons for a lot of years, as we see things compress closer and closer to Christmas, it winds up becoming more of an operational challenge than it really does becomes a promotional challenge, so it’s who’s in stock, who can process the business best that typically has done better. And then you are really riding on the brand.

One of the things we keep talking about, customer loyalty scores, is the fundamental thing that drives that last minute choice is where you selected to buy probably some time ago. I think that’s been kind of long-term and we feel like we are in a great position on all three of those fronts.

Robert A. Willett

Just to add on to Brad’s point, I think what you are seeing and what we are seeing as we go around stores at the moment is that the investments that we have been making, the work that the field teams have been doing, the investments we have been making from a technology and supply chain perspective are really starting to pay dividends. The quality of execution in the stores at the moment is just incredible. Even when you go in looking for trouble, frankly you can’t find it. You can always find bits of things going wrong in any business but overall materially, the quality of execution is just phenomenal and it’s getting better each year.

Bradbury H. Anderson

I don’t know, Bob. If you go in looking for trouble, you can’t find it?

[Multiple Speakers]

Shari L. Ballard

I’d say one thing, maybe it just underscores what Brad said; I think when we head into this weekend and the upcoming weekends, we still have a lot of traffic coming into the store. I mentioned it in my remarks but we have a fair number of customers who come into our stores every day, looking to do business with us and leave without being able to do it because they can’t find what they are looking for.

So the store teams in particular the online teams, are working really hard to get at the large percentage of folks that come in wanting to purchase and are leaving without that purchase. We see that as a huge opportunity for us with the traffic we have today to close out the holiday.

Jennifer Driscoll

Thank you. That was Jim, Brian, Brad, Bob, and then Shari. We’ll take our next question.


Your next question comes from Gregory Miller with Morgan Stanley. Please go ahead.

Gregory Miller - Morgan Stanley

Thanks, everyone. I just wanted to get a little bit more into the pros and cons on gross margin in the quarter. Jim, you talked about how the promotional environment faded and then some puts and takes last year. How much of a positive was the lapping of promotional, particularly in television if you look versus a year ago? And then a follow-up on some of the negative or pressures there.

James L. Muehlbauer

It’s really hard to tell when we pull apart the promotional environment last year versus the change in offers that we made but if you go back to the third quarter of last year, our gross profit was down roughly 85 basis points and if I recall, 30 to 40 basis points of that was driven by the rates we saw in the marketplace, particularly in home theater and notebooks during that time.

We’ve been very encouraged by the progress that we’ve made both last quarter and this quarter in our home theater space and I think it would be a mistake just to solely -- and I’m not suggesting you are doing this but to attribute too much of that improvement to just the promotional environments.

Our teams have gotten much, much more insight on the types of customer offers that drive the most interest in the marketplace and as you’ve probably seen, we’ve been refining our HDA advantage program over the year to get sharper on what our customers want and actually improving our margin performance in that space.

So that was a very important driver that we see as sustaining in the business. The promotional lever piece, you know, it may have been in the 15 to 20, 25 basis points range but once again, it’s very difficult to pull that apart when you look category by category, offer by offer.

Gregory Miller - Morgan Stanley

Sure, but it’s fair to say that there was a portion last year that was just promotion but then there were other improvements made to structurally improve gross margin in those categories.

James L. Muehlbauer

Yeah, that’s correct. I mean, we talked about last year on the call, we made some very specific investments to respond to the competitive environment to put us in a position to win for both last year and going forward. And as you’ll recall, our Q4 performance bore that out and certainly the way we’ve been building share in some of our key categories this year has been a continuing benefit of the statements we made in our choices last Q3.

Gregory Miller - Morgan Stanley

And on the negative side, was that pressure simply mix or was rate down within some of those categories?

James L. Muehlbauer

In Q3 of this year, Greg, it’s primarily mix. Our gaming business is on fire. It is an area of high, high consumer interest and we continue to have that business mix greater. We are going to see a -- it’s still going to be dilutive in the next quarter but we’re going to see a little less of that as we start to lap last year’s strong gaming performance when there was greater availability of some of the initial hardware launches.

Gregory Miller - Morgan Stanley

Great. Thanks.

Jennifer Driscoll

Thanks, Jim. Our next question, please.


Our next question comes from David Strasser with Banc of America Securities. Please go ahead.

David Strasser - Banc of America

A quick question to follow up on that, on the comment on gaming -- as we look into next year, how should we think about this shift from the hardware to the software and when do you think that becomes more prominent?

Julie Owen

Well, we’re looking pretty optimistically as we’ve seen a lot of the cycles in the past. You know, you start out with usually a new hardware release and then follow with the software titles. They don’t usually happen at the same time and we’ve had the same situation in this last 12 months with the releases. So we’re looking pretty optimistically for next year in terms of the software that’s going to continue to come out, especially as we seek a new kind of software in the social and casual gaming areas, so the Rock Band, Guitar Hero III, and then the excitement that we see for consumers around the Wii. So we see a lot of enthusiasm from customers wanting to get a lot more engaged in the gaming experience, not only on the individual level but with their families.

David Strasser - Banc of America

So do you think that next year becomes a better gross margin, maybe less comp?

Julie Owen

I think there’s an opportunity next year for us to continue to figure out how is the customer using the solution in their household and then what are the things that go with that solution? So as people bring in more gaming systems, how does that connect to their home theater system, what other accessories and things do they need? So we’re going to be doing a lot of the same kind of work for the customer that TVs and notebooks has done around putting together the best offer that really makes sure the customer is getting the full benefit of what they are trying to do.

David Strasser - Banc of America

And just a follow-up; one of the questions I keep getting is business has been strong now, it’s been a consumer electronics holiday, but what about ’08? Just from a bigger picture as you’re thinking about your plan for next year, what do you think are the products that continue to gain momentum versus products that maybe slowed down a little bit across the --

Bradbury H. Anderson

I’ll just make a macro comment that if you look at the balance of our products, we are very optimistic about ’08, whether it’s in the computer field, television field, gaming field, there’s a lot of products that have very good arcs. Plus combined with something we feel is that we are making improvements in our internal operation which allows us to I think actually grow businesses at a faster rate than they might growth otherwise.

David Strasser - Banc of America

If you the macro out of it, do you think there is a better product cycle next year than there is this year, if you look at it on a combined basis?

David Morrish

I’d like to answer that in this way; what we’ve been working on the last couple of years is really get an understanding of our customers’ needs as they look at their products. We’ve been taking those needs to our manufacturers and really developing products that allow us to shift what we’re trying to build and we’re focusing much more on the output of those machines and how do we create an experience for the customer. And I think as you read through our circular, what you are going to see -- what you’ve seen this year and what you are going to see more of next year is both private label products that deliver a different experience but also our branded partners are developing exclusive products for us that really give us an opportunity to accelerate growth from a experience perspective that also allows us to really add on all of the additional accessories that drive margin and sales opportunity for us.

Brian J. Dunn

Also, in conjunction with what Dave’s just said and Brad’s comments, what we are really enthusiastic about is what I believe is our most powerful growth engine and that is the fact that we are becoming more and more skilled in connecting and hearing what our employees in the field who are connecting with the customers every day have to say and turning that into actionable strategies. We’re enormously enthusiastic about what that means for next year and the 10 years after that.

Mike Vitelli

I just want to add one thing about one thing we’re expecting to hear over the course of the next year -- 14 months from today, the television system in the United States is going to switch from analog to digital on February 18, 2009. That’s going to happen. This next year, the drumbeat of that change is going to go through the country and we believe our employees in our stores are going to be in a great position to help our customers through that transition. It’s going to be one of the biggest transitions that happened anyplace in the world of changing an entire television system. And it’s complicated on one level and simple on one level but there’s going to be -- 300 million people are going to want to know what’s going on and we think Best Buy is going to be a great place for them to find that out.

David Strasser - Banc of America

Thank you very much.

Jennifer Driscoll

Thank you, David. Next question, please.


Our next question comes from Gerald Feldman with Telsey Advisory Group. Please go ahead.

Gerald Feldman - Telsey Advisory Group

Just a quick question about the stores -- you mentioned in the release that you now are going to open about 150 stores globally. I was wondering two things -- one is where exactly they will be? Are they mostly domestic or is it more on the international side? And also, what does this mean for next year? Does this mean you are going to open a little less than expected next year or it just -- how does that play out?

James L. Muehlbauer

Thank you for the question. A vast majority of the store openings that we are planning for this year are focused on our domestic business. We’ll be opening up roughly 100 stores this year. That’s up from the 90 stores that we forecasted at the beginning of the year.

We’re very pleased that we can have store growth outside of the U.S. of approximately 50 stores, including our Canadian and our international operations. We have not provided comments on what we think our store growth plans are going to be for next year. Suffice it to say, with some of the great opportunities our employees our unlocking in serving customers, some of the product cycle changes that Mike Vitelli and others just commented on, we are very bullish on the store runway we have in front of us yet and the returns we are seeing from our new stores planned.

Gerald Feldman - Telsey Advisory Group

Great. Thanks.

Jennifer Driscoll

Thanks, Joe and thanks, Jim. Next question, please.


Our next question comes from Chris Horvers with Bear Stearns. Please go ahead.

Chris Horvers - Bear Stearns

Thanks and good morning. First, a clarification question; on the shift in 3Q and 4Q, so are we talking about 300 basis points in domestic comps -- is that what you would expect to impact, come out of 4Q? And any estimate on what the EPS benefit was and then what comes out into 4Q?

And then, just a follow-on on the spending type question -- accelerating the store growth side in 4Q, that creates some SG&A pressure. As we look to ’08, is that an overall harbinger of what’s to come?

James L. Muehlbauer

On the calendar shift question, not that we look at this at all, but the impact was actually 2.5% in the third quarter. We actually expect that that will be a little less in the fourth quarter, just because of the size of the fourth quarter is so much bigger from a revenue perspective. That will moderate to something closer to 1% for the total fourth quarter.

As we look at the new store growth, we actually haven’t accelerate our openings in Q4. We accelerated our openings earlier in the year. I think I said in my comments that we had 72% more new store openings in the first half of the year. We really took it as a purposeful investment this year to get those stores opened early so that those teams would have more time on the ground before the holiday season. And we actually saw a benefit to doing that in our sales in the third and we certainly would expect that to continue to the fourth quarter.

So really, no -- if anything, we have fewer new store openings in Q4 this year than we’ve had in previous years.

Jennifer Driscoll

Jim, did you want to estimate the Q4 EPS impact of that calendar shift?

James L. Muehlbauer

Thank you, Jennifer. I think the question on the calendar shift, we estimate that it was worth roughly $0.03 to $0.04 on Q3, so from an operating income growth perspective, our reported operating income growth was up 79%. I think if we exclude the calendar shift, it merely would have been up 60% or so.

Chris Horvers - Bear Stearns

So does that mean -- so I guess we might read this as, just to play devil’s advocate, that you are less optimistic about 4Q?

James L. Muehlbauer

Less optimistic in what sense?

Chris Horvers - Bear Stearns

From an EPS growth perspective.

James L. Muehlbauer

I think given the shift in the calendar, which is going to have a similar $0.04 impact on the fourth quarter, although we have obviously a much larger base of EPS, and more importantly the loss of a 53rd week from last year, are the reasons we believe that the Q4 operating income and earnings growth will be less from a percentage standpoint.

We are certainly not bearish on Q4. We’re playing our plan out the way we intended all year long.

Chris Horvers - Bear Stearns

And just one follow-up; could you remind us what the 53rd week benefit was last year in 4Q?

James L. Muehlbauer

The 53rd week was roughly -- I think it was $0.03 to $0.05 is what we called out.

Chris Horvers - Bear Stearns

Thank you very much.

Jennifer Driscoll

Next question, please.


Our next question comes from Michael Baker with Deutsche Bank. Please go ahead.

Michael Baker - Deutsche Bank

Thanks, guys. I just wanted to ask about your Apple product a little bit. You mentioned it’s in 200 or so, 270 stores. How much of an impact is that having to the comps? Is that big enough, just that percentage of the stores to actually matter? And then, any insight into how you are going to roll that out? Next year you talked about some exclusive products. I imagine that that’s one there, how that might roll out and what kind of comp contributor that could be in the future.

David Ashan

First of all, let me talk about the impact. I think there’s a -- I mean, we really don’t discuss balance of sale with regard to any of our products but let’s say that from a standpoint, the Apple share has been growing in our stores as a result of our investment but more importantly, I think the impact has been solid in terms of the overall performance of our employees in those stores. They are excited to be able to offer another brand, another set of solutions to our customers and we’ve seen substantial growth not only in the Apple component but across the entire PC area of the store as a result of them being in the store.

As for next year, we have a very, very solid relationship with Apple. It continues to grow. They are very delighted with what it is we’ve been able to accomplish with them and I think you’ll see sustained activity in terms of many new stores being added to the stable each quarter as we go forward next year.

Michael Baker - Deutsche Bank

Okay, thanks. That helps. And then one follow-up, if I could; I’m just wondering, what was behind the strategy to now brand the home theater installation also under the Geek Squad umbrella? Was that something that your customers were telling you or just some color there?

David Ashan

It was just that simple. We asked our consumers what they thought of the Geek Squad brand and they already thought we were doing home theater install, so the benefit of connecting that and build brand awareness and take advantage of our service capability was to put that brand holistically over our mobile installation, our auto techs, or home theater installation, and our computer agents.

Barry Judge

And customers think about it that way so it enables us to put a more singular message into the marketplace and enables us to get more efficiency and higher awareness out of the Geek Squad brand.

And just tying back some of the comments that Shari made earlier about really building -- and Brian -- building up our loyalty with our best customers. Some of the things that we just talked about in terms of service and in-home installation and the Apple brand we’re finding are the -- our customers want -- our best customers want more. They want the great brands. They want the brands that do more, like Apple, and they want to do more with that experience, so that’s who we’re finding that is really attracted to our service offerings.

As we go forward and we try to please our best customers who are asking for more, you’ll see us pushing the edges of the different businesses that we are in.

Michael Baker - Deutsche Bank

Okay, great. Thanks.

Jennifer Driscoll

Thank you. And those answers were from David [Ashan] and Barry Judge. Next question and last question, please.


Our last question comes from Gary Balter with Credit Suisse. Please go ahead.

Gary Balter - Credit Suisse

There seems to be some confusion on Q4 and I thought it would be useful on the call to just go over it, because I think -- you tell me where I’m missing something but to do it properly, we should be thinking about essentially the 155 from last year being almost 145 when we take out the extra week, we take out the gift card, and we take out the shift in the week after Thanksgiving. So when we compare 175 to 145, that’s 20% up. That seems like a pretty nice estimate. Am I missing something there?

James L. Muehlbauer

Gary, I don’t think you are missing anything. We think if you look at the reported numbers and you adjust it for that 53rd week, we think we are going to be in a 20% earnings growth for the fourth quarter, which we are very pleased with.

Gary Balter - Credit Suisse

Okay, yeah, because that’s what we see but it seems like some people are not appreciating that 20% up in a difficult environment so I wanted to make sure everybody heard that. Thank you very much.

James L. Muehlbauer

I appreciate that and we are -- we are not voting for calendar shifts in the future. Thank you, Gary.

Charles Marentette

Thank you, Eric and thank you to our audience for participating in our third quarter earnings conference call. As a reminder, a replay will be available in the U.S. by dialing 1-800-405-2236, or 303-590-3000 internationally. The PIN number is 11103881. The replay will be available in about an hour and available until December 25th. You can also hear it on our website under For Our Investors.

If you have any additional questions, please call Jennifer at 612-291-6110, or if you can’t get Jennifer, call Carla Haugen at 612-291-6146, or me, Charles, at 612-291-6184, and reporters as always, please contact Sue Bush, our Director of Corporate Public Relations, at 612-291-6114. And that concludes our call, so if we can please end the call, Eric.


Thank you, sir. Ladies and gentlemen, this does conclude Best Buy's conference call for the third quarter of fiscal 2008. You may now disconnect and we do thank you for using ACT conferencing.

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