Best Buy Co., Inc. F4Q06 (Qtr Ending Feb 25, 2006) Earnings Conference Call Transcript (BBY)

| About: Best Buy (BBY)

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

Q4 FY2006 Earnings Conference Call

March 30, 2006 10:00 AM EST


Jennifer Driscoll - VP, IR

Brad Anderson - Vice Chairman, CEO

Brian Dunn - President, COO

Bob Willett - CEO International, CIO

Darren Jackson - EVP, CFO

John Walden - EVP, Customer Business Group

Ron Boire - EVP, Gen. Merch. Manager

Sean Scully - SVP, Services

Tom Healy - EVP, Business

Charles Marentette - Senior Director, IR


Dana Telsey - Telsey Advisory Group

Jack Murphy - William Blair

Chris Horvers - Bear Stearns

Danielle Fox - Merrill Lynch

David Schick - Stifel

Mike Baker - Deutsche Bank

Colln McGranahan - Bernstein

Daniel Binder - Buckingham Research


Welcome to Best Buy's conference call for the fourth quarter fiscal 2006. (Operator Instructions) I will now like the turn the conference call over to Jennifer Driscoll, Vice President of Investor Relations.

Jennifer Driscoll

Thank you. Good morning, everyone. I hope you enjoyed the on hold music by Holly Brooks. On behalf of Investor Relations thank you all for participating in our investor conference call for the fiscal fourth quarter and year end.

With me here this morning are four main speakers: Brad Anderson, CEO will discuss our fiscal 2006 accomplishments; Brian Dunn, President and Chief Operating Officer will share our goals for fiscal 2007; Bob Willett, CEO of International and CIO, who will discuss our international plans; and Darren Jackson, Executive Vice President of Finance and CFO who will cover the quarter results, our FY '07 earnings outlook and the change in our earnings guidance practices.

Also with me here in Minneapolis or on the phone today and available for our Q&A session are Shari Ballard, Executive Vice President Human Resources; Ron Boire, Executive Vice President and General Merchandise Manager; Tom Healy, Executive Vice President, Best Buy for Business; Mike Linton, Executive Vice President, Chief Marketing Officer; Tim McGeehan, Executive Vice President Retail Sales; John Walden, Executive Vice President Customer Business Group; Kevin Layden, President, Best Buy Canada; Sean Scully, Senior VP of Services; and Charles Marentette, Senior Director of Investor Relations.

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. Please note that our remarks on the call will compare results to prior year figures on an adjusted basis. We are providing these non-GAAP measures as we believe they provide better comparability.

A reconciliation of these non-GAAP measures is provided on our website. 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. Also the call is available for replay in case you miss a portion of the call.

Let me give you the replay instructions. Simply dial 973-341-3080 and then enter the personal identification number 7160760. The replay will be available from approximately 1 p.m. Eastern time today until midnight on Thursday April 6.

I would like to remind callers that we plan to take your questions after we conclude our prepared remarks. 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 couple quarters we will move to the end of the queue those who were able to ask a question on the last quarter's call. With that I will turn the call over to Brad Anderson, Vice Chairman and CEO who will begin our prepared remarks.

Brad Anderson

Thank you Jennifer, and good morning, everyone. My agenda for today's call includes two items. First, I will recap the fourth quarter and fiscal year end results; and second, I will share with you how we performed against our fiscal 2006 goals.

As we announced this morning our fourth quarter earnings grew 24% on a 15% revenue growth. These results were fueled by strong comparable store sales gains of 7.3% and an outstanding gross profit rate improvement.

We also had an exceptional year. Our fiscal year earnings per share grew 30% on revenue growth of 12%. These results clearly exceeded our expectation. I would like to thank our employees for a tremendous year that we just completed, and I am constantly in awe of their ability to connect with customers and offer compelling solutions. That's one of the reasons I so firmly believe that investing in our people is the way to satisfy our customers and deliver long-term sustainable growth.

We called fiscal 2006 our tipping point. That indeed is what it turned out to be. Customer centricity has become our strategic foundation. It is the lens through which we view our business, and it is also how we're going to continue to renew our business and sustain its growth rate for the long term.

Our people drive this change, and I am very proud of them. Not only do they deliver outstanding financial results, but they also achieved our five goals for the year, each of which were quite aggressive. As you may recall, we set out five goals for accelerating customer centricity. Let me briefly update you on the outcomes of each one of these.

First, we said we would convert more stores to customer centric operating model. We converted a record number of stores. Yes, as we talked last quarter, we struggled this past fall as we tried to accomplish too much at the same time. However, our converted stores led the chain in both revenue growth and operating income rates for the fiscal year.

Second, we said we'd expand our services offerings. We added 5,000 Geek Squad agents and had strong double-digit revenue growth. We also end of the the year with 1,500 home theater installers and acquired Audiovision a high-end customer electronics design and installation business. Our investment in our service capabilities continues to drive better customer experiences and future growth opportunities.

Third was boosting employee retention. Our employee turnover decreased from 81% to 69%, improving the retention rate within one year by 15 percentage points. Our focus on human capital and the creation of broad incentive programs for employees, which we call Blue Crew Bucks, led to the improvement.

Fourth, was adding individualized marketing capabilities, Reward Zone now has 7.2 million members which is up from 4.2 million members at the end of last year.

Our final goal was to simplify our internal processes. Our work in supply chain, price optimization, and tailored marketing assortments are getting results. We can see it in our gross profit rate. As an additional indication our in stock levels were up 600 basis points over the last two years, and that improvement not only helped sales, but it improved the customer experience.

On top of all that, another point of pride for me is Best Buy and Best Buy's Children's Foundation have contributed approximately $30 million to local Best Buy communities in fiscal 2006. These contributions included significant relief for the communities and people hurt by the hurricanes Katrina, Wilma, and Rita.

We've said before that if we become a customer centric company it would benefit not only our communities but our customers, employees, and shareholders. Specifically, we have told shareholders that we believe that we can boost our operating profit rate to 7%. We still are focused on that goal. Moreover today's numbers show that we've closed the gap by 50 basis points this year and we expect approximately another 40 basis point improvement in fiscal 2007.

In the coming year we'll continue to pursue the same vision. Our goals for fiscal 2007, which Brian will describe in a moment, build on the foundation we laid in fiscal 2006. We're looking at our recent progress and the plans ahead and we've just entered a very exciting year.

I am confident that we're setting a course that will enable us to continue to deliver profitable growth for the long-term, and we've just scratched the surface on the new opportunities that customer centricity is creating for us. Now I will turn it over to Brian Dunn, our President and Chief Operating Officer. Brian.

Brian Dunn

Thanks, Brad. Good morning, everyone. It is nice to have such great performance to talk about during my first investor call as President of the Company. It is certainly much more attractive than the alternative. Brad talked about a few of our successes from fiscal 2006. I have two additional things I would like to talk about.

First, I want to give you my point of view on how we'll build on Best Buy's track record of profitable growth, which I think will give you context for my second agenda item, namely our six priorities for fiscal 2007.

First let's talk about growth. I've worked here at Best Buy for more than two decades. I've seen the Company grow from twelve stores when I started, to today with 1,000 stores in sight. Over time I have noticed that the leaders who drove the most growth never forgot something true, maybe uniquely true, about Best Buy.

Best Buy is a story about people. Ordinary people who have done extraordinary things, things made possible because of a deep, rich, unique company culture that holds a few guiding values close to its core. Best Buy has in its DNA a willingness to embrace challenges and change and to accept nothing short of victory regardless of what the market throws at us.

No matter how the outward suppression of Best Buy changes, the core of Best Buy remains the same. By the way, we also have in our core an unwillingness to take ourselves too seriously, which I think might be the attribute that leads to all others, but that's another conversation.

Here is the thing: throughout the '80's and '90's, the energy and the passion of the people of Best Buy were directed intentionally at products. Our customers loved the stuff, and so did we. It was a mutual obsession with the latest and greatest products. We don't apologize for this. We're quite proud of it.

We became the best in our business in efficiently presenting and selling all the cool stuff. But things changed. The market changed. Customers changed. One thing that didn't change, however, was our people, thank goodness. Because of that our past was not an albatross holding us back; it was in fact a platform for change and growth.

So about three years ago we asked our people to direct our energy and passion not at products, not at the stuff, but toward other people. Three years ago the center of our organization was the product. Today two human beings form the nucleus of Best Buy, the customer and the employee.

It is the last ten feet, the interaction between an employee and a customer. It is what makes a store successful and ultimately it is what makes this company successful. That's why we're focusing so intently on the customer experience and the employee experience. We're starting to see results.

Expanding our services business improved the total experience for customers. The Magnolia store within a store differentiated us from the competition. Best Buy for Business gave small businesses a seamless way to buy and install new technology.

These experiences delivered on their promise only because of the culture in our stores. We supported and protected that culture by launching new incentive programs and more important by listening to their ideas. In fiscal 2007 we'll commit significant resources to the investments that we know improve the experience for our customers and employees. That will support our growth goals.

Let's talk about those goals, our company priorities. Tthe game plan should come as no surprise to you. We're simply scaling the best ideas from last year based on what we've learned.

First, we will implement a single customer centric operating model. By the end of the fiscal year all U.S. stores in the corporate offices will operate under a single model that exemplifies the best of customer centricity. That will allow us to eliminate redundant work and operate more efficiently.

More important, it will put all of our people on the same winning team which will help us create a better employee experience. We'll start in the first quarter by making changes in our corporate and field leadership structures as we align the entire organization behind one customer centric model.

Our second priority for fiscal 2007 is enhancing our ability to provide complete solutions to our customers. As digital technologies get more complex, consumers want more help with their purchase decisions. This year we'll give our stores better tools and capabilities for describing, demonstrating and selling complete solutions to customers.

Improving the customer experience is also the rationale behind our third priority, growing our services business. We expect another year of strong revenue growth in Geek Squad services and home theater installation. Our hiring plans for Geek Squad are nominal. Instead, we expect our revenue gain to be driven by productivity improvements. We will drive the improvements for the installation of new tools, the benefits of scale, and a market based approach to delivering in-home service.

As we've discussed in previous calls, our Magnolia store within a store experience emerged from our customer centricity work. It has been extremely well received by people from all of our customer segments. During this year we plan to open 200 more Magnolia home theaters inside Best Buy stores for a total of 300 by the holiday selling season.

This concept will lead the charge for us into nationwide high quality home theater installation. We're investing in the home theater installation capabilities in advance of the demand curve as we did last year with Geek Squad because we view this as a critical strategic capability.

Our fourth priority for fiscal 2007 is continuing to add new stores. Opening new stores in existing markets adds to customer convenience while growing profits and increasing market share. It also leverages our customer insights and the valuable input of our employees in those markets who are always our best source for ideas.

Our fifth goal is to build our Best Buy for Business capabilities and presence. We've announced plans to add enhanced small business capabilities to more than 120 additional stores in the country. We'll offer an expanded Geek Squad presence, small business products, help from business pro's and kiosks with additional solutions. By year end, we plan to have trained more than 900 Microsoft certified professionals giving us further authority to serve these customers.

That brings me to our final priority for the year. Our sixth priority is pursuing international growth opportunities. This work includes leveraging the investments we have put in place in Canada, as well as pursuing a controlled growth plan in China. Bob will give you his perspective on this key priority in just a moment. In closing I would like to leave you with these thoughts.

Customer centricity has helped us understand customers better than we ever have. We know how to win with customers. Our priorities include scaling the best ideas from last year and building new strategic capabilities supported by a single operating model.

Finally, we continue to be serious about growth. We grew our EPS from continuing operations by 30% this year. That's very exciting for any company, particularly one our size. We plan to continue to build capabilities in areas like services, small businesses, and international retailing so that we can maintain a high rate of growth for years into the future. Thank you.

Now I would like the turn the call over to Bob Willett, the Company's CEO of International and CIO for Best Buy.

Bob Willett

Thanks, Brian. Good morning, everyone. I would like to start by saying I am still heavily focused on the transformation of our supply chain and IT systems. This work is fundamental to customer centricity and is supporting our margin growth.

While I remain very focused on this work, my topic for today is the international segment, including our profit opportunities in both Canada and China. Best Buy International comprised of Future Shop and Best Buy operations in Canada also delivered a great fourth quarter.

Comparable store sales rose 6.4% on top of a gain of 0.5% in the prior year's fourth quarter. The international segments gross profit rate increased by 50 basis points. Our SG&A rate, however, was unfavorable due in large part to the $7 million in reorganization costs as we reduced our headquarter staff in Vancouver. Excluding these costs, our fourth quarter operating income rate modestly improved by some 20 basis points year-over-year.

I view Canada as a book with two halves. The first half of the book is about gaining market share by opening new stores and entering new provinces. The team has done this work extremely well. We opened a record number of new stores in fiscal 2006 including Best Buy's entrance into Quebec.

We also made investments in advertising to gain awareness of the Best Buy brand which was critical, as Best Buy was virtually unknown in the Canadian marketplace three years ago. We're encouraged by our combined 30% market share, especially as both of our brands posted gains this last quarter. This clearly shows we're winning with the customer.

The second half of the book is about optimization of the strategy; leveraging our scale and differentiating our two brands in the marketplace. If we do this work with a relentless focus on the customer experience, we will deliver on our 5% operating profit rate goal.

For example, we see enormous opportunity to bring our international efforts, capabilities we built in the United States, starting with supply chain and IT. Initially we suboptimized our international results because we did not share a common infrastructure. That is changing.

We extended our partnership with Accenture to include IT operations for Canada as well as the U.S. In the fourth quarter we began migrating our Canadian operations to the same systems used by our U.S. counterparts. That change will enable us, in the coming months, to bring capabilities such as price optimization and tailored market assortments to Canada.

In the longer term, this experience will help us to build an array of transferable capabilities that will assist us with our expansion into China and other countries as well. So taken in context, we have a great deal of work ahead of us, but I am encouraged by the significant opportunity to leverage our recent investments for both top line and bottom line growth.

Looking at fiscal 2007, our top priorities in Canada are closely aligned with the four key drivers that we believe will get us to our 5% operating margin goal. First, capture the benefits of enterprise scale and reposition the Future Shop brand. Second, optimize the store operating model for both brands. Third, refine and improve the returns on our online sites and services businesses. Fourth, increase efficiency by leveraging supply chain improvements already implemented in the U.S.

Turning to China, we recognize that China is a dramatic departure from how we do business in North America. Until recently, China has been considered a difficult market to enter. That is why we're focused on learning everything that we can about the intricacies of that market, its consumers, and what it takes to successfully compete and grow our business. In other words, we're learning carefully and scaling fast.

We expect to open a lab store in China by the end of fiscal 2007 which will help us learn more about this emerging market that is projected to reach 100 billion by 2010. We also will benefit from our current presence in China, namely three sourcing offices.

International growth is an important part of our long-term growth plans. We're committed to pragmatic but controlled approach to this growth. With that I would like to turn the call over to Darren.

Darren Jackson

Thanks, Bob. The results for the quarter and the year were good. So I plan to dwell on them in painstaking detail for the balance of the call. Frankly, the top line and the bottom line of our business performed exceptionally. Our results for the fourth quarter and the year benefited from and were challenged by the same factors. I will highlight the key drivers and then discuss the implications for fiscal 2007 and beyond.

Starting with the top line, we reported $10.7 billion in revenue for the fourth quarter and $30.8 billion for the year. The revenue gains were driven by an impressive 7.3% fourth quarter comparable store sales gain, and a 4.9% comp gain for the fiscal year.

Our sales performance was strong across all parts of our business. Our Magnolia standalone stores led the way with a 30% comparable store sales gain. Best Buy U.S. posted a very solid 7.3% comp gain for the quarter, including a 50% improvement in Finally, Canada's comps were up a strong 6.4%.

The comparable store sales gain for the quarter and the year were driven by increased average selling prices due to mix and improved productivity and store conversion rates. Clearly the product cycle has provided some momentum.

I should add that our segmented stores also did very well. Overall their comps were nearly 200 basis points better than the balance of the chain for the fourth quarter, and 360 basis points for the year. The marquee highlight for the quarter and the year was the gross profit rate improvement.

The 137 basis point gain for the fiscal year is extremely gratifying. The underlying drivers were improved capabilities, services, sourcing and supply chain efficiencies. The good news is the gains are structural in nature versus just being cycle driven.

We finished the year with a pleasant surprise. The fourth quarter gross margin gain of 144 basis points significantly exceeded our expectations. The combination of lower markdowns because of better inventory transitions, a reasonable promotional environment and higher sell throughs drove the outsized improvement.

Turning to SG&A, we did have some challenges during the year which resulted in our SG&A rate growing 80 basis points. Virtually all of the increase was in payroll and benefits at store level. Candidly, this was higher than we expected, but so was the improvement in employee turnover, employee engagement scores, comparable store sales gains and earnings growth for the year. We invested closer to the customer, and the fact is, it paid off. Our expectation is that fiscal 2007 will benefit from these same investments as well.

The 70 basis point increase in the fourth quarter was driven by the incentive compensation. 72 basis points to be exact. Now, a 7.3% comp gain and a 144 basis point margin rate jump tends to put pressure on bonus dollars. Specifically, this hike reflected a combination of more bonus eligible employees, our new Blue Crew Bucks program and a soft prior year bonus payout, as I can attest to.

A bright spot in the SG&A was modestly higher cost structure in our segmented stores which was offset by expense cuts in other areas. Overall we saw significant improvement in our expense leverage and advertising and in fixed areas of the fiscal fourth quarter.

Interest income and taxes continued their positive trends. Interest income grew $17 million in the fourth quarter versus the same quarter a year ago. Correspondingly, year-over-year interest grew $55 million driven by higher investment yields and higher average balances. We exited fiscal 2006 with $3.7 billion in cash and short term investments, up from $3.3 billion last year.

The income tax rate for the quarter was in line with our guidance. The tax rate for the year was 33.7%, down considerably from 38% two years ago. A combination of higher levels of tax exempt interest income and benefits from our foreign operations including our sourcing and China reduced the rate. Our expectation is the rate gains will moderate next year, resulting in a tax rate of 34 to 35%.

Overall, our income statement tells a pretty good story. Operating margins grew 73 basis points in the fourth quarter and over 56 basis points for the year. Diluted EPS grew 24% for the fourth quarter and 30% for the year. Quite simply this is an outstanding performance by any measure.

We are pleased that we were able to deliver this performance while achieving our capital investment and shareholder return objectives. Specifically, we invested $664 million in capital projects including $450 million for new stores, remodels, and other store projects; $115 million for technology including POS replacements and $99 million for supply chain and other projects.

We returned $922 million to shareholders via stock repurchases and dividends and 80% pay out of our net earnings and nearly a threefold increase over last year. I too, would express my appreciation to our family of Best Buy employees who drove these great results.

Now let's move to our expectations for fiscal 2007 and I will tell you we are optimistic as we kick off the year. We plan to open 75 to 80 stores in the U.S. and approximately 10 stores in Canada. We expect total fiscal 2007 revenue to grow 10% to 13% to $34 billion to $35 billion in top line sales.

Comparable store sales are expected to grow 3% to 5%. We anticipate revenue growth to be driven by strong comparable store sales gains from flat panel TV's, MP3 players, notebooks, video gaming, Geek Squad services, and the appliance business. Offsetting these results will be declining consumer interest in analog TV, landline phones, computer printers, and CD's.

Now, underlying these revenue drivers we see more affordable flat panel TV prices as a great opportunity this coming year. These gains will be fueled by our Magnolia home theater store within a store experience, and while price declines will likely be less than last year, although accelerating in the back half, this will be the first year when flat panel truly becomes accessible to a broad customer group.

Additionally, Xbox 360 will continue to add energy to the gaming space as more units become available this spring. We also look forward to the strong launch of PlayStation 3 as the Vista and the Vista operating system.

Now, looking at the next line of the income statement, I would love to be able to forecast another 137 basis point improvement in gross profit rate. But Ron won't let me. That said, we do have opportunities ahead of us. We expect to build on our 137 basis point increase by growing gross profit another 10 basis points in 2007.

The growth will be driven by the same capabilities, services, and solutions in 2007 that drove the 2006 improvement. Similarly, competition and commoditization will improve and limit those gains. Some could suggest we are being conservative. We hope so.

As you would expect, we're very focused on reducing our SG&A rate. We plan to make meaningful progress in fiscal 2007. We will increase productivity on labor across the board in our stores, our field leadership structure, and at our corporate campus. The changes we plan to make in the first quarter will bring greater benefits in the subsequent three quarters.

Additionally, we are curtailing the use of outside services and adjusting our advertising mix to improve our returns. For the year we expect a 30 to 40 basis point SG&A rate improvement. As a result, we plan to improve our operating income rate by 40 basis points for fiscal 2007.

Our fiscal 2007 guidance also includes capital expenditures in the range of $675 million to $725 million. This range excludes $410 million for the acquisition of Pacific Sales that closed in March and any additional acquisitions.

These assumptions bring us to our earnings range for fiscal 2007 of $2.65 to $2.80 per diluted share, an average increase of 20%. This guidance range is constrained by $0.03 to $0.05 of anticipated severance and reorganization costs in the first half.

These actions and costs allow us to redeploy resources and create the necessary capacity to fund our strategic growth initiative, further eliminating redundant and non-strategic work; increases our flexibility and ultimately our speed to market in key growth areas.

This is the point where I would usually lay out EPS range for the upcoming quarter, but we're out of time. No. As we looked at our guidance practices this year as we do every year, we debated this issue. We are committed to giving shareholders a high degree of transparency. At the same time we want our people focused on the long-term goals and growth of the Company.

We believe that offering annual guidance and eliminating quarterly earnings per share estimates allows us to do both. Furthermore, I can tell you that I do not see trends that suggest the seasonality of our business is changing. I expect that each of the first three quarters will continue to contribute 12% to 15% of the year's earnings as they historically have.

We are focused on driving the long term growth of Best Buy and are confident that this guidance philosophy is consistent with how we are running the business. Our intent is to update the market if we are confident that our annual results will materially differ from our guidance. From a quarterly perspective we feel no obligation to issue a news release if our internal projections for the quarter differ from the Street's consensus.

While we'll no longer be providing quarterly guidance to assist with the transition let me reiterate that we continue to expect a very modest improvement in the earnings in the first quarter as we previously announced, partly due to the severance and reorganization costs.

To conclude, we are proud of this year's performance, and we genuinely appreciate our employees hard work in delivering our first ever $1 billion bottom line, a 30% increase in our diluted EPS, a 15% improvement in our employee retention, record level market shares, and most importantly a company that we are all proud to be a part of.

As Brad discussed, our transition to customer centricity has passed the tipping point. The most significant accomplishment from fiscal 2006 was our cultural shift to customer centricity. This strategic foundation has opened up new areas of growth, identified new value creating capabilities, and will position Best Buy for sustained earnings growth for the long-term.

We are optimistic, confident, and committed to building on our consistent track record of success in 2007 and beyond. And with that we'll now take questions from our investor audience.

Question-and-Answer Session


(Operator Instructions) Your first question is coming from Dana Telsey with Telsey Advisory Group. Please go ahead.

Brad Anderson

Good morning.

Darren Jackson

Hi, Dana.

Dana Telsey - Telsey Advisory Group

Can you hear me okay?

Darren Jackson

Yes, we can.

Dana Telsey - Telsey Advisory Group

Wanted to follow-up a little bit on the customer centricity shift to one format from what you had before. Can you detail a little bit, what from your learnings of customer centricity will be applied to the one format now? Are the results of the customer centricity stores improving to the expectation that you would like? Thank you.

Brian Dunn
This is Brian, Dana. Thanks for the question. Before I turn this over to John, I just want to clarify that it is not one format. It is one support operating model to support the multiple formats.

As we went to do this work, to capture a speed to benefit and a speed to market, we purposely built some redundancies into the organization so that we could have teams focusing on the new work while we were continuing to drive strong performance in the base work. Now what you're hearing from us is we're going to move the support groups into one operating model to support multiple segments across the field. John.

John Walden

Thanks, Brian. We talked about this before. Last year we went at this by transferring stores from the old model to being customer centric model. We went from 67 stores a couple of years ago to what we hoped would be something like 300, 350 last year.

As we went through each wave, adding 50 more, we found that we could do it at a relatively small scale. We could put this new model into a store because we had a group of folks that could control the environment, teach, train, make sure the stores understood it.

Once we got to a point of fairly large scale, and we call that sometime about the third quarter, we got to a point we could no longer do that just at small scale because we were there, at that point, at a big scale. At that point, in order to move us from the old model to the new one we realized that we needed to go to one model. So everybody in the chain, our field leadership teams, our field support teams, our training teams, everybody, was teaching one model. It is that model we're really talking about this year.

Instead of the traditional way we've operated stores, we have chosen a model that incorporates the best of customer centricity and the best of being a disciplined operating environment. That's the model we're going to deploy this year.

When we talk about a single operating model, it is a model that understands who the customers are that are targeted in the stores. It has the appropriate level of discipline, and it knows how to help employees in those stores understand the financial impact of the decisions they make and more importantly engage, energetically and within sight with the customers that walk in the stores.

Brad Anderson

But the experience at the store level will still be differentiated.

Dana Telsey - Telsey Advisory Group

Thank you.

Jennifer Driscoll

That was Brian, then John, and then Brad Anderson responding. Next question, please.


Our next question is coming from Jack Murphy with William Blair.

Jack Murphy - William Blair

Good morning and congratulations.

Brad Anderson

Good morning, Jack.

Jack Murphy - William Blair

Good morning. On the flat panel digital TV's, could you revisit the average selling price declines and give us a sense of what you felt full year declines were there? I know you mentioned that you think it is going to be less of a decline, but maybe some order of magnitude there. Then if you could talk about, ballpark, what you think the growth rate in that category looks like for full year, that would be helpful.

Jennifer Driscoll

I will turn it over to Ron.

Ron Boire

Hi, Jack. Flat panel TV for all of last year we saw somewhere in the 20% to 22% range. We think about it on kind of a cost per inch, and we also look at it from a technology point of view. Broadly if you want a number, I would use somewhere in the 20% to 22%.

For this year, I think that the decline will obviously decelerate as we talked about on the call. Orders of magnitude, I would say that we're still going to see a double-digit decline but not nearly as high as we saw in 2005. I would also say that we will see a little bit of acceleration in the back half of the year on that.

Jack Murphy - William Blair

Would you just give us a sense of what you think the margin implications are? Do they still hold up as they have?

Ron Boire

Well, as price comes down, this includes a little bit of pressure on margin. As we saw last year, we expect more of that pressure to come in the back half of the year. But I think the advantage that we have around how we build a total solution for our customers, the things we're learning from centricity about how to build, display, and deliver that solution to the home is really where our margin opportunity is.

When you hear John talk about the operating model changes that we're making in the store, that's exactly where we're going. It's about building a better solution for a more profitable customer, and we see that as a significant advantage we have in the marketplace.

Jack Murphy - William Blair

Thank you.

Jennifer Driscoll

Thank you, Ron. Next question.


Our next question is from Chris Horvers with Bear Stearns.

Chris Horvers - Bear Stearns

Good morning. How should we think about the profit dollar flow through of Geek Squad revenues in 2006? In other words, if you keep your head count flat, would you treat payroll as largely fixed over year; and think about let's say a high 20% operating margin rate on those revenues?

Darren Jackson

I was going to say something like, you can think about it any way you want to think about it. As we look at next year, I would tell that you we're absolutely expecting to grow productivity as we've added Geeks this year to the tune of total Geek count was 12,000 at the end of the year. I can tell you we would actually expect higher profitability on each Geek.

Now, on the other hand, the other thing that we're doing this year is we're going to be making investments in what I will call capabilities, technology processes, and tools that allow us to do that. So the flow-through this coming year I don't think will ultimately represent what we see the future for Geeks.

What we see this year is an optimizing and an increase in the flow through, but part and parcel with that, we are going to be making investments in tools and capabilities to do that. I am not purposely dodging the 20%. We don't give out margin rates and flow-through rates on any one of our businesses except at the highest level, but I can tell you that as we look to this year, this upcoming year versus the past year, we see an enormous opportunity in terms of productivity improvements across our Geek force, driven by capability increases basically in technology, tools, processes, and the like.

Brad Anderson

I would also expect that the service businesses, which are highly complex and which we've grown at an inordinantly fast rate, it will be a multi-year story of refinement. It won't just be this year. We'll start refinement this year. But it will take us years to get to where we dream of being.

Chris Horvers - Bear Stearns

Just as a follow-up, any order of magnitude on how revenues will grow year-over-year or what they might be this year for Geek?

Sean Scully

Yes. This is Sean Scully. We said that they are going to grow in the high double digit rate in Geek Squad and in a triple digit, low triple-digit rate in home theater installation.

Chris Horvers - Bear Stearns

Thank you.

Jennifer Driscoll

Thank you. That was Darren, Brad, and Sean Scully.


Thank you. Our next question is from Danielle Fox with Merrill Lynch. Please go ahead.

Danielle Fox - Merrill Lynch

Thanks, good morning. I just wanted to follow up on where the SG&A improvement will come from in the current year. It sounds like you're still modestly adding Geek Squad agents and building out the home theater installation business.

So I am wondering actually where you're eliminating positions, and then also how we should think about lapping this increase in the compensation expense in the fourth quarter? It looks like it was maybe $75 million. Is that something that we should think about going away or just being flat year-over-year? How should we be thinking about that?

Darren Jackson

Yes. The way I would frame it is that as we look to next year, as we said in the conference call, we see 30 to 40 basis points of expense leverage on -- call it an average comp of 4%. Honestly we're looking for productivity improvements across every area of our SG&A, so we've announced internally that we are going to do some reorganization and restructuring and quite frankly that's taking out some of the fixed costs in our business as we look forward.

We will redeploy some of those costs against our growth initiatives in terms of investments and services, Best Buy for Business and other areas. Quite frankly, what's different is that this past year we essentially just invested and now we're making the trade-off and putting dollars against where we see the higher growth opportunities for the business and taking them out of the other parts of the business model where we see either the return cycle has passed or we can deploy them to higher and better use.

We're also looking at our advertising part of our business, and looking at the different returns on the different vehicles that we use, and quite frankly one of our best return vehicles is Reward Zone, and we're seeing great returns from that. In other parts of the portfolio we're not seeing as high returns.

We're looking into our advertising areas in order to drive more efficiency into our SG&A structure and then finally, as we said in the call, there is a level of outside service expenditure that we've made over the course of this past year in part to help drive the insights into the new growth markets and to build out the models and to support the transition past the tipping point that we don't see those repeating.

As we look to next year in terms of the bonus that we'll be lapping, you're right. On the one hand, if we don't have a good year, we'll get some of those bonus dollars back as we did a year ago. We plan to have a good year. So we're not expecting to see all those bonus dollars roll back in terms of the system. I think if you actually look and combine fiscal 2005 and 2006 in terms of the bonus dollars, what you'll see is they were helpful to the tune of 40 basis points the year before, and then this year 70, and on balance the two years combined are reasonable.

Danielle Fox - Merrill Lynch

So think of it as a very variable cost. Then just one quick follow-up. What do you expect EPS contribution from that extra week to be? Is there anything special about the extra week that we should be considering?

Darren Jackson

Yes, there will be some modest EPS accretion from that. Honestly, when we're into late February, early March, those are not our high volume weeks in the year. But there were a few pennies that we should benefit from because of that extra week.

Danielle Fox - Merrill Lynch

Sure. Thanks. Very helpful, Darren.

Darren Jackson

You're welcome.


Thank you. Our next question is from David Schick with Stifel. Please go ahead.

David Schick - Stifel

Good morning. Just two questions. Forgetting Geek operating margin and revenue numbers, can you talk more substantially about either Geek attachment rate, how many customers are adding on Geek services, how that's trending and the customer repeat rate for the Geek brand?

Then secondly, could you talk with some more time now about specific sales, kitchen and bath, as you looked at it and how you're going to migrate that business over time? Or what you're thinking its implications are? Thanks.

Darren Jackson

I can do a couple of the highlights and then Sean will jump in. When we look at attachment rates, maybe a way of thinking about it is fourth quarter last year, fourth quarter this year, and you've been with us long enough to know we don't hand out the attachment rate. Why don't I give you some of the trends. What we see is that in terms of attachment rates for Geek Squad, Q4 to Q4, they were up some 40% in terms of what we can see in the data.

The other thing that we see that's pretty exciting is that when we look at in-store or in-home visits, is that we see almost a tripling Q4 to Q4 in terms of the in-home visits that we're seeing in the business. The underlying trends and the in-store visits, as you would expect, are up 30%, 40%. The underlying health in terms of what the consumer is choosing, in terms of our Geek Squad service, I think as Ron said in the call, we've built out an infrastructure we think well ahead of where the demand curve is going to continue to go.

I would have you just think about if the Vista operating system starts to hit and people start to think about migrating their data and new PC cycles. I think quite honestly we feel like we're in a great place and particularly this year as we have the agents now it is growing the best and brightest of the agents and adding the tools positions us for a strong 2007 and beyond.

Sean Scully

I would say first and for most our Geek Squad business was in the very high double-digit growth year-over-year. Our operating profit in the fourth quarter improved higher than our revenue improved. That's our goal naturally for next year, that our operating margin improves at a higher rate than our revenue goals are.

Most of that is going to come off of productivity and consistency. We're doing a lot of wireless networking, a lot of operating system updates and upgrades in the home, and we're getting more density from it, and that naturally is going to improve our margin. As Darren spoke about, we really built for scale last year. Now we're able to come back and densify that scale with both market coverage and capability coverage better this year.

Ron Boire

Thanks, David. This is Ron Boire, the Pacific Sales, I would hold two thoughts in your head. One is Music Land and one is Magnolia. How we approach those businesses and think about how the lessons from Magnolia and the lessons from Music Land might be applied to this acquisition.

What we think we have with Pacific Sales is an absolute gem of business. They have a fantastic customer base, they have a fantastic market share in the high-end appliance business in southern California.

The first thing that we've decided to do is learn what we did well with Magnolia, which is take our time, understand deeply what the real operating model of that business is, the real culture of the business is, and frankly, we think we also acquired some great leadership.

The one thing we have done is assign one of our best field leaders to managing that business along with the existing Pacific Sales team, and I think if you could take the Magnolia idea of what we did over a number of years with Magnolia, a go slow to go very fast kind of strategy and project that onto Pacific, you would probably be in a pretty good place with how we're thinking about it. Bottom line, a gem of a business, and we're really proud to have it in the portfolio.

Brian Dunn

Ron, this is Brian. David, I would add just one thing. I think this is a very vivid example of some doors that our customer centricity and the work we've done there in terms of customer insights has unlocked some business extenders for us, so we're very, very excited about bringing that lens to this work.

David Schick - Stifel

Great. Thanks.

Jennifer Driscoll

Thank you, David. Next question, please.


Thank you. Our next question is coming from Mike Baker, Deutsche Bank. Please go ahead.

Mike Baker - Deutsche Bank

Thanks. Sounds like the Geek Squad is certainly additive to margins. How about the home theater business, with adding the 1,000 people there this year, is that going to be a year of investment in that business and then something that leverages in calendar 2007?

Brad Anderson

Yes. The first three quarters are essentially building the capability as we're building out both the Magnolia store within a store and clearly scaling our home theater year-over-year. We'll see triple digit revenue increases, but we're clearly -- we now own 100% of the capability providing that to our customers. In the fourth quarter is when we see it becoming profitable. It is still relatively smaller business for us, and relatively small profitability on the fourth quarter.

Mike Baker - Deutsche Bank

But triple-digit gains, so over 100% gain in the revenues and it sounds like the number of people you're adding is just under 100% if you go from 2,500 from 1,500. It should help drive profits. Can you remind us what are the drivers to your 7% operating margin gain, and is there a specific timeframe that you guys are aiming towards on that number?

Jennifer Driscoll

That is the second question. [Laughter]

Mike Baker - Deutsche Bank

It is one big question on margin outlook.

Brad Anderson

[Laughter] We don't answer second questions. It is Brad. 7% is still something that we see this business model being absolutely having the capability to achieve. I would say best case is it is still within two years. Practically it is probably closer to four years.

So as we look at the drivers of moving 7%, those haven't changed, and part of the evidence is this year. We said through our supply chain sourcing and capabilities we hope it is 50 basis points in terms of that bucket, and quite frankly we missed that number. We over-achieved it and we recognize going forward we're also going to have pressure in that space.

Canada, as Bob outlined in his comments, we absolutely see the opportunity to get to 5% operating margins, and when you look at getting to 5% operating margins on the total, that will continue to drive the rest of the way about 40 basis points.

IT, and we've said over the course of the Accenture contract through FY '08, we expect a 50 basis point improvement. Since the contract began, we have realized 20 of those basis points. I would tell you that we still see 50 basis points coming. But it is more practical. It might be a year out from what we said, in part because we're focusing investments and services and other capabilities, new POS that we didn't quite frankly anticipate at the beginning of the contract.

Last but not least, in terms of the organic growth bucket, in terms of what we're learning from customer centricity and probably more importantly the capabilities that we're building, that between our Best Buy for Business, our service insight and other pieces of business we're absolutely confident.

We saw modest improvement this year in terms of the overall organic side of the business, so all of those things continue to be part of the story to drive to 7%. There is no reason to believe that we're not every bit as committed and quite frankly, more excited. Some of that stuff is showing up in the results as we speak today.

Mike Baker - Deutsche Bank

Okay. Thanks.

Jennifer Driscoll

Thank you, Darren. Next question, please.


Our next question is coming from Colin McGranahan with Bernstein. Please go ahead.

Colln McGranahan - Bernstein

I would like to focus on the Best Buy for Business. Obviously you're hiring some dedicated sales people there. Could you talk a little bit about what portion of that is really technology sales? How that runs, and what the margin structure of that business is? Then, whether your service business there is structured more for small businesses, kind of a year-long service contract and what the overall relative profitability of that package looks like?

Tom Healy

Good morning Tom and thanks for the question. Tom Healy. The majority of the head count we're going to add are technology specialists. We have three categories of them. We have business technology specialists in the store, business technology consultants that are actually in the field predominantly. Overall those technology sales to business are higher in margin than our typical sale at a store and really the investment this year is going to be in adding the head count as well as adding training and support capabilities for those folks.

Colln McGranahan - Bernstein

The product you're selling there, that's not similar to the product in the store that you're just buying through value-added resellers?

Tom Healy

It is dissimilar to the ones in the store, yes, the servers, networking gear, e-mail, that sort of thing that wouldn't typically be sold in a Best Buy store. It would be sold in a value-added reseller.

In regard to the second half of your question there, about the ongoing service relationship, when you install a server you tend to have a much longer term relationship than if you were to just sell a typical computer in our stores.

Given that complete solution sale including the network, the server, and the ongoing maintenance, data migration et cetera that you're likely to get with that sale makes it a much stickier sale and a much long are term opportunity with those customers.

Brad Anderson

Tom, the other question was how are we going to source the product that's not normally in our assortment.

Tom Healy

We'll source it through the largest distributors of technology products, TechData, Ingram Micro, Synex, in a very similar manner to how CDW, InSite, some of the other channel distributors sell product. As well, we'll take inventory in those SKUs that are higher turning SKUs; but for the most part that extended assortment will be directly through distribution.

Colln McGranahan - Bernstein

Okay. Thank you.

Brad Anderson

Thanks, Tom.

Jennifer Driscoll

Thank you, Tom. Next question, please.


Our next question is from Daniel Binder with Buckingham Research. Please go ahead.

Daniel Binder - Buckingham Research

Good morning. Just a question on the home theater installation business, and the attachment rates that you're seeing there, at least the direction of it. I realize that business should be up given the higher mix of new technology TV's. But I am just kind of curious, if you look at the attachment rate on that specific part of the business, are you seeing the attachment rates rise on that, on the new technology TV business?

Darren Jackson

This is Darren. From Q4 of last year to Q4 of this year we saw a 50% increase in the attachment rates of the home install, home theater business, and the visits we saw almost a fivefold increase. Similarly I think as we're building capabilities and we're learning what those capabilities look like; trying to lay that foundation because the demand curve that we see is going to keep coming, gives us a lot of reason for excitement as we look to next year.

Brad Anderson

With that background I am getting more paranoid every day that Darren might be running this business. Probably most importantly is we really are building the competency which is all about customer satisfaction, not about revenue and margin at this point.

We know that home theater specifically, when people are buying high quality TV's, the content, the connection, making it work for the user is the most important thing to keep it in the home. We're focused on quality before we're focused on margin return. With that said, as we get scale and efficiencies which we really see coming in the fourth quarter, we know that we can make it a profitable business.

Daniel Binder - Buckingham Research

This is a follow-up on that. I saw an article yesterday regarding your involvement with wiring homes with Ryland. Is that initiative sort of moving beyond -- it sounded like you were kind of testing that for a while. Is that something that you're going to start developing more aggressively?

Tom Healy

This is Tom Healy. That falls under Best Buy for Businesses, our builder channel. Yes, it is something we're exploring, and doing very well with right now. What we've done in the last year is change the operating model from very similar to Sean's comments in regard to home theater, using subcontractors for the actual work to doing it ourselves.

We found that that by doing it ourselves, more gross margin and the effort as well as the quality control is so much improved. This year you will continue to see us roll that out with improved efficiencies and hopefully higher levels of customer service.

Brad Anderson

A follow up on that quickly, it allows us to get multi-tier of competency, as you can tell so we're able to deliver core installation, integrated home installation and even top line Magnolia quality installation, so it gives us better coverage, better consistency, and better quality across the market.

Daniel Binder - Buckingham Research

From a housekeeping standpoint, I just want to make sure we have a little clarity on two items. One is the $0.03 to $0.05 of severance costs all going to be captured in Q1? Then secondly, when you talk about a stable tax rate, is that stable with what we saw in Q4 or the overall a year?

Darren Jackson

Two things. I think the lion's share of the $0.03 to $0.05 is in Q1. There is a small likelihood that some of it could spill over into Q2, but I think the lion's share of Q1. In terms of the tax rate, what I would reflect on is in the conference call script. I said we're going to see a tax rate in the range for the fiscal year of '07 of 34% to 35%. Call it an average tax rate of 34.5%.

Daniel Binder - Buckingham Research

Great. Thanks.

Charles Marentette

Thank you, Darren and thank you Elsa. Thank you to all of you participating in our call today. Before we end, may I remind you that this conference call will be available to you for replay by dialing 973-341-3080 and entering the personal identification number 7160760. The replay will be available about 1 p.m. Eastern time today until midnight next Thursday April 6.

To hear the replay on the web, please visit us on our website under for our investors. If you have additional questions about our fourth quarter earnings or annual outlook please call Jennifer Driscoll on 612-291-6110 or you can call me, Charles at 612-291-6184. Services questions, call Darren and reporters, on the other hand, please contact Sue Bush our Director of Corporate Public Relations at 612-291-6114. With that we would like to conclude our call. Thank you very much.


Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.

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