Source: Seeking Alpha
Best Buy Co (NYSE:BBY)
Q2 2015 Earnings Conference Call
August 26, 2014 08:00 ET
Mollie O’Brien – VP, IR
Hubert Joly – President & CEO
Sharon McCollam – CAO & CFO
Simeon Gutman – Morgan Stanley
David Schick – Stifel Nicolaus
Alan Rifkin – Barclays Capital
Aram Rubinson – Wolfe Research
David Magee – SunTrust Robinson Humphrey
Mike Baker – Deutsche Bank
Brian Nagel – Oppenheimer
Welcome to Best Buy’s Second Quarter Fiscal Year 2015 Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to Mollie O’Brien, Vice President, Investor Relations.
Good morning and thank you. Joining me on the call today are Hubert Joly, our President and CEO; and Sharon McCollam, our CAO and CFO. As usual, the media will be participating in this call in a listen-only mode.
This morning’s conference call must be considered in conjunction with the earnings release that we issued earlier today. They both contain non-GAAP financial measures that exclude the impact of certain business events. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons, but should not be considered superior to as a substitute for and should be read in conjunction with the GAAP financial measures for the period. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning’s earnings release.
Today’s earnings release and conference call also include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, growth plans, operational investments and prospects of the company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company’s current earnings release and SEC filings for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.
In today’s earnings release and conference call, we refer to consumer electronics or CE industry trends. The CE industry, as defined by the NPD Group, includes TVs, desktop and notebook computers, tablets not including Kindle, digital imaging, and other categories. Sales of these products represent approximately 65% of our domestic revenue. It does not include mobile phones, gaming, movies, music, appliances or services.
I will now turn the call over to Hubert.
Good morning everyone and thank you for joining us. I will begin today with an overview of our second quarter results and then update you on the progress we’re making against our Renew Blue priorities. Then I will turn the call over to Sharon for additional details on our quarterly results and commentary on our financial outlook. So first, our financial results. In the second quarter we delivered $8.9 billion in revenue and $0.44 in non-GAAP diluted earnings per share versus $0.32 last year. The ongoing benefits of our Renew Blue cost reduction and other SG&A cost containment initiatives drove these better than expected results.
On the top line as expected sales in the NPD track consumer electronics category declined 2.5% in-line with our domestic comparable sales decline of 2.0%. Like other retailers and as reflected in this quarter’s performance we continue to see a shift in consumer behavior. Consumers are increasingly researching and buying online. As a result traffic to our brick and mortar stores continue to decline and yet our in-store conversion and online traffic continue to increase due to the execution of our Renew Blue strategy which is in direct alignment with this shift. Our Renew Blue strategy is designed to grow our online business, enhance our in-store customer experience and leverage out multi-channel capabilities or deliver to our customers great advice, service and convenience at competitive prices in the channel they want to be served. Each of these initiatives contributed to our second quarter results.
And so I’m pleased to update you today on the progress we’re making against our renewable transformation road-map which is built around following areas. Merchandising, marketing, online, stores, Geek Squad services, supply chain, cost structure and employee engagement. So first of these areas is merchandising. We believe we’re raising the bar in our retail channel by continuing to roll out compelling and differentiated customer experiences across major categories such as appliances, home theater and mobile. In the appliance category we opened 18 new Pacific Kitchen & Home stores within a store on our on track to end the year with approximately 115 stores versus 67 last year.
In the Home Theater category we opened seven new Magnolia design center stores within the store and our on track to the end the year with approximately 50 stores versus 33 last year. Both of these premium stores within the store concepts continue to outperform our expectations. We also rolled out over 800 Samsung and Sony Home Theater stores within a store during the quarter. This represents the first major merchandising transformation in Best Buy’s home theater department in almost 10 years. We believe that home theater transformation further solidifies our position as the destination for customers to discover and interact with industry leading home theater technology particularly ultra-high definition or 4k TVs and we’re encouraged by the early consumer response to our expanded ultra-high definition assortments.
We’re excited about the future of this technology even though we believe that the impact to our business this year will be limited.
In the mobile category in the second quarter we began offering customers the option to purchase installment billing plans with the Top 3 U.S. carriers. While mobile phone demand in the second quarter including year-over-year trading volume declined as customers wait for highly anticipated new product launches the penetration of installment billing progressively increased during the quarter and we believe we’re well-positioned to capitalize on the new products when they are introduced.
In the area of marketing, we made progress in our evolution from analog in mass to digital and targeted communications with our customers. During the quarter we continued to shift our marketing investment dollars towards digital media campaigns and away from print and television advertising.
We’re also leveraging our Athena customer database to pilot new targeted email campaigns, we’re in the early stages of being able to personalize marketing messages to individual customers which we view as a 2 or 3 year journey. We do however expect to see gradual and incremental improvements in marketing effectiveness every quarter our customer insights improve and our new personalization capabilities are rolled out.
In our online business in the second quarter we continue to leverage our ship from store, digital marketing and enhanced website functionality to drive a 22% increase in domestic comparable online sales. Similar to the first quarter ship from store represented over half of the online sales growth. We’re also using ship from store to drive gross profit improvements on our clearance and end-of-life inventory by exposing it not only to our retail customers but also to our online customers. We also launched several customer facing improvements on the website to drive increased engagements in a more seamless online shopping experience including number one a new global homepage that is easier for customers to navigate, number two significantly richer visual and editorial content for the ultra-high definition, digital imaging in the health and wearables category.
Number three, new text messaging options for order confirmation and delivery that are garnering significant customer adoption and number four visibility to customers Geek Squad purchases instead of their My Best Buy accounts on bestbuy.com.
As we head into the back half of the year we will continue to launch online shopping experience improvements, such as additional product category we designed, expanded wish list capabilities and improved checkout process in an expanded and more inspirational holiday gift center.
Of course we will also be continuing a significant behind the scenes work on the transformation of our e-commerce platform. In our retail stores the field and store structure changes we implemented last quarter are to-date generating results in-line with our expectations. We have consolidated and simplified the field organization, we organized to help drive local strategies and reduce the number of management level roles.
In total what our year-over-year retail labor cost are now lower, other investment in customer facing labor including vendor funded labor has increased. While we still have much to do in reinvigorating the customer experience, we are making progress and are pleased to see our in-store experience contribute significantly to the 400 basis point improvements in our overall NPS or Net Promoter Score that we saw in the second quarter.
In our Geek Squad Services business we continue to increase our net promoter scores and drive down cost to operational efficiencies. We also continue to focus on refining our existing service offerings, improving the merchandising of our services, and building new offerings that meet the needs of customers in the context of today’s rapidly evolving technology environment.
In our supply chain we continue to leverage and transform our distribution and fulfillment capabilities. In May, we implemented significant changes to our distribution operating model that aligned work schedules with customer demand including expanding our days and hours of operation. This implementation was seamless and we’re now able to replenish inventory to our stores and deliver to our online customers faster which is both a competitive top line and improved customer service opportunity particularly in advance of the holiday season. We also continue to leverage our ship from store capability. Not only does it continue to be a significant contributor to our online sales growth, it has also been expanded to drive increased sales out of our retail stores.
Let me explain. In the past when blue shirts were looking for a product that was out stock in a store the system they used could only see a variable inventory in the individual store and a distribution centers. Today using the exact same system the Blue Shirts can now see all available inventory in our distribution centers and our 1400 stores. As a result our Blue Shirts are gaining increased confidence in being able to serve their customer and drive incremental sales.
In the area of returns, replacements and damages we continue to make progress in the second quarter including launching a company-wide awareness program for our Blue Shirts, our Geek Squad agents and our corporate support teams. This program is focused on raising awareness of the operational behaviors that are contributing to the over $400 million in annual losses that we have historically been incurring. The program is also rolling out new operating procedures to reduce these losses. These procedures include number one setting the right product the first time, number two, enforcing the company’s return policy and increasing the frequency of exchanges. Number three inspecting return inventory, number four, culturally resetting in-store perception of the value of return inventory and number five exposing this inventory to our online shoppers.
As we have consistently said this online exposure is critical to optimize margin recovery because the majority of open box inventory is searched for and purchased online. And in the second quarter we began offering Geek Squad certified open box inventory online primarily in the computing and tablet categories. In the fourth quarter as new systems are implemented we will begin offering additional open box inventory that is in excellent conditions which represents the majority of our open box returns.
We’re seeing early sales in margin improvements from the roll out of these new procedures. We expect to see stronger results as the program matures and we improve the online searchability and overall multichannel customer experience over the next several quarters. Relating to our overall cost reduction initiatives in the second quarter, we eliminated an additional $40 million in annualized cost taking a total renewable cost reductions to $900 million towards our target of $1 billion.
Now as it relates to our international segment while we have made considerable progress in our Renew Blue cost reduction initiatives we have substantial work to do on top line stabilization. To address this we’re following the same kind of Renew Blue transformation roadmap that we’re pursuing in the U.S. So to recap, while the other consumer electronics environment continued to be soft, the second quarter ended better than expected primarily due to strong expense control.
In addition we made significant progress against our Renew Blue priorities and clearly demonstrated our increasing ability to tightly manage what we can control. And looking ahead our goal is to continue to create a significantly differentiated multi-channel customer experience such that every interaction customers have with us regardless of channel makes them a promoter of the Best Buy brands.
In support of this we will be intensifying our investments in customer facing initiatives across both channels in the back half of the year and Sharon will elaborate on this later in the call. In fact I will now turn the call over to Sharon to cover more details on our second quarter financial performance and our financial outlook.
Thank you Hubert and good morning everyone. Before I talk about our second quarter earnings results versus last year I would like to talk about them versus our expectation. As Hubert said during the quarter we continued to make meaningful progress against our Renew Blue priorities which resulted in a better than expected non-GAAP operating margin rate of 2.9% and non-GAAP diluted earnings per share of $0.44. These results versus our expectations were primarily driven by stronger SG&A cost containment initiatives, greater promotional effectiveness and better performance of our new credit card agreement.
I will now talk about the second quarter results versus last year. Enterprise revenue declined 4% to 8.9 billion. Enterprise non-GAAP diluted EPS increased 38% to $0.44 primarily driven by the flow-through of our Renew Blue cost savings and other cost containment initiatives. As expected the positive impact of these cost savings were partially offset by the negative impact of lower volume, higher year-over-year sales in the lower margin gaming and computing categories and the previously communicated negative impacts from our credit card agreement and structural price investments.
Domestic revenue of 7.6 billion declined 2.4% versus last year. This decline was primarily driven by a comparable sales decline of 2% and a revenue decline of 20 million or 25 basis points due to the less favorable economics of the new credit card agreement. Domestic, comparable online revenue however increased 22% to 581 million due to substantially improved inventory availability made possible by the chain wide roll-out of shipped from store last January. A higher average order value and increased traffic driven by greater investment in online digital marketing.
As a percentage of total domestic revenue, online revenue increased a 160 basis points to 7.7% versus 6.1% last year. From a merchandising perspective growth in gaming, computing appliances and televisions was more than offset by declines in other categories including mobile phones, tablets and services. Services comparable sales declined 8.9% primarily driven by lower mobile repair revenue due to our success in decrease claim severity and frequency. Lower attach rates and higher mobile warranty premium costs which translate into lower commission revenue. These were partially offset by a factory warranty recovery related impact that occurred in Q2, fiscal ’14 that did not recur this year.
International revenue of 1.3 billion declined 12% versus last year. This decline was primarily driven by a comparable sales decline of 6.7%. The negative impact of foreign currency exchange rate fluctuations and the loss of revenue from store closures in China.
Turning now to the gross profit, the enterprise non-GAAP gross profit rate for the second quarter was 23.1% versus 23.7% last year, an expected decline of 60 basis points. The domestic non-GAAP gross profit rate declined 50 basis points to 23.4% versus 23.9% last year. This decline was primarily due to a mix shift into the lower margin gaming and computing categories, structural investments and price competitiveness particularly in accessories a 20 basis point negative impact related to the less favorable economics as a new credit card agreement.
These declines were partially offset by an increased mix of higher margin large screen television and the realization of our Renew Blue cost reductions and other supply chain cost containment initiatives. The international gross profit rate was 21.1% versus 22.3% last year. This 120 basis point decline was primarily driven by our Canadian business due to increased promotional activity and an increased mix into the lower margin gaming category.
Now turning to SG&A, enterprise level non-GAAP SG&A was 1.8 billion or 20.2% of revenue versus 21.5% last year, a decline of a 189 million or a 130 basis points. Domestic non-GAAP SG&A was 1.5 billion or 19.9% of revenue versus 21.3% last year a decline of a 147 million or a 140 basis points. This rate decline was primarily driven by the realization of our Renew Blue cost reduction initiatives and tighter expense management throughout the company.
International non-GAAP SG&A was 290 million or 22.1% of revenue versus 22.3% last year, a decline of 42 million or 20 basis points. This rate decline was primarily driven by Renew Blue cost reductions and tighter expense management in Canada and to a lesser extent China.
Merchandize inventories increased a 146 million or 2.7% to 5.6 billion primarily due to deliberate investments in high demand back to school computing inventory and inventory to support our over 800 Samsung and Sony Home Theater stores within a store. As we enter the back-half we expect this increased level of inventory to continue in order to support our ultra-high definition TV and Pacific Kitchen & Home expansions as well as our initiatives to reduce retail out of stocks.
In our consumer surveys one of the top reasons customers say that they do not buy when they are in a Best Buy store is that the product they are looking for is not in stock in that store at that time.
Now looking forward to the back half, as Hubert remarked earlier, industry wide sales are continuing to decline in many of the consumer electronics categories in which we compete. We’re also seeing ongoing softness in the mobile phone category ahead of highly anticipated new product launches. Therefore absent any changes in these declining industry trends and with limited visibility to new product launch quantities. We continue to expect comparable sales to decline in the low single digits in both the third and fourth quarter.
From an operating income rate perspective in the back half we’re expecting the following business drivers versus last year. One, a similar promotional competitive environment but with better promotional effectiveness internally. Two, a greater mix of online revenue that will put pressure on the overall operating income rate, three, continued industry softness and higher promotionality in Canada and China; and four, a net positive impact from our Renew Blue cost reductions as they will more than offset our investments in structural pricing, the new credit card agreement and the new incremental investments we’re making in the back half of the year totaling 40 million to 50 million or $0.07 to $0.09 per diluted share to support the customer facing initiatives that Hubert referenced earlier.
This 40 million to 50 million will breakdown by quarter as follows, 10 million to 15 million in Q3 and 30 million to 35 million in Q4. As a result of all of these business drivers and particularly in-light of the fixed cost deleverage that will accompany an expected low single digit comparable sales decline, we’re expecting the non-GAAP operating income rate in Q3 and Q4 to increase in-line with the year-over-year improvement that we saw in the first half.
Additionally in the back half the estimated diluted earnings per share impact of the discreet tax items that we discussed last quarter will continue to be in the ranges of flat to negative one in Q3, and negative $0.09 to $0.10 in Q4.
With that I will now turn the call back over to the operator for questions. Thank you.
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