Best Buy Co. Inc (BBY) — Q4 2017 Earnings Call Transcript

Good morning and thank you. Joining me on the call today are Hubert Joly, our Chairman and CEO; and Corie Barry, our CFO. This morning’s conference call must be considered in light of today’s release, which contains non-GAAP financial measures provided to facilitate meaningful year-over-year comparisons, that should not be considered superior to or as a substitute for GAAP financial measures. A reconciliation of these non-GAAP financial measures to direct comparable GAAP financial measures, as well as an explanation of why these non-GAAP measures are useful, can be found on the investor section of our website, investors.bestbuy.com. Today’s earnings release and conference call also include forward-looking statements regarding the financial results of operations, business initiatives, growth plans, and operational investments, which 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 filings, including our most recent 10-K. The company undertakes no obligation to update or revise any forward-looking statements. Today’s earnings release also refers to NPD-tracked categories, which include desktop and notebook computers, tablets, digital imaging, and connected products. Products such as mobile phones, appliances, services, gaming, and the Apple Watch are not included.

Thank you, Mollie, and good morning, everyone. Thank you for joining us. I’ll begin today with a review of our fourth quarter performance and the progress we made against our fiscal 2017 priorities. I will then provide a preview of what we are focused on for fiscal 2018 before turning the call over to Corie for additional details on our quarterly results and our financial outlook. We’re pleased today to report very solid results for the fourth quarter and for the full year. In the fourth quarter, we delivered enterprise revenue of $13.5 billion, which is near the midpoint of our guidance range. We improved our non-GAAP operating income rate by 80 basis points to 6.7%, and we delivered higher than expected non-GAAP EPS of $1.95, up 27% compared to $1.53 last year. Our strong bottom line performance was driven by a disciplined promotional strategy, continued optimization of merchandise margins, and strong expense management. Our non-GAAP EPS results benefited approximately $0.10 year-over-year from a lower tax rate. Domestically, we continued to gain share across the majority of categories, which we believe was due to the quality of our assortment, the strong advertising and promotional cadence, and the superior customer experience across channels. We saw year-over-year sales growth in connected home, computing, headphones, and home theater. This was more than offset by declines in gaming, tablets, health and wearables, and mobile phones. We drove significant growth in our online channel, with e-commerce revenue increasing 17.5%. E-commerce revenue was 18.6% of total domestic revenue, compared to 15.6% in the fourth quarter of last year. Top line revenue was hindered by constrained product availability across multiple vendors and categories, some of which was not anticipated. We’ve experienced constrained product availability before, but this situation felt unprecedented due to the widespread nature of these issues. There have been public reports regarding several of our vendors on this topic impacting multiple categories, including phones, tablets, wearables, computing, and drones, in addition to the previously communicated $200 million of top line pressure related to the Samsung product recalls. Furthermore, the softness in the gaming category considerably impacted our top line results. We anticipated some decline in gaming sales heading into the quarter, but the overall industry softness across both gaming hardware and software was steeper than expected. The fourth quarter is significantly material for gaming, with 50% of annual revenue occurring during this period. In our international business, we improved profitability significantly, increasing the operating income rate 240 basis points to 7.1%. For the year, on a revenue of $13.4 billion, we raised our non-GAAP operating income rate from 4% to 4.5% and grew non-GAAP EPS by 28% from $2.78 to $3.56. Our free cash flow for the year was $2 billion, compared to $633 million last year, and we ended the year with $3.9 billion in cash and short-term investments. We returned $1.2 billion to our shareholders through dividends and share repurchases, and today we announced plans to increase these cash returns to shareholders over the next two years. During fiscal 2017, we executed against the three priorities we shared at the beginning of the year, which included building on our strong industry position in multi-channel capabilities to drive the existing business, driving cost reductions and efficiencies, and advancing key initiatives to foster future growth and differentiation. These efforts drove our positive results. We continued to gain share in home theater, appliances, computing, and nearly all major categories, despite market decline. We improved our Net Promoter Score by over 350 basis points and grew domestic online revenue 21%. The successful Canadian transformation was a primary driver of more than $100 million in international operating income, compared to a loss of $4 million last year. We achieved progressively realized cost-saving milestones that enable us to invest in customer experience, while maintaining near flat SG&A. Fiscal 2017 marked a year of exploration and experimentation, as we tested several concepts that could lead to compelling customer experiences in the future. Today we are unveiling Best Buy 2020: Building the New Blue. We're transitioning from turnaround to future shaping and focusing on creating a company loved by customers and employees while generating superior returns for shareholders. At the core of Best Buy 2020 is the customer. Technology is evolving in exciting ways, opening up possibilities, but also becoming more complex. We believe we are uniquely positioned to help customers meaningfully through our combination of online, store, and in-home capabilities. Our purpose is to help customers pursue their passions and enrich their lives with technology. We want to be their trusted advisor and solution provider, becoming a source of technology services for their home. Our customer value proposition is to be the leading technology expert, making it easy for them to learn about and confidently enjoy technology. We plan to focus on entertainment, communications, security, energy management, and health to expand our addressable market. Our financial goals include increasing revenue growth, pursuing ongoing cost savings to offset inflationary pressures, and establishing predictable revenue streams founded on recurring revenues and strong customer relationships. Best Buy 2020 will pursue three growth pillars: maximizing the multi-channel retail business, providing services and solutions that address real customer needs, and accelerating growth in Canada and Mexico. We will continue to innovate our digital capabilities and expand our In-Home Advisor program and test new concepts for customer experiences. Our international business will see growth from continued e-commerce success and store remodels in Canada, with nine new store openings in Mexico over the next two years. The second priority is to improve execution in key areas. We see significant opportunities to increase sales effectiveness, refine our supply chain, and enhance our services fulfillment capabilities. The third priority is to continue reducing costs and drive efficiency throughout the organization while investing in the necessary capabilities for growth. Looking ahead to fiscal 2018, we anticipate enterprise revenue growth of approximately 1.5%, and low single-digit growth in operating income. Our outlook reflects expected share gains and positive impacts from new initiatives, tempered by industry growth assumptions. Despite flat top and bottom line predictions for the full year, quarterly performance may fluctuate. Our Q1 fiscal 2018 guidance considers the softness reported thus far in the NPD tracked categories and continued struggles in mobile phone sales due to product recalls and anticipated new product launches later in the quarter. We expect enterprise revenue in the range of $8.2 billion to $8.3 billion, with a comparable sales decline of negative 1% to negative 2%. Domestic comparable sales are expected to decline by negative 1.5% to negative 2.5%, while international comparable sales are anticipated to grow flat to positive 3%. On the return of cash to shareholders, we remain committed to our capital allocation strategy, aiming to fund operations and growth investments before returning excess free cash flow to shareholders through dividends and share repurchases. Our Board approved an increase in our quarterly dividend to $0.34 per share, totaling $1.36 annually, and plans to spend $3 billion on share repurchases over the next two years. As we close out fiscal 2017, we’re proud of our results, excited about our opportunities, and committed to the strategy we’re pursuing. Thank you for your attention today.

Thank you, Hubert, and good morning, everyone. Before I discuss our fourth quarter results compared to last year, I would like to address them relative to the expectations we shared last quarter. As Hubert previously mentioned, our disciplined promotional strategy was essential in delivering better than expected profitability, despite enterprise revenue being near the midpoint of our fourth-quarter guidance. On enterprise revenue of $13.5 billion, we achieved non-GAAP earnings per share of $1.95, exceeding our expectations mainly due to a lower than expected effective income tax rate and domestic business outperformance driven by higher gross profit margins and lower than expected SG&A. Now, I will cover our fourth-quarter results compared to last year. Enterprise revenue decreased 1% to $13.5 billion, largely attributable to a comparable sales decline of 0.7%. Enterprise non-GAAP diluted EPS increased by $0.42 or 27% to $1.95, primarily due to a $0.14 per share benefit from a net share count change, along with positive domestic business performance owing to a higher gross profit rate and lower SG&A. We also saw a $0.10 per share benefit from a lower effective income tax rate, stemming from the resolution of some discrete tax matters. In the domestic segment, revenue decreased 1.4% to $12.3 billion, led by a comparable sales decline of 0.9% and the loss of revenue from 11 large format and 31 Best Buy mobile stores closed in the past year. Industry sales in the NPD tracked categories, excluding mobile phones and appliances, fell 2.8%. From a merchandising perspective, comparable sales growth in connected home, computing, headphones, and home theater was outweighed by declines in gaming, tablets, health and wearables, and mobile phones. Service revenue grew 6.3% primarily driven by increased warranty sales, coinciding with lapses in service pricing investments from last September. Online revenue reached $2.3 billion, increasing 17.5% on a comparable basis due to boosted traffic and higher conversion rates, with online sales constituting 18.6% of total domestic revenue, up from 15.6% last year. In our international segment, revenue rose 2.5% to $1.14 billion, supported by a comparable sales increase of 0.9%, mainly from our Mexican operations, along with a periodic profit-sharing benefit from our services plan portfolio and a favorable foreign currency impact. The enterprise non-GAAP gross profit rate grew 90 basis points to 22.5%. The domestic non-GAAP gross profit rate increased 70 basis points to 22.3%, thanks to improved margins in computing and home theater, and the positive impact from sales declines in lower-margin gaming and wearables. Internationally, the non-GAAP gross profit rate increased by 280 basis points to 24.6%, driven by better margin rates in Canada. At the enterprise level, non-GAAP SG&A was $2.1 billion or 15.8% of revenue, a decrease of $10 million. Domestic non-GAAP SG&A was $1.93 billion or 15.6% of revenue, down by $18 million, mainly due to reduced variable costs from lower revenue year-over-year. International non-GAAP SG&A was $200 million or 17.5% of revenue, up $8 million due to slightly higher payroll, benefits, and advertising costs. Our strong cash flow generation in fiscal 2017 was driven by working capital changes and increased profitability. Our working capital decrease stemmed from a higher accounts payable to inventory ratio resulting from last year when we pre-paid for inventory leading to a reduced AP to inventory ratio in fiscal 2016 and a lack of product availability in Q4. As a result of robust cash flow, we returned over $1.2 billion to our shareholders this year, in addition to $1.5 billion from the previous year. In terms of capital expenditures, we concluded fiscal 2017 with $582 million in capital spend, and we expect a fiscal 2018 capital expenditure total of around $650 million. I would now provide guidance for Q1 fiscal 2018. As previously mentioned, we are witnessing softness in the NPD tracked categories, partially attributable to delayed tax refunds preventing many consumers from having their refunds ready for the Presidents' Day retail holiday. Furthermore, we expect pressures in mobile, which is not included in NPD tracked categories, stemming from last year’s Samsung Note 7 recall impacting an estimated $50 million in lower revenue. We are incorporating this into our Q1 outlook. For Q1, we estimate enterprise revenue in the range of $8.2 billion to $8.3 billion, with enterprise comparable sales declining between negative 1% and negative 2%. We anticipate domestic comparable sales to decline within the range of negative 1.5% to negative 2.5%, while international sales may grow flat to positive 3%. International revenue growth is expected to decline low single digits due to anticipated foreign currency headwinds. We expect to achieve non-GAAP diluted EPS from continuing operations between $0.35 and $0.40, assuming a non-GAAP effective income tax rate of 38% to 38.5% and a diluted weighted average share count of approximately 313 million shares. This guidance range also incorporates a lapping of about $15 million, or $0.03 per share, from net negative impacts related to the periodic profit-sharing benefit of our Canadian service plan portfolio from Q1 of fiscal 2017. Lastly, as Hubert mentioned, fiscal 2018 will include a 53rd week, occurring in the fourth quarter, adding approximately 1.5% to annual sales at an operating income rate significantly higher than the fourth quarter due to the added leverage of our fixed costs. I will now turn the call over to the operator for questions.

Hi, thank you, good morning. Thanks for taking my question.

Good morning, Kate.

Good morning. Hubert, I was wondering if you could maybe walk us through the promotional environment in the fourth quarter, and how you managed through it. I think that was a highlight during in the press release today, that it was better managed. So if you could give a little bit more perspective on that versus last year that would be helpful.

Thank you, Kate. I think we’ve developed that capability. This is not the first year we’re doing this. We’ve been steady on this over the last three years. I must compliment our merchant and marketing team on this. There’s a greater science being applied to our marketing and promotional activities leading to this positive outcome. We aimed to be price competitive, and as we said three years ago, not chase every aggressive promotion that may not meet customer needs. Our focus has been on optimizing our merchandising activities, and the impact on gross profit margin. As you may have noticed, our customers favor advanced, higher-end premium products, and we have developed a superior merchandising and customer experience in both online and in our stores. That includes the TV category, and computing as well. Corie, anything I missed?

No, I think you hit most of it.

Okay. Thank you.

Thank you. Hubert, I was hoping maybe you could talk a little bit more about the opportunity on in-home advisory services and products, what you saw in the tests, and in terms of average spend, and the type of customers you’re targeting, and the scalability of that?

Yes. Thank you, Dan. We’re very excited about the customer experience from this program. As a reminder, this is an expert technology advisor who possesses both product proficiency across everything we sell and strong customer relationship skills, typically visiting customers' homes. This is crucial because many discussions about networking, home theaters, or home automation require being in the customer's space. Our motto is that no order is too small. We view this as the start of a lasting relationship. Customer satisfaction from this initiative has been substantial. The feedback from our frontline associates is also overwhelmingly positive. Financially, we’re seeing higher sales per visit, better gross profit margins due to more holistic solutions being offered. While we’re pacing ourselves in the rollout to ensure quality in selecting and training personnel, we’re optimistic about its scalability as we move forward.

Great. Thank you.

Yes, thank you, good morning. I wanted to ask about the consumer electronics category. Really a nice performance in that category in the quarter, and hoping you could talk about some of the potential catalysts for that category in 2017, particularly the performance of the home theater area?

Yes, good morning, Brad. This is Corie. There are several positive trends. Home theater has continued to perform well, though it isn't the primary driver for the growth we saw in Q4; categories like connected home products, home automation, and strong headphone sales have significantly contributed to performance. We're seeing good results sequentially and maintaining a positive outlook for these categories moving forward.

Got you. And how are you thinking about home theater in particular in 2017? Thank you.

While I won't provide specific category guidance, we anticipate continued good unit growth, driven by emerging technologies, despite lower ASPs. Our focus on selling premium features and the customer experience that comes with understanding and experiencing products firsthand is essential, and we are poised to navigate this evolving landscape.

Very helpful. Thank you, Corie.

Thank you.

Good morning. Thanks a lot for taking my questions. It dovetails on the whole market share conversation. Can you describe why this spread between your sales and the NPD results narrowed this quarter? And as part of that, where is your absolute level of market share today across all categories, and is it just harder to grow share at that level, absent more store closings from competitors?

I'll take these one at a time. First, the spread in the categories tracked by NPD showed similar behavior in Q4, as seen in Q2 and Q3 and may have slightly grown. The narrowing is attributed to category-specific declines in mobile and gaming, impacting our comparative results. We believe we are gaining share despite overall market declines. However, we have not publicly disclosed our precise total market share.

If I may add, historically our aggregate market share numbers were in the mid-teens, indicating the presence of growth opportunity. Our strategy is not only to enhance market share but to address customer needs with services and solutions, expanding our addressable market. We remain confident in capturing these growth opportunities.

Thanks so much.

Thank you, Michael.

Thank you.

Thanks so much and good morning. My question revolves around the mobile category. It’s been challenging now, I guess, for a year or more. And I understand there are some challenges with products and recalls, et cetera. Can this return to being a growth category for you as you think about market growth, your market share, and the profitability of the category?

Yes, so there are several factors. Market growth has slowed significantly, and we’re primarily in a replacement market now for smartphones. In addition, last quarter's performance was affected by the product recall issues and supply constraints from other vendors. Our focus will be on increasing market share rather than expecting substantial market growth.

If I could just ask a brief follow-up. If you think about the various pricing models and the way they have evolved over the past year or two, does that impact the margin structure of the category for you, or can the margins be as good as they are today?

I think it’s reasonable to expect some margin pressure in this category given evolutions in pricing models. We're also observing that the unlocked and prepaid markets are gaining traction, broadening our positioning options for consumers. This has contributed to margin pressures in recent quarters and is likely to persist.

Got it, thank you so much, guys.

Thank you, Matt.

Thank you.

Thanks. Good morning. My question is on the operating profit outlook. I noticed in the release that there's a $60 million headwind from profit share and natural cost creep. I've run various numbers. You can see anywhere between $50 million, $60 million maybe $100 million. Given that you're also investing in the business, can you break down where the planned cost reductions are coming from, especially as you continue to make investments?

Certainly. To address the cost outlook, we’re pleased with the progress made on our Renew Blue phase two cost reductions and believe we’re well positioned going into fiscal 2018. Our teams have focused on enhancing profitability through better inventory management and, in some cases, contract negotiations related to supply chain efficiency. We're committed to ongoing cost optimization and will have further updates as we progress.

Yes. Thanks very much, good luck.

To emphasize Corie’s point, I want to clarify that ongoing cost reductions remain a significant focus for us, and we believe that our approach to optimizing efficiency will continue to yield substantial benefits for the company, ensuring both growth and cost management go hand in hand.

Yes. Thanks Hubert. Very clear.

Thank you very much. My question has to do with product availability. At the beginning of the quarter, you mentioned approximately 150 basis points of impact on your guidance due to Samsung alone. As product availability issues extended beyond Samsung, what was the impact on dollar sales or comparable sales, and what leads you to believe these challenges will ease in the latter half of the fiscal year?

Calculating the missed opportunity is complex. We believe the impact of constrained product availability in Q4 was well over $100 million, possibly close to $200 million, in addition to $200 million from Samsung recalls. These issues have affected multiple categories. Moving into this fiscal year, while we anticipate some challenges in the first half due to delays in new product launches, we hope to see improved availability as we progress.

Thank you, Hubert.

Thank you, Alan.

Good morning and thanks for taking my questions. I had two questions. The first one was just in terms of the domestic gross margin. Obviously, the performance was very strong. Looks like you continue to do a very nice job of having effective promotions. But I wonder, do you worry that you might have left some sales on the table, maybe some gross margin dollars on the table, by not being a little bit more aggressive promotionally? How do you think about that?

We continuously evaluate promotional effectiveness, especially during the holiday quarter. We only generate more sales through promotions when it enhances profitability. The cap on our revenue is significantly affected by product availability issues and considerable softness in the gaming category, both of which limited our top line growth.

Okay, great. And then just real quickly…

I want to reiterate that we are focused on generating profitable sales, not just increasing sales volume.

Understood. Agreed. Agreed. And then just real quickly. One of your competitors, a multi-regional appliance and consumer electronics retailer, seems like they’re in a pretty bad spot right now. How do you think about the market share gain opportunity, if and when that happens, and the extent to which it could lead to significant store closings?

We won’t mention specific retailers, but they have about 200 stores, around 20% overlap with us, contributing about $1 billion in appliances. If they were to file for bankruptcy and close their stores, that revenue would be distributed among various competitors. Hence, while significant, this shift may not be transformative for us. The market is always fluctuating, and we remain excited about our ongoing performance in appliances.

Got it. That’s very helpful. Thank you.

Hi, good morning, and thanks for taking my question. I wanted to ask, just on e-commerce. We’ve seen a very strong performance out of your e-commerce sales over the past several quarters, now pushing toward almost 20% of your business. Two parts. One, any thoughts on where that ultimately drives to as a share of total sales? And second, as e-commerce is now a significant part of your business, any thoughts on how we should consider the profitability of those sales versus traditional store sales? Thanks.

Thank you, Brian. We’re very proud of our e-commerce channel, which has transformed considerably over the last four years. As customer shopping behavior evolves, we’re not directing them to one channel over another. Our strategy embraces the online experience, with many customers shifting between online and in-store visits seamlessly. I can’t predict the exact future percentage of total sales driven by e-commerce, though it's clear that it will continue to grow. Our customer experience combines both online and in-store assets effectively.

From a profitability perspective, although e-commerce tends to carry lower gross margins, improvements in online business profitability year-over-year offset some of that pressure. Our in-store expertise creates a balance with online sales, resulting in a more favorable economics than expected when evaluating channel shifts. While it’s important we remain focused on multiple channels working together, we’ve streamlined online functions and improved efficiency as part of that strategy.

Great. Thank you, very helpful.

Thank you.

Hi, this is Mike Lehrhoff on for Scot Ciccarelli. I was wondering if you could discuss your expectations for the gaming category in the coming year, as well as any guidance on future store closures this year?

Certainly. The gaming category has seen softness recently. We rely heavily on hardware sales and trends tied to major releases, making it challenging to anticipate how the market will recover. In terms of store closures, we have a structured approach, and with leases expiring, we will continue to reassess performance. We aim to maintain a high standard for our stores and will close underperforming locations as necessary, while we expect to see ongoing store closures in the coming year consistent with past performance.

Thank you, Corie. To summarize, we are proud of the results we delivered in fiscal 2017, and we’re excited about the next phase of our journey with Best Buy 2020. Thank you for your continued support and have a great day.