Best Buy Co. Inc (BBY) — Q1 2018 Earnings Call Transcript

Good morning, and thank you. Joining me on the call today are Hubert Joly and Corie Barry. This morning’s conference call must be noted that today’s release and conference call include GAAP financials. These non-GAAP financial measures provided are not to be considered superior to GAAP measures. Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in this morning’s earnings release as well as in the Investors section of our website at investors.bestbuy.com. Today’s earnings release and conference call also include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements address the financial conditions, results of operations, business initiatives, growth plans, and operational prospects of the company and are subject to risks and uncertainties that could cause actual results to differ from those projected. Please refer to the company’s current earnings filings, including our most recent 10-K, for more information. The company undertakes no obligation to update or revise any forward-looking statements to reflect events that may arise after the date of this call. Please note that beginning in Q1 fiscal ‘18, the company will no longer exclude non-restructuring property and equipment impairment charges. To ensure financial results are comparable, we have recast certain financial information for fiscal ‘16 and ‘17 by quarter to reflect the previously excluded fixed asset impairments that are now being included in net GAAP SG&A. The recast for fiscal ‘17 non-GAAP operating income is 1.5% to $1.73 billion for previously reported operating income. Please see this morning’s earnings release for more details. I will now turn the call over to Hubert.

Good morning, everyone, and thank you for joining us. I’ll begin today with a review of our first quarter performance and the progress we made against our fiscal 2018 priorities. I will then turn the call over to Corie for additional details on our quarterly results and our financial outlook. We are pleased today to report strong top and bottom line growth for the first quarter of fiscal 2018. We grew our Enterprise comparable sales by 1.6%, improved our non-GAAP operating income rate by 70 basis points to 3.5%, and delivered non-GAAP diluted EPS of $0.60, up 40% compared to $0.43 last year. Clearly, our revenue was higher than our expectations going into the quarter. This was due to strong performance in gaming, a better than expected result in mobile, and the improvement of our overall sales trends within the quarter due to the arrival of delayed federal tax refund checks. First, we delivered a strong performance in gaming due to robust customer demand and good product allocations for the new hardware that launched during the quarter. Second, while mobile was not a growth area due to last year’s product recall and the fact that new phones launched later in the quarter than they did last year, sales in the quarter were better than we expected as new unlimited data plan offers from carriers generated increased demand across devices. Additionally, our strong multichannel execution of the preorder process for the new phone that launched in April resulted in our highest Android preorder sales ever coupled with strong services sales. Lastly, in the Domestic business, we saw overall sales trend improve from the initial softness at the beginning of the quarter as consumers began receiving their delayed federal tax refund checks. We grew our Domestic comparable sales by 1.4% during the quarter, driven by strengths in computing, Connected Home, and gaming, partially offset by continued softness in tablets. We also continued to drive significant growth in the online channel, with Domestic online comparable sales increasing 22.5%, driven by conversion and traffic. Online revenue was nearly 13% of total Domestic revenue compared to 10.6% in the first quarter of last year. In the International business, we delivered a 4% comparable sales increase, driven by continued growth of online revenue in Canada and Mexico and positive sales lifts associated with the Canadian store redesigns. On the profitability side, at the Enterprise level, continued optimization of merchandise margins and good expense management drove the 70 basis point improvement in operating income rate. So altogether, our Q1 performance reflects the strength of our customer value proposition and continued momentum in the execution of our strategy. I want to thank all of our associates across the company for their hard work in delivering these results. Now I’d like to discuss our progress towards Best Buy 2020: Building the New Blue. Last quarter, we introduced this next phase of our transformation focused on shaping our future and creating a company that customers and employees love while continuing to generate a superior return for our shareholders. In March, we outlined four priorities we pursue during fiscal 2018. While it is early in the year, I will share some highlights of our progress thus far. The first priority is to explore and pursue growth opportunities around maximizing the multichannel retail business and providing services and solutions that solve real customer needs. We’re expanding several of the new concepts we’ve been testing related to services and solutions. Earlier this month, we publicly announced our plan to offer a new service, Best Buy Smart Home powered by Vivint, in more than 400 stores by holiday. Guided by in-store experts, customers select from a suite of leading smart home products and receive expert installation, app-based system control, and 24/7 professional monitoring service. We also expanded the test of our new approach to tech support. Last year in Canada, we began testing a new service offering that provides 24/7 support for all technology products a customer owns, regardless of where they were purchased. We expanded that pilot to additional markets in Canada and are now piloting a version of the program in a few U.S. markets. We continue to drive digital innovation, which is crucial to the success of Best Buy 2020. In Q1, online revenue reached $1 billion for the first time in a non-holiday quarter. We are pursuing growth around key product categories by refining how we sell, including emerging categories like Connected Home and mobile. In response to the changing landscape in mobile, we are improving the experience on our website and revamping mobile departments in many of our stores. For the new phone launched last month, we simplified the buying experience and provided clarity of carrier offers, resulting in our highest ever Android preorders. The second priority for this year is to improve our execution in key areas that support our growth strategy. For example, in our stores, we are focused on improving our sales effectiveness through systematic coaching, training and certification; increasing tenure in our store leadership roles; and lowering associate turnover. This is resulting in ongoing NPS improvements related to associate knowledge. Additionally, we’re selectively adding distribution center capacity to support business growth and get products closer to customers. The third priority is to continue reducing costs and driving efficiencies throughout the business. During the first quarter, we achieved another $50 million in annual cost reductions and gross profit optimization, reaching our $400 million target three fiscal quarters ahead of our original deadline. Today, we are announcing a new target of $600 million in additional cost reduction and gross profit optimization to be completed by the end of fiscal 2021. We see significant opportunities to reduce costs through the continuous improvement approach. In summary, we began fiscal 2018 with a strong start, and we are energized about our opportunities and the strategy we’re pursuing. We believe we are uniquely positioned to help our customers in a meaningful way with our combination of multichannel assets. I love how our teams are mobilized to deliver on our mission and Build the New Blue. Now I’d like to turn the call over to our CFO, Corie Barry, for more details on our Q1 performance and our Q2 and full year guidance.

Thank you, Hubert, and good morning, everyone. Before I talk about our first quarter results versus last year, I would like to discuss them versus the expectations we shared last quarter. On Enterprise revenue of $8.5 billion, we delivered non-GAAP earnings per share of $0.60, both of which exceeded our expectations. As Hubert mentioned, top line performance exceeded expectations due to gaming, mobile, and improvements in sales trends throughout the quarter as consumers received delayed federal tax refunds. Enterprise revenue increased 1% to $8.5 billion, primarily due to a comparable sales increase of 1.6%. Enterprise non-GAAP diluted EPS rose by $0.17 or 40% to $0.60, mainly driven by a higher gross profit rate in the Domestic business. In our Domestic segment, revenue increased 1.1% to $7.9 billion. This increase was driven by a comparable sales increase of 1.4%, partially offset by the loss of revenue from 12 large format and 40 Best Buy Mobile stores closed during the past year. Domestic online revenue of $1.02 billion increased 22.5% on a comparable basis, primarily due to higher conversion rates and increased traffic. Enterprise non-GAAP gross profit rate increased 50 basis points to 23.7% and Domestic non-GAAP gross profit rate increased 60 basis points to 23.6%. However, the International non-GAAP gross profit rate decreased 140 basis points to 24.5%. We ended the first quarter in line with our expectations, which included our planned increase in the quarterly dividend and the acceleration of our share repurchase plan. For Q2 fiscal ‘18, we expect Enterprise revenue in the range of $8.6 billion to $8.7 billion and Enterprise comparable sales growth in the range of 1.5% to 2.5%. On a segment basis, we estimate Domestic comparable sales growth in the range of 1.5% to 2.5% and International comparable sales in the range of flat to positive 3%. We expect to deliver non-GAAP diluted EPS from continuing operations in the range of $0.57 to $0.62, assuming a non-GAAP effective income tax rate of 36.5% to 37% and a diluted weighted average share count of approximately 310 million shares.

I wanted to follow up on the guidance for the second quarter. The acceleration that you’re embedding here, it sounds like part of that is just based on the improvement you saw throughout the first quarter. But as you think about Q2 versus Q1, can you maybe walk us through some of the incremental drivers that would support that acceleration? Is that primarily mobile and the launch late in the quarter or other drivers to consider?

As we said in the release, most of it is just the continuation of the momentum we had seen in Q1. You’re right to call out some of the later launch of mobile, which we had said earlier would push some of that into the second quarter. It’s really the acceleration we saw at the very end of the quarter pushing into Q2. Does that help?

That does help. And then from a flow-through perspective, obviously, very strong flow-through this quarter. Does that reflect some of the savings that you discussed? Or is there a timing dynamic here where you were assuming lower sales initially?

It was not as much about cost reductions. It was really a balance between investments and cost reductions in the quarter. It was more about the profitability we saw in our categories. And remember, I’d mentioned we had a small legal settlement as well that was not expected.

I was wondering, with a competitor of yours that recently liquidated and closed 220 stores, what you’re seeing in markets where you may overlap with those closed stores.

Yes. A competitor filed last quarter, and I think they’re finishing the closing of their stores. It’s always a little choppy initially, but we believe we’re seeing some lift in the sales in the stores around their locations in appliances and home theater.

And keep in mind, in the $2 billion number that Hubert cited, not all of that is appliances and home theater. There are categories in there that we also don’t participate in.

I wanted to talk about the TV category. You mentioned it was down, or at least, home theater. Was there a temporary impact that you think led to that? Or is it a case of where we are in the cycle in that business?

We continue to be excited by the TV category. There’s continued innovation coming online. Quarter-to-quarter, there will always be fluctuations based on product arrivals, capacity, pricing, and so forth. So I wouldn’t draw massive conclusions from the first quarter.

That being said, I think our guidance would imply a more moderate view on home theater. We’re watching it closely.

I wanted to address one of the concerns I receive when discussing Best Buy, which is that historically, the TV cycle has been significant, and as 4K technology ages, what do you think the counterargument would be?

Guidance for the full year takes into account whatever can be expected from a TV standpoint. We have a range of drivers and believe the penetration of 4K is still limited.