Best Buy Co. Inc (BBY) — Q2 2018 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 conjunction with the earnings press release we issued this morning. Today’s release and conference call 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 comparison 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 earning release, which is available in the Investors section of our website. 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 conditions, 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 including our most recent 10-K 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. Before I turn the call over to Hubert, I want to note that Best Buy will be holding an Investor Day on September 19th from 1 p.m. to 5 p.m. Central Time. The event will be webcast live on our Investor Relations website. I will now turn the call over to Hubert.

Good morning, everyone, and thank you for joining us. Before we begin with our prepared remarks, it is important to say that our thoughts and prayers this morning are with the affected population of Texas and especially with our associates as they continue to feel the effects of Harvey. We’re happy to announce that as of today, all of our associates are safe and we have mobilized to help those that have been displaced. That being said, the situation is still evolving and our primary commitment continues to be the safety of our teams. I will now provide a review of our second quarter performance and the progress we’ve made against our fiscal 2018 priorities. We are pleased today to report strong top and bottom line growth for the second quarter of fiscal 2018. We grew enterprise comparable sales by 5.4% and delivered non-GAAP diluted EPS of $0.69, up 21% compared to $0.57 last year. Our enterprise comparable sales performance was particularly strong. The strong top-line results were not isolated to a specific category or launch. We saw higher-than-expected comparable sales growth across the majority of our categories. This higher-than-expected growth was driven by stronger consumer demand for technology products and by the strong execution of our strategy. Against the backdrop of continued healthy consumer confidence, we believe broad-based product innovation is resonating with consumers and driving higher spending. With our effective merchandising and marketing activities, combined with our expert advice and service available online, in-store, and in home, we’re garnering an increasing share of these dollars. On the profitability side, at the enterprise level, our operating income rate improved by 20 basis points driven by sales leverage. As expected, expenses were higher than last year, as we’re investing in people and systems to drive growth, execution, and efficiencies. We also had an increase in incentive compensation related to the stronger than expected performance. In fact, I want to thank all our associates across the company for their hard work in delivering these results. Now, I’d like to discuss our progress toward Best Buy 2020: Building the New Blue, and the four fiscal 2018 priorities we outlined at the beginning of the year. 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 and help us build deeper customer relationships. We continue to drive digital innovation to improve the customer experience. In the second quarter, our domestic online comparable sales grew by 31%. Online sales were more than $1 billion for the second consecutive time in a non-holiday quarter, and were 13.2% of domestic revenue, up from 10.6% last year. We are on pace to generate well over $5 billion in domestic online sales this fiscal year. Another exciting opportunity to maximize the multichannel retail business is our In-Home Advisor program. Our In-Home Advisors are professional sales consultants with broad product knowledge. They provide free consultations and serve as the single point of contact covering all technology needs across all vendors. We’re currently rolling it out nationally. By the end of September, we will be offering these free in-home consultations across all major U.S. cities nationwide. We’re very focused on the smart home as a key part of our Best Buy 2020 strategy. We will continue to enhance this category across our stores and website this year. These enhanced experiences are unique to Best Buy, and show how you can completely utilize voice technology. Specially trained Blue Shirts are on hand to provide advice and, of course, our Geek Squad agents can help install, set up, and support the products. The new systems began arriving in stores in July and the rollout will be complete by the end of the third quarter. We’re continuing to work on a number of other initiatives around tech support, smart home, mobile, and appliances. The second priority for this year is to improve our execution in key areas. We’ve been intently focused on enhancing the customer experience around our appliance business. Our hard work in this area is being recognized, and I’m pleased to announce that according to the J.D. Power 2017 Appliance Retailer Satisfaction Study, Best Buy ranks highest in customer satisfaction amongst appliance retailers. We also continued to drive improvements in our sales effectiveness and overall customer interactions during the quarter. The third priority for this year is to continue to reduce costs and drive efficiencies throughout the business. Last quarter, we reached our previous goal of $400 million. We then announced a new target of $600 million in additional annualized cost reductions and gross profit optimization to be completed by the end of fiscal 2021. During the second quarter, we achieved our first $50 million towards our new goal. The fourth priority for this year is to build the capabilities necessary to deliver on the first three, which involves making investments in people and systems to drive growth, execution, and efficiencies. In summary, our Q2 performance reflects positive tailwinds, the strengths of our customer value proposition, and continued momentum in the execution of our strategy. Due to our unique positioning in the market, we continue to outperform the industry and strengthen our position as the leading destination for technology products and services. While we do not believe that mid-single-digit comps are a new normal, we’re excited about our opportunities going forward and the strategy we’re pursuing. We look forward to providing more details on that strategy during our upcoming Investor Day. To all of our associates across the U.S., Canada, and Mexico, again, thank you for your hard work, dedication, and your customer focus as we Build the New Blue. Without you, none of this is possible. I would now like to turn the call over to our CFO, Corie Barry, for more details on our Q2 performance, and our Q3 and full year guidance.

Thank you, Hubert, and good morning, everyone. Before I talk about our second quarter results versus last year, I would like to talk about them versus the expectations we shared with you last quarter. On enterprise revenue up $8.9 billion, we delivered non-GAAP earnings per share of $0.69, both of which exceeded our expectations. We saw better-than-expected top-line results across multiple categories, particularly computing, wearables, mobile, gaming, and tablets. The better-than-expected EPS was primarily driven by a lower-than-expected non-GAAP effective income tax rate and the flow-through of the higher revenue. I will now talk about our second quarter results versus last year. Enterprise revenue increased 4.8% to $8.9 billion. Enterprise non-GAAP diluted EPS increased $0.12 or 21% to $0.69. This increase was primarily driven by the flow-through of higher domestic revenue, a $0.03 per share benefit driven by our lower non-GAAP effective income tax rate, and a $0.02 per share benefit from the net share count change. These increases were partially offset by higher domestic SG&A from expected increases in growth investments, higher incentive compensation expenses, and higher variable costs due to increased revenue. Additionally, we had $11 million or $0.02 per share of net negative impact from wrapping the Q2 fiscal 2017 periodic profit-sharing benefit from our services plan portfolio. In our domestic segment, revenue increased 4.9% to $8.3 billion. This increase was primarily driven by a comparable sales increase of 5.4%, partially offset by the loss of revenue from 11 large format and 42 Best Buy Mobile stores closed during the past year. While difficult to exactly pinpoint, we believe competitor store closures resulted in approximately 30 to 50 basis points of benefit to domestic revenue growth. From a merchandising perspective, comparable sales growth in computing, wearables, smart home, mobile phones, and appliances was partially offset by the declines in tablets. Additionally, domestic online revenue of $1.1 billion increased 31.2% on a comparable basis, primarily due to higher conversion rates and increased traffic. In our international segment, revenue increased 3.7% to $668 million due to comparable sales growth of 4.7%, driven by growth in both Canada and Mexico. This comparable sales growth was partially offset by approximately 220 basis points of negative foreign currency impact. Turning now to gross profit, the enterprise non-GAAP gross profit rate decreased 10 basis points to 24.1%. The domestic non-GAAP gross profit rate was flat year-over-year at 24% as improved margin rates across multiple categories were offset by margin pressure in the mobile category. The international non-GAAP gross profit rate decreased 80 basis points to 25.1%, primarily due to a lower year-over-year gross profit rate in Canada due to lower rates in the computing and appliance categories. Now, turning to SG&A. Enterprise non-GAAP SG&A was $1.83 billion or 20.5% of revenue, which increased $58 million on a dollar basis but represented a 30 basis-point rate decline. Domestic non-GAAP SG&A was $1.67 billion or 20.2% of revenue, an increase of $61 million. This increase was primarily due to expected increases in growth investments, higher incentive compensation expenses, and higher variable costs due to increased revenue. These increases were partially offset by the flow through of cost reductions. The 20 basis-point rate decrease was driven by sales leverage. International non-GAAP SG&A was $161 million or 24.1% of revenue, a decrease of $3 million. This decrease was primarily driven by slightly lower payroll and benefits costs. From a cash flow perspective, we ended the second quarter in line with our expectations, which included our planned increase in the quarterly dividend and the acceleration of our share repurchase plan to $3 billion over two years. As it relates to capital expenditures, we are now expecting to spend approximately $700 million in fiscal 2018 as we have chosen to accelerate certain strategic investments in our e-commerce and supply chain functions. Before I talk about our guidance, I wanted to address the ongoing storms in Texas. With Harvey continuing to do damage in the area coupled with unknown recovery time, it is nearly impossible to predict the impact this could have on our business at this time. We continue to monitor the situation, first and foremost the safety of our people in the area and secondarily for the potential impact on our results. I would now like to talk about our full year fiscal 2018 guidance. Today, we are raising our topline guidance and are now expecting full year revenue growth of approximately 4% versus our previous outlook of 2.5%. On the profitability side, we are now expecting full year non-GAAP operating income growth of 4 to 9% versus our previous outlook of 3.5 to 8.5% growth. The increased top line expectations are being driven by the anticipation of continued positive industry and consumer momentum coupled with the impact of product launches. From a profitability perspective, while our original full year guidance anticipated an increased level of investments in our fiscal 2018, we have made strategic decisions to proactively make additional Q3 and Q4 investments to continue to drive the Best Buy 2020 strategy forward. Those additional investments will be in areas such as customer choice in shipping, e-commerce, and our long-term strategic vision for the supply chain. Additionally, our performance is expected to drive higher incentive compensation expenses consistent with what we saw in the second quarter. Our Q3 fiscal 2018 guidance includes positive consumer and industry factors along with the portion of the increased investment. With these incorporated, we expect enterprise revenue in the range of $9.3 billion to $9.4 billion and enterprise comparable sales growth in the range of 4.5% to 5.5%. I will now turn the call over to the operator for questions.

Good morning and thank you for taking my question. First of all, congratulations on a fantastic quarter, especially from a revenue standpoint. My question is for Hubert. I understand that we shouldn't expect mid-single digit comparisons to be the new standard. However, I was surprised by the performance given the forthcoming iPhone 8 launch. Can you explain how everything came together this quarter to achieve such a significant acceleration in the comparisons and the best performance we've seen in a while?

Anthony, thank you for your very kind comments. I’m going to have Corie talk about the forward-looking statements.

Yes. Let’s start with what all came together in Q2 and what really performed. If you look at really where we saw changes in trajectory, we had a couple of things happen. One, the NPD tracked categories, which represent about a little over 60% of our business, were up 1.1% versus down 3.2% in Q1. We saw strength in computing, which accelerated across the industry, as well as slightly less bad results in tablets. We also saw strength in wearables and a notable increase in the mobile business. A lot of that was due to offers that were specific to Best Buy, alongside the strengths, not just the new launches but in some of the older generations of phones as well. We offered our customers choice across a myriad of price points and releases. As we look forward into Q3, we expect this trajectory to continue in mobile, especially with the new launches we anticipate.

Thanks for taking the question. I’m continuing on the subject of comps, understanding that you may not maintain mid-single-digit comps in the long term. However, looking at Q4, it does imply a bit of a slowdown. Should we expect some positive trends given that there are big product launches on the horizon?

Q4 is not necessarily comparable to our other quarters, and it is highly competitive. We expect Q4 to continue to see growth, but we need to factor in the competitive nature and how sales flow within the quarter. While we expect some strength from mobile, we also anticipate changes due to market dynamics.

What’s driving such strong performance in the gaming business? You’re ahead of industry trends there.

We’re seeing strong performance in the Nintendo Switch, which has been a key driver in gaming. Our allocations have been effective, leading to better-than-expected results this quarter. However, I caution that the growth rate could moderate as we head into Q4, which is very competitive.

Thanks, good morning, nice results. Regarding your investments in Best Buy 2020, can you discuss which investments would not have been made or which would have delayed your top line growth? Is there an expectation that these investments will impact your flow-through negatively?

We’ll provide more details on growth opportunities and necessary investments next month. Our focus is on people-centric strategies, like the In-Home Advisor program, which require investment but are essential for our customer engagement.

We expect operating margins to moderate as we reinvest in the business. We’ll provide insights on our expectations for margins as they relate to our investments.

I want to discuss the surge in your online business and the small decline in service comps despite ramping up innovative service offerings. Could you address each of those?

Online growth is a key focus for us. Continued investments in customer experience have eliminated friction points. We’re also reinforcing our synergies between online and in-store sales.

The services line in our comps is tricky to track due to accounting differences for extended warranties. Historically, these have represented a significant revenue stream, but we are innovating in the technical service area. Revenue from these changes will be recognized over time.

Can you provide color on the product mix differences between store sales and e-commerce sales, as well as the profitability impact of this e-commerce growth?

The mix difference is less pronounced than in the past, but areas like mobile still require a physical experience. Accessories and services are where we see profitability variations, but we’re improving rates in our e-commerce channel.

What are the main specifics of the incremental investments you're making and what drove the $50 million in cost reductions?

Investments include enhancing our supply chain for faster shipping. For cost reductions, we focused on process improvements, particularly around returns and replacements, and optimizing areas like marketing.

What triggers customers to book appointments for the In-Home Advisor services?

Today, most customers learn about the service in-store. We're ramping up our awareness efforts through multiple channels. As we expand, we believe word-of-mouth will play a crucial role.

Given the gross margin trends, can you discuss how this unfolds heading into the second half of the year?

The gross margin ticked down slightly but was in line with our expectations. We anticipate a flattish performance in Q3, driven by consistent product mix and the efforts we've undertaken.

With your operating margins starting to decline and the increased costs from incentive compensation, should we expect your operating profit dollars to align more closely with sales going forward?

Our focus will be on growing revenue with differentiated customer experiences rather than solely on profit margin expansion. We’re committed to investment during this growth phase.

What are your thoughts on the smart home products? Are you attracting new customers, or just serving existing ones?

The typical customer for smart home solutions mirrors our broader customer base. Millennials are increasingly moving out and investing in their homes, presenting a great opportunity for us.

Can you discuss broader trends behind the strong growth in the computing segment?

Strong product innovation in the computing category, coupled with effective vendor partnerships, has driven demand. This trend should contribute positively for us moving forward.

What do you believe is the minimum number of large format stores needed to support your omni-channel strategy?

Our perspective on the store portfolio has been consistent. We believe in maintaining a strong footprint to drive a great customer experience, even as we optimize our stores gradually.

Keep in mind that our online growth is closely tied to our physical stores, with 50% of that made possible by our store operations.

Thank you all for your continued support and interest in Best Buy. We are especially thankful to our employees across all locations who made these results possible and are dedicated to building the New Blue. Thank you, and have a great day.