Best Buy Co. Inc (BBY) — Q2 2023 Earnings Call Transcript

Thank you, and good morning, everyone. Joining me on the call today are Corie Barry, our CEO; and Matt Bilunas, our CFO. During the call today, we will be discussing both GAAP and non-GAAP financial measures. 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, which is available on our website, investors.bestbuy.com. Some of the statements we will make today are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may address the financial condition, business initiatives, growth plans, investments and expected performance 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 our most recent 10-K and subsequent 10-Qs 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. I will now turn the call over to Corie.

Good morning, everyone, and thank you for joining us. I am incredibly proud of our teams as they continue to rise to the challenges over the past few years. With so much going on that is beyond their control, I remain impressed at their ability to manage the rapidly shifting business environment and priorities. As we said in March, we expected our financial results would be softer this year as we lapped record sales volumes. However, the macro environment has been more challenged and uneven than expected due to several factors. And that has put more pressure on our industry, changing the trajectory of our business versus our original plan. We are focused on balancing our near-term response to difficult conditions and managing well what is in our control, while also delivering on our strategic initiatives and what will be important for our long-term growth. Our strategy and our confidence in it remain unchanged. We have exciting opportunities ahead of us in a world that is more reliant on technology than ever. We are a financially strong company with a resilient world-class team that will successfully navigate the current environment. Now on to the second quarter results we reported this morning. Our comparable sales were down 12.1% as we lapped strong Q2 comparable sales last year of almost 20%. This represents 8.3% sales growth over the second quarter of pre-pandemic fiscal '20. Our non-GAAP operating income rate declined compared to last year on the SG&A deleverage from the lower revenue, the investments in our growth initiatives, and the increased promotional environment for consumer electronics. Our non-GAAP earnings per share was up 43% versus pre-pandemic fiscal '20. We are clearly operating in a volatile consumer electronics industry. We assume the CE industry would be lower following 2 years of elevated growth, driven by unusually strong demand for technology products and services and fueled partly by stimulus dollars. In addition, we expected to see some impact to our business as customers broadly shifted their wallet spend back into experience areas, such as travel and entertainment. We did not expect and compounding these impacts as a changing macro environment where consumers are dealing with sustained and record high levels of inflation in some of the most fundamental parts of their daily lives, like food. While these factors have led to an uneven sales environment, they have not deterred us from continuing to make progress on our initiatives. During the quarter, we drove broad customer NPS improvements even compared to pre-pandemic levels, particularly in installation and repair. We signed up new Best Buy Totaltech members and increased our delivery speed, delivering almost 1/3 of customer online orders in one day. We also completed store remodels, opened new outlet stores and began implementing newly signed deals with health care companies. From a top line perspective, we saw year-over-year sales declines across most product categories, with the largest impacts to comparable sales coming from computing and home theater. Although down from last year's strong sales compared to Q2 of fiscal '20, our computing revenue has grown more than 20%. Our Domestic appliance business comparable sales declined slightly as it laps more than 30% growth in the second quarter of last year, and revenue is up more than 45% compared to fiscal '20. Our data tells us that customers are making some decisions to trade down, particularly those in lower-income households. This is not across all categories. But for example, in the television category, customers are moving more into our lower price point exclusive brands products. We're also seeing more interest in sales events, such as Prime Day, tax-free events and other events geared at exceptional value. I applaud our team's proactive management of our inventory during the quarter as we saw the sales trajectory changing. Our inventory at the end of Q2 was down 6% from the second quarter of last year and up approximately 16% from pre-pandemic fiscal '20. Overall, our inventory is healthy and reflects an evolving mix of product in our network, including more high ASP appliances and larger-screen televisions, which also have longer lead times and a slower inventory turn. While we took more inventory markdowns than last year, the level reflected a normalization to pre-pandemic activity. Within our inventory numbers, there are categories where we have ample inventory supply and still pockets where we are constrained. In our industry, it's not as simple as we have inventory or we don't. It can be incredibly variable by product and even brands within a particular product. For example, we are also still experiencing inventory constraints in key models and brands across computing and gaming. As we move into the back half of the year, we are planning inventory thoughtfully, yet investing strategically for the holiday. While it is important to manage inventory against current demand, we also want to ensure we are well positioned to react to the ever-changing consumer needs. The promotional environment was more intense than last year and even more than we expected entering the quarter as sales demand softened. Some areas were quite aggressive from a promotional standpoint, especially where inventory was ample or in excess. Overall, we feel the level of promotionality has returned to pre-pandemic levels. Over the past few years, we have seen gross profit pressure from higher supply chain costs, which, of course, includes increased parcel costs from our higher mix of online sales. In addition, we estimate that roughly half of the increased supply chain cost this quarter versus the comparable period in fiscal '20 is being driven by cost increases or inflationary pressures. Conditions across the global supply chain continue to evolve. On a year-over-year basis, we saw higher costs in Q2 and expect that to continue through the remainder of the year. However, we are starting to see some signs that the market is stabilizing and moderating. During the pandemic, the capacity and rate pressure started in International and worked their way to Domestic logistics. Now we are experiencing some relief in International first and early signs of loosening markets domestically. For example, in Ocean Logistics, we are taking advantage of some rate opportunities, but continue to be mindful of ILWU labor discussions and overall U.S. port congestion as we move into the peak shipping season. As it relates to inbound Domestic transportation, while we are starting to see a more balanced capacity market, we continue to see inflationary pressures from higher fuel and labor costs and rail yard and general supply chain network congestion. I would like to provide an update on Totaltech, our unique membership program designed to provide customers with complete confidence in their technology, with benefits that include member pricing discounts, product protection, free delivery, and standard installation and 24/7 tech support. Considering the macro environment and decline in our product sales, we are encouraged with the pace at which we are acquiring new members. In Q2, nearly half of the new members joining the program were either new or lapsed customers, reinforcing how the value of this program resonates beyond our existing loyal customers. Our associates continue to embrace the program as the fulsome nature of the offering not only simplifies the sales interaction, it also is a program our team members can confidently stand behind as they believe in the value it provides to every single customer. In July, we enhanced our in-store point-of-sale tools to better assist our team in showcasing the value of Totaltech to potential new members, and their early results have been positive. At this point in the national launch, we continue to be encouraged by the higher engagement, customer satisfaction and increased revenue we're seeing from customers who have signed up to become members. As we have previously shared, from a financial perspective, Totaltech is a near-term investment to drive longer-term benefits. Over time, we expect the incremental spend we garner from members will lead to higher operating income dollars. As I've just covered, there are several things we are seeing with the program that give us confidence that customers value the membership and that our thesis in general is playing out. At the same time, consumer electronics is a low-frequency category. And we are in a unique macro environment, meaning it will take time for us to truly assess the performance. As you would expect, we will continue to monitor the program and iterate on the offering as we learn more. In addition to Totaltech, our Best Buy branded credit card continues to drive a valuable and sticky relationship with our customers. We continue to see growth in cardholders. More than 25% of our revenue is transacted on our Best Buy branded card. And cardholders have been increasing the use of their card outside Best Buy stores as well. These customers tend to be more engaged with Best Buy over time, with higher frequency and spend than non-cardholders. Combined with our partners' largest lease-to-own portfolio and our buy now, pay later test, this means we can offer our customers a variety of ways they can shop confidently with us. And we can leverage those relationships into our future. As we emerge from the pandemic, it is clear that our customer shopping behavior has changed. Our online sales as a percentage of Domestic revenue in Q2 was 31%, nearly twice as high as pre-pandemic. Virtual revenue via video, phone and chat is growing rapidly as well, as sales for the first 6 months of the year are already almost equal to the virtual revenue we generated for all of last year. While still small overall, sales in our virtual store are ramping quickly. And we recently expanded categories to include appliances and home theater. In addition, our high NPS in-home interactions continue to increase rapidly. In fact, in-home installations have seen double-digit growth versus the prior year in 5 of the last 6 quarters and year-to-date in-home sales consultations are up more than 30% over last year and pre-pandemic. Of course, our stores remain incredibly important for customers to see and touch products and get advice. In addition, they're crucial to our fulfillment strategy. In the second quarter, customers representing 42% of our online sales chose to pick up their products at our stores and an additional 18% of online sales were shipped out of our store to customer homes. These in-store pickup and ship from store numbers have remained incredibly consistent for the last several years, even as shipping speed and options have dramatically increased. It is imperative that we evaluate how we operate and service these evolving customer needs and make the necessary adjustments to ensure we come out of this not just a vital company, but a vibrant one. We tested new field operating models in 4 markets over the past year to help us better understand how to deploy leadership resources in a more digital world. As a result of these tests, earlier this month, we made structural changes to our operating model that resulted in some store roles being eliminated. We hope to retain as many of these talented associates as possible. This is one component of our enterprise-wide restructuring initiative that commenced this quarter. With these changes, we are able to reinvest back into frontline customer-facing sales associates. We are continuing to reimagine our physical presence in ways that cater to our customers' changing shopping patterns as well. As part of our Charlotte holistic market approach pilot, we are testing a new 5,000 square foot store with a unique digital-first approach. Just opened last month, the store includes a 7-foot tall digital display that customers will see as they enter the store that explains what's new and how customers can shop. The store includes curated assortments across our product categories, except for major appliances and other large products. The majority of products will primarily be on display to touch and try. To purchase, customers can scan the QR code on any product price tag using their phone. This immediately sends a notification to a Best Buy employee to pick up the product from the store's backroom and bring it to the register for checkout. Of course, customers who want to will be able to consult with sales associates, in-home consultants, and Geek Squad agents, who always have access to our complete assortment online using our increasingly rapid shipping. From an online sales fulfillment perspective, the store offers both in-store pickup and convenient lockers. The Charlotte market pilot also includes a traditional core store that we converted to an outlet store. The outlet has an expanded assortment of product categories, a dedicated team of employees and agents that rapidly quality check and repair all product for resale, a new services repair hub and spoke model, and an Autotech mega hub for car tech installation. This outlet is performing extremely well and is frankly on track to deliver revenue on par to the pre-converted conventional store, with a considerably lower operating cost and greater productivity. Those results give us confidence in our outlet strategy. During the quarter, we opened 2 new outlet stores in Virginia and Phoenix and just opened a location in Chicago earlier this month, bringing us to 19 locations. We see twice the recovery rate of our COGS when we sell open box, clearance and end-of-life inventory at our outlets versus alternative channels. With assortment expanded to include major appliances, large TVs, computing, gaming and mobile phones, we believe now is an opportune time to appeal to our existing Best Buy customers as well as an increasingly deal-seeking consumer overall. Our outlet store assortment is also available for purchase online, with many products eligible for national ship-to-home fulfillment as well as local store pickup. This capability unlocks a very productive way to refurbish inventory, giving it a new life, while also serving a deal-seeking customer. We still plan to double the number of outlets to approximately 30, although some may not open until fiscal '24. So far this year, we have invested in and completed 7 experienced store concept remodels. The results we are seeing in the existing 2 pilot remodels, including higher NPS and higher customer spend, continue to make us confident in and excited about this part of our strategy. We expect to complete a total of approximately 40 experienced store remodels this year. I am very proud of how much work the team has done to test and iterate multiple store and operating model concepts over the past few years in response to the dramatic pivot in customer behavior. We introduced a great deal of change into the field, not always perfectly. And we have learned and accelerated some initiatives while stopping others. On top of that, of course, the macro backdrop has shifted and the trajectory of the business has changed significantly in an incredibly short time. We continue to invest in our people and our stores, with an eye toward the best possible customer experience, leveraging our unique differentiators. Through all the changes, overarching store NPS is substantially higher than pre-pandemic, including more stores than we have ever seen at what we consider to be best-in-class level. This is entirely due to our amazing store associates' hard work and dedication to always being there for our customers. We have consistently invested in our employees over the past 3 years, including raising hourly wages more than 20% versus pre-pandemic and adding additional benefits, such as paid caregiver leave, financial hardship assistance and paid time off for part-time employees. Now I would like to touch on Best Buy Health. Our consumer health business, where we curate health and wellness products online and in our stores, is largely experiencing similar revenue trends as our core category. We are excited about the new FDA ruling that allows the sale of over-the-counter hearing aids. We just announced an expanded collection of hearing devices, an in-store experience in more than 300 stores and a new online hearing assessment tool, making it more convenient than ever for the millions of Americans with mild-to-moderate hearing loss to get the products and support they need. During the second quarter, we continued to see strong growth in new sign-ups for our active aging business that offers health and safety solutions to enable adults to live and thrive at home. Revenue for this business was slightly up in the quarter compared to last year. We are encouraged by the momentum we have built in the virtual care business in the first half of the year. We are very focused on successfully implementing the large U.S. health system accounts that have been won recently, including NYU Langone Health for hospital at home and Mount Sinai Health Systems for chronic disease management. And we are also making progress leveraging our Best Buy capabilities in this space. Our Geek Squad team successfully completed additional health training in Q2 and launched a new Geek Squad pilot service with Geisinger Health. As a reminder, the revenue contribution from virtual care is currently very small and will take time to ramp as the health industry has a longer return on investment. We just published our 17th annual ESG report, which outlines how we are working across the company to make a positive impact on our planet, employees, customers and communities. We continue to focus on ESG initiatives that drive sustainable long-term value creation. Last year, we made significant progress toward our goals to reduce our carbon footprint, attain our 2025 hiring commitments and expand our Best Buy Teen Tech Center program. We recently hit a milestone with the Best Buy Foundation Teen Tech Centers when we opened one earlier this month in Gary, Indiana, marking our 50th Teen Tech Center. These centers provide teens from disinvested communities with guidance, training and tech access to help successfully prepare them for the future. In terms of the environment, we continue to drive forward the circular economy, a system in which nothing is wasted. Since 2009, we have reduced our carbon emissions 62% through investments in renewable energy and operational improvements. We are on track to reduce our carbon emissions 75% by 2030. And last year, we became a founding member of the Breakthroughs 2030 Retail Campaign, which aims to accelerate climate action within our industry. We continue to operate the most comprehensive consumer electronics and appliances take-back program in the U.S., collecting more than 2.5 billion pounds since 2009. We also made significant progress toward our fiscal '25 hiring commitment to help ensure we build an inclusive, diverse and thriving workforce. In fiscal '22, we filled 37% of new salaried corporate positions with black, indigenous and people of color employees, ahead of our goal to fill 1 in 3 positions. And we filled 26% of new salaried field positions with women employees, marking progress on our goal to fill 1 in 3 positions. We're proud that 60% of our most senior leaders, including our Board of Directors and Executive team, is made up of women and people of color. We encourage you to review our full ESG report available on our corporate website. In summary, the first half of the year has been difficult from a sales perspective. And our employees have executed well in the evolving environment, in many cases, making hard decisions to run the business effectively and prioritize our customers. I just want to take a moment to address the fiscal '25 financial goals we introduced in March. We remain confident in the strategic premise covered in March. However, the current macro backdrop has changed in ways that we and many others were not expecting. As such, we are removing these targets. And we'll share more context on our midterm financial expectations once we begin to experience a more stable operating environment. As I said at the beginning of my remarks, we are managing thoughtfully and carefully, while still investing in our future. This includes actively assessing further actions to evolve our operating model, manage profitability and iterate on our growth initiatives. We fundamentally believe that technology is more important than ever in our everyday lives. And as a result of the past few years, consumers have even more technology devices in their homes that will need to be updated, upgraded and supported over time. As our vendor partners continue to innovate and the world becomes increasingly more digital in all aspects, we will be there to uniquely help customers in our stores, online, virtually and directly in their homes. This company has navigated monumental change, riding incredible highs and managing difficult lows since our founding 56 years ago. As we have done throughout our history, we will use this moment to lead and double down on our purpose, making it clear that we continue to uniquely support customers in ways literally no one else can. Now I would like to turn the call over to Matt for additional details on our second quarter results and outlook for the remainder of the year.

Good morning, everyone. Hopefully, you were able to view our press release this morning with our detailed financial results. I will walk through details on our Q2 results before providing insight into how we are thinking about the back half of the year. Enterprise revenue of $10.3 billion declined 12% on a comparable basis as we lapped very strong 20% comparable sales growth last year. Our non-GAAP operating income rate of 4.1% compared to 6.9% last year. As expected and similar to last quarter, our investment in Totaltech membership added approximately 100 basis points of operating income rate pressure this quarter compared to last year. Our non-GAAP SG&A expenses were $129 million lower than last year but were 120 basis points unfavorable as a percentage of revenue. Compared to last year, our non-GAAP diluted earnings per share of $1.54 decreased $1.44 or 48%. A lower share count resulted in a $0.16 per share benefit on a year-over-year basis. However, it was offset by a higher non-GAAP tax rate. In our Domestic segment, revenue decreased 13.1% to $9.6 billion, driven by a comparable sales decline of 12.7%. From a monthly phasing standpoint, fiscal June's comparable sales decline of 16% was the largest decline, whereas fiscal July was our best-performing month during the quarter compared to both last year and to the pre-pandemic fiscal '20 comparable period. As Corie noted, from a category standpoint, the largest contributors to the comparable sales decline in the quarter were computing and home theater. In our International segment, revenue decreased 9.3% to $760 million. This decrease was driven by a comparable sales decline of 4.2% in Canada and the negative impact of 420 basis points from unfavorable foreign currency exchange rates. This marks the first quarter where Mexico was fully removed from the prior year comparison. Turning now to gross profit. Our enterprise rate declined 160 basis points to 22.1%. The Domestic gross profit rate declined 170 basis points, which was primarily driven by the lower services margin rates, including pressure from Totaltech. In addition, lower product margin rates and the impact of higher supply chain costs also negatively impacted our rate during the quarter. These items were partially offset by higher profit-sharing revenue from the company's credit card arrangement. As a reminder, the approximately 100 basis points of gross profit rate pressure from Totaltech primarily relates to the incremental customer benefits and the associated costs compared to our previous Totaltech support offer. Our product margin rates were lower than our expectations in Q2, driven by higher levels of promotionality. Generally, lower consumer demand has combined with the higher levels of inventory across the CE industry, which has resulted in more discounting across most of our categories. As Corie mentioned, overall, the level of promotionality has returned to pre-pandemic levels, which is slightly ahead of our expectations earlier in the year. Moving next to SG&A. As I mentioned earlier, our enterprise non-GAAP SG&A decreased $129 million, while increasing 120 basis points as a percentage of sales. Within the Domestic segment, the primary driver of the reduced SG&A was lower incentive compensation of approximately $135 million. Let me add some additional details on the incentive compensation expense, which year-to-date is approximately $265 million lower than last year through the second quarter. Based on our current outlook for this year, we are expecting to be below the required financial thresholds for short-term incentive performance metrics. This compares to last year when payouts were near the maximum levels. As a result, we anticipate additional incentive compensation favorability in the second half of the year. On a non-GAAP basis, our effective tax rate was 16.7% versus 8.4% last year. For the full year, we now expect our non-GAAP effective tax rate to be approximately 23% versus our previous guidance of approximately 24%. Moving to the balance sheet. We ended the quarter with $840 million in cash. As Corie mentioned, at the end of Q2, our inventory balance was approximately 6% lower than last year's comparable period. And we continue to feel good about our overall inventory position as well as the health of our inventory. Year-to-date, we have returned a total of $862 million to shareholders through share repurchases of $465 million and dividends of $397 million. We paused share repurchases during the second quarter, spending only $10 million. Looking forward, we will continue to assess the appropriate timing for resuming share repurchases. We are committed to being a premium dividend payer. Based on our current planning assumptions for fiscal '23, our quarterly dividend of $0.88 per share will fall outside of our stated payout ratio target of 35% to 45% of our non-GAAP net income. We viewed this target as a long-term in nature and do not plan to reduce the dividend should it fall outside of the range in any one year. From a capital expenditure standpoint, we now expect to spend approximately $1 billion during the year. This is slightly lower than our previous outlook of approximately $1.1 billion. However, it exceeds the level of investment we have been making over the past few years. The largest driver of the increased spend this year compared to prior trends is store-related investments. This includes both our 40 experiential store remodels, as Corie mentioned, as well as general improvements in a number of our other locations after delaying the work the past couple of years during the pandemic. Let me next share more color on our guidance for the full year, starting with our revenue assumptions. As I mentioned at the start of my comments, we are assuming comparable sales for the year to decline in the range of around 11%, which represents a comparable sales decline for the remainder of the year and is similar to what we just reported for Q2. In addition, this reflects an assumption that our revenue growth versus fiscal '20 will continue to slow and that revenue in the second half of the year will be very similar to comparable pre-pandemic fiscal '20 time period. This is due to a belief that the current macro environment trends could be even more challenging and have a larger impact for the remainder of the year. This aligns with the trends we are seeing so far this quarter as August revenue declined approximately 10% versus last year. When comparing to fiscal '20, August revenue increased in the low single-digit range, which is a sequential decline from the second quarter trends. Our outlook for a non-GAAP operating income rate of approximately 4% for the year is anchored to our negative 11% comparable sales assumption. This represents a decrease of 200 basis points to last year, with roughly half of the decline from lower gross profit rates and half from higher SG&A rates. As you may recall, our original guidance entering the year included a non-GAAP operating income rate decline of approximately 60 basis points, which was expected to come almost entirely from the gross profit rates, with Totaltech being the primary driver. The pressure we are expecting from Totaltech continues to align with our original expectations, while the additional gross profit rate pressure in our revised outlook is largely due to higher promotional activity in the consumer electronics industry. From an SG&A standpoint, we have continued to lower our forecasted SG&A spend as the year has progressed, but not at the same pace as our lowered sales expectations. As I shared earlier, our outlook for the year assumes incentive compensation to be significantly below prior year levels. Compared to last year in our original outlook, we are planning for lower store payroll expenses and other variable expenses. We've also reduced spend in discretionary areas by increasing the rigor around backfilling corporate roles, capital expenditures, and travel. Partially offsetting these items are increased investments compared to last year in Best Buy Health, technology, and our store remodel work. Next, let me spend a few moments on restructuring. In light of the ongoing changes in business trends, during Q2, we commenced an enterprise-wide restructuring initiative to better align our spending to critical strategies and operations as well as to optimize our cost structure. We incurred $34 million of such restructuring costs in the second quarter, primarily related to termination benefits. We currently expect to incur additional charges to the remainder of fiscal 2023 for this initiative. Consistent with prior practice, restructuring costs are excluded from our non-GAAP results. Lastly, let me share a couple of comments specific to the third quarter. We anticipate that our third quarter comparable sales declined slightly more than the negative 12% we reported for the second quarter. We anticipate the year-over-year decline in our non-GAAP operating income rate will be similar to or slightly higher than our second quarter results. This includes a little less gross profit rate pressure as we lap the last year's national rollout of Totaltech during the quarter. However, we expect a little more SG&A rate deleverage in Q3 from the larger sales decline.

I'd like to start by discussing the third quarter guidance regarding the margin decline and its implications for the fourth quarter. I want to clarify that the operating income decline is expected to be in basis points compared to the second quarter, dropping to 60. Does this suggest that in the fourth quarter, the EBIT margin should only decrease by about 50 basis points and remain above 4%? I also have a follow-up question.

Yes. I think based on the implied comments for Q3, what we said is a similar OI rate decline as Q2, if not slightly higher, which is about 280 basis points on the math. It would imply that Q4 does improve from an EBIT rate perspective, the gross margin rate pressure in Q4 will abate a bit compared to the previous quarters as we've lapped the Totaltech. And we're beginning to lap some of the product margin rate pressures we experienced last year as promotionality started to return. But you're starting to see more SG&A to leverage in Q4 considering where sales are trending in comparison to the prior quarters.

Got it. And my follow-up was more on the top line on the consumer. I think, Corie, you mentioned seeing some trade down in some categories. Could you talk about which categories you're not seeing it in and where there seems to be a good sell-through and whatever you can get?

Yes. There are categories where price points and product choices are important, such as large TVs. In contrast, with mobile phones, the decision is less about trading up or down; consumers are typically looking for a specific brand or type. This trend is also evident in gaming, where consumers are eager to buy as much gaming hardware as they can find. Therefore, the dynamics within our business categories are not uniform; sometimes consumers are very brand-specific, while at other times they are more flexible and primarily focused on the overall experience.

I wanted to ask about the overall situation. A year ago, the atmosphere surrounding sales and promotions was different. Corie, is it becoming easier to predict the business and is the visibility improving? In other words, are we seeing a bottom in specific categories regarding units? Also, as you look ahead, do you think the current environment is stabilizing, whether it's due to promotions causing deflation or consumers opting for lower-priced options?

I wouldn't say it's become phenomenally easier to exactly see around the corner. Simeon, I give our teams a great deal of credit for working hard to catch trends quickly. I think what makes the current environment the most volatile that I've seen is the quantity of inventory at other retailers and the promotional activity correspondingly the markdowns with some of those heavier inventory levels. I think that's the part that right now makes the business a little more volatile. I think as some of those inventory levels normalize a little bit more, then I do think you're perhaps in a more normalized environment. And Matt even hit on it when he was talking about the Q4 EBIT rate. You start to lap some of those promos that we actually started to see in consumer electronics a more promotional environment in Q4 of last year. So I think as you work through the back half of this year, Simeon, my point of view is it starts to stabilize a little bit. But I hedge that just because there's so much inventory that's in the marketplace right now, A; and B, it is still a really volatile macro environment. And I think you've got a very uneven consumer who is making corresponding choices depending on how long inflation lasts, and like I said in my prepared remarks, especially in those core categories like food, rent, housing. So I'd love to say it's perfectly stabilizing, and we can predict it, but I still think you have a lot of factors at play that are influencing consumer behavior.

Is the increase in promotions causing year-over-year price deflation in the categories, or is it due to a lack of innovation, starting from a year-over-year deflationary price point that promotions are intensifying? Is the promotional aspect what resolves this issue, or is there innovation on the horizon that could shift the industry back toward inflation?

So 2 pieces. One, right now, I believe the impact is mainly promotionality, because you've had really a sustained period here of a couple of years where it was disproportionately low promotionality because there was such high demand and such low inventory levels. And so right now, it really is a function of those promotions coming back. To your second point, this is a really important part of the thesis and what I think is important about Best Buy. Our vendors who are sure are going to continue to innovate, looking for that kind of next cool product, that will continue to drive demand. And so I think my hypothesis is, it's been a little harder to have all your innovation engines flexing here in the last 2 years when you're trying so hard to produce at the levels that we've needed. So every ounce of energy has kind of been focused on production. And I think that in the future here, as especially these inventory levels normalize, I think you've got a number of vendors who are really interested in. Now that you have this much larger installed base of connected devices in people's homes, they're also going to be very interested in how do you upgrade those devices, how do you connect those devices, how do you help a customer live in their homes, which still increasingly people are spending more time in. So I think that's the next phase, Simeon, that I believe we'll see from here, which is more of that innovation engine. And it's always been true in CE. And the hardest part is I cannot always tell you exactly what the next innovation is going to be. But we definitely know that behind the scenes, you continue to see innovations in spaces like what you just talked about hearing, in spaces like computing, with hybrid work models clearly becoming the future and some of the replacement cycles there even speeding up a bit. So I think that will be the next level. But for right now, you're really just kind of course correcting for 2 years that were very, very low in terms of promotionality.

I guess my question was on the back-to-school selling season. Now you talked about the fact that August was down. August comps were down about 10%. And I guess, what does that say about how back-to-school performed? And is there any read through for back-to-school for holiday? I know they're different. But I don't know if that gives you any indication or any thoughts about the upcoming holiday selling season.

Yes, thanks, Anthony. Our back-to-school sales are slightly ahead of our tempered expectations. This follows a trend from before the pandemic where people shopped later. It's not surprising, considering this school year is quite different from the past two years. Parents and kids are figuring out how to prepare for a year that starts off more in-person, especially at the collegiate level. Overall, it has been a bit better than anticipated and is following the same trend. Regarding the holiday season, I believe it’s less about what back-to-school indicates and more about the general observations we have. We've noted that customers are more value-conscious and are leaning towards sale events. Our hypothesis is that this holiday season may resemble pre-pandemic times, possibly starting a bit later and leaning more towards promotions in our space. This expectation is reflected in the guidance that Matt discussed. Personally, I think it will be tougher to drive sales in October because, for the past two years, we were urging consumers to secure their inventory due to shortages. The situation now seems different, and I believe consumers may be inclined to wait for deals and search for great values. As I mentioned, I don’t think back-to-school serves as a predictor for this; it’s more about the broader market and consumer behavior we’re observing.

So I'll follow up on the prior question initially. So as you think about the minus 10% sales in August to date and a later arriving back to school, that would suggest you still have a few weeks ahead of you. But then the October's compare much harder. So are you basically taking the 3-year comp trend and degrading it into the rest of the quarter?

Yes, that's what the numbers would imply. I think 10% in August, if you consider the sequential stack of Q3 over a 3-year period, with a comparison that's slightly below the 12% we saw in Q2, would suggest that it falls in the low single-digit range for overall comp performance for the entire quarter. So yes, that assumes a sequential decline as the year continues, especially into Q3 and Q4.

Maybe I'll start and then Matt can add on. We are closely monitoring both the average selling price and the unit sales. Overall, we are noticing a stabilization of average selling prices year-over-year, which implies that we are seeing some decline in unit sales. What's interesting is that consumers are still spending quite actively, although they are being more selective, and their spending is uneven. This makes it challenging to determine exactly how much demand has been brought forward, especially compared to the situation six months ago. What's striking for us is that despite these changes, there is a significantly larger number of devices in households, and people are spending more time at home than ever. In the computing sector, we can already see some upgrade cycles occurring more quickly than in the past, suggesting that there are more incremental purchases, leading to upgrades over time. It has now been 2.5 years since many original computing devices were bought at the onset of the pandemic, which means we will likely see notable shifts in use cases over the next year or two. In summary, it is challenging to provide a precise assessment of how many units were brought forward versus incremental sales in the current economic environment. Instead, our focus remains on ensuring we have the right inventory for our customers and are prepared for when they are ready to upgrade their devices.

So regarding the pulling of the fiscal '25 targets that were originally communicated in March, what do you think is the biggest change that's occurred in the last 5 to 6 months? And is it more of the top line growth expectations that have become less attainable or the longer-term margin target?

Yes, I'll start and Corie can jump in. Yes, I think if you look at where we planned the year to be, at the beginning of the year, we planned comps in the minus 1% to minus 4% range. And now what we're seeing is it's around a minus 11% comp for the year. It's a pretty significant sales decline, again, more around the macro environment worsening. We expected the year to come down from an industry perspective as we cycle some of the very large growth over the last couple of years. So that change of the macro and the consumer has really caused the sales to be much lower this year. So I would say that's probably the biggest impact as you think about our FY '25 targets going forward because some of the targets that also need scale to drive some of the benefits of the bottom line as well. So that's what we need time to assess.

The only thing I would add is that, and I said in the prepared remarks, but it bears repeating, strategically, what we laid out, we still have incredible confidence in. And that's why we want to make sure we're getting updates on some of those strategic investments that we're making. I think the baseline of where we're starting from, to Matt's point, is quite different than what we originally assumed.

Putting aside the next quarter or 2, as you look towards next year, given some of the changes that you've made, like the restructuring, the rollout of the outlet locations and other streamlining, could your operating margin be flat to up on a flat to down sales number?

Yes, possibly. I believe we are working to evaluate what this year entails. We aim to strengthen our business and determine how to allocate resources effectively towards the strategically important aspects as well as our operations. Our goal is to keep assessing the overall market environment to gauge where sales might head next year, while being mindful that the sales growth rate leading up to the pandemic through FY '20, over the last three years, was more than 3%. We are confident that the industry, and Best Buy specifically, will eventually return to growth as we manage through these challenging times. Concurrently, we are taking the right measures to optimize our business and position ourselves effectively for the upcoming year and beyond while driving our strategy forward.

My follow-up question is on Totaltech support. You now will be lapping the full rollout this quarter. Given some of the longer tenure of the original members, are you seeing the sales lift from those folks that would justify the return on investment? And would you expect that the behavior of those newer members will be different? And if not or if it is, would you think about potentially rolling back Totaltech support if it wasn't meeting your return hurdles?

We discussed earlier that we are still positive about what we are observing regarding engagement and spending from the current group of Totaltech support members, even though we haven't completed a full year yet. Like with any membership program, we will keep evaluating the benefits offered, what customers value, and what keeps them loyal to Best Buy, and we will continually refine the offer. It’s not a straightforward situation where it’s either fully active or not; there are many aspects of the offer and customer behavior that are very encouraging. At the same time, we want the offer to be engaging and valuable to customers, ensuring it fosters long-term loyalty to our brand. As we mentioned, this is challenging because purchase frequency in our category is lower, which means it will take longer to assess the impact, especially given the significant changes in the macro environment. So, while we appreciate what we see in the customer segment right now, it's still early, and the situation is complex. We will keep refining the offer to ensure it keeps customers engaged with the brand.

I have two questions that I'll combine into one. First, regarding sales, are you experiencing any increased variability geographically or in other ways that might connect this to inflationary pressures or the ongoing effects of the pandemic? Secondly, looking at the different factors influencing sales, have your manufacturing partners reduced their focus on innovation during the pandemic due to supply chain constraints, and is that changing now as some of these constraints ease, potentially leading to improved sales?

Yes, sure. I'll start and then Corie can add on. Brian, I think from a sales perspective, from a geography base, I think nothing we would necessarily call out. I would say though that in some of our test markets, we are seeing good results in terms of how we're looking at our store portfolio. And in fact, we are seeing a bit of improvement on some of our experiential stores that we've rolled out. And we've rolled out 2, we're rolling out more, and we've seen a good lift in some of those locations. And so some of the tests are yielding some positive results from a store portfolio. But that wouldn't necessarily mean it's due to inflation being different across the country.

Yes, we touched on this earlier, Brian. I believe our manufacturing partners have been doing everything possible to produce as much product as they can over the past two years. From a broader industry perspective, it seems to me that this has made it somewhat challenging to innovate at the desired pace because they are so focused on meeting current demand. As we hopefully move towards a more normalized demand environment, I can't envision a scenario where our manufacturing partners aren't tirelessly working to innovate our existing products to encourage more replacement and consumption in the future. While I don't have specific measurements to compare last year's innovation to next year's, I genuinely believe that the manufacturers we collaborate with are eager to engage with an increasingly digital consumer who is more inclined to use these products in their homes.

I just wondered if you could help us think through the Totaltech support, not to beat a dead horse with regards to Totaltech support. But just with regards to its impact on gross margins. I know you're lapping the launch. But is it a bigger headwind sequentially? Just thinking through that maybe more people are going to come through the store for back-to-school and holiday versus maybe the first half.

No, I'll begin and Corie can add if she wants. Kate, the pressure does not increase as we progress into the second half of the year. In fact, it lessens a bit as we enter Q3 following the launch. Even with the anticipated higher volumes in Q3 or Q4 due to the holiday season, it doesn’t necessarily create more pressure on a year-over-year basis. It decreases as the quarters move forward. Earlier in the year, we mentioned that the pressure this year was between 60 and 80 basis points, and that’s about what we’re experiencing now. Compared to pre-pandemic levels, it would represent around 100 basis points of pressure from where we were previously. However, as we expand that offering and enroll more people, the pressure eases over time as we achieve more incremental product sales.

I think the key here is that the goal of the program is ultimately to create an offer that has further reach and has a broad appeal. And that, over time, we drive frequency and greater share of wallet with our customers. Obviously, that's going to take time. And to Matt's point, it's not that it's any more impactful. Actually, as we start to get scale, it is helpful on the Total business because you are in theory growing that frequency and growing that share of wallet. It just takes us time to get there.

I wanted to ask about promotions and inventories. What areas are you more or less promotional in? It seems like your inventory is in good shape, down 6%, while competitors still have high levels. Do you anticipate this situation improving by the holidays? Also, could you share any insights on gaming trends within the entertainment category, which was down about 9%, although slightly better than the total? How did gaming perform within that?

Sure. Overall, promotional activity is somewhat higher in Q2 than we anticipated, and we have factored this into our projections for the rest of the year. Generally, most categories are returning to pre-pandemic levels, although there are still a few areas that haven't fully recovered yet. Overall, we're seeing promotional levels return to where they were before the pandemic, which relates to the current inventory levels in the market. As consumer demand decreases and inventory rises, we are witnessing an increase in promotional activity. This increase is not due to the need to reduce inventory because it's in a healthy state; instead, it's more about normalizing back to our pre-pandemic situation. The competitive dynamics in the marketplace are contributing to this uptick in promotions, happening a bit faster than we had initially expected. Regarding gaming, demand continues to exceed supply, and if we had more inventory, we would be able to sell more. The gaming console segment has remained relatively flat compared to last year, while we are experiencing slightly more pressure year-over-year in software and peripherals. However, when considering the entire gaming sector, including PC gaming and VR, we see a growth of over 50% in Q2 compared to pre-pandemic levels. Although, like most categories, the total is experiencing a slight decline year-over-year.

Mike, I want to highlight that I'm very proud of the work the teams have done. I'm glad to be entering the holiday season with a healthy inventory position. As mentioned in our prepared remarks, this gives us more flexibility to invest where we anticipate strong consumer demand. Overall, it's a positive situation. With that, I believe yours was the final question. Thank you all for joining us today, and we look forward to updating you on our results and progress during our next call in November.