Welcome to Best Buy's Third Quarter Fiscal 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] As a reminder, the call is being recorded for playback and will be available by 11 a.m. Eastern Time today. [Operator Instructions] I would now like to turn the conference call over to Mollie O'Brien, Vice President, Investor Relations.

Good morning and thank you. Joining me on the call today are Hubert Joly, our President and CEO, and Sharon McCollam, our CAO and CFO. As usual, the media will be participating in this call in a listen-only mode. This morning's conference call must be considered in conjunction with the earnings release that we issued earlier today. They both contain non-GAAP financial measures that exclude the impact of certain business events. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons, but should not be considered superior to, as a substitute for, and should be read in conjunction with, the GAAP financial measures for the period. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning's earnings release. Today's earnings release and conference call also include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, growth plans, operational investments and prospects of the Company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the Company's current earnings release and SEC filings for more information on these risks and uncertainties. The Company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. In today's earnings release and conference call, we refer to the consumer electronics industry trends. The consumer electronics industry, as defined by the NPD Group, includes TVs, desktop and notebook computers, tablets not including Kindle, digital imaging, and other categories. Sales of these products represent approximately 65% of our Domestic revenue. It does not include mobile phones, gaming, movies, music, appliances or services. I will now turn the call over to Hubert.

Thank you, Mollie, and good morning everyone and thank you for joining us. I will begin today with an overview of our third quarter results and update you on the progress we are making against our Renew Blue priorities. I'll then provide thoughts on the upcoming holiday season and a discussion of our priorities beyond holiday before turning the call over to Sharon for additional details on our quarterly results and commentary on our financial outlook. So first, our financial results. In the third quarter, our teams delivered positive comparable sales, improved profitability and continued progress in our Renew Blue transformation. This resulted in a $9.4 billion in revenue and $0.32 in non-GAAP diluted earnings per share versus $0.18 last year. Operationally, this year-over-year improvement was primarily driven by a 0.6% revenue growth and the benefits from our Renew Blue and other SG&A cost reduction initiatives, partially offset by strategic pricing investments and the ongoing competitive pressure on our gross profit rate. On the top line, while sales in the NPD-reported Consumer Electronics categories declined 0.2%, our strength in televisions, computing, and tablets versus the industry, in addition to our growth in gaming and appliances, drove a Domestic comparable sales increase of 2.4%, excluding the 80 basis point estimated benefit associated with the classification of revenue for the new mobile carrier installment billing plans. Domestic online comparable sales increased 22%. Also during the quarter, we continued to make progress against our Renew Blue priorities. In merchandising, we continued to expand our appliance offering through the opening of 15 Pacific Kitchen and Home stores-within-a-store and are on track to end the year with 117 stores versus 67 last year. In home theater, we opened 10 Magnolia Design Center stores-within-a-store and are on track to end the year with 50 stores versus…

Thank you, Hubert, and good morning everyone. Before I talk about our third quarter results versus last year, I would like to talk about them versus our expectations. As Hubert said, during the quarter we continued to make meaningful progress against our Renew Blue priorities which resulted in better than expected non-GAAP diluted earnings per share of $0.32. This result versus our expectation was primarily driven by the sales declines in the NPD-reported Consumer Electronics categories being lower than previous quarters, higher than expected revenue in computing and tablets, higher mobile revenues due to better than expected results from new phone launches, better performance of our new credit card agreement, and greater pricing and promotional effectiveness, partially offset by increased investments in customer-facing initiatives. I'll now talk about our third quarter results versus last year. Enterprise revenue increased 0.6% to $9.4 billion. Enterprise non-GAAP diluted EPS increased $0.14 to $0.32, primarily driven by higher revenues and the flow-through of our Renew Blue and other cost reduction initiatives. We also saw a $0.02 per share benefit associated with the restitution from a legal claim. In addition, the lower tax rate this year drove an incremental $0.02 per share benefit due to favorable discrete tax events. These favorable impacts were partially offset however by ongoing competitive pressure on our gross profit rate. Domestic revenue of $8 billion increased 2.3% versus last year. This increase was driven by comparable sales growth of 3.2%, but excluding an 80 basis point estimated benefit associated with the classification of revenue for the new mobile carrier installment billing plans comparable sales increased 2.4%. This increase was partially offset by the timing of recovery on mobile phone trade-in liquidations, store closures, and $8 million or 15 basis points in less favorable economics of the new credit card agreement.…

[Operator Instructions] We'll take our first question from Kate McShane with Citi.

Good morning and congratulations. I was wondering if you could walk through in a little bit more detail the impact of mobile in Q3. Obviously there was the big launch in September. But I wondered if you could walk through what some of the dynamics were with the launch and how you think this will maybe differ in Q4.

So there are a couple of things I would highlight. Prior to this iconic launch, we saw continued pent-up demand. So the market dried up and had a significantly negative impact on our mobile revenue. Then at the launch we did quite well but then supply was uneven during the quarter. So that's a positive followed by a negative. We did see nice positives from our expanded accessories assortment. If you visited our store or the sites, I think you will have seen that. So that was a positive. Then you have the shift into installment billing. So if you remember last year, we didn't have installment billing. We started in the spring. It's now grown very significantly with the impact you've seen on our comps, that Sharon and I have split out. The benefit of installment billing is the increased attach rate on services and accessories as well as the mix into more expensive phones. This for the customer, it's great – installment billing is a great value proposition from a customer standpoint. Now we ourselves, we want to be agnostic, we want to sell whatever makes sense to the customers, it's a great value proposition for the customer and therefore they tend to buy a little bit more. So these are the various drivers. Now looking into Q4, a main uncertainty remains the availability of iconic phones, there's a number of them but we can think of at least one or two, and that's very difficult to focus. So we do expect to continue to be constrained during the quarter on that standpoint, which you will see however of course compared to last year is the fact that we now have installment billing which we didn't have last year. So I think in our prepared remarks we touched on that. So these are the factors I would highlight. I'm turning to Sharon to see whether I forgot anything notable.

No, Hubert, I think you've covered it.

We'll take our next question from Gary Balter with Credit Suisse.

First of all, congratulations to both of you on results to date and I'm sure further progress. The question I had was, last year – and you touched on it, Hubert and Sharon – last year between Black Friday and Christmas, you had trouble driving traffic to the stores, and I don't want you to give your competitive – given competitors are probably listening to this call, I don't want you to give competitive sensitive information, but could you describe if anything whatever you can share with us what your plans are between Black Friday and Christmas to create more excitement in the stores?

So you are right to highlight that week two and week three of December last year were quite extraordinarily bad, candidly not just for us, this was industry-wide. If you remember, you had a bit of a perfect storm last year with a rapid shift to online and traffic to the malls and the stores that was quite extraordinary. I think last year we all agreed was, there were so many unique factors that it's going to be hard to replicate the kind of drama that we had last year. I think we have detailed on the call the overall elements of our plan for holiday, I'm not going to give you the play-by-play, day-by-day because I know our friends [indiscernible] who are on the phone wouldn't appreciate that too much or other places in the world, but I think that the plans we've built really combine three elements. One is the cumulative effect of everything we've been working on over the last year to improve the customer experience with our advice, service, convenience, as well as all of the lessons from that including one I would highlight is gifting, as well as in particular gifting below $100 and improved – I think our improved messaging as well, marketing messaging, more targeted. Last year if you remember it was a little bit too much of, buy in the next two days otherwise it's going to be too late, and then three days later we would tell you, buy in the next two days or it's going to… So I think we're going to be – our marketing messages, you may have noticed that, were a bit more balanced, more targeted and hopefully create some more excitement. But to be candid, we are also prepared from the standpoint of combining science and judgment in our promotional activities and so forth. I must say that last year during these last two weeks, many of us were perplexed and there was a bit of overreaction at that time last year. So the program combines that, Renew Blue transformation and then the lessons from last year, and then wish us some luck, okay.

We'll move along to our next question, Dan Wewer from Raymond James.

Hubert, I just wanted to follow up on your comments beyond the fourth quarter of this year and specifically if you continue to believe Best Buy has the potential to reach a 5% operating margin rate, and if so, how do you envision the amount of square footage changing going forward, either closing Best Buy mobility stores, reducing the size of big-box stores and perhaps closing big-box stores if those leases expire?

So on the 5% to 6% operating income, we do believe that the structural industry changes we are seeing are going to put pressure on that range, but we also believe that these changes could drive opportunities for us as well. And so we'll continue to monitor both as we progress to the next phase of our transformation. As it relates to the store footprint, the way we think about this, and we've been very consistent in talking about ongoing thoughtful rationalization of our store footprint, I'll repeat something we said on the last call and maybe elaborate a little bit. We do see retailers shift to online. Customers are starting their shopping journey online. It's so convenient. Sometimes they are completing the shopping journey online. We like that. In our case, by the way, 40% of the revenue then gets picked up in the stores. And sometimes the transaction itself is completed in the stores. But the result of this is fewer trips to the store, right, either because you've completed the transaction online or because you've done so much research that you don't need as many trips to the store per purchase to complete the transaction. So what does it mean for the stores? It means that the trip to the stores need to be extraordinary from a customer experience standpoint for the transactions that are high-touch and large-cube, it needs to be an amazing customer experience, and it needs to be very efficient for in-store pickup or, I'm on a business trip, I forgot my phone charger and I need one quickly, and by the way the stores are still and probably forever will be the best solution if you want it now. Now is convenience. And so, our vision for the store footprint is related to…

Okay. And Sharon, one real quick question, you talked about a 15 basis point or $0.02 per share benefit from a tax settlement I think you said regarding inventory. Does that show up on the income statement on gross margin rate?

Yes. This was a legal settlement not a tax settlement. We have the tax issue and then the legal settlement. The legal settlement was around inventory, thus it's a reduction of cost of goods sold and it shows up in the gross profit.

We'll move along to our next question from David Strasser with Janney Capital Markets.

I guess a question, one of the things I notice more and more in the stores is the third-party salespeople and I'm trying to understand sort of the dynamic of that as far as whether or not – I've heard some people say, I'm pretty sure they're not your employees but they are employees of the vendors, I'm trying to understand that a little bit better, and as we go into the holiday season, how substantial you think that could be, is that helping on ASP, is that helping on close rates, at what times of the week these type of employees will be there? And I guess sort of a related question, that which could be construed as a follow-up would be, as I'm trying to look at the TV category, how much is ASP versus units in sort of the TV category strength that you saw in the third quarter?

So let me be very clear about the sales staff in the stores. With a couple of exceptions that date back a while, the labor that we have for our various vendor experiences is Best Buy labor. We get something from the vendors and they may have on their search, in reference to a specific vendor, to indicate their expertise but they are Best Buy labor. And they spend, as you would expect and appreciate, a lot of time in the stores and we pay a lot of attention to continuing to provide customers knowledgeable and biased advise because we feel that this is very valuable to the customers and so a very strong part of our culture. This being said, we like the fact that we have put an emphasis on customer facing labor, even though we've reduced our SG&A materially. As you know, we've put emphasis on customer facing labor. We like the fact that we are getting help from our vendors from that standpoint and we love the impact on the customer experience and of course the ability to sell more and sell better. We briefly alluded incidentally in our prepared remarks on an opportunity that we have that we are quite excited about, which is efforts in our retail stores to improve sales effectiveness and increase our leverage from labor that over time we'll be able to talk to you all about. And so that's what I would say in general about store labor. Now, Sharon, do you want to answer the question about TV ASPs and units?

Absolutely. As you'd expect, Dave, we're seeing favorability in both.

Is there one more dramatic than the other?

From a competitive point of view, we are not going to be disclosing a lot about the UHD cycle, but obviously you can see in the stores the pricing on the TVs, et cetera. So you're going to have an ASP benefit at the high end and then you're going to have – we're also as you know we play across the entire category. So a large piece of our TV business is not actually in UHD as well and we saw very strong television category this quarter, but we're going to be short on details from a competitive point of view as we go into holiday.

I guess I have to accept that. Thank you.

Okay, sorry.

And we'll move along to our next question from Michael Lasser with UBS.

As you look across the promotional landscape for the holidays and the deals that you're already able to see from others, what is your impression about the margin that your competition is willing to invest this year versus last year, and then how does that ebb and flow over the course of the period?

I would answer the following way. In general we are in line with our expectation. The promotional environment is very intense. It is certainly not less intense. I'm not sure, if anything it's probably a little bit more intense than last year. I think that all of you follow the sector, so I don't need to point you to this or that player. Don't know of course how much money people are spending, I don't have access to their P&L, but the promotional season is off to a very vibrant start, I would put it this way. So as a result, in our outlook for the Q, we've not been betting on help from that standpoint. In fact we've been quite realistic. The one thing I would highlight in that context in terms of what we do about it, is again the combination of science and judgment on our own promotional activities and competitive reaction.

Okay, that's helpful. And as a quick follow-up, can you give us a flavor for how well you are able to not only attach but also cross-sell that traffic that came into your stores in the third quarter for iPhones, and do you think you'll be able to sustain that type of performance into the fourth quarter?

Thank you for highlighting that. These iconic launches generate significant traffic. We are happy with the accessories and services attached. Now is that impact related to the installment billing? I think we've said that, and in general what one of the things we've said in our prepared remarks is that the traffic trend to our retail stores was still negative has improved compared to the first half of the year. Now, what is the weight of these phone launches versus other factors, I would actually say that the mobile part of our stores is by far not the only place in the stores where we have transformed the experience. So I wouldn't exaggerate the impact from a traffic standpoint of these launches.

Okay. Good luck with the holidays. Thank you so much.

We'll move along to our next question from Chris Horvers with JPMorgan.

So you've flipped to positive comps here, you're talking about sort of flat revenues in the fourth quarter, gross margin up, and all of these point to a building cash balance in the balance sheet, and I know it's been very important to see things like gross margin stabilize and sales stabilize, so how are you thinking about the cash as you get beyond the fourth quarter?

Chris, I'll take that. We of course have said consistently we're going to continue to maintain a very strong balance sheet. And once we get past the fourth quarter, of course the cash flows in the fourth quarter are significant, we understand that at that point there's going to be significant cash on the balance sheet and we will at that point start looking at alternatives. As you know, we continue to be deeply committed to our dividend. I know your question is really about, are you going to begin implementing share repurchase programs, and that is a discussion that we are not prepared and not wanting to have today, but when we go into next year rest assured that we know how important this is to our investors and we will continue to evaluate that. But the number one use of cash for us is investing in future growth right now. So where we can utilize that cash to drive these customer-facing initiatives, that will be our top priority, and then we will look to other vehicles for using the cash beyond that.

Understood. So as you – but I guess another way to think about it is, based on the up to date results, it would seem like you're going to have about $4 billion of cash in the balance sheet. Is there a level that your key vendor partners look to in saying, that's a cash value that is something that is a strong show of confidence and makes us feel really good about providing you great terms, as sort of a minimum cash balance level?

I think that we have an obligation to our vendors to maintain a strong balance sheet. When you look at the investment that our vendors have made in our stores in the last 12 months, 12 to 18 months, it is incredible, it is literally hundreds of millions of dollars that they have put into our stores to represent their customer experience. So we believe very strongly that our strong balance sheet has been one of the reasons why they have had great confidence in putting that kind of capital into their customer experience in our Best Buy stores. So you can never exactly square root what number is it that they are looking for on the balance sheet, but let's keep in mind that we are a 40-plus billion dollar retailer and we are heavily fourth quarter weighted. So I think that we need to be very – we're going to be very thoughtful about the intangibles as well as the tangible implications of any cash decision that we make. So I know that we've had this conversation and I so recognize and we recognize the importance of the discussion of uses of cash for our shareholders, I like the fact that you guys all understand how important it is to our vendors because I think we used this example in a couple of our meetings earlier this year, but when you think about it from a vendor point of view, right now some of our largest vendors are sitting with receivables from Best Buy unsecured, nobody wants their inventory back, and they may be lending you up to $2 billion at any point in time. So what looks like a lot to some, doesn't look like so much to another Board sitting across the country, right. So that's where we sit on that topic.

Understood. Thanks very much and good luck in the fourth quarter.

We'll move along to our next question from Matthew Fassler with Goldman Sachs.

My questions are focused on wireless. I guess as you look at all the significant changes in this marketplace focusing on installment billing and also the trade-in dynamic, which I know are present to many more transactions, how are these impacting the consumers' perception of affordability and the frequency of wireless purchases and also the basket that they seem to be looking for?

I think we continue to believe in a number of things. One is the wireless space is obviously a large and very dynamic market. Of course there's a bit of saturation from a smartphone penetration, but there's also new usage. The phone, the mobile phone is really the center of people's lives since it's highly connected, if I can use that phrase, to other topics such as connected home and health and fitness. So it's an area of very intense interest on our part and of the overall industry. The installment billing development is a positive development from a customer standpoint because it provides much more flexibility to the customer. As you know, after one year you can actually upgrade. And so while the previous contractual arrangement of post-paid was a two-year contractual commitment, you now have the ability to upgrade after one year. The fact that it's a monthly billing also is an encouragement to facilitate we find attaching, from a customer standpoint buying services and accessories. And so these are positive development. You mentioned trade-in. Trade-in, in effect with the installment billing is embedded into the program, and so which was a phenomenon in the last couple of years is now structurally integrated in these new offerings. So all of this constitutes a set of positive development and it's an area where we continue to see opportunities for us above and beyond simply the phone functionalities as we represent in our stores a broad range of products that can get connected in the homes and the lives of the customers.

And if I can just ask a brief follow-up, Sharon, you talked about the consumer electronics market expectation that drove your near flat comp assumption for the fourth quarter. What kind of wireless expectation is embedded into that [upside] [ph] of that CE number?

We're not guiding, Matt, by category but clearly when you think about – you know last year we had two issues in mobile. The first was that because of installment billing, the carriers stopped upgrades, early upgrades. Remember? In addition, we couldn't sell installment billing. So we had structural impediments in the fourth quarter of last year that we do not have this year. Therefore you could obviously expect that we would hope to see a significantly better mobile business in the fourth quarter this year versus last year.

What I would add to this, Matthew, is that the flat revenue and comp indication we are providing this morning incorporate, includes the mobile phone business, it's not limited to the NPD categories. As you know, Q4 is in an intensively competitive area where a lot of retailers use CE to carry the excitement in our stores and so forth. So flat overall is the number we have shared this morning.

We'll move along to our next question from Peter Keith with Piper Jaffray.

And this may be the last question so that people can move on to their rest of the day.

Good morning and congratulations. I'll just keep it to one question. As a follow-up to the last comment around the Q4, comp guide for Q4, one of the things that looked impressive in Q3 was that your GAAP relative to the NPD data widened, and it looks like for Q4 your comps were to kind of tighten up again. I guess I'm just wondering, structurally is there anything going on with product sales that's going to cause that tightening that we should be aware of?

I think one of the things I would highlight is the comment on discipline around promotional activities, and we are interested in comps but not [empty calories] [ph]. And so in some cases that – so in other words we don't want to be so addicted to the notion of positive comps that we would do unnatural thing from a promotional standpoint. So that may be what impacts our comments this morning on the outlook. And with that, I'd like to – or maybe, Sharon, you want to add something?

I'll just add, there's two more points. The first is that recall that last year that we had launched 400 stores that were shipping from store. So we created that inventory availability last year. Now this year we have the 1,400 stores shipping, but the 400 stores did, as you'll recall, drive increased revenue last year. The second point is, which I also mentioned in my prepared remarks, is that last year the new gaming consoles were launched and their deliveries were in the fourth quarter. We had the pre-order revenue in Q3 but the deliveries in Q4 and those were substantial. So as we look to the fourth quarter, we are expecting to see some potential differences in the strength of the hardware related to those consoles obviously. So those would be two other pressures, and remember that the gaming is not in those NPD categories that we discussed. So those are a couple of other points just to consider. We quantified that on the online growth last year at about 600 basis points of benefit last year, because remember we had over 25% growth in online last year. So I would not want you to put that in there when you're trying to do the math, that those two factors are necessary in order to get in line with the outcome that we put into the outlook.

Thank you so much, Sharon. And in closing, I wanted to do a couple of things. One, obviously thank our teams in all functions and geographies for the progress, continued progress and results that we collectively, they collectively have delivered, and of course for their very exciting mobilization for holiday. It's always a very special moment of the year. Our teams are ready to welcome all of our customers, including all of you on the call, and I want to salute them for their preparedness. And of course I want to thank you and everyone on the call for your continued support and wish you a wonderful holiday season, which I know would include a few trips to Best Buy. You have at least two reasons to do that, one is check how prepared we are, and of course at the same time you can make progress on your holiday shopping adventure. So we'll see you in the stores or on our site at your convenience. So have a great holiday with your families and we'll continue to be with you on the journey. Thank you so much.