Ladies and gentlemen, thank you for standing by. Welcome to the Best Buy's Second Fiscal Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded for playback and will be available by approximately 11:00 a.m. Eastern Time today. [Operator Instructions] I will now turn the conference call over to Mollie O'Brien, Vice President of Investor Relations.

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 remains 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,…

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…

[Operator Instructions] The first question comes from the line of Greg Melich from Evercore ISI.

I'd love to finish where you -- or start where you finished, which was the third quarter guidance on margin decline and what it implies for the fourth quarter. I want to make sure that, that OI decline that would be in basis points versus the second quarter down to 60. And does that imply that in the fourth quarter, EBIT margin should only be down maybe 50 bps and would be well above 4% in the fourth quarter? And then I have a follow-up.

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. I mean there's -- there are categories where the price points and decisions around the type of product matter. Large TVs is the example we use. There are other categories like let's take mobile phones where it's not as much a decision between trading up or trading down. You want a certain brand. You want a certain type of phone. And so -- or even some of what we're seeing in gaming, where as much of the kind of gaming hardware as we can get our hands on, the consumer is looking to purchase. So that's why it isn't perfectly even throughout the categories in our business, in particular, because sometimes, you're very brand-specific. And then sometimes, you're more brand-agnostic and you're just looking for the right experience.

We'll now take our next question from Simeon Gutman from Morgan Stanley.

I wanted to ask about just the high-level backdrop. Realized a year ago, things felt different in terms of sales and promotions. I wanted to ask you, Corie, is it getting easier to predict the business, is the visibility getting better? Meaning, are we bottoming in certain categories in terms of units? And then as you look around the corner to whether it's -- I don't know if it's promotions creating the deflation or it's consumers trading down. But do you see a flattening that the current environment we're in is starting to stabilize?

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.

And maybe the follow-up, is the promotions creating year-over-year price deflation in the categories, or is it the lack of innovation where you're already starting at "year-over-year" deflationary price point and then promotions are compounding that? And I guess the promotionality is the piece that resolves it or is there innovation around the corner where you -- where the industry moves back to some type of 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.

The next question comes from Anthony Chukumba from Loop Capital Markets.

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. For us, the back-to-school sales are actually slightly ahead of our, what I'll call, kind of tempered expectations. And it's following a trend that was really more pertinent prior to the pandemic, which is people were shopping later and later. And not super surprising given that this is a very different school year than we've seen for the past 2 years. And you probably got parents and kids who are just kind of really trying to figure out, how do I gear up for a year that at least is starting out much more in person and especially at the collegiate level much more on-campus. So if anything, it's been a little bit better than we had thought and it's following that same trajectory. In terms of implications for the holiday, I think it's less about what does back-to-school portend. I think it's more about kind of broadly what we're seeing. So we mentioned we're seeing a customer who's more value-oriented, who is definitely moving more towards some of those sale events. And so I think our hypothesis is you're going to see a holiday that starts to look a little bit more like what we saw pre-pandemic. Maybe comes a little bit later, it's probably promotional in our space. That's part of what is embedded in the guide that Matt talked about. And I think it's going to be, my personal point of view, a little harder to pull those sales into October when there's not -- remember, for 2 years, in October, we were yelling at the consumer, make sure that you get your inventory because there isn't enough. Obviously, the backdrop looks a little different there. And so I think you might have a consumer who's willing to wait, look for the deals and really look for those great values. And again, like I said, I'm not sure back-to-school is the indicator of that. I think that's just more broadly what we're seeing in the macro and in the consumer.

Chris Horvers from JP Morgan.

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 -- Chris, that's what the numbers would imply. I think 10% in August, if you think about the sequential stack of Q3 on a 3-year basis, with a comp that's slightly below a 12% that we saw in Q2, would imply that it's in the low single-digit area of comp performance for the entirety of the quarter. So yes, that's what assumes a sequential declining as the year progresses, and especially into Q3 and Q4.

Got it. And then have you -- I'm curious what -- how you're thinking about sort of unit pull forward versus dollar volume? Because obviously, to your point, Corie, dollar volumes are being exaggerated right now because of the level of inventory in the market. So how are you thinking about like the everlasting question of pull forward around the pandemic and share of wallet on the unit side within the computing and TV category?

Maybe I'll start and then Matt can add on. I think we are watching both sides of the equation carefully, both the kind of ASP side of things and also the unit side of things. Broadly, on the whole, we're seeing a stabilization of ASPs year-over-year. And so you can imply in that, obviously, you're seeing a bit of unit decline. And I think what's interesting right now is you've still got a consumer who is spending on the whole quite a bit. I think they're being choosier, and it's uneven as to where they're spending. And so I think it makes it a little hard to answer the question exactly how much is pulled forward because you're against a very different backdrop than you were even 6 months ago. I think what is -- again, and I'll go back to it, what for us is most compelling is that no matter what, you have a massively higher installed base that is in people's homes and people are spending more time in their homes than ever. And in a category like computing, we can already see that some of those upgrade cycles are happening a little bit faster than they were before. So that would imply, more than anything, it was more incremental purchases, and then you'll see that upgrade over time. And again, I mean, now it's been 2.5 years since some of the original computing devices were purchased at the very beginning of the pandemic. So you're going to have some compelling use case changes here over the next year or 2. So it's a long way of saying, I think it's difficult against the current macro backdrop to make a precise indication of how many units were pulled forward and how much was incremental. I think instead, we remain focused on making sure we have the right inventory there for our customers and being ready as they're more ready to upgrade their devices.

The next question comes from Liz Suzuki from Bank of America.

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.

Got it. Okay. So I mean, in theory, we could think about some of those targets as just being still achievable, but a little further down the line than what you originally thought given where the year is going to shake out.

I think the premise of us continue to grow our business and drive more efficiency and profitability in the business over time is absolutely what we intend to do as we think about once the business stabilizes and operationally, the strategies are all very sound, and we're very pleased with how they're progressing. It's just that the backdrop as much than it was.

Michael Lasser, UBS.

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, maybe. I mean I think what we're trying to do is assess what this year looks like. We're trying to, as you can imagine, fortify our business a bit and understand how do we point resources and work towards the strategically relevant important things as we -- as well as the operations. And I think what we're trying to do is continue to assess the top line environment, the macro environment to understand where sales will go next year, all the while knowing that the sales growth, the CAGR leading up to the pandemic through FY '20, the last 3 years, was over 3%. So we believe the industry, we believe Best Buy will return to growth at some point as we navigate some of these choppier waters. At the same time, we're taking the right steps forward to optimize our business and set ourselves up structurally as we look forward into next year and the years after that and drive our strategy at the same time.

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?

So we chatted a bit in the prepared remarks and said we still like what we were seeing in terms of -- for right now, and again, we haven't even lapped a year, in terms of the engagement and the spend of the existing cohort of Totaltech support members. We also said, just like you would with any membership program, we are going to keep looking at the benefits that are included, what customers value, what keeps customers sticky to Best Buy, and we will continue to iterate on the offer. So I don't think it's as simple as a light switch, like is it on or is it off? I think there's a lot about the offer and behaviors that we're seeing that is really compelling. And at the same time, we want to make sure that the offer is used and is engaging for customers and is over time keeping them sticky to the brand. And we said it in the remarks, it is difficult because frequency is lower in our category, so it takes us more time, especially against the macro backdrop that has changed as dramatically as this one has. It's going to take us more time to assess. Over the long term, is this doing what we want it to do? And so for right now, we like what we're seeing in the cohort of customers. It's still early. It's against an uneven backdrop. And we're going to continue to iterate on the offer to make sure, at the end of the day, what's most important is that it keeps customers engaged with the brand.

Brian Nagel, Oppenheimer.

So I have 2 questions. Maybe I'll just merge them together. I mean, first off, with regard to sales, are you seeing any increased variability across geographically or otherwise that would maybe tie this more together with either inflationary pressures or some of the lasting effects of the pandemic? And then my second question, I guess just stepping back, thinking about the different drivers of sales. From a manufacturing standpoint, your manufacturing partners, has there been a pullback on -- through the pandemic, through the supply chain constraint, it's pull back on sort of say, driving innovation that may be changing now as some of these constraint keys that could ultimately become a better sales driver?

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 so, 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 hit on this a little bit earlier, Brian. But I do think our manufacturing partners have been doing everything they can to produce as much product as possible over the last 2 years. So kind of writ large, if you think about the industry broadly. And a hypothesis would be that does make it a little bit more difficult to innovate at the pace that you would like because you're just working so hard to produce what you need to for the demand that's in front of you. And so I think as hopefully, you start to see a more -- a little bit more normalized demand environment, that absolutely -- I can't imagine a world where the manufacturers that we work with aren't working morning, noon and night to try to think through how to innovate on the products that we have today to drive more of that replacement, more of that consumption going forward. And so I don't have an exact measurement to tell you how much are they innovating last year versus next year. But I absolutely fundamentally believe, you've got a manufacturer set that is looking to capitalize on an increasingly digital consumer who is more and more willing to use these products in their home.

Kate McShane from Goldman Sachs.

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 to 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 start and Corie can add if she like. Kate, it's not a -- it doesn't -- the pressure does not increase as we get into the back half of the year. In fact, it abates a bit as you get into Q3 as we lap the launch. And so even with the higher volumes expected coming through in Q3 or Q4 from a holiday perspective doesn't necessarily create more pressure effectively on a year-over-year basis. It mitigates as the quarters progress. At the beginning of the year, we talked about how the pressure this year was between 60 and 80 basis points, and that's about what we are seeing right now for the year. On a pre-pandemic basis, it would represent about 100 basis points of pressure from where we were before. But again, as we -- as we scale that offer and we sign up more people, the pressure subsides as you scale on those sales over time when you drive 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.

Okay. And my follow-up question is, aside from some of the labor adjustment that you made, just where you're focused on reducing costs and better -- to better align costs with demand?

Sure. I think we have probably a whole lot more to say. As you can imagine, we're still working through those plans, and we would want to share internally as well before. I think the $34 million termination is basically termination benefits that we took in Q2. The 2 aspects of that are the voluntary early retirements and then the workforce optimization. Those are what we've done so far. We'll continue to evaluate other actions. But broadly speaking, we're looking to understand how our business has changed over the last number of years with a digital business that's now double what it used to be in a very different looking consumer to understand where do we need to point our resources and efforts strategically and operationally to make sure we're prepared for how our customers want to shop and providing the best experience for them. And so that will ultimately provide some -- also some efficiency opportunities as we look forward, but also just strategically position us better as we navigate through some of the difficult macro environments that we're seeing right now.

We'll now take our -- we have time for one last question today from Mike Baker from DA Davidson.

Okay. I wanted to ask about the promotions and inventories a little bit, just to follow up on that. What areas are you more or less promotional in? And it sounds like the issue to me -- it sounds like -- it looks like your inventory is pretty clean. It's down 6%, but competitors are still heavy. Do you expect that to be a situation to be rectified by the holidays? And then one last question, if I could squeeze it in. Any comments particularly on what you're seeing in terms of gaming trends within the entertainment category, which was down about 9%, a little bit better than the Total? How did gaming perform within that?

Sure. Overall, as we said, promotionality is a bit higher than in Q2 than we expected, and we built those expectations into the remaining part of the year. What we're seeing is generally more -- most of our categories are returning to pre-pandemic levels. So there really isn't -- there's always a few areas that may not be quite back there yet. But generally, we're back to where our levels of promotionality were before the pandemic started. And that has more to do with the general amount of inventory in the channel right now that, as the consumer demand wanes and inventory increases, there's just generally the dynamic of having more promotionality. It's less around needing to mark down our inventory more because it's not in a healthy position. It is a very healthy position. It's simply just normalizing to where we were pre-pandemic. And so that marketplace competitive dynamic is what's driving a little bit of that promotionality. Again, maybe not as much as others because we started the year expecting promotionality return to pre-pandemic at some point. It's just happening a little bit faster. In terms of gaming, it still continues to be an area where if we had more inventory, we would be able to sell it. The demand outpaces the supply as well. I think we're seeing actually some -- the gaming console side of the business is relatively flat to last year. We're seeing a little bit more pressure year-over-year from a software perspective and a peripheral perspective. But if you think about where gaming, if you took all of gaming, not just the console cycles, you took in PC gaming and you brought in VR and all the things related to a gaming area, it's actually up over 50% in Q2 versus the pre-pandemic level. So it's seeing a lot of growth over the last couple of years, although like most categories, Total is coming down a little bit on a year-over-year basis.

Mike, the last thing that I would add on the inventory question is, it is a -- I'm very proud of the work that the teams have done. I'm proud to head into holiday in a good healthy inventory position. And we said it in the prepared remarks, that allows us a little bit more space to invest in those places where we think there really will be consumer demand. So I think it is a really good situation to be in. And with that, I think yours was the last question. Thank you all so much for joining us today. And we look forward to updating you on our results and our progress during our next call in November.

Thank you. This concludes today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.