Ladies and gentlemen, thank you for standing by. Welcome to Best Buy’s second quarter fiscal 2014 earnings conference call. [Operator instructions.] As a reminder, this call is being recorded for playback and will be available by 12 p.m. Eastern Time today. (Operator Instructions) The call will end at 8.50 am Eastern Time.

I’d now like to turn the conference call over to Bill Seymour, vice president of investor relations. Please go ahead, sir..

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 press 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-on-year comparisons, but should not be considered superior to or as a substitute for, and should not 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 release.

Today’s press 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 operation, 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 press 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.

I would like to highlight that during our second quarter we reached settlements with multiple defendants under which we will receive a total of $229 million net of litigation costs.

These settlements were the result of a lawsuit filed by the company as disclosed in our most recent form 10-Q that alleges price fixing by certain manufacturers of TST LCD panels from 1998 to 2006. We have excluded the impact of the settlements reached during Q2 FY14, and our non-GAAP financial results provide meaningful comparisons versus last year.

And where applicable we will be referring to those non-GAAP results in this morning’s call. Again, complete information regarding our GAAP and non-GAAP results can be found in this morning’s release. I will now turn the call over to Hubert..

negative 90-110 basis points in Q3, and negative 40-70 basis points in Q4. While I will not discuss them now, continuing impacts into fiscal 2015 are also outlined in this morning’s release.

Again, these basis point estimates on the operating income rate only pertain to the specific P&L drivers I just outlined, and should not be used or interpreted in isolation as a calculated projection of our expected year over year change in the total company operating income rate, because as we have seen in the last three quarters, our core business performance is stabilizing, and our product mix and cost containment initiatives above and beyond our Renew Blue cost average have been stronger than expected.

As such, we expect that through continued improvement in our core business performance we will be able to offset some or all of these impacts. Thank you, and I’ll now turn the call over to the operator for Q&A..

[Operator instructions.] Our first question is from Matthew Fassler with Goldman Sachs. Please go ahead..

My question relates to the impact of the credit card item on gross margin in the second quarter. I guess it’s a quick two-part question.

The first part is can you tell us how much that aided gross margin here in Q2? And secondly, does that reflect any kind of change in the net economics of that deal? Or just some acceleration of the [pad] that you would have ultimately received?.

That was an acceleration of the payout that we would have received because the accounting requires that you book those bounties over time. As far as quantifying the amount, we obviously have confidentiality agreements, so I’m not going to go there. But let me just give you one other piece of information.

When you look at the gross profit this quarter, again, we have two offsetting items. We have the credit card income, but the offset is this Geek Squad protection warranty negative. And quite frankly, they virtually net each other out. So the margin that you’re looking at is very clean.

There’s two specific items within it, but net, when you’re looking at the actual number that we reported, it’s very clean..

So any gross margin discussions that anyone would have had a quarter ago, this 24.0% domestic would essentially be, on those same terms the other stuff cancels out?.

That’s right, and the reason for that versus last quarter is very much driven by mix. We talked about the product mix and this quarter we had very strong growth in the mobile and the appliance businesses, and with that comes a rate mix benefit..

Our next question is from Gary Balter with Credit Suisse. Please go ahead..

I’m just going to focus on the online. You mentioned the 50-store test that you’re doing. What’s different in that in terms of the pickup at store? Because right now when I go on, you see like 6-7 day delivery if you want to buy it at the stores, this next day pickup.

And as part of that, given the success that you’re having with it, why not roll it out faster?.

The buy online ship from store is invisible to the customer. Historically, as Hubert laid out in his prepared remarks, 2-4% every week of our customers come to bestbuy.com and ask to buy something, and because it is not in the online distribution center, we tell them that we do not have it. And yet much of the time, we have it in one or more stores.

So, by opening up those 50 stores, what happens is that when the system checks the online DC, and does not find the inventory, it then checks those 50 stores, and if that inventory is there, it fills the order, completely invisible to the customer.

In last quarter’s call, we talked about the reason that we were going to roll 200 stores for holiday, and why we haven’t rolled sooner, we had two systems issues to solve. Remember, we have never shipped out of the back room of the store, so this is a very different process.

The good news, that you just pointed out, is that the store associate has already learned by buy online pick up in store how to have a pick ticket dropped to the floor and to be able to pick the order and put it in the basket. Now, the next phase of that is to put it in a box, create a shipping label for UPS, and have it distributed.

The system had two enhancements that had to be made. The first is that because we had never shipped out of a store, we were not able to populate the UPS label, with shipping. So the back room associate is actually having to take the pick ticket and type in the address.

This is a very simple IT fix, and not the one that is the bigger of the two that’s caused us to push to 200 stores for holiday and then to open it up next year to a greater number of stores.

The second one is the fact that in our system - and this is very common in retailers - when inventory is actually sold, it takes up to 4 hours to be able to update the inventory.

And what we are working on today is the problem with that is during peak times it is very possible, if you only had two of an item left in a store, that you’re going to go ahead and promise it to that customer and you may sell it in that 4-hour period.

So we were not comfortable rolling this, because this is such a big NPS issue for the customer, that we had to get that timeframe down to 15 minutes before we were comfortable rolling it out. And that is what we will have achieved by the time we roll this with the 200 stores before holiday..

Your next question is from Anthony Chukumba with BBT Capital Markets. Please go ahead..

My question was actually related to your balance sheet. You got the money from Carphone Warehouse. You essentially refinanced on the debt, saved 175 basis points. You’re now going to be getting this money from the LCD settlement.

How do you think about starting to buy back stock? I understand why you stopped doing it last year, the numbers just continued to get worse, and there was a lot of uncertainty, but given the fact that it looks like things are on the right track, and your balance sheet is just so strong, how do you sort of think about that?.

We believe that having a strong balance sheet is a very important factor for our success. And in fact, when we look at a lot of our competitors and other players that do have very strong balance sheet, and so do a lot of our vendors, having a strong balance sheet is very helpful to us as we negotiate with our vendors.

You always want to be negotiating from a position of strength. So we have this as a governing thought to have a very strong balance sheet as we operate the business. For now, this is how we think about it.

I don’t know, Sharon, do you want to add anything to this?.

No, I couldn’t have articulated it better..

And our next question is from David Gober with Morgan Stanley. Please go ahead..

Just one quick clarification on the credit card agreement.

I know you said it didn’t have any impact on the gross margins, but given that there is a recognition of deferred revenue, did that have any impact on top line? And then just a follow up on the commentary on the TV business, definitely interesting to hear that that has flattened out after a sustained period of more difficult trends.

Can you give us a little bit more color on what you’re seeing there, in terms of whether it’s screen sizes or different technologies, what do you think is actually driving that? Or is it just a function of the more competitive pricing that’s been in the market..

I’ll take the question on the credit card. Obviously you completely understand the accounting for these credit card bounties. They do go into revenue. This is completely immaterial to our revenue. So it is not a huge number. It had the gross margin impact, which I answered the question on gross margin. It has an offset on the product warranty side.

So we have no material impact on either line. I don’t want to put this number in a bigger light than it should be..

And as it relates to the TV business, the driver of this more favorable performance from the comp store sales standpoint is the size of the TVs. The mix is shifting to larger screen TVs. The units have always been up. It was the average selling price that was the issue. The shift towards larger screen is helpful.

We are, of course, also intrigued by the innovation in the space with 4K TV, OLED TVs, and so forth. We love the fact that in our stores now there’s TVs with a price point of $15,000, $8,000, and that’s helpful from the top down selling standpoint..

And our next question is from Kate McShane with Citi. Please go ahead..

Sharon, I wondered if you could give a little bit more detail about the increase in investment in price competitiveness.

Is this mainly just for the holiday season? Or is this ongoing? And what form is this going to come in?.

We believe that investment in price competitiveness is the way we have to operate our business. I think in Hubert’s prepared remarks we call it table stakes. So the investments that we are making are where they’re needed, and where we see that, versus the marketplace and competitors that we believe are relevant, our pricing is not in the market.

We are making changes to that. There is the price matching, but that is not the big piece of this. We are proactively moving forward with price adjustments where we are not competitive. And we expect that to continue.

Really, it started in the back half of Q4, and then advanced in Q1, came again in Q2, the investments in Q3 and Q4, on a year over year basis, and then we’ll assess.

I think we’ve seen several analyst reports and various analyses that have been done on our pricing versus other retailers, and the general consensus seems to be, and we would agree, even from our own data, that we are getting closer to the competition every month that passes..

And our next question is from Chris Horvers from JPMorgan. Please go ahead..

You laid out the pressures in the coming four quarters or so from those three items.

Can you talk about how much those items impacted the second quarter here as well as the first quarter?.

The impact that we had in the second quarter obviously was substantially less than what we are anticipating for Q3 and Q4 on a year over year basis. Remember it’s all about your compares. So on a year over year basis, it’s substantial. On a sequential basis, it’s important.

So the pricing is one of the issues, but the second one that is even more substantial is this Geek Squad protection and the rapid exchange and the frequency that we’re seeing on repair. And we’ve sold a lot of phones, we’ve sold a lot of Geek Squad protection plans, and when frequency goes up, it is an expensive business proposition.

Obviously these legacy contracts that we sold, many of these contracts might be 24 months old, we are very very lenient in how we interact with the customer related to this. So it’s something we have to work through. But the biggest impact that we’re seeing from a sequential point of view is in the Geek Squad warranty protection..

And then just related to that, given the reflowing of the stores, the Samsung and the Microsoft, do some of the cost savings flow through on a more robust basis in the back half versus perhaps the second quarter as well?.

Hubert also, in his prepared remarks, called out that in Q2 we had an impact from the Samsung stores and Microsoft stores as well. But the impact of the Microsoft stores is substantially greater than what we did with Samsung. Because you’re talking about the entire computer department.

Also, the biggest piece of our own floor space optimization, where we’re moving everything around in the store, is in Q3. And that is going to have a significant impact and disruption in the store. We expect that to be substantially bigger than it was in Q2..

To elaborate a little bit, there is an impact on the top line. When a store is impacted by this optimization, the supply is impacted. And of course there is some cost associated with moving things around in the store.

We expect of course for this year to be completed by the end of Q3, as we wouldn’t want to be moving things around during the holiday season..

And I’ll add one more thing to that. That cost is going to show up predominantly in SG&A. A lot of the work we’re doing cannot be capitalized, and it will flow through in the SG&A line..

Our next question is from Michael Lasser with UBS. Please go ahead..

First, on the Samsung stores, now that you have the majority rolled out, what is the sales impact that you’ve been seeing from that initiative? And then second, what’s the early competitive response that you’ve seen from the pricing investments that you’ve made?.

On the Samsung Experience shops, we are seeing, number one, very positive customer response. The same with Windows, but of course Samsung started earlier. The customers really appreciate the live displays, that you can actually touch and feel live product, which is not the case for other types of stores.

They appreciate the combination of the expertise of the Samsung experts as well as the support and advice of the blue shirts. They appreciate the opportunity to navigate the store and look at these different ecosystems. Customer have choices. It’s a wonderful experience to look at these various vendors.

So a lot of positive feedback for Samsung, and the same is true for the Windows stores. There is of course a positive impact on the sales of the Samsung products, as you would expect. What we will be measuring is of course the impact on the overall store.

But the way we’ll measure it is in the overall comp store sales, because our goal as a company is of course to optimize and solve our two problems. And it’s still very early in the game. The best way to measure it will be the overall performance of our comp store sales throughout the stores. So we are very excited about this.

Your second question has to do with what’s the competitive response to our pricing actions. This is a very competitive space, so I will not comment on the reactions of our competitors. To be clear, our goal is not to be lower than the competition.

We believe that Best Buy offers a very compelling set of customer promises, with the assortment, the advice, the convenience, the service, and so our goal is simply to eliminate price as an obstacle to buy. We started with the price match.

A year ago, everybody was talking about showrooming and so forth, so we love the traffic on our site, in our stores, and we don’t want to lose a customer because of price. But we don’t [see there’s a need] to be lower than the competition, we just don’t want to be beat..

And our final question is from Mike Baker with Deutsche Bank. Please go ahead..

I wanted to ask a little bit more about the TV business. You said it was flat.

When was the last time it was flat? Do you think you’re gaining share there? Or is that more a function of what’s going on in the market? And you said one of the reasons for that was higher ASPs as the mix is getting to bigger TVs, but can you talk about the ASPs on a like-to-like TV this year versus last year? Has that started to stabilize at all?.

We believe that it’s been three years since the comps in TVs were flat, which is why we highlighted this today. I want to also highlight the fact that while we have a positive impact on the top line from a comp standpoint, the U.S. consumer is still value-oriented.

And so the choice the consumer is making is very much biased towards opening price points in these larger screen TVs. And so that means there continues to be margin pressure from that standpoint in the category. And frankly, I highlighted 4K and OLED and so forth, and why I think all of us can be excited by these shiny new objects.

We don’t expect that this is going to have a significant impact from the volume standpoint, but I would still encourage all of you on the call to consider visiting our stores, and we’ll take care of you..

And do you think it’s a function of share because of your aggressive in price, or is it the market doing better in TVs?.

We have been very competitive in TVs, so we’re feeling good about our market share, our trends, again, our value proposition to the customer in that space..

I’d now like to turn the conference back to Bill Seymour for closing comments..

That concludes our call. Thank you, operator..