Best Buy Reports Dissapointing Sales & Outlook, But Strong Expense Control Improves Non-GAAP Earnings

As anticipated, Best Buy (NYSE:BBY) reported another quarter of declining sales in Q2 2015 (reported on August 26). At $8.9 billion, revenue declined 4% annually and 1.5% sequentially. However, supported by the company’s ongoing benefits of the Renew Blue cost reduction and other SG&A cost control initiatives, Best Buy’s non-GAAP diluted earnings improved from $0.32 in Q2 2014 to $0.44 in Q2 2015. Strong expense control resulted in a better than expected non-GAAP operating margin rate of 2.9%. The positive impact of the cost savings initiatives were partially offset by lower volumes, higher sales in the lower margin gaming and computing categories, and the negative margin impact from the credit card agreement and structural price investments.

Best Buy reported a 2.7% decline in its same store sales in Q2 2015. Sales in the NPD track consumer electronics category (industry-wide) declined 2.5%, in line with expectation, which was the main reason for the 2% decline in Best Buy’s domestic comparable sales. A weak consumer electronics market, as well as growing competition from retail giants including Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT), have impacted Best Buy’s top line growth. The company continues to see a shift in consumer behavior, as they are increasingly researching and buying online. Though the trend negatively impacts the traffic in Best Buy stores, in-store conversion and online traffic continues to rise due to the successful execution of the Renew Blue turnaround strategy.

Best Buy expects its comparable sales to decline in the low-single-digit in the next two quarters of fiscal 2015. The weak guidance led to a greater than 5% decline in its stock price after the earnings announcement. Nevertheless, the company seems confident that significant progress against several Renew Blue priorities will help re-accelerate its growth in the future.

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Significant Progress Against The Renew Blue Strategies

Introduced at the start of 2013, Best Buy’s “Renew Blue” program focuses on the following key areas:  1) merchandising and marketing; 2) increasing its online sales;  3) leveraging its Geek Squad to grow the service business; and, 4) improve its supply chain, cost structure and employee engagement. The company claims that it continued to make considerable progress on all the above initiatives in Q2 2015.

We will now break this out more specifically:

1. Merchandising -Best Buy continues to add differentiated in-store customer experiences in several key categories, including appliances, home theater and mobile. In the appliance category, it opened 18 new Pacific Kitchen & Home stores-within-a-store and is on track to end 2014 with approximately 115 stores (versus 67 last year). In the home theater category, it opened seven new Magnolia design center stores-within-a-store, reaching closer to its target of taking the total to 50 stores in 2014 (versus 22 in 2013). Both Pacific Kitchen & Home as well as Magnolia design center stores-within-a-store continue to beat Best Buy’s expectation. In the mobile category, Best Buy introduced the selling of new installment billing plans with Sprint and Verizon in Q1 2015, and started selling AT&T’s plans in Q2 2015. It claims that customer adoption of these plans has been growing. Best Buy is now the only national retailer to launch installment billing plans with multiple carriers.

2. Marketing – In Q2 2015, Best Buy continued to shift its marketing investment dollars towards digital media campaigns and away from print and television advertising. It has been working on a big data project called Athena that will shift its marketing efforts to more personalized email messages and offers, which will enable a more targeted approach to customer marketing. Best Buy has one of the largest repositories of customer data derived from individuals’ past purchases, browsing histories, locations and demographics. It plans to leverage this database to pilot new targeted email campaigns and more personalized marketing messages, which Best Buy views as a 2-3 year journey.

3. Increasing Online Sales – Accelerating growth in its online segment remains one of the main focus for Best Buy, as it aims to update its website to get on par with Amazon (NASDAQ:AMZN) and other competitors. Online sales as a percentage of total domestic sales increased by 160 basis points (to 7.7%) in Q2 2015. Best Buy’s domestic comparable online sales increased by 22% in the quarter driven by its ship-from-store initiative, digital marketing and enhanced website functionality. Ship-from-store, which enables all its distribution centers (and not just the ones previously allocated to e-commerce) to handle online orders, accounted for over half of the online sales growth. In the next 24 months, Best Buy aims to further improve its online shopping experience by enhancing search tools, recommendations, and product and price information to make it easier for customers to find and choose products.

4. Geek Squad Service – Best Buy has consolidated and simplified its field organizational structure, which is now reorganized around key markets with the goal of having the local strategy for each of those markets. It has also reduced the number of management-level roles within the stores. Though it has increased the percentage of retail labor that is customer-facing, it has managed to lower its labor cost.

5. Supply Chain – In May, Best Buy implemented significant changes to its distribution operating model that aligned work schedules with customer demand including expanding the company’s days and hours of operation. It claims that it is now able to both replenish inventory to its stores more efficiently and deliver products to its online customers faster. This will be a competitive advantage that improves product availability to both online and in-store shoppers in advance of the holiday season.

6. Cost Reduction – Best Buy eliminated an additional $40 million in annualized cost in Q2 2015, taking the total renewable cost reductions to $900 million. Its Renew Blue cost reduction target is $1 billion. Excluding the impact of the increased mobile warranty expense, Best Buy’s cost savings and other operational improvements have materially offset its price matching policy and other Renew Blue investments. The company plans to intensify its investments in customer facing initiatives across both channels (retail and online) in the back half of the year.

Best Buy is following the same kind of Renew Blue transformation for its international operations as well. While it claims to have made considerable progress on the same, it believes it has substantial work to do on top line stabilization in international markets.

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