Bruce H. Besanko: The economy is tough. It’s not helping us right now but there’s at least two pieces of good news. First, we’re in a solid growing industry despite the economic headwinds, the consumer electronics association (CEA) is still forecasting a mid-single-digit growth this year.
Second, our issues are less about the macro environment, although it is affecting us particularly in traffic. It’s more about remediating the self-induced issues that we incurred last year. Those issues that we face are all fixable. We are doing that. We are rebuilding our retail selling culture, as evidenced by the improvements in our close rates, our customer first scores and our third-party mystery shop scores. We are fixing gross margin as evidenced by the improvements in our higher gross margin attachments. Q1 saw the smallest decline in five quarters in our gross margin rate.
We are getting our disciplines back in inventory shrink and store initiated markdowns. Our compliance on shrink related activities, which will help our gross profit, have increased each month for the past four months and we beat our internal target in markdowns in Q1. We’ve had great controls in terms of our expense structure and are helping our bottom line performance.
As it relates specifically to the stimulus checks, we did see improvement in an overall weaker economy in the first half. We saw some improvement, particularly in the latter part of April and through May. We attribute that performance increase in part to the work that we’ve done and what has been done by the field teams in terms of improving our store environment and customer service, this being in combination with the tax stimulus checks. That’s helped as well.
Thus from an outlook perspective, given all the work that we are doing and the traction that we expect to get, we are comfortable maintaining the guidance that we earlier talked about.
Christopher Horvers (J.P. Morgan): In the SG&A, you cut back on store expenses, more significantly why we saw a rise in the overall G&A expense. Can you comment on that in light of your overall focus on customer service and re-engaging the workforce?
Bruce H. Besanko: Last year we reacted to compressing gross margins by developing plans to take out about $150 million of expenses in fiscal 2008 and we did that. We achieved more than that by about $50 million. We achieved $203 million in cost take-out versus our target. About half of that was store related and field related and the other half was in our corporate centers.
It’s important to realize that some of those costs were reinvested in our IT systems, such as our new point of sale system, as well as the growth initiatives that we have in consumer direct and our Firedog services.
The key drivers of the savings were that we haven’t anniversaried all the cost take-out from last year. Secondly, we had tighter expense management throughout the company but including the corporate centers, such as the headcount and consulting spend.
John T. Harlow: The reason I am so optimistic about the go-forward for Q2 and Q3 relates to how the work that we are doing on the top line and rebuilding the selling culture is resonating with the consumer. The traction that we are seeing sequentially each month on a broad base of metrics, whether it’s close rate, attach, fundamentally improving our margin rate and better merchandising and having better in-stock in the store shows me that we will continue to see that trend improve, even with traffic that may be softer.
As it relates to the store piece, the numbers are better but they are not through reductions; they are actually through better productivity levels behind the scenes at the store. Every store has built a specific plan to drive their behind-the-scenes and selling productivity and that’s actually what’s given us the ability to improve the top line metrics, the customer satisfaction metric, as well as bring our SG&A or store labor productivity up. This is giving us some of the benefit that we are seeing today. That’s also coupled with measures that we have built in from our supply chain to better support the stores and workload planning from this building. Aligning this building and our supply chain to the stores is giving us even better efficiencies to not only free up time to drive the selling side of the business but also to allow productivity at store level to continue to improve and that will ramp up.
Christopher Horvers (J.P. Morgan): What drove the increase in G&A expense year-over-year?
Bruce H. Besanko: We have a particular contract and one associated with our information technologies that began more toward the middle of the year rather than the beginning of the year and because we haven’t anniversaried that, you’d see an increase in G&A.
Philip J. Schoonover: How much of that is new store openings?
Bruce H. Besanko: We do have some new store openings this year and that’s probably a double-digit millions of dollars of G&A expense.
Philip J. Schoonover: The first quarter is certainly the most difficult quarter on the two-year comps for us. As we go through the year, the ability to sustain and build versus an area where we had slipped last year, we see that as being another level of our ability to deliver for Q2 and beyond.
Michael Baker (Deutsche Bank): TVs remain strong, up high-single-digits. What does the supply in the market look like in terms of manufacturing or you are seeing more TVs come online ahead of potential demand for the Olympics? What could that mean for pricing and margins in the back half of the year for flat panel TVs?
John J. Kelly: We continue to see increased interest in flat panel, specifically large flat panel televisions and in better technology such as 1080 and 120 hertz as well as plasma. We are very bullish and optimistic about supply and we think the supply will be adequate and it will be in line with industry forecasts. We continue to see consumer demand and consumer desire to purchase these products actually increasing as we go through the year with the Olympics and the holiday season coming, and the conversion to digital next February.
Michael Baker (Deutsche Bank): You were up high-single-digits this quarter. It is down from Q4 though but do you expect that will increase through the year partly because of the Olympics?
John J. Kelly: Yes and even towards the holiday season. The plan is very doable and we are optimistic about what’s happening in this business.
John T. Harlow: We’ve made fundamental changes on how our home entertainment department delivers against not only the vision but to build the top line. These changes relate to management, supervision, training and team-based incentives. We see the changes as being additive to the merchandising trends.
Michael Baker (Deutsche Bank): Do you think you can take back some market share because of your in-store improved performance?
John T. Harlow: Yes we do.
Michael Lasser (Lehman Brothers): Much focus has been on the in-store experience and you are pleased with the gains that made with improving the close rate. What are you doing to improve traffic and the draw rate?
John J. Kelly: We obviously had been using our movies and music departments to drive traffic. Now we’ve moved into some of the more commodity type of products, such as Flash media and other types of media, product-centric and PC accessories to drive traffic. You are seeing demand for that type of product as prices come down and it begins to enhance our ability to use those products as traffic drivers and use them out in the front covers and back covers of our task to drive people into the building to purchase these products and we can use that to offset what we see as a decline in music and movies.
John T. Harlow: Our plans and strategies this year focus on close rate and basket attach. We expect, in a tougher economy with declining industry trends in packaged media, to actually see less traffic.
Our first quarter was our toughest comp. It was also our toughest traffic comp for the year last year and we have aggressive promotional calendars throughout the year around all the holiday drive times, beginning with back-to-school later this summer.
But bottom line is most of the changes we’ve made are in the home entertainment side of our store. That’s roughly half of our company’s revenue and more than half the company’s profit. We are focused on optimizing those customers from a revenue and profit standpoint.
The other driver of traffic is virtually 100% comp store growth. We do very little outside of comp store. The web business also drives traffic to our stores. We had a disappointing performance in our web business. It wasn’t without some forethought. We left some computer business on the table intentionally that we just couldn’t see a way to make money on and there are some strategies as we move forward in the year to get our web business back up to historical comp rates. This implies 50% of that web traffic ending up in our stores.
Michael Lasser (Lehman Brothers): On the CapEx guidance, it was reduced by $10 million yet the store count for new store openings has not changed. Can you rectify where the difference is coming from?
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