Best Buy Co., Inc. — Q3 FY2015 Form 10-Q
Reporting period: Three and nine months ended November 1, 2014. Best Buy is a multinational, multichannel retailer of technology products and services, reporting Domestic and International segments. Results are seasonal, with a larger share of revenue and earnings typically in the fourth quarter.
Financial performance
- Q3 revenue: $9.38 billion, up 0.6% year over year; comparable sales rose 2.2%. Domestic revenue increased 2.3%, while International revenue fell 8.4%.
- Q3 profitability: Gross profit was $2.13 billion (22.7% of revenue), versus $2.16 billion (23.1%) a year earlier. SG&A declined to $1.93 billion (20.6% of revenue) from $2.04 billion (21.8%). Operating income rose to $190 million from $90 million; operating margin was 2.0%, versus 1.0%.
- Q3 earnings: Continuing-operations net earnings attributable to Best Buy shareholders were $107 million, or $0.30 diluted EPS, compared with $43 million, or $0.12, excluding prior-year discontinued-operations earnings. Non-GAAP diluted EPS from continuing operations was $0.32 versus $0.18.
- First nine months: Revenue was $27.31 billion, down 2.3%; comparable sales declined 0.8%. Operating income was $625 million versus $671 million. Continuing-operations net earnings attributable to shareholders were $714 million versus $377 million; diluted EPS was $2.02 versus $1.09. Non-GAAP diluted EPS was $1.09 versus $0.83.
- Cash flow and investment: Nine-month operating cash flow was $774 million, versus $324 million. Capital expenditures were $425 million. Investing activities used $1.34 billion, primarily reflecting $2.07 billion of investment purchases, partly offset by investment sales. Cash and equivalents were $1.93 billion at quarter-end; short-term investments were $1.21 billion.
- Debt and liquidity: Long-term debt, including current maturities, was $1.64 billion. The company had no borrowings under its $1.25 billion five-year revolving facility and reported compliance with its financial covenants. Current ratio was 1.4; non-GAAP debt to EBITDAR was 3.1.
Material changes and management commentary
- Q3 operating-income improvement chiefly reflected Renew Blue cost savings, tighter expense control and Domestic comparable-sales growth, partly offset by lower gross margin. Renew Blue cost reductions reached $965 million toward a $1 billion target; the company eliminated an additional $65 million in annualized costs during the quarter.
- Domestic comparable sales increased 3.2% (2.4% excluding the estimated 0.8 percentage-point effect from mobile installment-plan revenue classification). Domestic online comparable sales grew 21.6%. Services comparable sales declined 10.3%, including lower mobile repair revenue and lower attachment rates.
- International comparable sales declined 3.0%; segment revenue was pressured by foreign exchange, store closures and weaker sales. The segment continued to report an operating loss, although the loss narrowed year over year.
- For the first nine months, lower reported gross profit partly reflected the absence of prior-year LCD legal settlements. The company received $314 million of such settlements in the prior-year period cited in the segment discussion ($264 million in Q2 and $50 million in Q1).
- Q3 tax expense was $69 million. The nine-month tax benefit of $133 million included a $353 million noncash benefit from a tax election involving a U.K. subsidiary and related intangible tax basis. Excluding that benefit, the company reported a 37.9% effective tax rate for the nine-month period.
Outlook, risks and unusual items
- Q4 outlook: Management expected near-flat year-over-year revenue and comparable sales, assuming consumer-electronics category declines were in line with Q3; an improved gross-profit rate; and flat SG&A. The expected net result was approximately 0.5 percentage-point year-over-year expansion in the Q4 non-GAAP operating-income rate. This was an outlook, not a guarantee.
- Management cited promotional competition, product availability constraints, possible West Coast port delays, lower-margin product and online-channel mix, incentive compensation, and increased customer-facing investments as factors that could pressure operating income.
- The accelerated tax benefit will not recur; management expected the higher tax rate going forward and estimated known discrete tax items would reduce Q4 diluted EPS year over year by $0.09 to $0.10.
- On December 3, 2014, Best Buy agreed to sell Five Star and exit its China retail business, subject to conditions including regulatory approval. Closing was expected in Q1 FY2016; the company did not expect a material financial impact and anticipated held-for-sale/discontinued-operations treatment beginning Q4 FY2015.
- A securities class action related to historical earnings guidance had been certified; Best Buy was pursuing an interlocutory appeal. The company said it intended to defend the case and that reasonably possible losses could not be estimated. Other ordinary-course legal proceedings were not expected to have a material effect.
- Key business risks include consumer demand and confidence, intense price competition, product cycles and supply, foreign exchange, tax outcomes, cost-reduction execution, and seasonal holiday performance.
Important facts for investors to verify
- Whether Q4 sales and margin expectations were achieved, particularly given holiday promotions, supply constraints and port delays.
- Underlying sales and profitability after accounting for mobile installment-plan revenue classification and the prior-year LCD settlement comparison.
- Recurring earnings and cash taxes after the one-time $353 million tax benefit, including the stated Q4 EPS tax headwind.
- Progress toward the $1 billion Renew Blue cost-reduction target and whether savings can offset pricing and investment pressures.
- Developments in the securities litigation and completion, timing and accounting treatment of the Five Star sale.