Business context and reporting period
Best Buy Co., Inc. is a multinational retailer of consumer electronics and related services, including Geek Squad. This unaudited Form 10-Q covers the quarter ended November 2, 2013 (fiscal 2014 Q3) and the first nine months of fiscal 2014. The company reports Domestic and International segments. Best Buy Europe was sold on June 26, 2013, and is presented as discontinued operations.
Comparability is affected by the fiscal calendar: the first nine months of fiscal 2014 included 39 weeks versus 40 weeks in the prior-year period. Best Buy also cautions that its fourth quarter, which includes most holiday-season sales, is typically its largest.
Financial performance and position
| Metric | Fiscal 2014 Q3 | Prior-year Q3 | Fiscal 2014 first nine months | Prior-year first nine months |
|---|---|---|---|---|
| Revenue | $9.362 billion | $9.381 billion | $28.042 billion | $29.093 billion |
| Gross profit | $2.170 billion | $2.228 billion | $6.809 billion | $7.073 billion |
| Gross margin | 23.2% | 23.8% | 24.3% | 24.3% |
| SG&A | $2.048 billion | $2.192 billion | $6.093 billion | $6.467 billion |
| Operating income | $91 million | $2 million | $672 million | $354 million |
| Net earnings attributable to Best Buy shareholders | $54 million | Loss of $10 million | $239 million | $160 million |
| Diluted EPS | $0.16 | Loss of $0.03 | $0.69 | $0.47 |
Q3 diluted EPS from continuing operations was $0.12, versus a loss of $0.03. Nine-month diluted EPS from continuing operations was $1.09, versus $0.56. The nine-month result includes a $264 million gross LCD-panel antitrust settlement benefit recorded in cost of goods sold, partly offset by $35 million of related legal expenses in SG&A; adjusted measures exclude the net settlement effect.
Q3 comparable sales rose 0.3% overall, including 1.7% growth in Domestic and a 6.4% decline in International. Domestic gains in computing/mobile phones and appliances contrasted with sharp declines in entertainment and consumer electronics. International results were pressured by weak demand, Canadian mobile-phone inventory constraints, promotions, and currency translation. The International segment reported an operating loss of $20 million for Q3 and $81 million for the first nine months.
For the first nine months, operating cash flow was $324 million, compared with cash used of $121 million in the prior-year period. Investing activities used $315 million and financing activities provided $359 million. Cash and cash equivalents were $2.170 billion at quarter-end, versus $1.826 billion at fiscal year-end and $309 million a year earlier. Management attributed the year-over-year cash increase principally to operating cash generation and proceeds from the Europe sale.
At November 2, 2013, total debt was $1.669 billion, including $45 million current and $1.624 billion long-term; no short-term facility debt was outstanding. Cash exceeded reported debt by approximately $501 million, before considering restricted cash of $315 million. The current ratio was 1.3. Adjusted debt to EBITDAR, which capitalizes operating leases using the company’s methodology, was 2.8, versus 2.6 a year earlier. The company issued $500 million of 5.00% notes due 2018 and retired $500 million of notes that matured in July.
Material changes and unusual items
- Q3 operating income increased by $89 million year over year, mainly due to lower SG&A from Renew Blue cost reductions and tighter expense management; this improvement occurred despite a 0.6 percentage-point decline in gross margin.
- Nine-month operating income increased to $672 million from $354 million, reflecting lower SG&A, lower restructuring charges, and the LCD settlement benefit. The prior-year comparison included an extra operating week.
- The company completed the sale of its 50% interest in Best Buy Europe. Consideration included net cash of £341 million ($526 million), CPW shares subsequently sold for $123 million, and deferred payments. Nine-month discontinued operations attributable to shareholders recorded a loss of $138 million, including Europe-related impairment and restructuring effects.
- Fiscal 2014 restructuring charges were $44 million in continuing operations for the first nine months, including $52 million of Renew Blue charges offset by reductions from prior restructuring programs. An additional $100 million of charges related to Europe was classified in discontinued operations.
- The company recognized $16 million of investment impairments in continuing operations and a $175 million impairment of its Europe investment as part of the sale accounting.
Outlook, management commentary, and risks
Management said Renew Blue progress included 15.1% growth in Domestic comparable online sales, a nearly 400-basis-point improvement in Net Promoter Score, and $505 million in annualized cost reductions against a previously announced $725 million target. The company planned to continue its online, multichannel, pricing, store-space, supply-chain, and cost initiatives. No specific full-year earnings or revenue guidance is provided in the supplied filing text.
For fiscal 2014 Q4, management anticipated a competitive holiday environment and increased promotions, with potential pressure on gross margin from price investments. It also identified $150 million to $200 million of incremental fiscal 2014 Renew Blue SG&A investments, higher mobile-phone warranty costs, and less favorable private-label credit-card economics as expected headwinds. Management expected cost savings to substantially offset these costs and investments, but said holiday results remained difficult to predict.
Principal risks include consumer confidence and discretionary spending, intense competition and pricing, product availability and technology cycles, execution of cost reductions and restructuring, foreign-exchange movements, credit-market conditions, and the ability to access financing on acceptable terms. Moody’s rating was Baa2 with a Negative outlook; Fitch rated the company BB- Stable and S&P BB Stable. The company reported compliance with credit-facility covenants and no outstanding borrowings under its facilities at December 4, 2013.
Legal matters include securities litigation for which the company says reasonably possible losses cannot be estimated, and a trade-secrets case with a $22 million jury award, $5 million exemplary damages, and $6 million in attorney fees and costs; Best Buy appealed. In its LCD antitrust case, a jury awarded $7.5 million against a remaining defendant, but the company did not expect additional amounts beyond prior settlements. Management stated disclosure controls were effective and no material change in internal control occurred during the quarter.
Important facts for investors to verify
- Whether Domestic comparable-sales growth and Renew Blue cost savings can continue, and whether the $725 million annualized cost-reduction target is achieved.
- Whether holiday promotions, mobile warranty claims, credit-card economics, and planned investments materially reduce gross margin or offset cost savings.
- The sustainability of operating cash flow and liquidity, including collection of the remaining $127 million in LCD settlement receivables and the terms and availability of credit facilities.
- The effect of the Europe divestiture and related discontinued-operation charges on ongoing results, and the final outcomes of the securities and trade-secrets litigation.
- Comparability of year-over-year results given the extra week in the prior-year nine-month period and the classification of Europe as discontinued operations.