Business context and reporting period
Best Buy Co., Inc. filed this unaudited Form 10-Q for the quarter ended August 3, 2013 (second quarter of fiscal 2014). It operates Domestic and International retail segments, selling consumer electronics, appliances and related services through stores and online channels. The business is seasonal, with a larger share of revenue and earnings typically generated in the holiday-season fourth quarter.
Results are presented on a continuing-operations basis after the June 26, 2013 sale of Best Buy’s 50% interest in Best Buy Europe to Carphone Warehouse Group plc (CPW). Prior periods were recast to classify Europe, Napster and certain China stores as discontinued operations. The six-month comparison is also affected by the prior year having 27 weeks versus 26 weeks in fiscal 2014.
Financial results and liquidity
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $9,300 | $9,339 | $18,680 | $19,712 |
| Gross profit | $2,469 | $2,261 | $4,639 | $4,845 |
| Gross margin | 26.5% | 24.2% | 24.8% | 24.6% |
| Operating income | $413 | $88 | $581 | $352 |
| Operating margin | 4.4% | 0.9% | 3.1% | 1.8% |
| Continuing-operations net earnings | $237 | $31 | $334 | $200 |
| Diluted EPS from continuing operations | $0.69 | $0.09 | $0.97 | $0.59 |
Q2 net earnings attributable to Best Buy shareholders were $266 million, including a $29 million net gain from discontinued operations; the comparable prior-year amount was $12 million. For the six months, shareholder net earnings were $185 million, including a $149 million loss from discontinued operations, versus $170 million including a $30 million discontinued-operations loss a year earlier.
- Revenue and comparable sales: Q2 revenue declined 0.4%; comparable sales declined 0.6%. Domestic comparable sales fell 0.4%, while International comparable sales fell 1.8%. Six-month revenue declined 5.2%, including the effect of one fewer week in fiscal 2014.
- Profit and margins: Q2 operating income rose by $325 million year over year, primarily due to LCD panel antitrust settlements and lower restructuring charges. The settlements contributed $264 million of gross proceeds, less $35 million of legal costs, or $229 million net in the company’s adjusted operating-income reconciliation. Q2 adjusted operating income was $206 million versus $181 million; adjusted diluted EPS was $0.32 versus $0.26. For the six months, adjusted operating income was $392 million versus $586 million, and adjusted diluted EPS was $0.65 versus $1.03.
- Cash flow: First-half operating cash flow was $19 million, compared with cash used of $222 million in the prior-year period. Investing activities used $203 million; financing activities provided $292 million. Cash increased $84 million to $1.910 billion.
- Balance sheet and liquidity: At August 3, cash was $1.910 billion, current assets were $9.414 billion and current liabilities were $7.028 billion; the current ratio was 1.3. Total debt, including current maturities, was $1.678 billion. The company reported no borrowings under its U.S. or International revolving facilities and was in compliance with financial covenants. Adjusted debt to EBITDAR was 2.9, unchanged from fiscal year-end; the company’s debt-to-trailing-net-earnings ratio was negative because trailing earnings were affected by a prior goodwill impairment.
- Capital allocation: First-half capital expenditures were $301 million and dividends paid were $116 million. The share-repurchase program remained suspended. The quarterly dividend was $0.17 per share.
Material changes versus the prior comparable period
- Q2 revenue was nearly flat, while comparable sales remained slightly negative. Domestic computing and mobile, appliances and services grew; consumer electronics and entertainment declined. Entertainment sales were affected by weaker gaming and movie demand ahead of new gaming platforms.
- Q2 gross margin improved by 2.3 percentage points, substantially reflecting the LCD settlements. Excluding those settlements, Best Buy reported a slight Domestic gross-margin decline, citing price investments and higher warranty costs, partly offset by improved product mix.
- Q2 restructuring charges fell to $7 million from $91 million. First-half charges fell to $13 million from $218 million.
- Domestic Q2 operating income increased to $420 million from $83 million. International reported a $7 million operating loss versus $5 million of income, amid lower revenue and gross margin despite lower SG&A.
- The sale of Best Buy Europe generated $526 million cash at closing, $123 million from the subsequent sale of CPW shares, and additional deferred consideration of £25 million plus interest due in each of 2014 and 2015. The six-month cash flow statement reports $67 million net proceeds from business sales, reflecting its cash-flow presentation and transaction timing.
Outlook, management commentary, risks and unusual items
- Management’s Renew Blue priorities include online growth, improving the multichannel customer experience, optimizing store space, reducing cost of goods sold through supply-chain efficiencies, optimizing U.S. real estate and lowering SG&A. Management reported Domestic comparable online sales growth of 10.5%, a customer Net Promoter Score improvement of more than 300 basis points, and estimated annualized cost reductions of $390 million to date.
- Management expected further pricing and SG&A investments in the second half of fiscal 2014, including price competitiveness, mobile marketing, multichannel improvements, store-space optimization and website re-platforming. It anticipated some offset from core-business improvement and cost savings. No specific full-year revenue or earnings guidance is provided in the filing text.
- Management expected pressure in the third and fourth quarters from elevated claims frequency on legacy Geek Squad protection programs and less favorable economics for the private-label credit-card program following its transfer from Capital One to Citibank.
- Risks include uncertain consumer confidence and discretionary spending, intense competition and pricing pressure, product life cycles and new-product adoption, execution of cost savings and restructuring, foreign-exchange movements, and access to financing. Moody’s outlook was Negative; Fitch and S&P had Stable outlooks. The company noted that credit-rating changes could affect borrowing costs and access to capital.
- Unusual items include the $229 million net LCD settlement benefit in Q2 operating results, a $175 million impairment of the Best Buy Europe investment during the first quarter, and significant Europe restructuring and asset-impairment charges reported in discontinued operations.
- Legal matters include securities litigation with potential losses not estimable from the filing, and an appealed trade-secrets judgment and awards totaling $33 million. A post-quarter jury verdict in the LCD case found $7.5 million in damages against one defendant; Best Buy said it did not expect additional receipts beyond settlements already reached.
Important facts for investors to verify
- How much of reported Q2 earnings and margin improvement is attributable to the LCD settlements rather than recurring retail operations; compare GAAP results with the company’s adjusted measures.
- Whether Renew Blue cost reductions and online growth can offset price investment, warranty claims and the less favorable credit-card agreement economics.
- Trends in Domestic and International comparable sales, gross margins and International operating losses, accounting for the prior-year extra week and discontinued-operations recast.
- Cash conversion and working-capital movements, including the timing and collection of LCD settlement receivables and deferred Best Buy Europe consideration.
- Debt, lease-adjusted leverage, credit ratings and facility availability, along with developments in the securities and trade-secrets litigation.