Business Context and Reporting Period
Company: Best Buy Co., Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 25, 2006 (Fiscal Third Quarter 2007)
Business Overview: Best Buy is a specialty retailer of consumer electronics, home-office products, entertainment software, appliances, and related services. Operations are divided into two segments: Domestic (U.S.) and International (Canada and China). The period includes the impact of two major acquisitions: Pacific Sales Kitchen and Bath Centers (acquired March 2006) and a 75% interest in Jiangsu Five Star Appliance Co., Ltd. (acquired June 2006).
Key Financial Metrics
| Metric ($ in millions, except per share) | Three Months Ended Nov 25, 2006 |
Three Months Ended Nov 26, 2005 |
Nine Months Ended Nov 25, 2006 |
Nine Months Ended Nov 26, 2005 |
|---|---|---|---|---|
| Revenue | $8,473 | $7,335 | $23,035 | $20,155 |
| Gross Profit | $1,995 | $1,788 | $5,662 | $5,057 |
| Gross Margin % | 23.5% | 24.4% | 24.6% | 25.1% |
| Operating Income | $196 | $189 | $863 | $689 |
| Net Earnings | $150 | $138 | $614 | $496 |
| Diluted EPS | $0.31 | $0.28 | $1.24 | $0.99 |
| Cash from Operations (9mo) | $257 (2006) vs $380 (2005) | |||
| Total Cash & Short-term Investments | $2,715 (as of Nov 25, 2006) | |||
| Total Debt (Current + Long-term) | $650 (as of Nov 25, 2006) |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 16% in the quarter and 14% for the nine-month period. Growth was driven by new store openings (approx. 40% of increase), comparable store sales gains (4.8% in the quarter), and acquisitions (Five Star and Pacific Sales).
- Margin Compression: Gross profit rate decreased to 23.5% (from 24.4% prior year) due to a more promotional environment, a shift to lower-margin products (notebooks, gaming), and the inclusion of Five Star's lower-margin model. SG&A rate improved to 21.2% (from 21.8%) due to revenue leverage and productivity gains.
- Segment Performance:
- Domestic: Revenue up 11%; Operating income down to $186M (from $198M) due to gross margin decline, though SG&A rate improved.
- International: Revenue up 51%; Operating income turned positive to $10M (from a $9M loss) driven by Five Star revenue and SG&A leverage.
- Acquisitions: Pacific Sales contributed $77M in revenue for the quarter. Five Star contributed $217M in revenue for the quarter (consolidated on a two-month lag).
Guidance, Outlook, and Risks
- Capital Expenditures: Management expects fiscal 2007 capital expenditures to be between $750 million and $800 million (excluding acquisitions), an increase from the prior estimate of $675M-$725M, reflecting expanded home theater investments and the Shanghai store.
- Outlook: The company plans to issue a news release on January 5, 2007, regarding revenue for the fiscal month and ten months ended December 30, 2006, and will comment on the outlook for the remainder of fiscal 2007 (which includes a 53rd week).
- Debt Reclassification: $402 million of convertible debentures were reclassified from long-term to short-term debt as holders may require repurchase on January 15, 2007.
- Risks & Contingencies:
- Legal: A class action lawsuit regarding alleged discrimination (Jasmen Holloway, et al. v. Best Buy Co., Inc.) is pending; management intends to defend vigorously.
- Market Risk: Exposure to foreign currency fluctuations (Canada/China) and interest rate changes on investments. A 10% adverse currency change is not expected to have a significant impact.
- Accounting Changes: Adoption of FSP No. FAS 123(R)-3 regarding tax effects of stock-based compensation resulted in cash flow reclassifications but no impact on net earnings.
Investor Verification Checklist
- Inventory Levels: Verify the sustainability of the $6.08 billion inventory balance (up significantly from $3.34 billion at the start of the fiscal year) and its impact on future cash flow.
- Debt Maturity: Confirm the status of the $402 million convertible debentures due for potential repurchase in January 2007 and the company's liquidity plan to address this.
- Acquisition Integration: Monitor the integration progress and margin performance of Five Star (China) and Pacific Sales (U.S.) to ensure they meet accretive expectations.
- Comparable Store Sales: Track the 4.8% comparable store sales gain to determine if it is driven by volume or price, given the noted decline in average selling prices for key categories like flat-panel TVs.
- Legal Exposure: Review updates on the pending class action lawsuit regarding employment discrimination.