Best Buy Co., Inc. — Q2 FY2016 Form 10-Q
Business context and reporting period. The quarter ended August 1, 2015; comparisons are with the quarter ended August 2, 2014. Best Buy operates Domestic and International segments and notes that results are seasonal, with a larger share of revenue and earnings typically generated in the holiday quarter. The International segment includes Canada and Mexico. Five Star, Best Buy’s China business, was sold in February 2015 and is reported as discontinued operations.
Key financial metrics
| Metric | Q2 FY2016 | Q2 FY2015 | First six months FY2016 | First six months FY2015 |
|---|---|---|---|---|
| Revenue | $8.528 billion | $8.459 billion | $17.086 billion | $17.098 billion |
| Operating income | $288 million | $225 million | $374 million | $435 million |
| Operating margin | 3.4% | 2.7% | 2.2% | 2.5% |
| Continuing-operations net earnings | $164 million | $137 million | $201 million | $606 million |
| Diluted continuing-operations EPS | $0.46 | $0.39 | $0.57 | $1.73 |
| Operating cash flow | Not separately reported for quarter | Not separately reported for quarter | $308 million | $487 million |
Q2 gross profit was $2.098 billion, or 24.6% of revenue, versus $1.978 billion and 23.4% a year earlier. SG&A was $1.811 billion (21.2% of revenue), compared with $1.748 billion (20.7%). Q2 diluted non-GAAP continuing-operations EPS was $0.49 versus $0.42. For the first six months, non-GAAP diluted EPS was $0.86 versus $0.77.
At August 1, 2015, cash and cash equivalents were $1.800 billion and short-term investments were $1.695 billion. Total debt was $1.609 billion, including $382 million classified as current, principally the $350 million notes due March 15, 2016. Current assets were $10.245 billion and current liabilities $6.838 billion; the reported current ratio was 1.5. The $1.25 billion revolving credit facility had no borrowings outstanding, and Best Buy reported compliance with its financial covenants. Six-month capital expenditures were $293 million.
Material changes versus the prior comparable period
- Q2 revenue rose 0.8%; comparable sales increased 3.8%, or 2.7% excluding the estimated effect of mobile installment billing classification. Domestic revenue rose 3.9%, while International revenue fell 25.6%.
- Domestic operating income increased to $309 million from $258 million; International posted an operating loss of $21 million versus $33 million. The International decline reflected the Canadian store and brand consolidation, currency effects and softness in Canada.
- First-half operating income declined to $374 million from $435 million, primarily because of $182 million in restructuring charges, including the Canadian consolidation. First-half results also included $75 million of net CRT litigation settlement proceeds, which benefited operating income.
- First-half continuing-operations net earnings fell sharply from $606 million to $201 million. The prior-year period included a $353 million discrete tax benefit from reorganizing European legal entities; without that benefit, the prior-year effective tax rate would have been 36.8%.
- First-half net earnings attributable to Best Buy shareholders included a $92 million gain from discontinued operations, principally the $99 million gain on the Five Star sale. Cash and short-term investments declined from $3.888 billion at fiscal year-end to $3.495 billion, mainly reflecting share repurchases and dividends, partly offset by operating cash generation.
- Best Buy repurchased 9.5 million shares for $324 million during the first six months and paid $341 million in dividends, including a special dividend. Q2 regular dividend was $0.23 per share, versus $0.17 a year earlier.
Outlook, management commentary and risks
- For Q3 FY2016, management expected Domestic revenue growth ranging from flat to low single digits and an approximately flat Domestic operating-income rate. International revenue was expected to decline approximately 30%, with a non-GAAP operating-income rate of negative 2.5% to negative 3.5%.
- Enterprise Q3 outlook was flat to negative low-single-digit revenue growth and operating-income-rate change ranging from flat to negative 20 basis points. Management cited continuing Canadian consolidation effects, currency, inflation and growth investments. It expected a 39%–40% non-GAAP continuing-operations tax rate and estimated a $0.01 per-share year-over-year tax impact.
- The Canadian consolidation closed 66 Future Shop stores and converted 65 others to Best Buy. First-half related restructuring charges were $184 million; total expected pre-tax charges, including other costs and impairments, were $200 million–$280 million, of which approximately $140 million–$180 million were expected to be cash charges. Management expected substantial completion in FY2016, while some vacated-store lease payments would continue.
- Management said Renew Blue had eliminated $100 million in annualized costs toward a $400 million three-year cost-reduction goal, while expected FY2016 growth investments were approximately $120 million. It cited Domestic comparable-sales gains, including online growth, appliances and large-screen televisions, but noted continued services revenue pressure from lower extended-warranty claims and declining traditional warranty sales.
- Key stated risks include consumer spending and confidence, competition and promotional pricing, product cycles and availability, foreign-exchange movements, execution and costs of restructuring and growth initiatives, supply-chain disruption, cybersecurity and data protection, and tax uncertainty.
- Best Buy disclosed securities litigation tied to historical earnings guidance; it said reasonably possible losses could not be estimated and that it intended to defend the claims. The company received $75 million net from CRT settlements in the first half, but further recovery was uncertain. Other proceedings were not expected by management to materially affect the company.
- After quarter-end, S&P, Moody’s and Fitch upgraded Best Buy’s long-term ratings, each with a Stable outlook. Management cautioned that ratings may change and could affect borrowing costs, capital access, vendor financing and leasing costs.
Most important facts for investors to verify
- Whether Domestic sales and margin improvement persist after adjusting for installment-billing effects, CRT settlement proceeds and other non-recurring items.
- Actual total cash and earnings costs of the Canadian consolidation, its execution timeline, and the trajectory of International revenue and operating losses.
- Whether operating cash flow recovers from the first-half year-over-year decline and how liquidity is managed around the $350 million notes due in March 2016.
- Progress toward Renew Blue cost savings and the returns from planned growth investments, including online and services initiatives.
- Developments in securities litigation and any additional CRT settlements, for which the filing says outcomes or recoveries cannot be assured.