Best Buy Co., Inc. — Q3 FY2017 Form 10-Q
Reporting period: Third quarter and first nine months ended October 29, 2016; the nine-month periods each comprised 39 weeks. Best Buy operates Domestic and International segments and notes that results are seasonal, with a higher share of revenue and earnings typically in the holiday-season fourth quarter.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Revenue | $8.945 billion | $8.819 billion | $25.921 billion | $25.905 billion |
| Comparable sales | +1.8% | +0.8% | +0.8% | +1.7% |
| Gross margin | 24.6% | 23.9% | 24.7% | 24.1% |
| Operating income | $312 million | $230 million | $973 million | $604 million |
| Operating margin | 3.5% | 2.6% | 3.8% | 2.3% |
| Continuing-operations net earnings | $192 million | $129 million | $600 million | $330 million |
| Diluted EPS from continuing operations | $0.60 | $0.37 | $1.85 | $0.93 |
Q3 total net earnings were $194 million, including $2 million from discontinued operations; nine-month total net earnings were $621 million, including $21 million from discontinued operations. Management reported non-GAAP diluted EPS from continuing operations of $0.62 for Q3 versus $0.41, and $1.63 for the nine months versus $1.27. These adjusted figures exclude specified items, including CRT settlement proceeds and restructuring and impairment charges.
- Segments: Domestic Q3 revenue rose 1.3% to $8.192 billion, with operating income of $298 million versus $244 million. Domestic comparable online sales grew 24.1%; online revenue was 10.8% of segment revenue. International Q3 revenue grew 3.3% to $753 million (4.0% in constant currency), and operating income was $14 million versus a $14 million loss. International nine-month revenue declined 1.8% reported, but grew 2.3% in constant currency.
- Cash flow: Nine-month operating cash flow was $1.395 billion versus $463 million; capital expenditures were $445 million versus $493 million. Investing activities used $856 million and financing activities used $1.187 billion. Cash and cash equivalents declined $635 million to $1.341 billion.
- Liquidity and debt: Cash plus short-term investments totaled $3.118 billion. Current assets were $11.021 billion and current liabilities $8.166 billion; the reported current ratio was 1.3. Total debt, including lease obligations, was $1.367 billion. Best Buy had repaid its $350 million 2016 notes in March and had a $1.25 billion revolving facility with no borrowings outstanding and the full amount available, subject to covenants. The company reported compliance with its financial covenants.
- Capital returns: Best Buy repurchased 16.0 million shares for $528 million in the first nine months; approximately $2.5 billion remained authorized. It paid $417 million in dividends in the period; the regular quarterly rate was $0.28 per share.
Material changes and unusual items
- Q3 revenue increased 1.4% year over year and comparable sales accelerated to 1.8%. Gross margin improvement helped lift operating income; lower restructuring costs also supported year-over-year comparisons, particularly over the nine-month period.
- In the first nine months, Best Buy recognized $161 million net from CRT antitrust settlements. The settlements were recorded in cost of goods sold and boosted reported Domestic results; the company excludes them from its non-GAAP measures. It had received $127 million and expected to receive the remaining $34 million by January 2017 or earlier. The matter was described as resolved.
- Nine-month restructuring charges fell to $30 million from $189 million, largely because the prior-year period included Canadian brand-consolidation charges. Current-year charges included $26 million for Renew Blue Phase 2. Management said it had achieved $300 million of annualized cost reductions and gross-profit optimization toward a $400 million target by the end of FY2018.
- Q3 included $8 million of non-restructuring property and equipment impairments. Discontinued-operations results included a $16 million after-tax gain from the May 2016 sale of a Shanghai property associated with the prior sale of Five Star.
Outlook, management commentary and risks
- Management expected the impact of highly publicized mobile-phone and appliance recalls to be more material in Q4 than in Q3, because the Q4 impact would cover the full quarter. The Galaxy Note 7 was recalled and no longer produced or sold; appliance recalls and shipping delays also constrained inventory late in Q3.
- Management expected to maintain flat SG&A for FY2017 while improving customer experience. It emphasized online growth, home theater and emerging categories, service initiatives, and cost reduction. The filing does not provide a clear numerical full-year revenue or EPS forecast in the text provided.
- Management said available liquidity and operating cash flow were expected to fund operations, planned investment, dividends and repurchases, but cautioned that future cash generation and access to borrowing cannot be assured. Key disclosed risks include consumer demand and preferences, competition and promotions, vendor and product availability, recalls, foreign exchange, cost-reduction execution, supply-chain disruption, labor, data-system risks, and tax matters.
- A securities class action relating to fiscal 2011 guidance remained pending; the appellate court reversed class certification, and the plaintiffs did not seek Supreme Court review. Best Buy disputed the allegations; potential loss, if any, could not be estimated. Other legal matters were not expected by management to have a material effect.
- The company adopted a new $1.25 billion five-year revolving facility, expiring in June 2021. Credit ratings disclosed in the filing were BBB-/Stable from S&P and Fitch and Baa1/Stable from Moody’s. Adoption of the new leases accounting standard was expected to materially increase reported assets and liabilities; the overall impact remained under evaluation.
Most important facts for investors to verify
- How much of reported earnings and margin improvement reflects recurring operations versus the $161 million CRT settlement, asset impairments, restructuring and discontinued-operation gains.
- Whether holiday-quarter sales and margins withstand the anticipated full-quarter effects of product recalls, inventory constraints and competitive promotions.
- Whether strong operating cash flow is sustainable, given management’s explanation that inventory payment timing and working-capital movements materially affected the year-over-year comparison.
- How continued share repurchases and dividends affect cash, share count and financial flexibility, especially alongside seasonal inventory requirements.
- Progress against the $400 million Renew Blue Phase 2 target and the potential balance-sheet effect of forthcoming lease-accounting changes.