Company Plans For Challenging Environment, Reduces Fiscal 2010 Spending Plans
“The historic slowdown in the economy and its effect on our business over the past 90 days have been the most challenging consumer environment our company has ever faced,” said Brad Anderson, vice chairman and CEO of Best Buy. “We believe that there has been a dramatic and potentially long-lasting change in consumer behavior as people adjust to the new realities of the marketplace. We also believe that customers will continue to reward those retailers who understand their needs and desires, and offer relevant solutions at fair prices. Yet we clearly recognize that these changes require us to make significant adjustments to our present cost structure.”
Best Buy announced that effective Dec. 15, 2008, nearly all of its corporate employees are eligible for a voluntary separation package in order to reduce its corporate expenses significantly. This package provides an incentive for employees who choose to leave the company by offering a significant increase in the company’s base severance offer. Vice Chairman and CEO Brad Anderson and his direct reports, who recommended the package, are not eligible for the voluntary separation plans. The company also stated that involuntary reductions in corporate staff may be required, depending on the outcome of the voluntary program.
“We view our employees as the primary strength of this organization,” added Anderson. “However, based on the recent changes we’ve seen in consumer behavior and the potential for worsening consumer spending, we need to prepare our organization to operate in a wide range of potential macro economic scenarios in the coming year. Additional prudent actions will be taken to prepare the business, such as reducing our capital spending by approximately 50 percent next year, including a substantial reduction in new store openings in the United States, Canada and China. We also are reducing legacy expenses in our model as quickly as we can without affecting the customer’s shopping experience. In the current year, SG&A spending, excluding Best Buy Europe, is expected to grow approximately 9 percent; in contrast, we are planning for SG&A dollars next year to grow by no more than 2 percent over this year’s levels. To bring our cost structure to that level, our efforts have to include savings in corporate staffing. We want to do it in such a way as to minimize involuntary separations. We believe our broad, voluntary program helps prepare us for the unpredictable year ahead while reflecting our company values and respect for our people.”
The costs and future savings associated with the anticipated reduction in force during the fourth quarter and other potential actions to shed costs have not yet been finalized and therefore are excluded from the company’s earnings guidance until more information is available.
Third-Quarter Highlights
While the company continues to prepare for the difficult period ahead, it recognized several successes in the most recent quarter:
- The company estimated that its domestic market share in the calendar third quarter continued to grow, increasing by 1.7 percentage points compared with the prior year’s period, driven by strong execution by employees. The market share gains included strong performance in computing and televisions.
- The company’s domestic customer satisfaction scores continued to set record highs. U.S. employee turnover also decreased on a year-over-year basis, to 45 percent, as the company continued its focus on using employee insights to drive local growth.
- Best Buy expanded its service offerings by adding Geek Squad Black Tie Protection service to all U.S. Best Buy stores during the quarter. Geek Squad Black Tie Protection is a premium assurance offer that combines the features of extended warranties with other benefits, such as enhanced service levels and Reward Zone points for unused warranties. The domestic segment generated a low single-digit comparable store sales gain in its warranty category for the third quarter by offering this premium service.
- The international business brought the Best Buy Mobile store-within-a-store concept to select Best Buy locations in Canada and enhanced the wireless experience in select Future Shop stores.
- The company ended the quarter with a successful Black Friday and kickoff to the holiday selling season, marked by a strong consumer response, effective promotions and outstanding in-store execution. As a result of weeks of preparation, both customers and employees provided positive feedback on this shopping tradition.
“I am proud of the performance of our people in an environment marked by unprecedented economic turmoil,” said Brian Dunn, president and chief operating officer of Best Buy. “We continued to gain market share, improve gross profits, manage our costs and bring down our domestic inventory levels despite volatile consumer demand. We have some tough choices to make in response to the turbulent conditions our customers are facing, but our recent revenue performance versus the industry reinforces our commitment to our long-term strategy of helping people unlock the promises of technology.”
Third Quarter Brings Improved Gross Profit Rate
For the fiscal 2009 third quarter, Best Buy’s revenue increased 16 percent to $11.5 billion, compared with revenue of $9.9 billion for the third quarter of fiscal 2008. The revenue increase reflected the inclusion of Best Buy Europe’s revenue, which is reported on a two-month lag, and gains from the net addition of 181 new stores in the past 12 months. These revenue gains were offset by a comparable store sales decline of 5.3 percent and the unfavorable impact of foreign currency fluctuations. Excluding Best Buy Europe, total fiscal third-quarter revenue declined modestly versus the prior year period.
The comparable store sales decline for the third quarter was driven by a decrease in customer traffic and an unfavorable calendar shift, as the quarter had seven fewer post-Thanksgiving shopping days than the prior year’s period. By month, domestic comparable store sales declined by 2.4 percent, 7.8 percent and 8.7 percent for fiscal September, October and November, respectively. The company estimates that November’s comparable store sales in the domestic segment were essentially flat after adjusting for the calendar shift. Partially offsetting the decline in traffic was an increase in the average ticket for the quarter as the company’s revenue mix continued to shift toward large-ticket items, such as notebook computers and mobile phones.
The gross profit rate for the fiscal third quarter was 24.9 percent of revenue, compared with 23.5 percent of revenue for the prior-year period. This improvement was driven by the inclusion of Best Buy Europe, which predominantly features sales of higher-margin mobile phones. The improvement was also fueled by higher gross profit rates in the domestic business due to rate improvements in nearly all key product categories, partially offset by an unfavorable mix shift to notebook computers, which carry a lower gross profit rate. The company commented that the promotional environment was largely similar to what the company expected for the period.
Best Buy’s selling, general and administrative (SG&A) expense rate increased to 22.5 percent of revenue for the fiscal third quarter, compared with 20.0 percent of revenue for the prior year’s fiscal third quarter. The inclusion of Best Buy Europe’s higher-cost model for selling mobile phones contributed to the increase. Deleverage of expenses associated with the comparable store sales decline also prompted the change. Partially offsetting those factors, SG&A expense benefited from lower incentive compensation due to the company’s expected earnings performance. As planned, the company also actively lowered spending in discretionary areas and met its expectations for cost reductions in the period. Key areas of cost savings in the third quarter were a reduction in the hiring of seasonal staff, as well as reductions in advertising, discretionary store and corporate projects, and consulting expenses.
The company reported investment expense of $3 million, compared with $32 million of investment income for the prior year’s fiscal third quarter. The expected reduction in investment income reflected the impact of lower average cash and investment balances. Interest expense grew to $35 million, versus $23 million in the prior year’s quarter, primarily reflecting financing costs related to debt incurred in connection with the purchase of Best Buy Europe.
Best Buy’s effective tax rate increased to 54.6 percent for the third quarter of fiscal 2009, compared with 35.6 percent for the third quarter of the prior fiscal year, an increase of 19 percentage points. The increase in the company’s effective tax rate versus the prior year’s period was due primarily to the limited tax benefit from the investment impairment charge. Excluding the impairment charge, the effective tax rate for the fiscal third quarter was 36.5 percent.
The company’s merchandise inventory increased 10 percent year over year, to $8.2 billion. The increase primarily reflected the addition of inventory from Best Buy Europe and new store openings in the U.S. and other countries. Starting in September, the company began adjusting its domestic inventory position as consumer spending abruptly softened. Domestic inventory finished the third quarter essentially flat to last year on a comparable store basis, which was a significant improvement versus the end of the second quarter.
Market Conditions Drive Impairment Charge
In the second quarter of fiscal 2008, Best Buy purchased nearly 3 percent of the outstanding shares of CPW common stock, reflecting its continued relationship with CPW. Due to the duration and significance of the decline in the fair value of the investment, coupled with recent turmoil in the global financial markets, the company cannot reasonably predict the timeframe as to when the investment will return to its original cost. This noncash impairment charge reflects the current (Nov. 29, 2008) market price for CPW’s stock and does not reflect Best Buy’s own outlook on the intrinsic or strategic value of CPW’s business, or its long-term expectations for the Best Buy Europe venture.
Company Maintains Annual EPS Outlook, Excluding Investment Impairment Charge
Jim Muehlbauer, Best Buy’s executive vice president of finance and CFO, said, “While the environment is clearly challenging, we are satisfied with the reductions in discretionary spending we made in the quarter. However, we realize that there is much more work to do to position our business for the near-term challenges ahead. We will continue to evaluate every aspect of our business to prepare for the range of potential outcomes that we could see in fiscal 2010.”
The company stated that results in the third quarter were modestly ahead of its revised expectations based on stronger performance over the Thanksgiving holiday weekend. While post-Thanksgiving revenue trends have slowed further as expected, the company anticipates a December comparable store sales decline within the company’s previously announced guidance. The company maintained its guidance range for fiscal 2009 of earnings per diluted share of $2.30 to $2.90, excluding the investment impairment charge. This guidance now assumes an annual comparable store sales decline of 1 percent to 5 percent. Furthermore, the company estimated an annual gross profit rate improvement of approximately 60 basis points, compared with fiscal 2008. Excluding Best Buy Europe, SG&A spending for fiscal 2009 is expected to increase by approximately 9 percent versus the prior year. The retailer anticipates significant deleverage in its SG&A rate caused by the addition of Best Buy Europe, which carries a higher SG&A cost structure; a comparable store sales decline; and ongoing costs related to investments made in the first half of the fiscal year. Including the negative tax impact of the investment impairment charge, the company now expects its effective income tax rate for fiscal 2009 to be approximately 39.0 percent.
The investment impairment charge, as well as any costs associated with reductions in staffing or other potential restructuring activities, is excluded from the above earnings guidance.
