Best Buy Net Earnings Down 18%, Comps Fall

by Steve Smith -- TWICE, 6/19/2007 6:42:00 AM

Minneapolis — Best Buy reported higher revenue but lower comp-store sales and net earnings for its fiscal first quarter, ended June 2.

Net earnings were $192 million, down 18 percent from $234 million in the prior year’s first quarter.

“Our first-quarter results fell short of our expectations. Strong revenue results from lower-margin products significantly cut into our gross profit rate,” said Brad Anderson, vice chairman and CEO of Best Buy, in a statement. “Yet our customers continued to increase our market share. Our share gains, combined with other indicators we see, show that our core business is healthy.”

Also cutting into earnings were higher fixed costs, including wages and rents, which outpaced U.S. sales.

Total revenue increased 14 percent to $7.9 billion compared with revenue of $7 billion for the previous year’s first quarter. The increase reflected the net addition of 230 new stores (including 131 acquired stores) in the past 12 months and a comp-store gain of 3.0 percent. Last year’s first quarter generated comp-store sales gains of 4.9 percent.

Best Buy also noted that consumers made more purchases online and the company continued to add features and capabilities to its Web sites. Total first quarter online revenue grew more than 20 percent as compared with the same quarter of the prior year.

Domestically, Best Buy, which is comprised of Best Buy, Geek Squad, Magnolia Audio Video and Pacific Sales, reported first-quarter revenue of $6.7 billion, up nearly 9 percent. Comp-store sales were up only 1.7 percent vs. 4.6 percent during last year’s first quarter. Online revenue grew nearly 25 percent and Pacific Sales, a retailer of high-end appliances and home improvement products, contributed revenue of $71 million in the first quarter.

Domestic segment operating income was $270 million, down $64 million from $334 million on an adjusted basis. Operating income reduction for the quarter was due to an increased mix of lower-margin products, such as gaming hardware and notebook computers. Significant product transitions in the flat-panel TV business put pressure on the gross profit rate for the quarter, the company said.

Brian Dunn, Best Buy’s president/COO, acknowledged the weak quarterly results, but stood behind the company’s core customer-centric business model, which continues to boost market share and customer satisfaction scores. “We firmly believe that our investment in solving technology problems for customers is extending our lead over the competition,” he said. He added that the specialty chain is “nowhere close” to improving its customer-focused strategy and customer experience.

Revenue mix by product category remained almost exactly the same with last year’s first quarter, with consumer electronics at 43 percent, home office at 32 percent, entertainment down a point to 17 percent and appliances up a point to 8 percent.

Specifically, CE was up 1.4 percent in comparable store sales led by “solid” double-digit comp gains in flat-panel TV, attributed to higher volumes, improved assortments in larger screen sizes and the opening of more Magnolia Home Theater in-store shops. Other strong performers were navigation, up triple digit, and home theater installation, which enjoyed “very strong” double-digit gain. The increases were offset by declines in tube and projection TVs and MP3 players.

Entertainment comps were up 1.3 percent, led by “solid” double-digit gains in gaming hardware and software, which partially offset expected declines in CDs and DVDs.

Appliances edged up 0.7 percent, although major appliances were up by the low single digits, far exceeding industry-wide sales, which the company attributed to “an expanded assortment, improved store experience and knowledgeable, engaged employees.”

During the quarter Best Buy opened 30 flagship locations, vs. 11 during the year-ago period, including four 45,000-square-foot; 20 30,000-square-foot, and six 20,000-square-foot stores. The company also closed five Geek Squad stores, leaving seven in operation at the end of the quarter, and shut one Magnolia Audio Video location, leaving 19.

The chain also reported that during its fiscal first quarter it repurchased about 8.7 million shares of common stock, a total of $412 million, and plans to expand its international presence to Mexico and Turkey.

Wall Street took Best Buy to task for missing its first quarter earnings forecasts and lowered 2007 guidance. “There is very little to be encouraged about in the quarter,” wrote Bank of America analyst David Strasser in a research note. “Comps [were] in line at 3 percent, but as is the case in consumer electronics, you can always get comp at the expense of margin. Profitless sales are nothing to be excited about.”

Looking ahead, CFO Jackson offered a mixed outlook for the back half of the year, which he said will be marked by accelerating sales of low-margin categories like gaming hardware and notebook computers. He believes Best Buy will benefit from competitors’ store closings, an expanded product assortment, and a seasonal spike in flat panel TV demand. – Additional reporting by Alan Wolf