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Best Buy Cuts Costs Amid Slower Sales

In response to a recent slowdown in sales and foot traffic, Best Buy plans to aggressively cut costs by imposing a hiring freeze, trimming consultants, direct sourcing commodity products, and closing or downsizing unprofitable Musicland stores.

Speaking at a Goldman Sachs retail conference, here, earlier this month, CFO Darren Jackson described the belt tightening as “managing in difficult times.” He told attendees that the company is taking out expenses, managing head count and lowering its same store sales expectations in response to what he had earlier described as “a significant change in consumer behavior” in July.

“We hope we’re overreacting,” he said.

The announcement followed the release of the company’s second quarter sales results for fiscal 2003. Fueled by 76 new Best Buy stores and the inclusion of Future Shop revenue, total company-wide sales grew 20 percent to $5 billion for the three months ended Aug. 31.

But minus the new additions, same store sales rose a more modest 2 percent, reflecting continuing declines at the Musicland and Magnolia Hi-Fi chains and a slowdown in summertime traffic.

In addition, the company announced that it is taking a $348 million goodwill impairment charge after taxes against its first quarter results reflecting the decline in value of its Musicland and Magnolia acquisitions.

Broken out by chain, Best Buy stores grew 14 percent for the quarter to $4.26 billion, while same store revenue rose 2.7 percent, buoyed by sales of video game and DVD software and digital TVs and cameras. Those gains were partially offset by softness in desktop PCs and major appliances, with the latter showing mid single-digit declines according to vice chairman/CEO Brad Anderson.

Indeed, speaking before the retailing conference, Anderson acknowledged that Best Buy’s current appliance strategy “hasn’t worked” and described the category as a disappointment.

At Musicland, total sales slipped 3 percent to $380 million for the quarter while comps slid 3.4 percent, due to continued softness in sales of prerecorded music, the company said.

Anderson conceded that Best Buy’s plan to introduce personal audio and other CE products into Musicland stores “has not worked,” although he said the music chain had benefited from the addition of DVDs and video games.

To that end, the company plans to expand Musicland’s DVD and gaming strategy, and will also open more rural Sam Goody stores.

Moreover, Best Buy will take advantage of the relatively short, three-year leases on Sam Goody’s largely mall-based locations by closing unprofitable units or moving to a smaller footprint, Anderson said.

Best Buy doesn’t break out sales at Magnolia, but allowed that comps sagged by “the low single digits” at the high-end A/V chain. Nevertheless, in its pursuit of higher income customers, the company is proceeding with plans to open six new Magnolia units this year, Anderson said.

Business remained robust north of the border, however. Total sales at Future Shop and at Best Buy’s sole Canadian outpost rose 13 percent to $340 million while comps grew 6.9 percent. The company attributed the strong results to the addition of 12 new stores plus strong demand for DTV, DVD and digital cameras.

Despite the slowdown, sales in August stabilized from the dramatic downturn the company reported in July. Said Anderson, “Comparable store sales during August were fairly steady, as were traffic levels in our stores.”

But despite the uptick in August activity, the company again lowered its second quarter earnings projections to the low end of its previously reduced forecast of 17 cents to 21 cents per share.

While Anderson noted that the austerity measures will reduce bureaucracy and result in a more efficient enterprise, CFO Jackson stressed that the cutbacks “won’t touch mission-critical spending and won’t impair the brand.” Indeed, observing that “in difficult times it’s easy to grow share,” Jackson said the company will increase its store count and commit more resources to its e-commerce operations, which have enjoyed an “uptick in business.”

Moreover, the company is taking measures to counter CE inroads by Wal-Mart, Anderson said. Citing the discount king as an “ongoing substantial challenge” that is “substantially gaining CE share,” he said Best Buy would borrow from Wal-Mart’s playbook by tailoring its stores’ merchandise mix to local markets and would source more commodity products from China and other areas.

Best Buy also blamed slowing sales for its $348 million impairment charge. The company based the fair value decline of Musicland on “the current retail environment and the uncertainty associated with future trends in prerecorded music.”