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Best Buy Raises Q4 Profit Concerns

MINNEAPOLIS — Cost controls and improved operational efficiencies returned Best Buy to profitability in the third quarter, but a possible profit hit from a highly promotional holiday season dampened investor enthusiasm.

Best Buy shares fell more than 9 percent on chief financial officer Sharon McCollam’s gross margin warning after the retailer released it earnings last month. Wall Street was also spooked by the flat net revenue and comps, which were dragged down by offshore store closings and unfavorable currency fluctuations.

Net earnings for the three months, ended Nov. 3, rose to $54 million, compared with a year-ago loss of $10 million, on total revenue of $9.3 billion.

Comps improved over last year’s 5.1 percent decline, while in the U.S., revenue rose 2.3 percent to $7.9 billion and comps increased 1.7 percent. Excluding disruptions from sales floor re-merchandising and the rollout of Windows Store departments to 500 stores, domestic comps would have grown about 2 percent, Best Buy said.

What’s more, U.S. online comps rose 15.1 percent on sales of $499 million due to increased site traffic, bigger average ticket, more online orders placed in Best Buy stores, and greater inventory availability as the chain earmarked additional warehouse space for web orders and began fulfilling some dot-com purchased from more than 400 stores.

Driving the online and in-store increases were gains in mobile, majaps and notebooks, which were partially offset by anticipated declines in gaming, movies and digital imaging. Broken out by category, majap comps increased 23.5 percent; computing and mobile phone comps rose 6.7 percent; and services comps gained 3.3 percent. In contrast, CE comps declined 2.5 percent and entertainment comps fell 26.8 percent.

Domestic selling, general and administrative expenses (SG&A) declined 180 basis points, from $1.8 billion or 23.5 percent of revenue last year to $1.7 billion or 21.8 of revenue during the quarter, as Best Buy implemented tighter company-wide expense management; lowered store labor costs; completed separation payouts to prior management; and cut another $115 million in annualized costs, for a total of $505 million toward its goal of $725 million in yearly savings.

Overseas, revenue fell 11.2 percent to $1.5 billion and comps declined 6.4 percent due to store closings in Canada and China and unfavorable currency exchange rates.

On an earnings call, president/CEO Hubert Joly ticked off a litany of third-quarter accomplishments under his one-year-old “Renew Blue” initiative. Website improvements included better search functionality; integrating an enhanced loyalty program into the e-commerce site; increasing the number of customer product reviews; and an easier process for in-store service plan attachments when picking up online orders.

In stores, improved training for Blue Shirts and Geek Squad staff, as well as online and phone support personnel, has resulted in higher customer satisfaction scores, while the company continues to devote more floor space to growing, profitable categories like mobile, tablets, and large and small appliances. Other sales floor changes included the Windows department rollouts, the debut of Google displays in 750 stores, and redesigned display space for the Xbox One and PlayStation 4 launches.

Fulfilling online orders directly from stores has helped reduce website stock-outs and has generated more, and more profitable, sales of clearance and open-box merchandise, Joly said, while new store-replenishment processes, and devoting more space to online inventory in the distribution centers, have together shaved another $100 million in cost of goods sold.

Leveraging the stores for online fulfillment and to resell returns has made them an asset rather than an albatross, Joly explained. “The financial economics of closing stores is becoming less compelling,” he said, and the chain closed only two Best Buy Mobile and four Pacific Sales stores during the quarter, while continuing to renegotiate rent reductions on expiring leases.

Still, chief financial officer McCollam cautioned that the company’s commitment to remain competitive in a holiday season marked by deep discounts and long holiday hours will likely impact fourth-quarter profitability.

“First and foremost, we are committed to being competitive on price,” she said on the call. “As Hubert mentioned, it is table stakes in our transformation. So if our competition is in fact more promotional in the fourth quarter, we will be too and that will have a negative impact on our gross margin.”

Despite the resulting stock hit, many analysts shrugged off the fourthquarter’s challenges as fleeting. “This is not a structural issue but a transitory one, and the ability and willingness to face it head on will prove a positive longer term,” said Janney Montgomery Scott analyst David Strasser.

Aram Rubinson of Wolfe Research lauded Best Buy for its aggressive third-quarter costs cuts, “indicating that new management is on top of the situation,” while Credit Suisse’s Gary Balter reminded investors that despite some impact on near-term gross margins, Best Buy is fighting a long-term war in which “the trend is moving in the right direction and management appears to be making the right moves to improve future results.”