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Best Buy: Sales Up, Profits Down

Minneapolis — Best Buy reported mixed results for its first fiscal quarter, ended May 31.

Net revenue was up 13.4 percent worldwide to nearly $9 billion; same-store sales rose 3.7 percent, and operating income increased 4.1 percent to $277 million.

But net earnings declined 6.8 percent to $179 million for the four-month period, which Best Buy attributed to stronger-than-expected revenue from low-margin categories like notebook computers and video game consoles. Earnings were also pressured by capital investments in IT, new Best Buy Mobile locations and overseas expansion, and by a 52 percent drop in investment income.

Domestically, net revenue rose 11 percent to $7.5 billion, aided by the addition of 106 new stores over the past year, while same-store sales increased 3.5 percent, well ahead of Wall Street’s flat expectations. In a conference call, chief financial officer Jim Muehlbauer attributed the sales strength to improved availability of gaming products, the release of government stimulus checks and the increased use of low-cost financing promotions.

Best Buy estimated that its domestic market share grew 1.5 percent during the quarter, particularly in TV, mobile phones, gaming and computing. Computer share was up 3.5 percent and notebook share grew by the double digits, president/COO Brian Dunn said during the call, while extended-warranty attachments increased for computers and 30-inch and larger TVs.

Online comp sales rose 30 percent, Muehlbauer said, although store traffic continued to decline as sales of CDs and DVDs, both traditional traffic drivers, remained soft.

Domestic operating margin slipped 30 basis points to 3.7 percent due to the revenue mix shift and a slightly higher expense rate. Offsetting the decline were increased sales of mobile phones and more rational promotional activity, particularly in TV where Best Buy emphasized extended-financing offers over price cuts. The company had renegotiated credit terms with its key lender, explained Mike Vitelli, customer operating groups executive VP, and simplified its no-interest offers by making them consistent across all departments.

Broken out by category, home office accounted for 31 percent of fiscal first-quarter revenue and led the period in revenue growth with a 9.3-percent comp-sales gain, driven by a double-digit comp increase for notebook computers. Best Buy attributed the increase to the growth of multi-computer households, the expansion of Apple products to almost 500 stores, and the addition of Dell computers to the assortment last December.

Mobile phones also experienced a “strong” double-digit comp-sales gain, led by the expansion of the company’s autonomous Best Buy Mobile departments, which offer improved assortments and customer service.

The chain operated 599 Best Buy Mobile locations within its U.S. stores at the end of the quarter (roughly half its domestic store base), and expects to convert the balance of its stores by the end of the year. Best Buy Mobile locations posted a 50 percent increase in the number of wireless connections (including cellular phones and wireless broadband cards) and outpaced unconverted Best Buy stores four-to-one, Dunn said.

Entertainment software comprised 18 percent of first-quarter revenue and increased 8.2 percent on a comp-sales basis. A “solid” double-digit gain in video game comps was fueled by new software releases and strong sales of consoles, which benefited from increased availability and lower pricing. The gains were partially offset by continued comp declines for CDs and DVDs, the company said.

The services category accounted for 6 percent of first-quarter revenue and saw a 5 percent increase in first-quarter comps, reflecting a high-single-digit gain in computer services, a low-double-digit gain in home theater services and a mid-single-digit increase in extended-warranty comps. The company attributed the reversal in warranty-attachment trends to the increased volume of large-ticket items such as flat-panel TVs and notebook computers.

Best Buy’s consumer electronics category, which represented 39 percent of first-quarter revenue, posted a 0.6 percent comp store decline. The downturn was led by “strong” comp sale declines in projection and tube TVs, as consumers abandoned the former and Best Buy exited the latter. Digital imaging also experienced a “low” double-digit comp sales decline due to market saturation, the company said.

Offsetting these declines were “solid” double-digit increases in flat-panel TVs and GPS products.

Appliances comprised 6 percent of the revenue mix and experienced a comp decline of 10.6 percent, driven by a “low” double-digit decline in major appliances amid a weak industrywide environment. The results were partially offset by an increase in average selling prices over the prior year, Best Buy said, and estimates that it is increasing its market share in majaps despite negative industry trends.

During the conference call, Vitelli said that Best Buy will survive CE inroads from mass-merchant discounters by providing services that enhance the customer experience of complex, higher-end electronics products. The company’s essential strategy, he said, is to combine the customer care of an independent dealer with the comprehensive assortments and economies of scale of a national chain.

By way of example, Vitelli cited the $50 gift cards it gave away to customers who had purchased HD DVD players at its stores. “We felt it was the right thing to do” after Toshiba retired the format, he said, although customers wound up spending 50 percent more than the cards’ face value upon redemption.

Underscoring the point, an additional 3 million customers joined Best Buy’s Rewards Zone loyalty program during the quarter, bringing membership up to 29 million, the executives said.

During the quarter, the company opened 26 U.S. Best Buy stores, including six of its 45,000-square-foot stores, 18 of its 30,000-square-foot stores and two of its 20,000-square-foot stores. At the end of the first quarter, the domestic segment included 949 Best Buy stores, 14 Best Buy Mobile stand-alone stores, seven Geek Squad stand-alone stores, 13 Magnolia Audio Video stores and 20 Pacific Sales showrooms.

The company plans to open its first store in Mexico during the fourth quarter of 2008, and will open its first store in Turkey next spring in Istanbul.