The SG&A rate was 17.2% of revenues for the second quarter and 17.7% of revenues for the first six months compared with 16.8% in the comparable periods of the prior year. The increase for quarter reflects the impact of higher depreciation expenses associated with new stores and other capital investments, operating more new stores and increased employee health care expenses. This was substantially offset by the leverage of a higher sales base and tight expense controls including hiring constraints, reduced use of outside contractors and increased productivity. The increase for the first six months reflects the deleveraging impact of flat comparable store sales growth as well as the same factors that impacted second quarter expenses.
The following table presents selected financial data for the Musicland segment ($ in millions):
Musicland revenues for the second quarter were consistent with last year’s pro forma results decreasing only 1.0% to $396 million from $400 million. Revenues for the first six months declined 3.6% to $781 million from last year’s pro forma revenues of $810 million. Comparable store sales declined 0.4% in the quarter and 3.3% for the first six months due to a challenging economy and continued softness in sales of prerecorded music and VHS movies. The declines were partially offset by strong sales of DVD movies and gaming hardware and software.
Gross profit margins decreased to 35.9% of revenues in the quarter and first six months of fiscal 2002 from the pro forma results of 38.6% of revenues and 37.7% of revenues, respectively, in the comparable periods of last year. The decreases are primarily due to the shift in the sales mix to lower-margin DVD movies from prerecorded music and VHS movies and a reduction in space allocated to higher margin, non-strategic products.
The SG&A rate remained virtually unchanged in the quarter from last year’s pro forma results and increased 0.9% of revenues for the first six months. The change in the SG&A rates from the pro forma rates reflect the deleveraging impact of the comparable store sales decline. Tight expense controls and realization of support function synergies limited the increase in the SG&A rate. SG&A includes $4 million and $8 million of goodwill amortization for the second quarter and first six months of fiscal 2001 and 2002.
The Company had net interest expense of $10 million in the second quarter and $9 million for the six-month period, compared to interest income of $9 million and $17 million, respectively, in the same periods last year. The three-month and six-month periods of the current fiscal year include an $8 million pre-tax charge, or $.02 on a diluted per share basis, from the early retirement of debt acquired as part of the Musicland acquisition. The balance of the decline results from interest expense on Musicland debt and lost interest income on the cash used to acquire Musicland and Magnolia Hi-Fi, as well as lower yields on investments.
Effective Income Tax Rate
The Company's effective income tax rate increased to 39.1%, up from 38.3% last year. The increase in the effective income tax rate is due primarily to the nondeductibility of goodwill resulting from the Company’s acquisitions in fiscal 2001.
Liquidity and Capital Resources
Cash and cash equivalents totaled $961 million at September 1, 2001, compared to $747 million at fiscal year-end and $845 million at the end of last year’s second quarter. The increase from year-end is due to $382 million in cash provided by operating activities and $330 million in net proceeds from the issuance of convertible debt offset by $257 million in capital spending and the retirement of $278 million in debt. The increase in cash and cash equivalents from last year is due to net cash provided by financing activities and the excess of operating cash flows, reduced by capital investments including the acquisitions of Musicland and Magnolia Hi-Fi.
Merchandise inventories increased $635 million from last year’s second quarter, including $406 million related to acquired businesses. The remainder of the increase came from the addition of 66 Best Buy stores in the last 12 months. Inventory turns were 7.4 times at Best Buy stores, consistent with last year. Best Buy’s average inventories per store as of September 1, 2001, were down approximately 4.0% from last year’s second quarter. Merchandise inventory increased $325 million over year-end primarily due to seasonal increases, new stores and improved in-stock positions at Best Buy stores.
All other current assets increased $35 million in the aggregate from year-end. The increase is primarily due to increased receivables resulting from higher business volume. The increase in all other current assets over the second quarter last year was $76 million in the aggregate, due primarily to business acquisitions and higher business volume.
Capital spending for the first six months of fiscal 2002 was $257 million, on pace with last year’s $266 million. Capital spending in the current year includes investment in new stores, core financial and operating systems and the initial stages of construction of a new corporate headquarters facility.
Accounts payable increased $285 million from year-end in line with the increase in merchandise inventories. The increase over last year’s second quarter was $579 million, of which approximately half is due to business acquisitions and the remainder is related to the additional merchandise inventories associated with new Best Buy stores. All other current liabilities, exclusive of the current portion of long-term debt, declined $40 million in the aggregate from year-end. The decline was due to the normal timing associated with the payment of year-end accrued expenses. All other current liabilities, exclusive of the current portion of long-term debt, increased $356 million in the aggregate over last year’s second quarter. A significant portion of the increase came from business acquisitions, and the remainder came from the volume associated with the growth in the business and advances received under vendor alliances. Other long-term liabilities increased from year-end, and the prior year, primarily due to advances received under vendor alliances and increased deferred taxes.
During the six months ended September 1, 2001, the Company redeemed all, or $110 million, of Musicland’s outstanding 9% Senior Subordinated Notes due in 2003. The Company has also redeemed 97%, or $156 million, of Musicland’s outstanding 9.9% Senior Subordinated Notes due in 2008. The premium paid on the early redemption of the debt resulted in a second quarter pre-tax charge of $8.4 million, which has been included in interest expense.
On June 27, 2001, the Company sold, in a private offering, convertible debentures having an aggregate initial principal amount at maturity of $492 million. The proceeds from the offering, net of $7 million in offering expenses, were $330 million. The debentures mature in 20 years and are callable at the Company’s option on or after June 27, 2004. Holders may require the Company to purchase all or a portion of their debentures on June 27, 2004, June 27, 2009, or June 27, 2014, at a purchase price equal to the accreted value of the debentures plus accrued and unpaid cash interest. Each debenture will be convertible into 7.8714 shares of the Company’s common stock at an initial conversion price of $86.87 per share if the closing price of the Company’s common stock exceeds a specified price (initially, 120% of the conversion price, or $104.24 per share) for a specified period of time, or otherwise upon the occurrence of certain events. The debentures have an initial yield to maturity of 2.75%, including a cash payment of approximately 1.0% and an initial accretion rate of approximately 1.75%. The yield to maturity will be reset, but not below 2.75% or above 3.75%, on December 27, 2003, December 27, 2008 and December 27, 2013. The debentures and the underlying common stock were registered on October 9, 2001 with the Securities and Exchange Commission to enable selling security holders to resell their debentures and the shares of common stock issuable upon conversion of their debentures.
The Company currently has authorization to repurchase $300 million of its common stock. No stock has been purchased through the first six months of fiscal 2002.
In August 2001, the Company announced its intent to acquire Future Shop Ltd., pursuant to a tender offer, in a transaction valued at approximately $377 million. Future Shop is the largest Canadian retailer of consumer electronics with 90 stores. Consummation of the acquisition is subject to successful completion of the tender offer, approval by Canadian regulators and other customary closing matters, and is expected to occur by the end of the Company’s third quarter. The Company expects to complete the acquisition with existing cash and cash equivalents.
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. Application of the nonamortization provision of SFAS No. 142 is expected to result in an increase in net earnings for the Company of approximately $20 million per year. In fiscal 2003, the Company will perform the required impairment tests of goodwill and indefinite lived intangible assets. It is not currently possible to determine what the impact of the impairment testing, if any, will be on the earnings and financial position of the Company.
Outlook for Fiscal 2002
On September 18, 2001, the Company communicated its expectations for its third quarter financial results. In its communication, the Company’s management stated that the third quarter comparable store sales change at Best Buy and Musicland stores was expected to range from 0% to a 2% increase. In addition, gross margins at Best Buy were expected to increase on a year-over-year basis, although the rate of improvement in the second half of the fiscal year was anticipated to be slower than in the first half. The Company also stated its expectations that it would gain some expense leverage compared to last year’s third quarter. Based on the assumptions above, the Company had indicated that third quarter earnings could range from $ .34 to $ .36 per share.
At this time, it is difficult to accurately predict the ultimate impact that the events on and after September 11 will have on consumer spending and on the Company’s third quarter financial results. Yet, based upon quarter-to-date trends, management now believes that the comparable store sales change for the third quarter is likely to be slightly less than indicated on September 18, in a range from 0% to a 2% decline. However, third quarter gross margin rates are expected to be slightly better than previously anticipated. In light of these changes in assumptions, management currently expects that earnings for the third quarter will be at the lower end of the range that was previously communicated, or $ .34 per share. Trends and experience to date may not be reflective of actual results for the third quarter as a whole because the majority of the Company’s sales and earnings for the third quarter are traditionally generated late in the quarter. The Company plans to continue to monitor and manage inventories and promotional activity, as well as tightly control expenses.
Safe Harbor Statement Under the Private Securities Litigation Reform Act
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, provide a "safe harbor" for forward–looking statements to encourage companies to provide prospective information about their companies. With the exception of historical information, the matters discussed in this Quarterly Report on Form 10-Q are forward–looking statements and may be identified by the use of words such as "believe," "expect," "anticipate," "plan," "estimate," "intend" and "potential." Such statements reflect the current view of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. A variety of factors could cause the Company's actual results to differ materially from the anticipated results expressed in such forward–looking statements, including, among other things, general economic conditions, acquisitions and development of new businesses, product availability, sales volumes, profit margins, weather, availability of suitable real estate locations, and the impact of labor markets and new product introductions on the Company's overall profitability. Readers should review the Company's Current Report on Form 8-K filed on May 16, 2001, that describes additional important factors that could cause actual results to differ materially from those contemplated by the forward–looking statements made in this Quarterly Report on Form 10-Q.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company’s operations are not currently subject to market risks for interest rates, foreign currency rates, commodity prices or other market price risks of a material nature.
PART II – OTHER INFORMATION
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
| | a) | The Regular Meeting of the Shareholders of the Company was held on June 26, 2001. The following individuals were elected at the meeting as Class 2 directors of the Company to serve until the 2003 Regular Meeting of Shareholders. Shares voted were as follows: |
| Robert T. Blanchard | |
| | Shares For | 193,423,065 |
| | Shares Withheld | 1,341,032 |
| Jack W. Eugster | |
| | Shares For | 193,407,705 |
| | Share Withheld | 1,356,392 |
| Elliot S. Kaplan | |
| | Shares For | 192,667,041 |
| | Shares Withheld | 2,097,056 |
| Richard M. Schulze | |
| | Shares For | 165,055,876 |
| | Shares Withheld | 29,708,221 |
| Hatim A. Tyabji | |
| | Shares For | 151,561,606 |
| | Shares Withheld | 43,202,491 |
Shareholders ratified the appointment of the following individual as a Class 1 director of the Company to serve until the 2002 Regular Meeting of Shareholders. Shares voted were as follows:
| Allen U. Lenzmeier | |
| | Shares For | 193,596,370 |
| | Shares Against | 287,702 |
| | Shares Abstaining | 880,025 |
| ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K: |
| | b. | Reports on Form 8-K: |
| | | |
| | (1) | Announcement of a private offering of approximately $300 million in convertible debentures, filed on June 26, 2001. |
| | | |
| | (2) | Announcement of the commencement of The Musicland Group, Inc.’s (a wholly-owned indirect subsidiary) tender offer to repurchase its 9.875% Senior Subordinated Notes due in 2008, filed on July 19, 2001. |
| | | |
| | (3) | Announcement of the consummation of a Support Agreement between a wholly-owned subsidiary of Best Buy Co., Inc. and Future Shop Ltd., filed on August 24, 2001. Pursuant to the Support Agreement, the wholly-owned subsidiary of Best Buy Co., Inc. commenced a cash takeover bid to acquire all of the issued and outstanding shares of common stock of the Future Shop Ltd. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | BEST BUY CO., INC. |
| | (Registrant) |
| | | |
| | | |
| | | |
| Date: October 11, 2001 | By: | /s/ Darren R. Jackson |
| | |
|
| | | Darren R. Jackson |
| | | Senior Vice President - Finance, Treasurer
and Chief Financial Officer
(principal financial and accounting officer) |
