10-K 1 a06-10808_110k.htm ANNUAL REPORT PURSUANT TO SECTION 13 AND 15(D)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

(Mark One)

x        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 25, 2006

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to               

Commission file number 1-9595


GRAPHIC

BEST BUY CO., INC.

(Exact name of registrant as specified in its charter)

Minnesota

 

41-0907483

State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization

 

Identification No.)

7601 Penn Avenue South

 

55423

Richfield, Minnesota

 

(Zip Code)

(Address of principal executive offices)

 

 

 

Registrant’s telephone number, including area code 612-291-1000

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $.10 per share

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes o No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x       Accelerated filer o                 Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) o Yes x No

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of August 26, 2005, was approximately $18.976 billion, computed by reference to the price of $46.01 per share, the price at which the common equity was last sold on such date as reported on the New York Stock Exchange-Composite Index. (For purposes of this calculation all of the registrant’s directors and executive officers are deemed affiliates of the registrant.)

As of April 24, 2006, the registrant had 485,671,000 shares of its Common Stock issued and outstanding.

 




DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement dated May 18, 2006 (to be filed pursuant to Regulation 14A within 120 days after the Registrant’s fiscal year-end of February 25, 2006), for the regular meeting of shareholders to be held on June 21, 2006 (Proxy Statement), are incorporated by reference into Part III.

CAUTIONARY STATEMENT PURSUANT TO THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act), 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 Annual Report on Form 10-K 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 our current view with respect to future events and are subject to certain risks, uncertainties and assumptions. A variety of factors could cause our future results to differ materially from the anticipated results expressed in such forward-looking statements. Readers should review Item 1A, Risk Factors, of this Annual Report on Form 10-K for a description of important factors that could cause future results to differ materially from those contemplated by the forward-looking statements made in this Annual Report on Form 10-K. In addition, general economic conditions, acquisitions and development of new businesses, product availability, sales volumes, profit margins, weather, foreign currency fluctuation, availability of suitable real estate locations, our ability to react to a disaster recovery situation, and the impact of labor markets and new product introductions on our overall profitability, among other things, could cause our future results to differ materially from those projected in any such forward-looking statements.




BEST BUY   FISCAL   2006   FORM 10-K

TABLE OF CONTENTS

PART I

 

 

Item 1.

 

Business.

 

5

 

Item 1A.

 

Risk Factors.

 

13

 

Item 1B.

 

Unresolved Staff Comments.

 

17

 

Item 2.

 

Properties.

 

18

 

Item 3.

 

Legal Proceedings.

 

19

 

Item 4.

 

Submission of Matters to a Vote of Security Holders.

 

22

 

 

 

 

 

PART II

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

23

 

Item 6.

 

Selected Financial Data.

 

25

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

27

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk.

 

50

 

Item 8.

 

Financial Statements and Supplementary Data.

 

51

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

93

 

Item 9A.

 

Controls and Procedures.

 

93

 

Item 9B.

 

Other Information.

 

93

 

 

 

 

PART III

 

 

 

Item 10.

 

Directors and Executive Officers of the Registrant.

 

95

 

Item 11.

 

Executive Compensation.

 

95

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

95

 

Item 13.

 

Certain Relationships and Related Transactions.

 

96

 

Item 14.

 

Principal Accounting Fees and Services.

 

96

 

 

 

 

 

PART IV

 

 

Item 15.

 

Exhibits, Financial Statement Schedules.

 

97

 

 

 

Signatures

 

99

 

       

 

 

 

EXHIBIT INDEX:

 

 

 

Exhibit 3.1

 

 

 

 

 

Exhibit 3.2

 

 

 

 

 

Exhibit 4.1

 

 

 

 

 

Exhibit 4.2

 

 

 

 

 

Exhibit 4.3

 

 

 

 

 

Exhibit 10.1

 

 

 

 

 

Exhibit 10.2

 

 

 

 

 

Exhibit 10.3

 

 

 

 

 

Exhibit 10.4

 

 

 

 

 

Exhibit 10.5

 

 

 

 

 

Exhibit 10.6

 

 

 

 

 

Exhibit 10.7

 

 

 

 

 

Exhibit 10.8

 

 

 

 

 

Exhibit 10.9

 

 

 

 

 

Exhibit 10.10

 

 

 

 

 

Exhibit 12.1

 

 

 

 

 

Exhibit 21.1

 

 

 

 

 

Exhibit 23.1

 

 

 

 

 

Exhibit 23.2

 

 

 

 

 

Exhibit 31.1

 

 

 

 

 

Exhibit 31.2

 

 

 

 

 

Exhibit 32.1

 

 

 

 

 

Exhibit 32.2

 

 

 

 

 

 




PART I

Item 1. Business.

Description of Business

Best Buy Co., Inc. (Best Buy, we or us) is a specialty retailer of consumer electronics, home-office products, entertainment software, appliances and related services. We operate retail stores and commercial Web sites under the brand names Best Buy (BestBuy.com and BestBuyCanada.ca), Future Shop (FutureShop.ca), Magnolia Audio Video (MagnoliaAV.com) and Geek Squad (GeekSquad.com and GeekSquad.ca). References to our Web site addresses do not constitute incorporation by reference of the information contained on the Web sites, and such information is not part of this document.

Our vision is to make life fun and easy for consumers. Our business strategy is to treat each customer as a unique individual, meeting their needs with end-to-end solutions, and engaging and energizing our employees to serve them, while maximizing overall profitability. We believe we offer consumers meaningful advantages in store environment, product value, product selection and a variety of in-store and in-home services related to the merchandise we offer, all of which advance our objectives of enhancing our business model, gaining market share and improving profitability. We believe that our strategic initiatives will further enhance our business model. Additional information on our strategic initiatives is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report on Form 10-K.

Organizational Changes

In January 2006, we announced changes to our organizational structure to support our commitment to deliver long-term, profitable growth. Specifically, effective at the beginning of fiscal 2007, Brian J. Dunn was promoted to President and Chief Operating Officer of the company, and Robert A. Willett was promoted to Chief Executive Officer — Best Buy International. In addition, Allen U. Lenzmeier has decided to remain in his current role as Vice Chairman, serving on a part-time basis to support our international expansion.

The changes reflect our strategy of driving the performance of the current business while investing in targeted long-term growth opportunities. We believe the new organizational structure increases accountability and collaboration while enabling our leadership team to focus on growth strategies and our ongoing transformation to customer centricity.

Information About Our Segments

During fiscal 2006, we operated two reportable segments: Domestic and International. The Domestic segment is comprised of all U.S. store and online operations, including Best Buy, Magnolia Audio Video and Geek Squad. Best Buy stores offer a wide variety of consumer electronics, home-office products, entertainment software, appliances and related services. Magnolia Audio Video stores offer high-end audio and video products, and services. Geek Squad offers residential and commercial computer support. The International segment is comprised of all Canadian store and online operations, including Future Shop, Best Buy and Geek Squad. The International segment offers products and services similar to those offered by the Domestic segment. However, Canadian Best Buy stores do not carry appliances.

Financial information about our segments is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 10, Segments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Domestic Segment

We were incorporated in the state of Minnesota in 1966 as Sound of Music, Inc., and changed our name to Best Buy Co., Inc. in 1983. We began as an audio components retailer and, with the introduction of the videocassette recorder in the early 1980s, expanded into video products. In 1983, we revised our marketing strategy and began using mass-merchandising techniques, which included offering a wider variety of products and operating stores under a “superstore” concept. In 1989, we dramatically changed our method of retailing by introducing a self-service, noncommissioned, discount-style store concept designed to give the customer more control over the purchasing process.

5




The Best Buy store format has evolved to include more interactive displays and, for certain products, a higher level of customer service, with the latest version designed to increase labor efficiency and to improve merchandising. In fiscal 2000, we introduced a small-market Best Buy store concept that offers merchandise in the same product groups as larger stores, with a product assortment tailored to each respective community.

In fiscal 2000, we also established our first online shopping site, BestBuy.com. Our “clicks-and-mortar” strategy is designed to empower consumers to research and purchase products seamlessly, either online or in our retail stores. The BestBuy.com online shopping site offers expanded assortments in all of our principal product groups.

In fiscal 2001, we acquired Magnolia Hi-Fi, Inc. — a Seattle-based, high-end retailer of audio and video products and services — to access an upscale customer segment. During fiscal 2004, Magnolia Hi-Fi began doing business as Magnolia Audio Video.

In fiscal 2003, we acquired Geek Squad, Inc. (Geek Squad). Geek Squad provides residential and commercial computer support services. We acquired Geek Squad to further our plans of providing technology support services to customers. We have since expanded Geek Squad service to be available in all U.S. Best Buy stores, as well as in 12 stand-alone stores, with more than 12,000 agents. Our goal is to build Geek Squad into North America’s largest consumer provider of computer repair, support and services, and we believe that over time it will become a significant component of our business.

In fiscal 2005, we opened our first Magnolia Home Theater store-within-a-store experience within a U.S. Best Buy store. We believe Magnolia Home Theater — with its high-end brands, home-like displays and specially trained employees — offers a unique solution for our customers. The Magnolia Home Theater store-within-a-store experience was offered in 107 and 23 U.S. Best Buy stores, at February 25, 2006, and February 26, 2005, respectively.

In fiscal 2005, we converted 67 U.S. Best Buy stores to our customer centricity operating model (segmented stores). Segmented stores offer variations in product assortments, staffing, promotions and store design, and are tailored toward key customer segments. The segmented stores tailor their store merchandising, staffing, marketing and presentation to address specific customer groups, including affluent professional males, young entertainment enthusiasts who appreciate a digital lifestyle, upscale suburban moms, families who are practical technology adopters and small businesses.

During fiscal 2006, based on the segmented stores’ operating results, as well as positive customer feedback, we continued to expand the roll-out of the customer centricity operating model. During fiscal 2006, we opened or converted 233 U.S. Best Buy stores to the customer centricity operating model. At the end of fiscal 2006, we operated 300 segmented stores, or 40% of total U.S. Best Buy stores.

During fiscal 2007, we plan to transition all remaining U.S. Best Buy stores to the customer centricity operating model. We plan to add the Magnolia Home Theater store-within-a-store experience to approximately 200 U.S. Best Buy stores and expand the products and services we offer to small businesses in at least 120 U.S. Best Buy stores in fiscal 2007. Further, we plan to refine our store and support functions to an integrated operating model that supports customer centricity.

At February 25, 2006, we operated 742 U.S. Best Buy stores in 49 states and the District of Columbia that averaged approximately 41,300 retail square feet. Collectively, U.S. Best Buy stores totaled approximately 30.6 million retail square feet at the end of fiscal 2006, or about 90% of our total retail square footage. For fiscal 2006, U.S. Best Buy retail stores generated average revenue of approximately $38.9 million per store.

At February 25, 2006, we operated 20 Magnolia Audio Video stores in California, Washington and Oregon that averaged approximately 9,700 retail square feet. Collectively, Magnolia Audio Video stores totaled approximately 194,000 retail square feet at the end of fiscal 2006, less than 1% of our total retail square footage. For fiscal 2006, Magnolia Audio Video retail stores generated average revenue of approximately $8.2 million per store.

International Segment

Our International segment was established in connection with our acquisition of Canada-based Future Shop Ltd. in fiscal 2002. The Future Shop acquisition provided us with an opportunity to increase revenue, gain market share and

6




leverage our operational expertise in consumer electronics retailing. Since the acquisition, we have continued to build on Future Shop’s position as the leading consumer electronics retailer in Canada.

During fiscal 2003, we launched our dual-branding strategy in Canada by introducing the Best Buy brand. The dual-branding strategy allows us to retain Future Shop’s brand equity and attract more customers by offering a choice of store experiences. As we expand the presence of Best Buy stores in Canada, we expect to gain continued operating efficiencies by leveraging our capital investments, supply chain management, advertising, merchandising and administrative functions. Our goal is to reach differentiated customers with each brand by giving them the unique shopping experiences they desire. The primary differences between our two Canadian brands are:

In-store experience — The customer’s interaction with store employees is different at each of the two brands. Future Shop stores have mostly commissioned sales associates who take a more proactive role in assisting customers. Through their expertise and attentiveness, the sales associate drives the transaction. In contrast, Canadian Best Buy store employees are noncommissioned, and the stores offer more interactive displays and grab-and-go merchandising. This design allows the customer to drive the transaction as they experience the products themselves, with store employees available to demonstrate and explain product features.

Store size — At the end of fiscal 2006, the average Future Shop store was approximately 20,700 retail square feet, compared with an average of approximately 25,400 retail square feet for Canadian Best Buy stores. Canadian Best Buy stores generally have wider aisles, as well as more square footage devoted to entertainment software. Further, Canadian Best Buy stores do not carry appliances.

We have expanded Geek Squad service to be available in all Canadian Best Buy stores, as well as in five stand-alone stores.

At February 25, 2006, we operated 118 Future Shop stores throughout all Canadian provinces and 44 Canadian Best Buy stores in Ontario, Quebec, Alberta, British Columbia, Manitoba and Saskatchewan. Collectively, International stores totaled approximately 3.6 million retail square feet at the end of fiscal 2006, or about 10% of our total retail square footage. For fiscal 2006, International retail stores generated average revenue of approximately $22.7 million per store.

As previously announced, we have begun exploring the opportunity of expanding outside of North America. In fiscal 2007 we expect to open our first store in Shanghai, China.

Acquisitions

In the third quarter of fiscal 2006, we acquired certain assets of AV Audiovisions, Inc., a California company, for $7 million; in the fourth quarter of fiscal 2006, we acquired Howell & Associates, Inc., an Ontario company, for $1 million. Both companies specialize in the design, sales and installation of high-end home entertainment systems.

In the first quarter of fiscal 2007, we acquired Pacific Sales Kitchen and Bath Centers, Inc. (Pacific Sales). Pacific Sales, based in southern California, operates 14 showrooms that cater to home-remodeling customers. In calendar 2005, Pacific Sales generated revenue of approximately $325 million. The company specializes in the sales of premium kitchen appliances, plumbing fixtures, home entertainment products and home furnishings. We acquired Pacific Sales to enhance our ability to grow with an attractive customer base and sell premium brands using a proven and successful showroom format. We expect to expand the number of Pacific Sales stores in order to capitalize on the rapidly growing high-end segment of the U.S. appliance market. Pacific Sales’ results of operations will be included in our Domestic segment results starting in fiscal 2007.

Discontinued Operations

We acquired Musicland Stores Corporation in fiscal 2001. The original strategy behind our Musicland acquisition was to bring Best Buy’s core competencies in retailing consumer electronics to new customer segments, including segments typically underserved by our Best Buy stores. However, the Musicland acquisition did not meet our financial objectives. In fiscal 2004, we sold our interest in Musicland. The transaction resulted in the transfer of all of Musicland’s assets other than a distribution center in Franklin, Indiana, and selected nonoperating assets. The sale of our interest in Musicland has allowed us to focus on our core businesses,

7




which are our primary growth and profit drivers. Musicland’s financial results have been classified separately as discontinued operations in our consolidated financial statements for all periods presented.

Operations

Domestic Segment

U.S. Best Buy store operations are organized into eight territories. Each territory is divided into districts and is under the management of a retail field officer who oversees store performance through district managers. District managers monitor store operations and meet regularly with store managers to discuss merchandising, new product introductions, sales promotions, customer loyalty programs, employee satisfaction surveys and store operating performance. Similar meetings are conducted at the corporate level with divisional and regional management. Each district also has a loss prevention manager, with product security personnel employed at each store to control physical inventory losses. Advertising, merchandise buying and pricing, as well as inventory policies are centrally controlled.

U.S. Best Buy stores are generally open 78 hours per week, seven days a week, with extended holiday hours. An average store is typically staffed by one general manager and five managers. The average staff per store in fiscal 2006 was approximately 132 employees and varied by store depending on sales volumes.

U.S. Best Buy stores follow a standardized and detailed operating procedure called our Standard Operating Platform (SOP). The SOP includes procedures for inventory management, transaction processing, customer relations, store administration, product sales and services, and merchandise display. All stores operate in the same manner under the SOP.

Magnolia Audio Video stores are typically managed by a store manager, an audio/video sales manager and, if the store contains mobile products, a mobile electronics sales manager. Magnolia Audio Video stores are generally open 72 hours per week, seven days a week. Depending on an individual store’s volume and product offerings, store staffing includes six to 20 commissioned sales personnel and one to eight hourly personnel. Corporate management for Magnolia Audio Video stores centrally controls advertising, merchandise buying and pricing, as well as inventory policies.

International Segment

International store operations are organized to support two brands, each headed by a vice president. Each vice president has national management who closely monitors store operations and meets regularly with store managers to review management and staff training programs, customer feedback and requests, store operating performance and other matters. Meetings involving store management, product managers, advertising, financial and administrative staff, as well as senior management, are held quarterly to review operating results and to establish future objectives.

International stores are generally open 60 to 75 hours per week, seven days a week. A typical Future Shop store is staffed by a general manager, an operations manager, several department managers and 48 to 95 sales associates, as well as part-time sales associates. A typical Canadian Best Buy store is staffed with a general manager; assistant managers for operations, merchandising, inventory and sales; and 80 to 110 sales associates, including full-time and part-time sales associates. The number of sales associates is dependent upon store size and sales volume.

International stores use a standardized operating system. The operating system includes procedures for inventory management, transaction processing, customer relations, store administration, staff training and performance appraisals, as well as merchandise display. Advertising, merchandise buying and pricing, and inventory policies are centrally controlled.

Merchandise

Domestic Segment

U.S. Best Buy stores offer merchandise in four product groups: consumer electronics, home-office, entertainment software and appliances. Consumer electronics, the largest product group for fiscal 2006 based on revenue, consists of video and audio products and services. Video products include televisions, digital cameras, DVD players, digital camcorders and accessories. Audio products include MP3 players, home theater audio systems, mobile electronics including car stereo and satellite radio products, and related accessories. The home-office product group

8




includes notebook and desktop computers, computer support services, telephones, networking and accessories. Entertainment software products include DVD movies, video game hardware and software, CDs, computer software and subscriptions. The appliances product group includes major appliances as well as vacuums, small electrics, housewares and services.

We also provide a variety of services related to the merchandise offered within the product groups. In-store services include computer set-up, repair and software installation, as well as the installation of mobile electronics. In-home services include computer set-up, repair, software installation and home networking, and the delivery and installation of appliances and home theater systems. Services were not a significant part of our revenue in fiscal 2006. Our services business does generally provide higher gross margins than our merchandise assortment and has been a contributor to year-over-year gross margin gains. However, the infrastructure supporting that business has also increased our selling, general and administrative expenses (SG&A) rate. We expect to grow our services business such that over time service revenue will become a more significant component of our business.

Magnolia Audio Video stores offer merchandise in two product groups: consumer electronics and home-office. Consumer electronics, the largest product group for fiscal 2006 based on revenue, consists of video and audio products. Video products include digital televisions, DVD players, digital broadcast satellite systems, digital imaging, home theater installation, warranties and accessories. Audio products include home audio components, mobile electronics, home theater audio systems, warranties and accessories. The home-office product group consists primarily of home theater furniture.

International Segment

International stores offer merchandise in four product groups: consumer electronics, home-office, entertainment software and appliances. Consumer electronics, the largest product group for fiscal 2006 based on revenue, consists of video and audio products. Video products include televisions, digital cameras, DVD players, digital camcorders and accessories. Audio products include MP3 players, home audio components, car stereos, speakers and accessories. The home-office product group includes desktop and notebook computers, telephones and accessories.

Entertainment software products include DVDs, video game hardware and software, computer software and CDs. The appliances product group includes major appliances as well as small electrics, vacuums and housewares. Canadian Best Buy stores do not carry appliances.

Although the two store brands of our International segment carry similar product categories, there are differences in product brands and depth of selection within product categories. On average, approximately 42% of the product assortment (excluding entertainment software) overlaps between the two store brands.

Distribution

Domestic Segment

Generally, U.S. Best Buy stores’ merchandise, except for major appliances and large-screen televisions, is shipped directly from manufacturers to our distribution centers located in California, Georgia, Indiana, Minnesota, New York, Ohio, Oklahoma and Virginia. Major appliances and large-screen televisions are shipped to satellite warehouses in each major market. U.S. Best Buy stores are dependent upon the distribution centers for inventory storage and shipment of most merchandise. However, in order to meet release dates for selected products and to improve inventory management, certain merchandise is shipped directly to the stores from our suppliers. All inventory is bar-coded and scanned to ensure accurate tracking. In addition, a computerized inventory replenishment program is used to manage inventory levels at each store. On average, U.S. Best Buy stores receive product shipments two or three times a week, depending on sales volume. Contract carriers ship merchandise from the distribution centers to stores. Generally, online merchandise sales are either picked up at U.S. Best Buy stores or fulfilled directly to customers through our distribution centers.

Magnolia Audio Video stores’ merchandise is received and warehoused at either a distribution center in Washington, a distribution center in California or the U.S. Best Buy distribution center in California. All inventory is bar-coded and scanned to ensure accurate tracking. In addition, a

9




computerized inventory replenishment program is used to manage inventory levels at each store. Merchandise is delivered to stores an average of three times each week pursuant to an in-house distribution system.

International Segment

Our International stores’ merchandise is shipped directly from our suppliers to our distribution centers in British Columbia and Ontario. Our International stores are dependent upon the distribution centers for inventory storage and shipment of most merchandise. However, in order to meet release dates for selected products and to improve inventory management, certain merchandise is shipped directly to the stores from manufacturers and distributors. All inventory is bar-coded and scanned to ensure accurate tracking. In addition, a computerized inventory replenishment program is used to manage inventory levels at each store. Our International stores typically receive product shipments twice a week, with accelerated shipments during periods of high sales volume. Contract carriers ship merchandise from the distribution centers to stores.

Suppliers

Our strategy depends, in part, upon our ability to offer customers a broad selection of name-brand products and, therefore, our success is dependent upon satisfactory and stable supplier relationships. For fiscal 2006, our 20 largest suppliers accounted for approximately three-fifths of the merchandise we purchased, with five suppliers — Sony, Hewlett-Packard, Gateway, Toshiba and Apple — representing approximately one-third of total merchandise purchased. The loss of or disruption in supply from any one of these major suppliers could have a material adverse effect on our revenue and earnings. We generally do not have long-term written contracts with our major suppliers that would require them to continue supplying us with merchandise. We have no indication that any of our suppliers will discontinue selling us merchandise. We have not experienced significant difficulty in maintaining satisfactory sources of supply, and we generally expect that adequate sources of supply will continue to exist for the types of merchandise sold in our stores.

We operate three global sourcing offices in China in order to purchase products directly from Asian manufacturers. These offices have improved our product sourcing efficiency and provide us with the capability to offer private-label products that complement our existing product assortment. In the future, we expect purchases from our global sourcing offices to increase as a percentage of total purchases. We also believe that the expected increase in our global sourcing volumes will help drive gross profit rate improvements by lowering our overall product cost.

Store Development

The addition of new stores has played, and we believe will continue to play, a significant role in our growth and success. Our store development program has historically focused on entering new markets; adding stores within existing markets; and relocating, remodeling and expanding existing stores. During fiscal 2006, we opened 105 new stores, converted 163 existing U.S. Best Buy stores to our customer centricity operating model, relocated 16 other stores and remodeled three other stores. While a majority of the new stores opened in fiscal 2006 were in existing markets, some were in new markets, including the opening of Canadian Best Buy stores in Quebec. During fiscal 2006 we closed one U.S. Geek Squad store and one Future Shop store.


10




The following table reconciles U.S. Best Buy stores open at the beginning and end of each of the last five fiscal years (excluding 12, six and one Geek Squad stand-alone stores at the end of fiscal 2006, fiscal 2005 and fiscal 2004, respectively):

Fiscal Year

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal Year

 

Balance forward

 

 

NA

 

 

NA

 

 

419

 

2002

 

 

62

 

 

 

 

481

 

2003

 

 

67

 

 

 

 

548

 

2004

 

 

60

 

 

 

 

608

 

2005

 

 

61

 

 

1

 

 

668

 

2006

 

 

74

 

 

 

 

742

 

 

The following table reconciles Magnolia Audio Video stores open at the beginning and end of each of the last five fiscal years:

Fiscal Year

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal Year

 

Balance forward

 

 

NA

 

 

NA

 

 

13

 

2002

 

 

 

 

 

 

13

 

2003

 

 

6

 

 

 

 

19

 

2004

 

 

3

 

 

 

 

22

 

2005

 

 

 

 

2

 

 

20

 

2006

 

 

 

 

 

 

20

 

 

The following table reconciles Future Shop stores open at the beginning and end of each fiscal year since the date of acquisition:

Fiscal Year

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal Year

 

Balance forward(1)

 

 

NA

 

 

NA

 

 

91

 

2002

 

 

4

 

 

 

 

95

 

2003

 

 

9

 

 

 

 

104

 

2004

 

 

4

 

 

 

 

108

 

2005

 

 

6

 

 

 

 

114

 

2006

 

 

5

 

 

1

 

 

118

 

 

(1)                  As of the date of acquisition, November 4, 2001

The following table reconciles Canadian Best Buy stores open at the beginning and end of each fiscal year since inception of the International segment (excluding five Geek Squad stores at the end of fiscal 2006):

Fiscal Year

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal Year

 

Balance forward

 

 

NA

 

 

NA

 

 

NA

 

2002

 

 

 

 

 

 

 

2003

 

 

8

 

 

 

 

8

 

2004

 

 

11

 

 

 

 

19

 

2005

 

 

11

 

 

 

 

30

 

2006

 

 

14

 

 

 

 

44

 

 

During fiscal 2007, we expect to open nearly 90 new stores in the United States and Canada (not including the stores acquired in the Pacific Sales acquisition). Most of the new stores will be opened in markets where we already have stores, leveraging our infrastructure and making shopping more convenient for our customers. We anticipate opening 75 to 80 U.S. Best Buy stores, as well as relocating 10 to 15 existing U.S. Best Buy stores. We also expect to open approximately three Best Buy stores in Canada. We anticipate opening four to five Future Shop stores, as well as relocating approximately four existing stores. On a long-term basis, we plan to operate at least 1,200 stores in North America. Additionally, in fiscal 2007 we expect to open our first store in Shanghai, China.

Additional information regarding our Outlook for Fiscal 2007 is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report on Form 10-K.

Intellectual Property

We believe we own valuable intellectual property including trademarks, service marks and tradenames, some of which are of material importance to our business, and include “Best Buy,” “Yellow Tag” logo, “Geek Squad,” “Future Shop,” “Magnolia Audio Video” and “Pacific Sales.” Some of our intellectual property is the subject of numerous United States and foreign trademark and service mark registrations. We believe our intellectual property has significant value and is an important factor in the marketing of our company, our stores and our Web sites. We are not aware of any facts that could negatively impact our continuing use of any of our intellectual property.

11




In accordance with accounting principles generally accepted in the United States (GAAP), our balance sheets include the cost of acquired intellectual property only. The only material acquired intellectual property presently included in our balance sheets is the Future Shop tradename, which had a carrying value of $44 million at the end of fiscal 2006. The value of the Future Shop tradename is based on the continuation of the Future Shop brand in Canada and currently is considered an indefinite-lived intangible asset. If we ever were to abandon the Future Shop brand, we would incur an impairment charge based on the then-carrying value of the Future Shop tradename.

Seasonality

Our revenue and earnings are typically greater during our fiscal fourth quarter, which includes the majority of the holiday selling season.

Working Capital

We fund the growth of our business through a combination of available cash and cash equivalents, short-term investments and cash flows generated from operations. In addition, our revolving credit facilities are available for additional working capital needs or investment opportunities.

Customers

We do not have a significant concentration of sales with any individual customer and, therefore, the loss of any one customer would not have a material impact on our business. No single customer has accounted for 10% or more of our total revenue.

Backlog

Our stores and online shopping sites do not have a material amount of backlog orders.

Government Contracts

No material portion of our business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government.

Competition

The consumer electronics and home-office retail industry is highly competitive. Our stores compete against other consumer electronics retailers, specialty home-office retailers, mass merchants, home-improvement superstores and a growing number of direct-to-consumer alternatives. Our stores also compete against independent dealers, regional chain discount stores, wholesale clubs, video rental stores and other specialty retail stores. Mass merchants continue to increase their assortment of consumer electronics products, primarily those that are less complex to sell, install and operate and have been expanding their product offerings into higher-end categories. Similarly, large home-improvement retailers are expanding their assortment of appliances. In addition, consumers are increasingly downloading entertainment and computer software directly via the Internet.

We compete principally on the basis of customer service; installation and support services; store environment, location and convenience; product assortment and availability; value pricing; and financing alternatives.

We believe our store experience, broad product assortment, store formats and brand marketing strategies differentiate us from most competitors by positioning our stores as the destination for new technology and entertainment products in a fun and informative shopping environment. Our stores compete by aggressively advertising and emphasizing a complete product and service solution, value pricing and financing alternatives. In addition, our trained and knowledgeable sales and service staffs allow us to tailor the offerings to meet the needs of our customers.

Research and Development

We have not engaged in any material research and development activities during the past three fiscal years.

12




Environmental Matters

We are not aware of any federal, state or local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, that have materially affected, or will materially affect, our net earnings or competitive position, or have resulted or will result in material capital expenditures. During fiscal 2006, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.

Number of Employees

At the end of fiscal 2006, we employed approximately 128,000 full-time, part-time and seasonal employees. We consider our employee relations to be good. There are currently no collective bargaining agreements covering any of our employees, and we have not experienced a strike or work stoppage.

Financial Information About Geographic Areas

We operate two reportable segments: Domestic and International. Financial information regarding the Domestic and International geographic areas is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 10, Segments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Available Information

We are subject to the reporting requirements of the Exchange Act and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the Securities and Exchange Commission (SEC). Copies of these reports, proxy statements and other information can be read and copied at:

SEC Public Reference Room
100 F Street NE
Washington, D.C. 20549

Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

The SEC maintains a Web site that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s home page at http://www.sec.gov.

We make available, free of charge on our Web site, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file these documents with, or furnish them to, the SEC. These documents are posted on our Web site at www.BestBuy.com — select the “For Our Investors” link and then the “SEC Filings” link.

We also make available, free of charge on our Web site, the charters of the Audit Committee, Compensation and Human Resources Committee, and Nominating, Corporate Governance and Public Policy Committee, as well as the Corporate Governance Principles of our Board of Directors (Board) and our Code of Business Ethics (including any amendment to, or waiver from, a provision of our Code of Business Ethics) adopted by our Board. These documents are posted on our Web site at www.BestBuy.com — select the “For Our Investors” link and then the “Corporate Governance” link.

Copies of any of the above-referenced information will also be made available, free of charge, upon written request to:

Best Buy Co., Inc.
Investor Relations Department
7601 Penn Avenue South
Richfield, MN 55423-3645

Item 1A. Risk Factors.

Described below are certain risks that our management believes are applicable to our business and the industry in which we operate. There may be additional risks that are not presently material or known. There are also risks within the economy and the capital markets, both domestically

13




and internationally, that affect business generally, and our company and industry as well, such as inflation; higher interest rates; higher fuel and other energy costs; higher transportation costs; higher costs of labor, insurance and healthcare; foreign exchange rate fluctuations; and higher levels of unemployment, which have not been described. You should carefully consider each of the following risks and all other information set forth in this Annual Report on Form 10-K.

If any of the events described below occur, our business, financial condition, results of operations, liquidity or access to the capital markets could be materially adversely affected. The following risks could cause our actual results to differ materially from our historical experience and from results predicted by forward-looking statements made by us or on our behalf related to conditions or events that we anticipate may occur in the future. All forward-looking statements made by us or on our behalf are qualified by the risks described below.

If we do not anticipate and respond to changing consumer preferences in a timely manner, our operating results could suffer.

Our business depends, in large part, on our ability to introduce successfully new products, services and technologies to consumers, the frequency of such introductions, the level of consumer acceptance, and the related impact on the demand for existing products, services and technologies. Failure to predict accurately constantly changing consumer tastes, preferences, spending patterns and other lifestyle decisions, or to address effectively consumer concerns, could have a material adverse effect on our revenue, results of operations and standing with our customers.

Our growth is dependent on the success of our strategies.

Our growth is dependent on our ability to identify, develop and execute strategies. While we believe customer centricity and the pursuit of international growth opportunities will enable us to grow our business, misjudgments could have a material adverse effect on our business, financial condition and results of operations.

Our results of operations could deteriorate if we fail to attract, develop and retain qualified employees.

Our performance is dependent on attracting and retaining a large and growing number of employees. We believe our competitive advantage is providing unique end-to-end solutions for each individual customer, which requires us to have highly trained and engaged employees. Our success depends in part upon our ability to attract, develop and retain a sufficient number of qualified employees, including store, service and administrative personnel. The turnover rate in the retail industry is high, and qualified individuals of the requisite caliber and number needed to fill these positions may be in short supply in some areas. Competition for such qualified individuals could require us to pay higher wages to attract a sufficient number of employees. Our inability to recruit a sufficient number of qualified individuals in the future may delay planned openings of new stores or affect the speed to enter new growth areas such as Best Buy For Business and services. Delayed store openings, significant increases in employee turnover rates or significant increases in labor costs could have a material adverse effect on our business, financial condition and results of operations.

We face strong competition from traditional store-based retailers, Internet businesses and other forms of retail commerce, which could materially affect our revenue and profitability.

The retail business is highly competitive. We compete for customers, employees, locations, products and other important aspects of our business with many other local, regional, national and international retailers. Pressure from our competitors, some of which have a greater market presence than we do, could require us to reduce our prices or increase our costs of doing business. As a result of this competition, we may experience lower revenue and/or higher operating costs, which could materially adversely affect our results of operations.

14




Our growth strategy includes expanding our business, both in existing markets and by opening stores in new markets.

Our future growth is dependent, in part, on our ability to build or lease new stores. We compete with other retailers and businesses for suitable locations for our stores. Local land use, local zoning issues, environmental regulations and other regulations applicable to the types of stores we desire to construct may impact our ability to find suitable locations, and also influence the cost of constructing and leasing our stores. We also may have difficulty negotiating leases or real estate purchase agreements on acceptable terms. Failure to manage these and other similar factors effectively will affect our ability to build or lease new stores, which may have a material adverse effect on our future profitability.

We seek to expand our business in existing markets in order to attain a greater overall market share. Because our stores typically draw customers from their local areas, a new store may draw customers away from our nearby existing stores and may cause comparable store sales performance and customer traffic at those existing stores to decline.

We also intend to open stores in new markets. The risks associated with entering a new market include difficulties in attracting customers due to a lack of customer familiarity with our brand, our lack of familiarity with local customer preferences and seasonal differences in the market. In addition, entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. And while we have a strong track record of profitable new store growth, we cannot ensure that our new stores will be profitably deployed; as a result, our future profitability may be materially adversely affected.

Risks associated with the vendors from whom our products are sourced could materially adversely affect our revenue and gross profit.

The products we sell are sourced from a wide variety of domestic and international vendors. Global sourcing is becoming an increasingly important part of our business and positively affects our financial performance. Our 20 largest suppliers account for approximately three-fifths of the merchandise we purchase. If any of our key vendors fails to supply us with products, we may not be able to meet the demands of our customers and revenue could decline. We require all of our vendors to comply with applicable laws, including labor and environmental laws, and otherwise be certified as meeting our required vendor standards of conduct. Our ability to find qualified vendors who meet our standards and supply products in a timely and efficient manner is a significant challenge, especially with respect to goods sourced from outside the United States. Political or financial instability, merchandise quality issues, trade restrictions, tariffs, currency exchange rates, transportation capacity and costs, inflation, outbreak of pandemics and other factors relating to foreign trade are beyond our control. These and other issues affecting our vendors could materially adversely affect our revenue and gross profit.

We are subject to certain regulatory and legal developments which could have a material adverse impact on our business.

Our regulatory and legal environment exposes us to complex compliance and litigation risks that could materially affect our operations and financial results. In our major global markets, we are subject to increasing regulations, which increase our cost of doing business. The most significant compliance and litigation risks we face are:

·        The difficulty in complying with sometimes conflicting regulations in local, national or international jurisdictions and new or changing regulations that affect how we operate;

·        The impact of changes in tax laws (or interpretations thereof);

·        The impact of litigation trends, including class actions involving consumers and shareholders, and labor and employment matters; and

·        The significant uncertainties of operating globally, including the costs and difficulties of managing international operations, foreign currencies, complex laws, contractual obligations and intellectual property rights.

15




We rely heavily on our management information systems for inventory management, distribution and other functions. If our systems fail to perform these functions adequately or if we experience an interruption in their operation, our business and results of operations could be materially adversely affected.

The efficient operation of our business is dependent on our management information systems. We rely heavily on our management information systems to manage our order entry, order fulfillment, pricing, point-of-sale and inventory replenishment processes. The failure of our management information systems to perform as we anticipate could disrupt our business and could result in decreased revenue, increased overhead costs and excess or out-of-stock inventory levels, causing our business and results of operations to suffer materially.

A disruption in our relationship with Accenture, who manages our information technology and human resources operations, could materially adversely affect our business and results of operations.

We have engaged Accenture Ltd to manage our information technology and human resources operations. We rely heavily on our management information systems for inventory management, distribution and other functions. We also rely heavily on human resources support to attract, develop and retain a sufficient number of qualified employees. Any disruption in our relationship with Accenture could result in decreased revenue and increased overhead costs, causing our business and results of operations to suffer materially.

Failure to protect the integrity and security of our customers’ information could expose us to litigation and materially damage our standing with our customers.

The increasing costs associated with information security — such as increased investment in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud — could cause our business and results of operations to suffer materially. Additionally, the success of our online operations depends upon the secure transmission of confidential information over public networks, including the use of cashless payments. While we are taking significant efforts to protect customer and confidential information, there can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography or other developments will prevent the compromise of our customer transaction processing capabilities and personal data. If any such compromise of our security were to occur, it could have a material adverse effect on our reputation, business, operating results and financial condition and may increase the costs we incur to protect against such security breaches.

Failure in our pursuit or execution of new business ventures, strategic alliances and acquisitions could have a material adverse impact on our business.

Our growth strategy includes expansion via new business ventures, strategic alliances and acquisitions. While we employ several different valuation methodologies to assess a potential growth opportunity, we can give no assurance that new business ventures and strategic alliances will positively affect our financial performance. Acquisitions may result in difficulties in assimilating acquired companies, and may result in the diversion of our capital and our management’s attention from other business issues and opportunities. We may not be able to integrate companies that we acquire successfully, including their personnel, financial systems, distribution, operations and general operating procedures. If we fail to integrate acquired companies successfully, our business could suffer materially. We may also encounter challenges in achieving appropriate internal control over financial reporting in connection with the integration of an acquired company. In addition, the integration of any acquired company, and its financial results, into ours may have a material adverse effect on our operating results.


 

16




We are highly dependent on the cash flows and net earnings we generate during our fourth fiscal quarter, which includes the majority of the holiday selling season.

Approximately one-third of our revenue and more than one-half of our net earnings are generated in our fourth fiscal quarter, which includes the majority of the holiday selling season. Unexpected events or developments such as natural disasters, man-made disasters and adverse economic conditions in our fourth quarter could have a material adverse effect on our revenue and earnings.

The foregoing should not be construed as an exhaustive list of all factors that could cause actual results to differ materially from those expressed in forward-looking statements made by us or on our behalf.

Item 1B. Unresolved Staff Comments.

At February 25, 2006, there were no unresolved comments from the SEC staff regarding our periodic or current reports.


 

17




Item 2. Properties.

Stores, Distribution Centers and Corporate Facilities

The following table summarizes the geographic location of our stores at the end of fiscal 2006:

 

Domestic Segment

 

International Segment

 

 

 

U.S. Best Buy
Stores

 

Magnolia Audio
Video Stores

 

U.S. Geek Squad
Stores

 

Canadian Best
Buy Stores

 

Future Shop
Stores

 

Canadian Geek
Squad Stores

 

Alabama

 

 

8

 

 

 

 

 

 

 

 

 

 

 

Alaska

 

 

1

 

 

 

 

 

 

 

 

 

 

 

Arizona

 

 

16

 

 

 

 

 

 

 

 

 

 

 

Arkansas

 

 

4

 

 

 

 

 

 

 

 

 

 

 

California

 

 

80

 

 

11

 

 

2

 

 

 

 

 

 

 

Colorado

 

 

12

 

 

 

 

1

 

 

 

 

 

 

 

Connecticut

 

 

10

 

 

 

 

 

 

 

 

 

 

 

Delaware

 

 

3

 

 

 

 

 

 

 

 

 

 

 

District of Columbia

 

 

1

 

 

 

 

 

 

 

 

 

 

 

Florida

 

 

41

 

 

 

 

 

 

 

 

 

 

 

Georgia

 

 

23

 

 

 

 

3

 

 

 

 

 

 

 

Hawaii

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Idaho

 

 

4

 

 

 

 

 

 

 

 

 

 

 

Illinois

 

 

42

 

 

 

 

 

 

 

 

 

 

 

Indiana

 

 

18

 

 

 

 

 

 

 

 

 

 

 

Iowa

 

 

12

 

 

 

 

 

 

 

 

 

 

 

Kansas

 

 

7

 

 

 

 

 

 

 

 

 

 

 

Kentucky

 

 

7

 

 

 

 

 

 

 

 

 

 

 

Louisiana

 

 

8

 

 

 

 

 

 

 

 

 

 

 

Maine

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Maryland

 

 

17

 

 

 

 

 

 

 

 

 

 

 

Massachusetts

 

 

19

 

 

 

 

 

 

 

 

 

 

 

Michigan

 

 

30

 

 

 

 

 

 

 

 

 

 

 

Minnesota

 

 

19

 

 

 

 

2

 

 

 

 

 

 

 

Mississippi

 

 

5

 

 

 

 

 

 

 

 

 

 

 

Missouri

 

 

17

 

 

 

 

 

 

 

 

 

 

 

Montana

 

 

3

 

 

 

 

 

 

 

 

 

 

 

Nebraska

 

 

4

 

 

 

 

 

 

 

 

 

 

 

Nevada

 

 

6

 

 

 

 

 

 

 

 

 

 

 

New Hampshire

 

 

6

 

 

 

 

 

 

 

 

 

 

 

New Jersey

 

 

18

 

 

 

 

 

 

 

 

 

 

 

New Mexico

 

 

5

 

 

 

 

 

 

 

 

 

 

 

New York

 

 

33

 

 

 

 

 

 

 

 

 

 

 

North Carolina

 

 

22

 

 

 

 

 

 

 

 

 

 

 

North Dakota

 

 

4

 

 

 

 

 

 

 

 

 

 

 

Ohio

 

 

33

 

 

 

 

 

 

 

 

 

 

 

Oklahoma

 

 

6

 

 

 

 

 

 

 

 

 

 

 

Oregon

 

 

6

 

 

2

 

 

 

 

 

 

 

 

 

Pennsylvania

 

 

24

 

 

 

 

 

 

 

 

 

 

 

Rhode Island

 

 

1

 

 

 

 

 

 

 

 

 

 

 

South Carolina

 

 

9

 

 

 

 

 

 

 

 

 

 

 

South Dakota

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Tennessee

 

 

10

 

 

 

 

 

 

 

 

 

 

 

Texas

 

 

74

 

 

 

 

3

 

 

 

 

 

 

 

Utah

 

 

7

 

 

 

 

 

 

 

 

 

 

 

Vermont

 

 

1

 

 

 

 

 

 

 

 

 

 

 

Virginia

 

 

23

 

 

 

 

 

 

 

 

 

 

 

Washington

 

 

16

 

 

7

 

 

 

 

 

 

 

 

 

West Virginia

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Wisconsin

 

 

19

 

 

 

 

1

 

 

 

 

 

 

 

Wyoming

 

 

 

 

 

 

 

 

 

 

 

 

 

Alberta

 

 

 

 

 

 

 

 

7

 

 

15

 

 

 

British Columbia

 

 

 

 

 

 

 

 

6

 

 

21

 

 

3

 

Manitoba

 

 

 

 

 

 

 

 

2

 

 

5

 

 

 

New Brunswick

 

 

 

 

 

 

 

 

 

 

3

 

 

 

Newfoundland

 

 

 

 

 

 

 

 

 

 

1

 

 

 

Nova Scotia

 

 

 

 

 

 

 

 

 

 

2

 

 

 

Ontario

 

 

 

 

 

 

 

 

20

 

 

45

 

 

2

 

Prince Edward Island

 

 

 

 

 

 

 

 

 

 

1

 

 

 

Quebec

 

 

 

 

 

 

 

 

8

 

 

22

 

 

 

Saskatchewan

 

 

 

 

 

 

 

 

1

 

 

3

 

 

 

Total

 

 

742

 

 

20

 

 

12

 

 

44

 

 

118

 

 

5

 

 

Note: At the end of fiscal 2006, we owned 52 of our U.S. Best Buy stores and three of our Canadian Best Buy stores. All other stores at the end of fiscal 2006 were leased.


18




Domestic Segment

At the end of fiscal 2006, we operated 742 U.S. Best Buy stores, 20 Magnolia Audio Video stores and 12 Geek Squad stores, totaling approximately 30.8 million retail square feet.

The operations of the Domestic segment are serviced by the following distribution centers:

Location

 

Square
Footage

 

Owned
or Leased

 

Dinuba, California

 

1,028,000

 

 

Owned

 

Findlay, Ohio

 

1,010,000

 

 

Leased

 

Nichols, New York

 

720,000

 

 

Owned

 

Ardmore, Oklahoma(1)

 

720,000

 

 

Owned

 

Franklin, Indiana

 

714,000

 

 

Owned

 

Staunton, Virginia

 

709,000

 

 

Leased

 

Dublin, Georgia

 

638,000

 

 

Leased

 

Bloomington, Minnesota

 

425,000

 

 

Leased

 

Kent, Washington

 

54,000

 

 

Leased

 

Hayward, California

 

13,000

 

 

Leased

 

Total

 

6,031,000

 

 

 

 

 

(1)                  During fiscal 2005, we opened a new distribution center in Ardmore, Oklahoma. The new and larger distribution center replaced a 566,000-square-foot owned distribution center also located in Ardmore. The 566,000-square-foot owned distribution center is currently being marketed for sale or lease.

We lease space in 13 satellite warehouses in major metropolitan markets for home delivery of major appliances and large-screen televisions. U.S. Best Buy stores utilize approximately 2.7 million square feet in these warehouses.

Our principal corporate office is located in Richfield, Minnesota, and is an owned facility consisting of four interconnected buildings totaling approximately 1.5 million square feet. During fiscal 2006 we sold a 360,000-square-foot facility in Eden Prairie, Minnesota, which previously served as our principal corporate office. At the end of fiscal 2006, we also leased approximately 420,000 square feet of additional office space.

International Segment

At the end of fiscal 2006, we operated 118 Future Shop stores, 44 Canadian Best Buy stores and five Geek Squad stores, totaling approximately 3.6 million retail square feet.

The operations of our International segment are serviced by two leased distribution centers located in Langley, British Columbia, and Brampton, Ontario. The British Columbia distribution center is 419,000 square feet, and the Ontario distribution center is 1,041,000 square feet. During fiscal 2007, we expect to open another leased distribution center in Brampton, Ontario, having approximately 79,000 square feet.

The principal offices for our International segment are located in a 141,000-square-foot leased facility in Burnaby, British Columbia. At the end of fiscal 2006, we also leased 60,000 square feet of additional office space for various International segment regional offices in Ontario, Quebec, British Columbia and Alberta.

Global Sourcing

In support of our global sourcing initiative, we lease office space in China totaling approximately 32,000 square feet at the end of fiscal 2006.

Operating Leases

Almost all of our stores and a majority of our distribution facilities are leased. Terms of the lease agreements generally range from 10 to 20 years. Most of the leases contain renewal options and escalation clauses.

Additional information regarding our operating leases is available in Note 7, Leases, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Item 3. Legal Proceedings.

On December 8, 2005, a purported class action lawsuit captioned, Jasmen Holloway, et. al. v Best Buy Co., Inc., was filed in the U.S. District Court for the Northern District of California alleging we discriminate against women and minority individuals on the basis of gender, race, color and/or national origin with respect to our employment policies and practices. The action seeks an end to discriminatory policies and practices, an award of back and front pay, punitive damages and injunctive relief, including rightful place relief for all class members. We believe the allegations are without merit and intend to defend this action vigorously.

19




We are involved in various other legal proceedings arising in the normal course of conducting business. We believe the amounts provided in our consolidated financial statements, as prescribed by accounting principles generally accepted in the United States, are adequate in light of the probable and estimable liabilities. The resolution of those other proceedings is not expected to have a material effect on our results of operations or financial condition.


Executive Officers of the Registrant:

(As of February 25, 2006)

Name

 

Age

 

Position With the Company

 

Years
With the
Company

Bradbury H. Anderson

 

56

 

Vice Chairman and Chief Executive Officer

 

33

Richard M. Schulze

 

65

 

Founder and Chairman of the Board

 

40

Allen U. Lenzmeier

 

62

 

Vice Chairman

 

22

Brian J. Dunn

 

45

 

President and Chief Operating Officer

 

21

Robert A. Willett

 

59

 

Chief Executive Officer — Best Buy International

 

2

Kevin T. Layden

 

45

 

President and Chief Operating Officer — Best Buy Canada

 

9

Shari L. Ballard

 

39

 

Executive Vice President — Human Capital and Leadership

 

13

Ronald D. Boire

 

44

 

Executive Vice President — General Merchandise Manager

 

3

Thomas C. Healy

 

44

 

Executive Vice President — Best Buy For Business

 

16

Darren R. Jackson

 

41

 

Executive Vice President — Finance and Chief Financial Officer

 

6

Michael A. Linton

 

49

 

Executive Vice President — Consumer and Brand Marketing and Chief Marketing Officer

 

7

Michael London

 

57

 

Executive Vice President — Sourcing and Alliances

 

10

Timothy D. McGeehan

 

39

 

Executive Vice President — Retail Sales

 

18

Kalendu Patel

 

42

 

Executive Vice President — Strategy and International

 

3

Greg Thorson

 

52

 

Executive Vice President — Enterprise Transformation

 

1

John C. Walden

 

46

 

Executive Vice President — Customer Business Group

 

7

Susan S. Hoff

 

41

 

Senior Vice President and Chief Communications Officer

 

23

Joseph M. Joyce

 

54

 

Senior Vice President — General Counsel and Assistant Secretary

 

15

James L. Muehlbauer

 

44

 

Senior Vice President — Finance

 

4

Ryan D. Robinson

 

40

 

Senior Vice President — Finance and Treasurer

 

4

 


Bradbury H. Anderson has been a director since August 1986 and is currently our Vice Chairman and Chief Executive Officer. He assumed the responsibility of Chief Executive Officer in June 2002, having previously served as President and Chief Operating Officer since April 1991. He has been employed in various capacities with us since 1973. In addition, he serves on the board of the Retail Industry Leaders Association, as well as on the boards of the American Film Institute, Junior Achievement, Minnesota Public Radio and Waldorf College.

Richard M. Schulze is a founder of Best Buy. He has been an officer and director from our inception in 1966 and currently is Chairman of the Board. Effective in June 2002, he relinquished the duties of Chief Executive Officer. He had been our principal executive officer for more than 30 years. He is on the board of trustees of the University of St. Thomas, chairman of its Executive and Institutional Advancement Committee, and a member of its Board Affairs Committee. Mr. Schulze is also chairman of the board of governors of the University of St. Thomas Business School.

Allen U. Lenzmeier has been a director since February 2001 and is currently our Vice Chairman, serving on a part-time basis to support our international expansion. Prior to his promotion to his current position, he served in various capacities since joining us in 1984, including as President and Chief Operating Officer from 2002 to 2004, and as President of Best Buy Retail

20




Stores from 2001 to 2002. He serves on the board of UTStarcom, Inc. He is also a national trustee for the Boys and Girls Clubs of America and serves on its Twin Cities board of directors, and serves on the board of the Catholic Community Foundation of the Archdiocese of St. Paul and Minneapolis.

Brian J. Dunn was named President and Chief Operating Officer in February 2006. Prior to his promotion to his current position, he served as President — Retail, North America since December 2004. Mr. Dunn joined us in 1985 and has held positions as Executive Vice President, Senior Vice President, Regional Vice President, regional manager, district manager and store manager.

Robert A. Willett became our Chief Executive Officer — Best Buy International in February 2006. He previously served as Executive Vice President — Operations since April 2004. In April 2002, we engaged Mr. Willett as a consultant and special advisor to our Board on matters relating to operational efficiency and excellence. Prior to that, he was the global managing partner for the retail practice at Accenture LLP, a global management consulting, technology services and outsourcing company, and was also a member of its Executive Committee. Mr. Willett began his career in store management at Marks & Spencer P.L.C., a British department store chain, and has held executive positions at F.W. Woolworth & Co., a department store chain, as well as several other retailers in the United Kingdom.

Kevin T. Layden was named President and Chief Operating Officer — Best Buy Canada (formerly Future Shop Ltd.) in 1999. Mr. Layden joined us in 1997 as Vice President — Merchandising. Prior to joining us, he spent approximately 17 years with Circuit City Stores, Inc., a retailer of consumer electronics, serving in positions of increasing responsibility, including most recently as assistant vice president and general manager for New York.

Shari L. Ballard was named Executive Vice President — Human Capital and Leadership in December 2004. Ms. Ballard joined us in 1993 and has held positions as Senior Vice President, Vice President, and general and assistant store manager.

Ronald D. Boire joined us in June 2003 as Executive Vice President — General Merchandise Manager. Prior to joining us, he spent 17 years at Sony Electronics Inc., an electronics manufacturer, where he held various executive, sales and marketing positions before becoming president of Sony’s Personal Mobile Products Company. Most recently, he was president of the Sony Electronics Consumer Sales Company, and was responsible for managing sales and distribution of Sony’s consumer electronics products throughout the United States. Mr. Boire also was a member of Sony’s Operations Committee.

Thomas C. Healy was named Executive Vice President — Best Buy For Business in December 2004. Mr. Healy joined us in 1990 and has held positions as President — Best Buy International, Senior Vice President, Regional Vice President, district manager and store manager.

Darren R. Jackson was named Executive Vice President — Finance and Chief Financial Officer in April 2002. Mr. Jackson joined us in 2000 as Senior Vice President — Finance and Treasurer and was promoted to Chief Financial Officer in 2001. Prior to that, Mr. Jackson served as chief financial officer of the Full-Line Store Division at Nordstrom, Inc., a department store chain, from 1998 to 2000 and as chief financial officer of Carson Pirie Scott & Co. Inc., a department store chain, from 1996 to 1998. A certified public accountant, Mr. Jackson has 17 years of experience in the retail industry. Mr. Jackson serves as a director of Advanced Auto Parts, Inc. and serves on the Marquette University board of trustees.

Michael A. Linton was promoted to Executive Vice President — Consumer and Brand Marketing and Chief Marketing Officer in March 2002. Mr. Linton joined us in 1999 as Senior Vice President — Strategic Marketing. Prior to that, Mr. Linton held positions as vice president of marketing at Remington Products Corporation, a maker of personal care and grooming products; vice president and general manager of a product category at James River Corporation, a manufacturer and marketer of consumer products, food and packaging; and a general manager at Progressive Insurance. Mr. Linton began his career at Procter & Gamble Company. Mr. Linton also serves as a director of Peet’s Coffee & Tea, Inc.

Michael London has served as an Executive Vice President since April 2005 on a part-time basis to support our leadership group. He served as Executive Vice President — Sourcing and Alliances from December 2004 to April 2005. He served as Executive Vice President —

21




Global Sourcing from February 2004 to December 2004 and Executive Vice President — Customer Centricity from July 2003 to February 2004. Prior to that, he served as Executive Vice President — General Merchandise Manager from 2001 to 2003, as Senior Vice President — General Merchandise from 1998 to 2001 and as Vice President — General Merchandise from 1996 to 1998. Prior to joining us in 1996, Mr. London was a senior vice president for NordicTrack, a fitness equipment manufacturer, and executive vice president for Central Tractor Farm & Country, a specialty farm products retail supplier.

Timothy D. McGeehan was named Executive Vice President — Retail Sales in June 2005. Mr. McGeehan joined us in 1988 and has held positions as Senior Vice President, Regional Vice President, regional manager, district manager and store manager.

Kalendu Patel was named Executive Vice President — Strategy and International in April 2005. Mr. Patel joined us in 2003 and has held positions as Senior Vice President and Vice President. Prior to joining us, Mr. Patel was a partner at Strategos, a strategic consulting firm. Prior to that, he held various positions with KPMG Consulting Inc. and Courtaulds PLC in the United Kingdom.

Greg Thorson joined us in June 2005 as Executive Vice President — Enterprise Transformation. Prior to joining us, Mr. Thorson was a retail partner at Accenture LLP, a global management consulting, technology services and outsourcing company, where he worked with large retailers on strategic initiatives. Prior to that, he spent more than 15 years in restaurant development and operations.

John C. Walden was named Executive Vice President — Customer Business Group in December 2004. Mr. Walden served as Executive Vice President — Human Capital and Leadership from 2002 to 2004 and President of BestBuy.com, Inc. from 1999 to 2002. Prior to joining us in 1999, Mr. Walden served as chief operating officer of Peapod, Inc., an Internet retailer of groceries. Mr. Walden has also held executive positions with Ameritech Corporation, a telecommunications company, and Storage Technology Corporation, a maker of data storage products. Earlier he practiced corporate and securities law with Sidley Austin Brown & Wood LLP.

Susan S. Hoff was named Senior Vice President and Chief Communications Officer in April 2004. Previously, she had served as Senior Vice President — Public Affairs and Investor Relations Officer since 2000. Since joining us in 1983, Ms. Hoff has served in various capacities including Vice President of Corporate Communications and Public Relations.

Joseph M. Joyce was promoted to Senior Vice President — General Counsel and Assistant Secretary in 1997. Mr. Joyce joined us in 1991 as Vice President — Human Resources and General Counsel. Prior to joining us, Mr. Joyce was with Tonka Corporation, a toy maker, having most recently served as vice president, secretary and general counsel.

James L. Muehlbauer was named Senior Vice President — Finance in June 2003. He joined us in 2002 as Vice President and Chief Financial Officer of Musicland. Prior to joining us, Mr. Muehlbauer spent 10 years with The Pillsbury Company, a food manufacturer, where he held various senior-level finance management positions, including vice president and worldwide controller, vice president of operations, divisional finance director, director of mergers and acquisitions, and director of internal audit. A certified public accountant, Mr. Muehlbauer spent eight years with Coopers & Lybrand LLP and most recently served as a senior manager in the firm’s audit and consulting practice.

Ryan D. Robinson was named Senior Vice President — Finance and Treasurer in September 2005. Mr. Robinson joined us in 2002 as Vice President — Finance and Treasurer. Prior to joining us, he spent 15 years at ABN AMRO Holding N.V., a leading international bank, and most recently served as senior vice president and director of that financial institution’s North American private equity activities. Mr. Robinson also held management positions in ABN AMRO Holding N.V.’s corporate finance, finance advisory, acquisitions and asset securitization divisions.

Item 4. Submission of Matters to a Vote of Security Holders.

There were no matters submitted during the fourth quarter of the fiscal year ended February 25, 2006, to a vote of security holders, through the solicitation of proxies or otherwise.


 

22




PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock is traded on the New York Stock Exchange under the ticker symbol BBY. The table below sets forth the high and low sales prices of our common stock as reported on the New York Stock Exchange — Composite Index during the periods indicated. The stock prices below have been revised to reflect a three-for-two stock split effected on August 3, 2005.

 

 

Sales Price

 

 

 

High

 

Low

 

Fiscal 2006

 

 

 

 

 

First Quarter

 

$

36.99

 

$

31.93

 

Second Quarter

 

53.17

 

36.20

 

Third Quarter

 

50.88

 

40.40

 

Fourth Quarter

 

56.00

 

42.75

 

Fiscal 2005

 

 

 

 

 

First Quarter

 

$

37.50

 

$

30.10

 

Second Quarter

 

36.42

 

29.25

 

Third Quarter

 

41.47

 

30.57

 

Fourth Quarter

 

40.48

 

33.91

 

 

Holders

As of April 24, 2006, there were 2,632 holders of record of Best Buy common stock.

Dividends

In fiscal 2004, our Board initiated the payment of a regular quarterly cash dividend, then $0.07 per common share per quarter. A quarterly cash dividend has been paid in each subsequent quarter. Effective with the quarterly cash dividend paid in the third quarter of fiscal 2005, we increased our quarterly cash dividend per common share by 10 percent. Effective with the quarterly cash dividend paid in the third quarter of fiscal 2006, we increased our quarterly cash dividend per common share by 9 percent to $0.08 per common share per quarter. The payment of cash dividends is subject to customary legal and contractual restrictions.

Future dividend payments will depend on the Company’s earnings, capital requirements, financial condition and other factors considered relevant by our Board.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

In April 2005, our Board authorized a $1.5 billion share repurchase program. The program, which became effective on April 27, 2005, terminated and replaced a $500 million share repurchase program authorized by our Board in June 2004. Effective on June 24, 2004, our Board authorized the $500 million share repurchase program, which terminated and replaced a $400 million share repurchase program authorized by our Board in fiscal 2000.

During the fourth quarter of fiscal 2006, we purchased and retired 7.1 million shares at a cost of $338 million. Since the inception of the $1.5 billion share repurchase program in fiscal 2006, we purchased and retired 16.5 million shares at a cost of $711 million. We consider several factors in determining when to make share repurchases including, among other things, our cash needs and the market price of the stock. At the end of fiscal 2006, $790 million of the $1.5 billion originally authorized by our Board was available for future share repurchases. Cash provided by future operating activities, available cash and cash equivalents, as well as short-term investments, are the expected sources of funding for the share repurchase program.


23




The following table presents the total number of shares repurchased during the fourth quarter of fiscal 2006 by fiscal month, the average price paid per share, the number of shares that were purchased as part of a publicly announced repurchase plan, and the approximate dollar value of shares that may yet be purchased pursuant to the $1.5 billion share repurchase program as of the end of fiscal 2006:

Fiscal Period

 

Total Number
of Shares
Purchased

 

Average Price
Paid per Share

 

Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs

 

Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans or
Programs

 

November 27, 2005, through December 31, 2005

 

 

1,553,081

 

 

$

44.15

 

 

1,553,081

 

 

$

1,059,000,000

 

January 1, 2006, through January 28, 2006

 

 

3,049,730

 

 

46.32

 

 

3,049,730

 

 

918,000,000

 

January 29, 2006, through February 25, 2006

 

 

2,540,750

 

 

50.52

 

 

2,540,750

 

 

790,000,000

 

Total Fiscal 2006 Fourth Quarter

 

 

7,143,561

 

 

$

47.34

 

 

7,143,561

 

 

$

790,000,000

 

 


Additional information regarding our share repurchase program is included in the Liquidity and Capital Resources and Outlook for Fiscal 2007 sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included as Item 7 of this Annual Report on Form 10-K.


 

24




Item 6. Selected Financial Data.

The following table presents our selected financial data. The table should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Certain prior-year amounts have been reclassified to conform to the current-year presentation. In fiscal 2004, we sold our interest in Musicland. All fiscal years presented reflect the classification of Musicland’s financial results as discontinued operations.

Five-Year Financial Highlights

$ in millions, except per share amounts

Fiscal Year

 

2006

(1)

2005

(2)

2004

 

2003

 

2002

(3)

Consolidated Statements of Earnings Data

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

30,848

 

$

27,433

 

$

24,548

 

$

20,943

 

$

17,711

 

Operating income

 

1,644

 

1,442

 

1,304

 

1,010

 

908

 

Earnings from continuing operations

 

1,140

 

934

 

800

 

622

 

570

 

Loss from discontinued operations, net of tax

 

 

 

(29

)

(441

)

 

Gain (loss) on disposal of discontinued operations, net of tax

 

 

50

 

(66

)

 

 

Cumulative effect of change in accounting principles, net of tax(4)

 

 

 

 

(82

)

 

Net earnings

 

1,140

 

984

 

705

 

99

 

570

 

Per Share Data(5)

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

2.27

 

$

1.86

 

$

1.61

 

$

1.27

 

$

1.18

 

Discontinued operations

 

 

 

(0.06

)

(0.89

)

 

Gain (loss) on disposal of discontinued operations

 

 

0.10

 

(0.13

)

 

 

Cumulative effect of accounting changes

 

 

 

 

(0.16

)

 

Net earnings

 

2.27

 

1.96

 

1.42

 

0.20

 

1.18

 

Cash dividends declared and paid

 

0.31

 

0.28

 

0.27

 

 

 

Common stock price:

 

 

 

 

 

 

 

 

 

 

 

High

 

56.00

 

41.47

 

41.80

 

35.83

 

34.31

 

Low

 

31.93

 

29.25

 

17.03

 

11.33

 

14.95

 

Operating Statistics

 

 

 

 

 

 

 

 

 

 

 

Comparable store sales gain(6)

 

4.9

%

4.3

%

7.1

%

2.4

%

1.9

%

Gross profit rate

 

25.0

%

23.7

%

23.9

%

23.6

%

20.0

%

Selling, general and administrative expense rate

 

19.7

%

18.4

%

18.6

%

18.8

%

14.9

%

Operating income rate

 

5.3

%

5.3

%

5.3

%

4.8

%

5.1

%

Year-End Data

 

 

 

 

 

 

 

 

 

 

 

Current ratio(7)

 

1.3

 

1.4

 

1.3

 

1.3

 

1.2

 

Total assets(7)

 

$

11,864

 

$

10,294

 

$

8,652

 

$

7,694

 

$

7,367

 

Long-term debt, including current portion(7)

 

596

 

600

 

850

 

834

 

820

 

Total shareholders’ equity

 

5,257

 

4,449

 

3,422

 

2,730

 

2,521

 

Number of stores

 

 

 

 

 

 

 

 

 

 

 

U.S. Best Buy stores(8)

 

742

 

668

 

608

 

548

 

481

 

Magnolia Audio Video stores

 

20

 

20

 

22

 

19

 

13

 

International stores(8)

 

162

 

144

 

127

 

112

 

95

 

Total retail square footage (000s)

 

 

 

 

 

 

 

 

 

 

 

U.S. Best Buy stores(8)

 

30,610

 

28,260

 

26,421

 

24,243

 

21,599

 

Magnolia Audio Video stores

 

194

 

194

 

218

 

189

 

133

 

International stores(8)

 

3,555

 

3,139

 

2,800

 

2,375

 

1,923

 

 

(1)                  In the first quarter of fiscal 2006, we early-adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (123(R)), requiring us to recognize

Footnotes continue on next page.

25




$ in millions, except per share amounts

(footnotes continued)

expense related to the fair value of our stock-based compensation awards. We elected the modified prospective transition method as permitted by SFAS No. 123(R) and, accordingly, financial results for fiscal years prior to 2006 have not been restated. Stock-based compensation expense for fiscal 2006 was $132 ($87 net of tax). Stock-based compensation expense recognized in our financial results for years prior to fiscal 2006 was not significant.

(2)                  During the fourth quarter of fiscal 2005, following a review of our lease accounting practices, we recorded a cumulative charge of $36 pre-tax ($23 net of tax) to correct our accounting for certain operating lease matters. Additionally, during the same quarter, we established a sales return liability which reduced gross profit by $15 pre-tax ($10 net of tax).

(3)                  During the third quarter of fiscal 2002, we acquired Future Shop Ltd. During the fourth quarter of fiscal 2001, we acquired Musicland Stores Corporation and Magnolia Hi-Fi, Inc., which began doing business as Magnolia Audio Video during fiscal 2004. The results of operations of these businesses are included from their respective dates of acquisition.

(4)                  Effective on March 3, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets. During fiscal 2003, we completed the required goodwill impairment testing and recognized an after-tax, noncash impairment charge of $40 that is reflected in our fiscal 2003 financial results as a cumulative effect of a change in accounting principle. Also effective on March 3, 2002, we changed our method of accounting for vendor allowances in accordance with Emerging Issues Task Force (EITF) Issue No. 02-16, Accounting by a Reseller for Cash Consideration Received from a Vendor. The change resulted in an after-tax, noncash charge of $42 that also is reflected in our fiscal 2003 financial results as a cumulative effect of a change in accounting principle. Fiscal 2002 has not been restated to reflect the pro forma effects of these changes.

(5)                  Earnings per share is presented on a diluted basis and reflects three-for-two stock splits effected in August 2005 and May 2002.

(6)                  Comprised of revenue at stores and Web sites operating for at least 14 full months, as well as remodeled and expanded locations. Relocated stores are excluded from the comparable store sales calculation until at least 14 full months after reopening. The calculation of the comparable store sales percentage gain excludes the effect of fluctuations in foreign currency exchange rates.

During fiscal 2004, we refined our methodology for calculating our comparable store sales percentage gain to reflect the impact of non-point-of-sale (non-POS) revenue transactions. We refined our comparable store sales calculation in light of changes in our business. Previously, our comparable store sales calculation was based on store POS revenue. The comparable store sales percentage gains for fiscal 2006, fiscal 2005 and fiscal 2004 have been computed using the refined methodology. The comparable store sales percentage gains for prior fiscal years have not been computed using the refined methodology. Refining the methodology for calculating our comparable store sales percentage gain did not impact previously reported revenue, net earnings or cash flows.

(7)                  Includes both continuing and discontinued operations. The current ratio is calculated by dividing total current assets by total current liabilities.

(8)                  Excludes Geek Squad stand-alone stores.

26




Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

We believe transparency and understandability are the primary goals of successful financial reporting. We remain committed to increasing the transparency of our financial reporting, providing our shareholders with informative financial disclosures and presenting an accurate view of our financial position and operating results.

In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of our internal control over financial reporting and concluded that such controls were effective as of February 25, 2006. Our independent registered public accounting firm expressed an unqualified opinion on management’s assessment of the effectiveness of our internal control over financial reporting. Management’s report on the effectiveness of our internal control over financial reporting and the related report of our independent registered public accounting firm are included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in eight sections:

·        Overview

·        Strategic Initiatives

·        Results of Operations

·        Liquidity and Capital Resources

·        Off-Balance-Sheet Arrangements and Contractual Obligations

·        Critical Accounting Estimates

·        New Accounting Standards

·        Outlook for Fiscal 2007

We believe our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

On June 23, 2005, our Board approved a three-for-two stock split. Shareholders of record as of July 13, 2005, received one additional share for every two shares owned, with fractional shares being redeemed for cash. The additional shares were distributed on August 3, 2005. All share and per share information herein reflect this stock split.

Unless otherwise noted, this MD&A relates only to results from continuing operations. All periods presented reflect the classification of Musicland’s financial results as discontinued operations.

Overview

Best Buy Co., Inc. is a specialty retailer of consumer electronics, home-office products, entertainment software, appliances and related services.

We operate two reportable segments: Domestic and International. The Domestic segment is comprised of the operations of U.S. Best Buy, Magnolia Audio Video and U.S. Geek Squad. U.S. Best Buy stores offer a wide variety of consumer electronics, home-office products, entertainment software, appliances and related services, operating 742 stores in 49 states and the District of Columbia at the end of fiscal 2006. Magnolia Audio Video stores offer high-end audio and video products and services from 20 stores located in California, Washington and Oregon at the end of fiscal 2006. U.S. Geek Squad offers computer repair, support and installation services in all U.S. Best Buy stores and 12 stand-alone stores at the end of fiscal 2006. Pacific Sales Kitchen and Bath Centers, Inc. (Pacific Sales), which we acquired in March 2006, will be included in the Domestic segment starting in fiscal 2007.

The International segment was established in connection with our acquisition of Future Shop in the third quarter of fiscal 2002. At the end of fiscal 2006, the International segment consisted of 118 Future Shop stores operating throughout all Canadian provinces, and 44 Canadian Best Buy stores operating in Ontario, Quebec, Alberta, British Columbia, Manitoba and Saskatchewan. In addition, Canadian Geek Squad offers computer repair, support and installation services in all Canadian Best Buy stores and in

27




five stand-alone stores at the end of fiscal 2006. The International segment offers products and services similar to those offered by the Domestic segment, although Canadian Best Buy stores do not sell appliances.

In support of our retail store operations, we also operate Web sites for each of our brands (BestBuy.com, BestBuyCanada.ca, FutureShop.ca, MagnoliaAV.com, GeekSquad.com, GeekSquad.ca and PacificSales.com).

Our business, like that of many retailers, is seasonal. Historically, we have realized more of our revenue and earnings in the fiscal fourth quarter, which includes the majority of the holiday selling season, than in any other fiscal quarter. The timing of new-store openings, costs associated with the development of new businesses, as well as general economic conditions may also affect our future quarterly results.

Financial Reporting Changes

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (123(R)), effective for a company’s first fiscal year beginning after June 15, 2005. SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires all stock-based compensation, including grants of stock options, to be recognized in the consolidated statements of earnings.

During the first quarter of fiscal 2006, we early-adopted SFAS No. 123(R), and elected the modified prospective transition method. This method permits us to apply the new requirements on a prospective basis. Our selling, general and administrative expenses (SG&A) rate for fiscal 2006 included an increase in stock-based compensation expense of $133 million ($88 million net of tax, or $0.17 per diluted share), which increased our SG&A rate by approximately 0.4% of revenue compared with the prior fiscal year. For additional information on our adoption of SFAS No. 123(R), see Note 1, Summary of Significant Accounting Policies — Stock-Based Compensation, of the Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

During the third quarter of fiscal 2006, we reclassified variable-rate demand notes from cash and cash equivalents to short-term investments. Prior-year amounts have been reclassified to conform with the current-year presentation. These reclassifications had no effect on previously reported total assets or net earnings. For additional information regarding our variable-rate demand notes, refer to Note 3, Investments, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Strategic Initiatives

Our vision is to make life fun and easy for consumers. Our business strategy is to treat each customer as a unique individual, meeting their needs with end-to-end solutions, and engaging and energizing our employees to serve them, while maximizing overall profitability. During fiscal 2006, our primary strategic initiative was accelerating our transformation to a customer-centric organization. Customer centricity contributed to our strong growth during fiscal 2006 and is expected to provide the framework to grow and further enhance our business in the future.

Customer Centricity

Our customers are at the core of all of our business strategies. Customer centricity has moved beyond an initiative and is now how we do business. Customer centricity means treating each customer as a unique individual, meeting their needs with end-to-end solutions, and engaging and energizing our employees to serve them. Mass merchants, direct sellers, other specialty retailers and online retailers are increasingly interested in our product categories because of rising demand. If we can understand our customers better than our competitors do, and if we can inspire our employees to have richer interactions with customers, then we can more effectively compete. Customer centricity has been, and will continue to be, a growth driver for us.

Accelerating Our Transformation

In fiscal 2006 we implemented five key strategies to accelerate our customer centricity initiative.

First, we converted or opened a record number of stores with the customer-centric operating model, finishing the

28




fiscal year with 300 customer centricity stores, or 40% of U.S. Best Buy stores.

Second, we expanded and strengthened our services offering by adding 5,000 Geek Squad agents. In addition, we brought our previously outsourced home theater installation services in-house to serve our customers better.

Third, we expanded individualized marketing capabilities through our Reward Zone customer loyalty program. Memberships in Reward Zone increased approximately 50% to more than seven million members and gained key insights about customer purchase patterns.

Fourth, because customer centricity relies on employees engaging with customers in new ways, we focused on increasing employee retention. During the fiscal year we changed how we manage our people, made more extensive use of strengths-based tools and created an incentive system in which all store employees could be effectively rewarded. Our efforts reduced store employee turnover by 15% compared with the previous fiscal year.

Fifth, we embarked on a three-year plan to re-engineer our supply chain and information technology systems. This work is aimed at streamlining our processes in order to improve the customer experience in important areas such as product in-stock levels. Initial results are promising — our systems are faster, cost less and have the flexibility to adjust as we transform the customer experience.

Profitably Scaling Customer Centricity

Scaling and refining our customer-centric operating model remains our primary strategy for fiscal 2007. Customer centricity allows us to better serve the unmet needs of consumers and develop new growth channels. During fiscal 2007, we are committed to scaling the model profitably across U.S. Best Buy.

We have set six priorities for fiscal 2007 that support our transformation to a customer-centric company.

·        One, we plan to implement a single, customer-centric operating model at our corporate campus by the end of fiscal 2007. Moving to a single operating model will eliminate redundant work and unify the organization. We also will divest resources in mature areas so we can invest resources in growth areas, such as small businesses, services and home theater.

·        Two, we will continue to grow organically. We plan to open approximately 90 new stores in North America. We also anticipate opening 200 more Magnolia Home Theaters inside U.S. Best Buy stores, taking advantage of rising consumer interest in flat-panel TVs.

·        Three, we plan to build our small-business capabilities. This priority includes increasing our Best Buy For Business locations to more than 200 stores and training more than 900 Microsoft-certified professionals by year end.

·        Four, we expect to grow our services business by driving productivity improvements in computer services and home theater installation. We also plan to drive gains through the implementation of new tools, the benefits of scale and a market-based approach to home visits.

·        Five, we plan to enhance our ability to provide complete solutions to customers by giving our employees better tools and capabilities for describing, demonstrating and selling solutions such as digital music subscriptions, digital cable and voice-over-Internet telephony.

·        Six, we plan to pursue international growth opportunities. Specifically, we anticipate leveraging our investments in Canada, where we operate both Future Shop and Best Buy stores, while we embark on a controlled growth strategy in China.

Our company priorities are aimed at refining this model and investing in the capabilities and customer experiences that will drive long-term profitable growth.

Results of Operations

Fiscal 2006 Summary

·        Earnings from continuing operations for fiscal 2006 increased 22% to $1.1 billion, or $2.27 per diluted share, compared with $934 million, or $1.86 per diluted share, for fiscal 2005. The increase was driven by revenue growth, including a comparable store sales gain of 4.9%, and an increase in our gross profit rate, and

29




was partially offset by an increase in our SG&A rate. In addition, earnings from continuing operations for fiscal 2006 benefited from net interest income of $77 million, compared with net interest income of $1 million for the prior fiscal year, and a lower effective income tax rate.

·        Net earnings for fiscal 2006 reflect the impact of early-adopting SFAS No. 123(R), which resulted in an increase in stock-based compensation expense of $132 million ($87 million net of tax, or $0.17 per diluted share). In addition, net earnings for fiscal 2006 included income of $43 million ($29 million net of tax, or $0.06 per diluted share) related to our initial recognition of gift card breakage (gift cards sold where the likelihood of the gift card being redeemed by the customer is remote). Gift card breakage income was not recorded in fiscal 2005 or prior years.

·        Revenue for fiscal 2006 increased 12% to $30.8 billion. The increase reflected market share gains and was driven by the net addition of 103 new stores during fiscal 2006, a full year of revenue from stores added in fiscal 2005 and the 4.9% comparable store sales increase. The remainder of the increase was due primarily to the favorable effect of fluctuations in foreign currency exchange rates.

·        Our gross profit rate for fiscal 2006 increased by 1.3% of revenue to 25.0% of revenue. The increase was driven by the continued transformation of our supply chain, which enabled us to improve margins through lower product costs, more effective pricing strategies, and increased sales of higher-margin services and private-label products. We also benefited from better product transition management and a more stable promotional environment.

·        Our SG&A rate for fiscal 2006 increased by 1.3% of revenue to 19.7% of revenue. The increase was due primarily to increased performance-based incentive compensation resulting from our strong financial performance, a growing number of stores operating under the higher-cost customer-centric labor model and costs associated with supporting our services business, and was partially offset by expense leverage resulting from a higher revenue base. The change in our accounting for stock-based compensation increased our fiscal 2006 SG&A rate by approximately 0.4% of revenue compared with the prior fiscal year.

·        During fiscal 2006, we opened 70 U.S. Best Buy stores and converted 163 existing U.S. Best Buy stores with the customer-centric operating model (segmented stores). At the end of fiscal 2006, we operated 300 segmented stores, or 40% of total U.S. Best Buy stores.

·        Effective with the cash dividend paid in the third quarter of fiscal 2006, we increased our quarterly cash dividend by 9 percent, to $0.08 per common share. During fiscal 2006, we made four dividend payments totaling $0.31 per common share, or $151 million in the aggregate.

·        During fiscal 2006, we purchased and retired 18.3 million shares at a cost of $772 million pursuant to our share repurchase programs.

·        In fiscal 2006, we and the Best Buy Children’s Foundation contributed approximately $30 million to local communities, including contributions for the communities and people affected by Hurricanes Katrina, Wilma and Rita.


 

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Consolidated Results

The following table presents selected consolidated financial data for each of the past three fiscal years ($ in millions, except per share amounts):

Consolidated Performance Summary

 

2006

 

2005

(1)

2004

 

Revenue

 

 

$

30,848

 

 

$

27,433

 

 

$

24,548

 

Total revenue gain %

 

 

12

%

 

12

%

 

17

%

Comparable stores sales % gain(2)

 

 

4.9

%

 

4.3

%

 

7.1

%

Gross profit as % of revenue

 

 

25.0

%

 

23.7

%

 

23.9

%

SG&A as % of revenue

 

 

19.7

%

 

18.4

%

 

18.6

%

Operating income

 

 

$

1,644

 

 

$

1,442

 

 

$

1,304

 

Operating income as % of revenue

 

 

5.3

%

 

5.3

%

 

5.3

%

Earnings from continuing operations

 

 

$

1,140

 

 

$

934

 

 

$

800

 

Gain (loss) from discontinued operations, net of tax

 

 

$

 

 

$

50

 

 

$

(95

)

Net earnings

 

 

$

1,140

 

 

$

984

 

 

$

705

 

Diluted earnings per share — continuing operations

 

 

$

2.27

 

 

$

1.86

 

 

$

1.61

 

Diluted earnings per share

 

 

$

2.27

 

 

$

1.96

 

 

$

1.42

 

 

Note: All periods presented reflect the classification of Musicland’s financial results as discontinued operations.

(1)                  During the fourth quarter of fiscal 2005, following a review of our lease accounting practices, we recorded a cumulative pre-tax charge of $36 ($23 net of tax, or $0.05 per diluted share) to correct our accounting for certain operating lease matters. Additionally, we established a sales return liability which reduced revenue by $65 and gross profit by $15 ($10 net of tax, or $0.02 per diluted share). Finally, based on the favorable resolution of outstanding tax matters with the Internal Revenue Service regarding the disposition of our interest in Musicland, we recorded a $50 tax benefit. The tax benefit is included in gain (loss) from discontinued operations.

(2)                  Comprised of revenue at stores and Web sites operating for at least 14 full months, as well as remodeled and expanded locations. Relocated stores are excluded from the comparable store sales calculation until at least 14 full months after reopening. The calculation of the comparable store sales percentage gain excludes the effect of fluctuations in foreign currency exchange rates.


Continuing Operations

Fiscal 2006 Results Compared With Fiscal 2005

Fiscal 2006 earnings from continuing operations were $1.1 billion, or $2.27 per diluted share, compared with $934 million, or $1.86 per diluted share, for fiscal 2005. The increase was driven by revenue growth, including the addition of new stores during fiscal 2006 and a comparable store sales gain of 4.9%, and a significant increase in our gross profit rate. These factors were partially offset by an increase in our SG&A expenses. In addition, earnings from continuing operations for fiscal 2006 benefited from net interest income of $77 million, compared with net interest income of $1 million for the prior fiscal year, and a lower effective income tax rate.

Revenue for fiscal 2006 increased 12% to $30.8 billion, compared with $27.4 billion for fiscal 2005. The increase resulted from the net addition of 103 stores during fiscal 2006, a full year of revenue from new stores added in fiscal 2005, the 4.9% comparable store sales gain and the favorable effect of fluctuations in foreign currency exchange rates. The addition of new stores during the past two fiscal years accounted for more than one-half of the revenue increase for fiscal 2006. The comparable store sales gain accounted for nearly two-fifths of the revenue increase, and the remainder of the revenue increase was due primarily to the favorable effect of fluctuations in foreign currency exchange rates, as well as income related to our initial recognition of gift card breakage.

We believe our comparable store sales gain for fiscal 2006 benefited from continued demand for the latest technologies and advanced product features. In addition, the increased affordability of consumer electronics products contributed to the comparable store sales gain. Products having the largest impact on our fiscal 2006 comparable store sales gain included flat-panel televisions, MP3 players and accessories, notebook computers, digital cameras and accessories, and video gaming hardware. Flat-panel

31




television sales were very strong as unit-volume growth and increased screen size more than offset declines in the average selling prices of these products. MP3 products also generated strong comparable store sales gains as customers continue to adopt, upgrade and add accessories to digital music players.

Our gross profit rate for fiscal 2006 increased by 1.3% of revenue to 25.0% of revenue. The increase was driven by the continued transformation of our supply chain, which enabled us to improve margins through lower product costs, more effective pricing strategies and increased sales of higher-margin services; and private-label products. We also benefited from better product transition management and a more stable promotional environment.

Our SG&A rate for fiscal 2006 increased by 1.3% of revenue to 19.7% of revenue. The increase was due primarily to increased performance-based incentive compensation resulting from our strong financial performance; a growing number of stores operating under the higher-cost, customer-centric labor model; costs associated with supporting our services business and the absence of favorable settlements with two credit card companies as recognized in fiscal 2005. These factors were partially offset by expense leverage resulting from a higher revenue base, as well as the absence of charges recognized in fiscal 2005 to correct our accounting for leases and to settle litigation. The change in our accounting for stock-based compensation increased our fiscal 2006 SG&A rate by approximately 0.4% of revenue compared with the prior fiscal year.

Because retailers do not uniformly record costs of operating their supply chain between cost of goods sold and SG&A, our gross profit rate and SG&A rate may not be comparable to certain other retailers. For additional information regarding costs classified in cost of goods sold and SG&A, refer to Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financials Statements and Supplementary Data, of this Annual Report on Form 10-K.

Fiscal 2005 Results Compared With Fiscal 2004

Fiscal 2005 earnings from continuing operations were $934 million, or $1.86 per diluted share, compared with $800 million, or $1.61 per diluted share, for fiscal 2004. The increase was driven primarily by revenue growth, including a comparable store sales gain of 4.3%, and an improvement in our SG&A rate, and was partially offset by a decrease in our gross profit rate. In addition, earnings from continuing operations for fiscal 2005 benefited from net interest income of $1 million, compared with net interest expense of $8 million for fiscal 2004, and a lower effective income tax rate.

Revenue for fiscal 2005 increased 12% to $27.4 billion, compared with $24.5 billion for fiscal 2004. The increase resulted from the addition of 78 stores in fiscal 2005, a full year of revenue from new stores added in fiscal 2004, the 4.3% comparable store sales gain and the favorable effect of fluctuations in foreign currency exchange rates. The addition of new stores during the past two fiscal years accounted for approximately three-fifths of the revenue increase for fiscal 2005. The comparable store sales gain accounted for nearly two-fifths of the revenue increase, and the favorable effect of fluctuations in foreign currency exchange rates accounted for the remainder of the revenue increase.

We believe our comparable store sales gain for fiscal 2005 reflected improved in-store execution, including our ability to increase the close rate and average ticket, which more than offset customer traffic declines in our stores. In addition, our fiscal 2005 comparable store sales gain benefited from continued demand for digital products and our effective advertising and promotional campaigns, including a full year of Reward Zone, our customer loyalty program introduced in the second quarter of fiscal 2004. Products having the largest impact on our fiscal 2005 comparable store sales gain included digital televisions, MP3 players, digital cameras and accessories, notebook computers, DVDs and major appliances. We believe the increase in revenue from digital products reflected the continued consumer migration to and increased affordability of digital products, while the increase in notebook computers was driven primarily by consumers’ continued attraction to the portability of these products.

Our gross profit rate for fiscal 2005 declined by 0.2% of revenue to 23.7% of revenue. The decrease was due primarily to a more promotional environment compared with fiscal 2004, including a full year of impact from and increased membership in Reward Zone. Reward Zone contributed to the revenue gain for fiscal 2005, but reduced the fiscal 2005 gross profit rate by approximately 0.5% of

32




revenue, compared with a 0.3% of revenue reduction in the gross profit rate for fiscal 2004. In addition, our gross profit rate was affected by a higher level of promotional activity initiated to increase revenue and stem customer traffic declines, a trend we believe was experienced throughout the consumer electronics retail industry. The increase in promotional activity was partially offset by the increase of services revenue in the revenue mix, as services carry a higher gross profit rate, and benefits from our global sourcing initiative which enabled us to improve margins through lower product costs.

Our SG&A rate for fiscal 2005 declined by 0.2% of revenue to 18.4% of revenue. The improvement was due primarily to reduced performance-based incentive compensation, expense leverage from the comparable store sales gain and the addition of new stores, and the realization of cost savings from our efficient enterprise initiative. Our fiscal 2005 SG&A rate also benefited from favorable settlements with two credit card companies. These factors were partially offset by additional expenses associated with our customer centricity initiative, and charges to correct our accounting for leases and to settle litigation which, collectively, increased our SG&A rate for fiscal 2005 by approximately 0.2% of revenue.


Segment Performance

Domestic

The following table presents selected financial data for our Domestic segment for each of the past three fiscal years ($ in millions):

Domestic Segment Performance Summary (unaudited)

 

2006

 

2005

 

2004

 

Revenue

 

 

$

27,380

 

 

$

24,616

 

 

$

22,225

 

Total revenue gain %

 

 

11

%

 

11

%

 

15

%

Comparable stores sales % gain(1)

 

 

5.1

%

 

4.4

%

 

7.4

%

Gross profit as % of revenue

 

 

25.3

%

 

23.8

%

 

24.1

%

SG&A as % of revenue

 

 

19.5

%

 

18.2

%

 

18.4

%

Operating income

 

 

$

1,588

 

 

$

1,393

 

 

$

1,267

 

Operating income as % of revenue

 

 

5.8

%

 

5.7

%

 

5.7

%

 

Note: All periods presented reflect the classification of Musicland’s financial results as discontinued operations.

(1)                  Comprised of revenue at stores and Web sites operating for at least 14 full months, as well as remodeled and expanded locations. Relocated stores are excluded from the comparable store sales calculation until at least 14 full months after reopening.


For fiscal 2006, our Domestic segment’s operating income was $1.6 billion, or 5.8% of revenue, compared with $1.4 billion, or 5.7% of revenue, for fiscal 2005. The Domestic segment’s operating income rate for fiscal 2006 benefited from revenue gains, including the addition of new stores during fiscal 2006 and a 5.1% comparable store sales increase, and an increase in the gross profit rate, partially offset by an increase in the SG&A rate.

Our Domestic segment’s revenue for fiscal 2006 increased 11% to $27.4 billion. The addition of new stores during the past two fiscal years accounted for over one-half of the revenue increase for fiscal 2006, and the remainder of the revenue increase was due primarily to the 5.1% comparable store sales gain.

We believe our Domestic segment’s comparable store sales gain for fiscal 2006 benefited from continued demand for increased features, assortment, portability and affordability of consumer electronics products. Our Domestic segment’s consumer electronics product group posted a 15.0% comparable store sales gain for fiscal 2006, driven by sales of flat-panel televisions, and MP3 players and accessories. Strong sales of flat-panel televisions resulted from unit-volume growth and increased screen size, which more than offset declines in the average selling prices of these products. MP3 products also generated strong comparable store sales gains as customers continued to adopt, upgrade and add accessories to digital music players. A 0.3% comparable store sales gain in our Domestic segment’s home-office product group was driven primarily by sales of

33




notebook computers, reflecting expanded assortments and continued customer demand for portable technology, and an increase in computer services revenue. A 6.3% comparable store sales increase in our Domestic segment’s appliances product group was driven primarily by the expansion of our improved appliance assortments and an increase in the average selling prices of major appliances.

Our Domestic segment’s entertainment software product group recorded a 5.7% comparable store sales decline for fiscal 2006. Continued softness in the sales of new movie and music releases contributed to the comparable store sales decrease. This decrease was partially offset by strong customer response to the launches of PlayStation Portable and the Xbox 360 console, which more than offset softness in sales of gaming platforms leading up to these anticipated launches.

Our Domestic segment’s gross profit rate for fiscal 2006 increased by 1.5% of revenue to 25.3% of revenue. The increase was driven by the continued transformation of our supply chain, which enabled us to improve margins through lower product costs, more effective pricing strategies, and increased sales of higher-margin services and private-label products. We also benefited from better product transition management, a more stable promotional environment and income related to our initial recognition of gift card breakage.

Our Domestic segment’s SG&A rate for fiscal 2006 increased by 1.3% of revenue to 19.5% of revenue. The increase was due primarily to increased incentive compensation based on our strong operating results, a growing number of stores operating under the customer-centric labor model and costs associated with supporting our services business, partially offset by expense leverage resulting from a higher revenue base and the absence of charges recognized in fiscal 2005 to correct our accounting for leases and to settle litigation. The change in our accounting for stock-based compensation increased our fiscal 2006 SG&A rate by approximately 0.5% of revenue compared with the prior fiscal year.


The following table reconciles Domestic stores open at the beginning and end of fiscal 2006:

 

 

Total
Stores at
End of
Fiscal 2005

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal 2006

 

U.S. Best Buy

 

 

668

 

 

74

 

 

 

 

742

 

Magnolia Audio Video

 

 

20

 

 

 

 

 

 

20

 

U.S. Geek Squad

 

 

6

 

 

7

 

 

1

 

 

12

 

Total

 

 

694

 

 

81

 

 

1

 

 

774

 

 

Note: During fiscal 2006, we converted 163 existing U.S. Best Buy stores to our customer centricity format, relocated 10 other U.S. Best Buy stores and remodeled one other U.S. Best Buy store. At the end of fiscal 2006, we operated 742 U.S. Best Buy stores in 49 states and the District of Columbia. No Magnolia Audio Video or U.S. Geek Squad stores were relocated or remodeled during fiscal 2006. At the end of fiscal 2006, we operated 20 Magnolia Audio Video stores in California, Washington and Oregon, and operated 12 U.S. Geek Squad stores in Texas, Georgia, California, Minnesota, Wisconsin and Colorado.

The following table reconciles Domestic stores open at the beginning and end of fiscal 2005:

 

 

Total
Stores at
End of
Fiscal 2004

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal 2005

 

U.S. Best Buy

 

 

608

 

 

61

 

 

1

 

 

668

 

Magnolia Audio Video

 

 

22

 

 

 

 

2

 

 

20

 

U.S. Geek Squad

 

 

1

 

 

5

 

 

 

 

6

 

Total

 

 

631

 

 

66

 

 

3

 

 

694

 

 

Note: During fiscal 2005, we converted 67 existing U.S. Best Buy stores to our customer centricity format and relocated six other U.S. Best Buy stores. No other U.S. Best Buy stores were remodeled or relocated during fiscal 2005. At the end of fiscal 2005, we operated 668 U.S. Best Buy stores in 48 states and the District of Columbia. No Magnolia Audio Video or U.S. Geek Squad stores were relocated or remodeled during fiscal 2005. At the end of fiscal 2005, we operated 20 Magnolia Audio Video stores in California, Washington and Oregon; and operated six U.S. Geek Squad stores in Georgia, California, Minnesota and Wisconsin.

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International

The following table presents selected financial data for our International segment for each of the past three fiscal years ($ in millions):

International Segment Performance Summary (unaudited)

 

2006

 

2005

 

2004

 

Revenue

 

 

$

3,468

 

 

$

2,817

 

 

$

2,323

 

Total revenue gain %

 

 

23

%

 

21

%

 

41

%

Comparable stores sales % gain(1)

 

 

2.8

%

 

3.3

%

 

4.7

%

Gross profit as % of revenue

 

 

22.9

%

 

22.5

%

 

22.2

%

SG&A as % of revenue

 

 

21.3

%

 

20.7

%

 

20.6

%

Operating income

 

 

$

56

 

 

$

49

 

 

$

37

 

Operating income as % of revenue

 

 

1.6

%

 

1.7

%

 

1.6

%

 

(1)      Comprised of revenue at stores and Web sites operating for at least 14 full months, as well as remodeled and expanded locations. Relocated stores are excluded from the comparable store sales calculation until at least 14 full months after reopening. The calculation of the comparable store sales percentage gain excludes the impact of fluctuations in foreign currency exchange rates.


For fiscal 2006, our International segment’s operating income was $56 million, or 1.6% of revenue, compared with $49 million, or 1.7% of revenue, for fiscal 2005. The International segment’s $7 million increase in operating income resulted primarily from revenue gains, including the addition of new stores during fiscal 2006 and a 2.8% comparable store sales increase.

Our International segment’s revenue for fiscal 2006 increased 23% to $3.5 billion for fiscal 2006, compared with $2.8 billion for fiscal 2005. The addition of new stores during the past two fiscal years accounted for over one-half of the revenue increase for fiscal 2006; fluctuations in foreign currency exchange rates accounted for approximately one-third of the revenue increase; and the 2.8% comparable store sales gain accounted for the remainder of the revenue increase. We believe the comparable store sales increase reflected market share gains and was driven by increased revenue from flat-panel televisions, and MP3 players and accessories.

Our International segment’s consumer electronics and appliances groups posted an 8.2% and 18.0% comparable store sales gain for fiscal 2006, respectively. Our International segment’s home-office and entertainment software groups recorded a 0.2% and 7.6% comparable store sales decline for fiscal 2006, respectively.

Our International segment’s gross profit rate for fiscal 2006 increased by 0.4% of revenue to 22.9% of revenue. The increase was due primarily to improved product margins and the favorable comparison with an early contract termination penalty incurred in the prior fiscal year.

Our International segment’s SG&A rate for fiscal 2006 increased by 0.6% of revenue to 21.3% of revenue. The increase was due primarily to costs incurred as a result of restructuring our International segment’s operations, including severance costs associated with staff reductions, as well as incremental costs to roll out Canadian Best Buy stores in Quebec. The change in our accounting for stock-based compensation increased our fiscal 2006 SG&A rate by approximately 0.1% of revenue compared with the prior fiscal year.

During the fourth quarter of fiscal 2006, we completed our annual impairment testing of goodwill and the Future Shop tradename. Based on expectations for the business and the prevailing retail environment, we determined that no impairment existed. However, if future results are not consistent with our assumptions and estimates, or if we ever were to discontinue the use of the Future Shop tradename as a result of abandoning our dual-branding strategy in Canada or otherwise, we may be exposed to an impairment charge in the future.


35




The following table reconciles International stores open at the beginning and end of fiscal 2006:

 

 

Total
Stores at
End of
Fiscal 2005

 

Stores
Opened

 

Stores
Closed

 

Total
Stores at
End of
Fiscal 2006

 

Future Shop

 

 

114

 

 

5

 

 

1

 

 

118

 

Canadian Best Buy

 

 

30

 

 

14

 

 

 

 

44

 

Canadian Geek Squad

 

 

 

 

5